The insurance sector is suffering from overexposure to environmentally unsustainable assets – some classified as stranded assets - and unanticipated or premature write-downs, devaluations or conversion to liabilities. Environment-related and climate risks are often poorly understood and regularly mispriced by insurers.
An expert panel at a recent S&P Global Market Intelligence webinar discussed the ways in which environmentally generated risks can profoundly alter asset values across a wide range of sectors, ultimately damaging financial health, and how the insurance sector is responding to the growing ESG risks and opportunities.
The regulatory world is progressively adopting mandates for insurers to assess both their underwriting and investment portfolios and to determine impacts of climate-related risks. While fast-moving regulatory changes are a fact of life, there are also new tools available to the industry to assess, address and disclose inherent risks.
Dave Jones, insurance commissioner and emeritus director of the climate risk initiative at UC Berkeley School of Law, Center for Law, Energy & the Environment, said: "If I were an insurance company CEO, I wouldn't wait until my regulator told me that I need to begin to seriously address and disclose these risks, using the TCFD disclosure framework, and to begin to incorporate considerations of stress testing and scenario analysis in my overall enterprise operation. I would start doing it now."
The ultimate goals of the initiatives such as those represented by Jones and other panelists participating in the webinar, are to guide a transition of investment and underwriting portfolios away from fossil fuels; to fully integrate ESG concerns into decision-making frameworks; to partner with policymakers to further develop ESG management; and to enhance disclosure of environmental performance.
Governments were also advised to play a role in aiding the transition by structuring transition investment opportunities that guarantee predictable and long-term cash flows, which are of course very attractive to investors.
But how seriously should insurance companies be looking at transition risk exposure on both the investment management and the underwriting sides? The risks on both sides are material and should be addressed by insurance companies as a part of routine enterprise risk management processes. On the underwriting side, the enormity of exposure is evidenced by regional and global losses driven by catastrophic weather events that, in turn, are driven by climate change.
Risk factors include:
- Environmental challenges
- Changing resource landscapes
- New government regulations
- Decreasing clean technology costs
- Evolving social norms and consumer behaviour
- Litigation and changing statutory interpretations
Butch Bacani, program leader for the UNEP Principles for Sustainable Insurance, outlined the way in which the insurance industry could leverage the multifaceted nature of their businesses, by utilizing the inherent synergies that exist between risk management, underwriting and investment management.
"More often than not, there's cognitive dissonance within insurance companies, where portfolio managers on the asset side don't talk to the underwriters on the other side of the balance sheet. Increasingly, however, we are seeing insurance companies becoming more cognitively consonant, where the investment side talks to the underwriting side and vice versa."
In Bacani’s view this dialogue is vital because in the context, for example, of climate change and net zero, companies may be investing in the best renewables but then undermining that with underwriting practices that actually work against the net zero agenda.
"There is a big opportunity within the insurance industry to work towards a total balance sheet approach to sustainability," he said. "The industry has a significant, influential role to play. It can use the power of both underwriting and risk management to drive changes in behaviour and factors that will result in outcomes that are sustainable."
"The reason why we are doing all of this, at this speed, scale and urgency, is because of the big picture," Bacani concluded. "The two foundations of everything on this planet, and I mean everything, are a stable climate and a rich biodiversity of life. Based on science both are under threat, and we may reach tipping points in the coming years that could be irreversible."
Therefore, the decade leading up to 2030 has to be a decade of action, he argued, for us to have the possibility of a more sustainable future and a sustainable economy: "When we talk about sustainability, the insurance industry and the wider financial sector is crucial to achieving that goal."