In 2021 the value of the global insurance industry was estimated to have reached USD 6 trillion in global premiums and USD 36 trillion in assets under management. This represents a significant portion of global economic assets and liabilities, a staggering amount when you consider the humble beginnings of an industry that started out in London coffeehouses with businessmen meeting to arrange insurance for ships and cargo heading overseas.
While the insurance industry has expanded far and wide since then, the core premise of measuring risk and developing pricing and solutions to cover the risk is as relevant to businesses and consumers today as it was to those early global traders back in the 1800s.
The industry has dealt with multiple significant challenges over the years, and the latest challenge is managing ESG and climate-related risks. The good news is that when it comes to ESG risk, the insurance sector is ahead of the curve in incorporating ESG measurement into their overall risk management practice, focusing on both measuring business resilience to environmental and social risks as well as measuring the sustainable impact of investments and underwriting of businesses. However, as the old adage goes, the devil is in the details. And measuring the impact of climate change, which has been more rapid, devastating and all-encompassing than anyone could have imagined, is notoriously difficult. Difficult, but not impossible.
More than before, insurance companies are exposed to increasingly higher levels of risk, driven by increasing and intensifying climate change events, such as flooding, stronger hurricanes, and wildfires, collectively referred to as physical risks. 2021 provided a noteworthy range of examples of climate change events and their increasing frequency and intensity. It also provided some insights into the range of possible impacts from these extreme weather events. From the record temperatures and wildfires in the northwest of the USA and southern Europe, to the devastating floods in Germany and the terrifying scenes of flooded subways in China, to the wildfires in Siberia and the accelerated melt of the permafrost.
For some time now, scientists have been ringing the alarm that this would happen. However, the latest IPCC Report has provided some sobering reading to an already dark and gloomy world. The report reinforces that we are already facing the impacts of climate change, impacts more severe than were anticipated. The report highlights the urgent need for rapid investment in climate adaptation and resilience to address the worst current and near-future impacts of climate change. The report also provides a glimmer of hope – that we still have a chance to prevent much more severe impacts of climate change by reducing greenhouse gas emissions (by 50% by 2030) and scaling up adaptation resilience.
We still have a chance to prevent the much more severe impacts of climate change but the window to act is closing fast. And so, clearer than ever is that we need to do more, faster.
To guide these efforts, the Financial Stability Board (FSB) created the Task Force on Climate-related Financial Disclosures (TCFD) to improve and increase reporting of climate-related financial information focusing on the four key financial sectors: asset management, asset owners, banks and insurance.
In this article, we take a closer look at the Insurance sector and the role it can play. Similar to other sectors in the finance industry, Insurers can and do play a significant role. In addition to measuring their own carbon footprint, insurers are in a unique position to control and influence their client companies. This is particularly relevant given that ESG and climate-related risks are increasingly material for insurers given the increase in losses. Typically, Insurers and their clients face a range of climate-related risks and opportunities which fall into three categories:
- Physical risks related to the increase in frequency and intensity of extreme weather events.
- Transition risks driven by the move towards a decarbonized economy and related fundamental changes in the underlying economy.
- Litigation risks pertaining to climate change and breach of underlying legal frameworks.
What Actions Can Insurers Take?
Critically examine underlying client exposures
Insurance companies are increasingly exposed to certain industries. It is in their interests to move away from industries that are driving and exacerbating climate change (GHG sensitive industries such as coal, oil & gas, and related industries) and, to the extent possible, replace them with clients in lower-risk industries.
Providing coverage for clean-green energy sources naturally involves less risk for an insurance seller as there is no fear of massive oil spills, explosions, and other inherent dangers.
Understand the ESG or climate-related risks
Pursue Opportunities to Enhance Underwriting Decisions
Insurers can gain a competitive advantage by ensuring their existing and prospective clients undertake such assessments or evaluations. This helps the underwriter make more informed and therefore better decisions.
Concurrently, it provides the client or prospect organization with a roadmap for how to address the ESG or climate-related risk landscape.
Adopting a robust ESG Risk Framework
In addition to considering implementing ESG Risk Assessments or Initial Evaluations, organizations can consider adopting prudent risk management processes that follow established guidelines.
Whether such risk management processes include TCFD or COSO or any other risk framework, they will most likely result in improved risk governance, and more finely tuned ESG and climate-related strategies which in turn will lead to better underwriting outcomes, benefitting both the underwriter and the client.
Adopting a robust ESG Risk Framework
TCFD follows an established and well-considered approach across its key dimensions of consideration – Governance, Strategy, Risk Management and Metrics & Targets. Similar to other sectors in the Finance Industry, it provides tailoring for the Insurance sector which can include:
Key Challenges integrating ESG in Private Equity
General Partners (GPs) often cite several challenges in assessing, managing, and reporting on climate-related risks, including:
- Ongoing resource constraints and lack of specific expertise on ESG and climate-related risk assessments.
- Difficulty navigating the ESG and climate data landscape (lack of transparency, and lack of standardized definitions).
- Productionizing climate change assessments for an entire portfolio.
These challenges are compounded by Partner (LP) investors increasingly requiring GPs to disclose on how they are addressing climate-related risks.
Application of the TCFD Framework in Insurance
TCFD provides an established and well considered approach across its key dimensions and has a tailored version of its technical manual specifically for PE firms. For each portfolio company or significant holding, GP considerations follow the four key areas established by TCFD:
Things To Consider
Climate Risk Governance
Increase climate awareness and education throughout the organization (board, executive team, management team, customers)
Ensure governance is in place to manage climate-related risks
Climate Risk Strategy
Develop a simplified roadmap that focuses only on the material issues impacting the portfolio company
Describe the impact of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning.
Describe the resilience of the organization’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario.
Climate Risk Management
Ensure climate risk is integral to investment processes
For holdings, provide support structure:
- Consider climate risks that may affect valuations based on material climate indicators
- If/when material risks are identified, define climate targets at a portfolio level.
Describe the organization’s processes for managing climate-related risks.
Metrics & Targets
Disclose the metrics used by the organization to assess climate-related risks and opportunities in line with its strategy and risk management process.
Addressing the ESG and climate-related risks in both your and your clients’ organization now puts you at a competitive advantage, freeing up time to focus on the day job of growing your business. Whether you pursue an initial ESG or climate risk assessment or evaluation, or a more in-depth framework review, your business will reap the benefits and thrive.