How the insurance industry can boldly shape a more sustainable future | EY - Global

Why the insurance industry must play a more critical role in combating the climate crisis and improving sustainability.

As climate change gains movement as a global issue, the insurance industry is weighing in on the debate and the role it will play on the world stage. Climate talks, carbon offsets and the future of the planet were key discussion points at COP25, the 25th UN Conference of the Parties on climate change in December 2019. And the UN’s Emission Gap Report 2019 highlights that the goal of holding climate change at 1.5°C is nearly impossible to reach. Rather, the planet is on track for 3.2°C of warming above pre-industrial level by 2100.

According to the UN, this means:

• 23% global GDP impact
• +28% likelihood of a Category 4 to 5 cyclone
• +70% in extreme rainfall or about 275m people worldwide in areas that will be flooded and inhabitable

Closing the protection gap

As mentioned in our 2020 Global Insurance Outlooks (pdf), insurers are uniquely positioned to help people, companies and communities recognize the need for more protection and to close the massive natural catastrophe-related protection gap that currently exists. According to Swiss Re, this gap now accounts for US$221b, with catastrophe losses at 29%, the same level of two decades ago.

The insurance industry is aware of the importance of its role. As early as 2012, the UNEP FI Principles for Sustainable Insurance were launched to focus on embedding environmental, social and governance issues in insurance decision-making, raise awareness of the same with clients and business partners, and promote action with governments, regulators and key stakeholders. Many insurers are signatories to these principles and some of the most forward-looking ones have also committed to become carbon neutral by 2050.

Regulators are also increasingly active in this space and climate change is finding its way into regulatory frameworks and capital regimes of insurers.

Four steps in the right direction

Insurers need to take a more proactive role in multiple areas otherwise climate risk will have a profound impact on insurability and pricing of certain assets or events, potentially rendering them uninsurable in the long run. This is already happening and is exemplified by insurers’ decisions to not renew 350,000 homeowners’ policies over the last four years in California due to wildfire risks.

Here are four potential steps for insurers to take:

• Some insurers thought they could increase prices during the annual renewal cycle to reflect the higher risk, but affordability is already a critical issue with several regions and segments of the population – especially in low- and medium-income countries – likely to be unable to insure themselves in the future. Likewise, the availability and cost of reinsurance cover for weather-related risks may become prohibitive for smaller insurers in certain markets – potentially leading to a reinsurance gap. To avoid this dangerous situation, insurers will need to offer preventive and recovery (or post-event) services.
• Another option is to follow the example from California and cancel policies when the risk is considered too high, increasing the protection gap. But governments are watching carefully; in December 2019, California took the unusual step of banning insurers from canceling homeowners’ policies in fire-prone areas for one year to enable the government to find future- looking solutions with insurers. The answer is not exclusion of risks but inclusion of responsibility across government, insurers and individuals.
• As risk management shows some limits, insurers must play a bigger role on the risk prevention side. This means working with government, public bodies and municipalities not just in developing climate risk-resilient infrastructure, but also in nudging them toward disaster protection.
• Insurers need to decide their appetite toward underwriting and investing in asset classes that are most likely to generate or to be affected by climate change. Decisions in these two areas should be consistent. Underwriters have a role to play in helping clients in the transition by adapting policy and pricing through the transformation to more sustainable businesses.

We are seeing some proactive insurers making clear decisions in this space. For example, the top 10 European P&C insurers have ceased or restricted insurance coverage of coal-related assets, and some are actively divesting from certain asset classes – such as coal and oil sands businesses – to prepare for the future.

In the long-term, insurers will be key to mobilizing capital for building climate risk-resilient infrastructure. Required investment is beyond the capacity of the public sector alone. Investing in such assets offers insurers a good investment with long-term liabilities matching and enhanced portfolio diversification, not to mention the potential for lower future claims from catastrophe events.

These kinds of decisions can also directly impact the talent pipeline in an industry that needs highly skilled people to maximize its results. Our NextWave report shows that the next generation of talent need to feel that they are working for organizations that have a strong sense of purpose – especially concerning ESG factors. Insurance companies that clearly communicate their purpose and the meaningful action they are taking to comply with ESG frameworks will have greater success in attracting the talent they need.

Opportunities for collaboration and understanding

Insurers and public bodies should work closely together to create new and effective platforms for infrastructure investments and to improve clarity around required regulations. Forward-looking insurers are exploring these collaboration opportunities:

• Homeowners certified with Wildfire Partners will not face renewal rejection against wildfire hazard, which will help close the gap of those that are “uninsurable” due to wildfire risk.
• Reinsurers are working with governments around the world to develop low-carbon benchmarks, guidelines for sustainable insurance and open standards for projecting future climate-related repair and replacement costs of buildings and infrastructure.
• Many other initiatives are ongoing from collaboration around smart city sustainable technology to partnerships to unlock clean infrastructure projects.

To reinforce prevention, insurers have a key role to play in spurring innovation in spatial and meteorological sciences, data and risks modeling. They could share more information and data with other stakeholders and clients to enhance prevention and broaden new propositions such as those around parametric weather coverage.

Success will demonstrate how insurers can act together with all stakeholders to protect what is most valuable and deepen the trust toward the sector. Failure will not only negatively affect the industry’s reputation, but also widen the protection gap, and bring massive dislocation from coastal areas together with broader social and financial instability.

We are acutely aware of this threat and opportunity and we believe that focusing on sustainability and innovation around these changes is critical to unlock the potential of the NextWave of Insurance.

Summary

Insurers must be more proactive in preventing climate-related calamities and accelerating meaningful action among businesses, governments and wider society to improve sustainability measures.