Silent climate: why re/insurers must turn risk into opportunity

COP26 was a gamechanger for the investment and banking community. The Glasgow Financial Alliance for Net Zero (GFANZ) that was unveiled at the United Nations climate talks held in the Scottish city in November 2021, commits private capital—by over 450 firms across 45 countries—to delivering the estimated $100 trillion of finance needed for net zero over the next three decades.

The event was not, however, necessarily a gamechanger for the insurance community.

Nigel Brook, partner at Clyde & Co and advisor to the Insurance Development Forum (IDF), has been working actively in the climate space for six years. That might not seem a long time, but it is for the re/insurance market. That’s because it is only recently that re/insurers have begun to understand their exposure to climate change.

“The re/insurance market is grappling with the risk of ‘silent climate’, but it actually has an opportunity to be a steward on the path to net zero, and thus help create new markets,” said Brook, who leads Clyde & Co’s global Resilience and Climate Risk practice.

“A group of us took a strong interest in climate risk about six years ago and we started putting out material on this when relatively few re/insurers were actively engaging with the topic. It really was a different time then. It wasn’t clear how re/insurers could translate climate risk into their business models,” he said.

The catalyst for change came from the Bank of England Prudential Regulation Authority (PRA) and its April 2019 supervisory statement “Enhancing banks and insurers’ approaches to managing the financial risks from climate change”. All insurers supervised by the PRA had to meet its expectations on climate risk by the end of 2021.

“What the PRA helpfully did was press insurers to look forward 10, 20, 30 years. By then the transition to net zero will have fundamentally reshaped the business they underwrite, and climate change will have supercharged weather risks. Current business models will be up-ended along the way.

“There are some loose parallels with cyber risk. Over the last few years the market came to appreciate that this was embedded in conventional property or liability business, but it wasn’t measured, managed or priced. Re/insurance underwriters have since adapted their risk appetite and coverage terms to address this systemic ‘silent cyber’ exposure. We may be on a similar trajectory with ‘silent climate’ risk.”

Bermuda’s ambition

Brook is well aware of Bermuda’s ambition to be the capital of climate risk finance.

“Bermuda certainly has a story to tell, with the catastrophe re/insurance expertise it offers, regulatory flexibility and its track record of innovation in areas such as parametrics. It also provides a platform for capital markets risk transfer as an alternative to insurance products.”

Brook sees a valuable role for the re/insurance market in enabling the technologies that will play a key role in the energy transition.

“Wind and solar power are rapidly approaching maturity. But the transition requires decarbonisation of a range of ‘hard to abate’ sectors such as cement, steel and aluminium production, and the creation of infrastructure around low- or zero-carbon fuels such as hydrogen. Novel and untested prototypes need to be scaled rapidly to commercial production. New types of risks are bound to emerge during this process and re/insurers willing to take these on will help to unlock the flow of investment and lending required. London, Zurich and Bermuda (among other re/insurance centres) have the depth of engineering expertise to take this on. It could become a huge market.”

The need for mitigation expertise

There is a “dawning realisation”, Brook said, of the need to add mitigation of carbon emissions to the re/insurers’ toolkit, alongside their existing expertise in adaptation to climate change through, for example, measures to increase property resilience.

A lot of re/insurers want to be “part of the solution” in that way, he said, and the most ambitious among them are members of the Net-Zero Insurance Alliance (NZIA).

UN-convened NZIA is a group of over 29 leading insurers representing more than 14 percent of world premium volume globally.

“They’re trying to cut their own emissions and also their responsibility for emissions and so it’s a stewardship role that they’re getting to grips with,” Brook said.

He pointed to Munich Re’s recently announced new policy on oil and gas.

The German reinsurer says it has tightened its oil and gas investment and underwriting policies, describing this as an “environmentally conscientious” business decision. Munich Re has committed that, as of April 1, 2023, it will no longer invest in or insure contracts/projects exclusively covering the planning, financing, construction or operation of new oil and gas fields. Munich Re’s syndicate at Lloyd’s recently committed to stop underwriting all traditional oil and gas business by January 1, 2023.

Another example is Swiss Re, which pledged earlier this year that, from July 2023, it will no longer provide individual insurance covers for those companies that are responsible for the world’s 10 percent most carbon-intensive oil and gas production.

Brook noted that, until recently, the focus was on coal, the most carbon-intensive fossil fuel. Unfriend Coal, a global coalition of non-governmental organisations and social movements, pressured insurance companies to get out of the coal business and support the transition to clean energy. Many re/insurers have adopted new policies on underwriting of coal, and now activists are turning their attention to oil and gas.

“When you see the likes of Munich Re and Swiss Re declaring ‘no new oil’, that’s profound because it’s going to affect the appetite of the worldwide front-end market. Things are moving fast.”

That movement is in line with the International Energy Agency’s warning last year that, if the world has any hope of achieving the ‘1.5 degrees’ target, then there can’t be any new coal, oil or gas exploration projects.

“Re/insurers are starting to encourage fossil fuel insureds to get on the glide path towards net zero. That is the stewardship role they can play.”

Insist on the truth

Another source of pressure is activists calling out companies on “greenwashing”, Brook said, giving as an example a case against Santos. The Australian oil and gas giant is accused of giving misleading statements in its 2021 annual report. Santos claims that it has a clear and credible plan to achieve net zero emissions by 2040, but it is alleged that the company plans to expand its natural gas operations and that its “net zero” target would depend on undisclosed assumptions about the effectiveness of carbon capture and storage processes.

Examples like these are making other companies ask themselves whether they can back up their own green claims.

“Activists’ core objective is to keep companies honest about their climate performance and strategies, so stakeholders can tell whether they are properly performing their role in the transition,” Brook said.

Will COP27 be a gamechanger for the re/insurance sector?

“COP26 in Glasgow last year was designated as the highest ambition meeting since COP21, which delivered the Paris Agreement. COP31 in 2026 would ordinarily have been the next ‘high ambition’ COP, but there was consensus in Glasgow that this five-year rhythm is simply too slow given the urgent need for concerted action.

“At COP26, Mark Carney got financial institutions across the world to agree on an ambitious programme, and I think we’ll hear more on that at Sharm el-Sheikh. But a major focus of COP27 will be on ‘loss and damage’, with less developed countries looking for compensation from those who have industrialised through the use of fossil fuels,” Brook said.

He concluded: “A range of industry sectors will be transformed by the race to decarbonise. This will involve multiple, parallel industrial revolutions, on a scale and at a pace never seen before. The associated risks are substantial, but these provide huge opportunities for re/insurers. For the brave, there’s a big opportunity to win a whole new market.”