With the UN secretary general’s call in December 2020 for all countries to declare climate emergencies, a change in the resident of the US White House in January 2021 to a leader who recognises the threat of climate change, and the scheduled COP26 meeting in Glasgow, UK, to discuss global environmental targets in November 2021, climate change is squarely on the agenda for world leaders in the year ahead.

For the insurance industry, the question of a collective response has been a topic of discussion for a while, but as yet there is no formal industry consensus on how to work together across all the issues it covers and what stance to take.

Intelligent Insurer’s Re/insurance Lounge brought together five industry experts to discuss a way forward that could bring the industry together to pull in one direction, in a panel discussion titled “Climate change: is it time the industry took a stance?”.

The panel included Ariane West, director, structured finance at Nephila Climate; Ben Howarth, manager, climate change and open data policy at the Association of British Insurers (ABI); Katherine Greig, senior transition specialist at Flood Re; Robert Muir-Wood, chief research officer at RMS; and Nigel Brook, partner at Clyde & Co, with Intelligent Insurer deputy editor Claire Churchard as moderator.

The panellists were quick to highlight the increases in climate-related regulations and the wider push to decarbonise the global economy, with the implications for insurers’ portfolios and policies.

Change is already happening, so managing the transition risk for insurers is essential as the global economy begins the move to a net zero carbon world.

Clyde & Co’s Brook pointed to developments in 2020 with China, Japan and South Korea setting tough climate targets for 2050 and 2060, adding that other countries will also be looking to do this. “Pressure is being put on governments to be more ambitious, including through the courts,” he said.

The impact of this is an acceleration in the move away from fossil fuels towards renewables, supported by a substantial fall in the price of renewables such as wind and solar as the technology scales up and battery technology improves.

But, Brook warned, the transition is much bigger than that. “We need whole new economies to spring up, the hydrogen economy for example.”

He also highlighted a major shift that is expected to come in agriculture as it changes from being a 30 percent-plus contributor to global warming and potentially becomes a carbon sink.

“All of these developments, some of which are needed and some of which are already under way, are going to create winners and losers. There are going to be stranded assets, there already are, and we’re seeing COVID-19 accelerating that as well, with oil and gas reserves being written off.

“Those developments, especially if we get a disorderly transition, which is perfectly possible, will then create massive losses. That in itself could require litigation and that is perhaps one of the main areas where the transition could have a direct impact on insurers.”

Avoiding a disorderly transition

The longer-term impact of climate change will be a reordering of many books of business, Brook said. “In 10 years’ time the companies that insurers are covering could be very different, and the kind of risks they’ll be writing will be very different.”

Such fundamental change will be challenging but, he said, underwriters are already looking out for potential new customers.

“There may be companies they don’t insure today that could become major customers in a few years’ time. Also they’re trying to look forward to the changing risk profile.

“To avoid a disorderly transition, ideally the world would get a coordinated activity in place so that we space out this transition without destroying too much value along the way.

“But if there isn’t that political consensus, and the COP26 talks are fundamentally important in this, that’s where transition risk could figure quite large,” he said.

There are a couple of ways to think about tackling or mitigating climate transition risk, according to Nephila Climate’s West. One is looking at books of business as they exist today and how they might change as customers change the nature of the risk. Another is to consider how to support those changes.

“A lot of these transitions to more sustainable technologies, such as wind and solar power, need huge investment and there is still a great deal of uncertainty around the timing around the developments of those markets,” West said.

“Traditional approaches to financing, which the building of these projects rely on, also have large amounts of risk.

“The investment industry, as well as the insurance industry, have a role to play in terms of financing that transition. These industries have a role in ensuring that financing also develops risk management products for capital and that these technologies come together and realise that transition on a schedule that many people are now targeting—it’s a very quick turnaround schedule, faster than previous ambitions were anticipating,” she added.

In terms of traditional insurance books, she emphasised that there are already exclusionary policies to limit support.

“The key is looking at how we can evolve risk management and insurance products to bring a new level of support, an active level of support to the transition rather than reacting.”

Commitment at the top

When it comes to the industry pulling together, there is good news. At a recent ABI board meeting with the chief executives of the big industry players, the level of commitment to respond to climate related changes was clear, said ABI’s Howarth.

“They were all challenging the ABI and saying ‘we want you to be as ambitious as possible’. So that’s heartening—I think the commitment to do it is there.”

There’s a recognition that there’s a lot more to do, with COP26 helping to focus minds, Howarth added.

The level of buy-in from the UK government is another incentive for insurers across the industry to be collaborative and make sure it responds to that challenge.

“The announcements we heard from the UK chancellor on November 10, 2020, on ‘green’ bonds are really significant. As big institutional investors, one of the barriers for insurers has been that Solvency II tends to require you to oversimplify and be relatively safe in your investments.

“The fact that the government has committed to a green bond should encourage and make investments in green infrastructure a bit easier for the insurance sector within the current Solvency II framework,” he said.

Howarth sees lots of opportunities for innovation within individual firms, adding: “Insurance is unique as a sector in having lots of capacity to drive this as investors but also in the firing line as the people who are ultimately going to pay significant claims out if we don’t address this.”

Broaden your horizons

Risk modellers have a key role to play in helping insurers navigate transition risks together and as individual companies. They have a particular opportunity to support industry change by ensuring the modelling is there to help insurers find new ways to price and insure sustainable technologies, from autonomous vehicles to solar or wind power and carbon capture and storage, said RMS’s Muir-Wood.

But, he said, there is a much bigger agenda for risk modellers and insurers.

“We live in a world where we used to believe that there’s stationarity about the occurrence of extremes, that we can use the average of history and it would tell us about the risk today—but in lots of areas of climate that is no longer the case. That makes our lives more difficult.

“It means we want to stretch the horizon insurers have. Insurance has originally been very focused on a one-to-three-year perspective of risk but we need to be looking longer term now.

“We need to be looking at 10, 20 and 30 years, and often we don’t know the pace at which the change is going to happen.”

There is an expectation among consumers that insurers are the “mouthpiece” of information about risk to many parts of the community, which is “a tall order”, Muir-Wood said.

On top of this, it has become increasingly complicated to model the future to identify which pathway of emissions to expect, to identify what these changes are likely to be and to highlight the uncertainty, he added. “There’s going to be significant uncertainty as we project the future, and we need to communicate that, not hide it.”

Despite the challenges, Muir-Wood said modellers can help insurers to communicate risk to other sectors who want to know the future.

“As risk modellers we have an expanded agenda here to be intermediaries between the best sciences of climate and its application in terms of risk modelling. You will see much more from us in delivering information on risk at different points in the future, not just over the next one to two years.”

The need for a much longer-term view in insurance is one that Greig from Flood Re shares. Her organisation was established in 2016 and spent the first three years putting operations in place. Flood Re’s strategy day in December 2019 brought climate change to the fore as a transition risk, she recalled.

“Flood Re was born out of the gentleman’s agreement that basically said the UK promises to invest more in defences and resilient adjustments to households and in return the insurance industry would provide homeowners with affordable insurance.

“We stepped into the breach on the tails of continuing agreement by government to invest in defences. And now we’re talking about physical transition, not economic transition. In that space, in an absence of climate change, there could be a mode where we could withdraw from the market.”

Flood Re, which underwrites residential homeowners’ flood exposure, is expected to exit from the market in 2039 as the scheme was set up to run for just 25 years.

“With climate change we are on a bit of a treadmill, however, and it will behove all of us to continue to invest in the ‘install base’ of homes with resilient measures, and even more vitally to talk about the long-term insurability of homes and physical assets as they’re being built.

“There’s so much, as yet, unbuilt infrastructure that is going to be a bigger problem if it’s not built resiliently today,” Greig said.

“Until you stretch the horizon of an insurer’s view beyond a year there is very little to align economic incentives with climate change targets,” she added.