Stockholm (NordSIP) – The insurance industry is one of the sectors most affected by climate change. As the incidence and magnitude of devastating weather events increase with global warming, so too should the expected payments of insurance companies to its customers.
Correctly pricing the new probability and impact of these events is crucial for the global insurance industry’s solvency. However, the nature of the problem creates new hurdles for the implementation of existing insurance models. To address these concerns, the UN Environment Programme’s Principles for Sustainable Insurance Initiative (PSI) published a report discussing the use of new approaches to assessing climate-related risks in the insurance business better.
“This is the type of effort needed for insurers to address climate risks more efficiently, to be at the forefront of risk management, and to drive greater climate action by the wider insurance industry, its policyholders, and its stakeholders,” says Mark Carney, UN Special Envoy on Climate Action & Finance, in his foreword for the PSI report. “Amid a changing climate, insurers are developing innovative ways to protect vulnerable communities, to safeguard natural ecosystems that build resilience and store carbon, and to align their business activities with the Paris Agreement. More and more leading insurers are transitioning their investment portfolios to net-zero emissions, and it is time for a similar effort in their underwriting portfolios,” Carney adds.
The UNEP PSI
The study responds to the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD). It captures the insights from a year-long collaboration of specialists working for the 22 leading insurers and reinsurers that make up the PSI TCFD pilot group. Convened in November 2018 by the UNEP, the group includes Länsförsäkringar Sak and Storebrand and represents over 10% of world premium volume and US$6 trillion in assets under management. PwC and the Sabin Center for Climate Change Law also contributed to the report.
“We entered this global collaboration in order to improve our understanding of climate risk and opportunities and how to contribute to the transition towards a net-zero emissions society. Our next step is to continue this journey more prepared than ever—together we can fight climate change,” says Björn Dalemo, CEO, Länsförsäkringar Sak Försäkrings AB.
The relevance of the UNEP PSI’s work is not confined to insurance companies. Given its US$6 trillion in world premium volume and US$36 trillion in AUM, the global insurance industry represents one of the significant aggregate balance sheets in the world. The potential spillovers should the industry mismanage the climate transition could be catastrophic.
“Looking at the bigger picture, based on the latest climate science, this decade leading to 2030 represents the most critical period for the world to bend the global emissions curve in order to achieve the aims of the Paris Agreement. At the same time, it is important to cope with adverse climate change impacts that are already being seen and felt worldwide in terms of human tragedy, food and water insecurity, major economic losses, biodiversity loss, and ecosystem degradation,” says Butch Bacani, Programme Leader at UN Environment Programme PSI. “Using both hindsight and foresight, this report represents another concrete step and contribution by the insurance industry towards a risk-aware world and the urgent climate transition needed.”
The report is divided into three main sections discussing physical, transition, and litigation risk assessments. Each chapter reviews methods to define the scope of analysis and impact pathway, suitable climate data, models, and key takeaways. Given the existing expertise of the insurance industry, the report notes that “the integration of climate change scenarios is a natural extension of existing techniques.”
“Difficulties arise in the treatment of proprietary elements in the context of disclosures. This difficulty was encountered in the project’s assessment of financial impacts,” the report adds. “While economic losses were derived in the analysis, company-specific insured losses rely on proprietary information which cannot be readily standardised across the insurance industry. Beyond hazard and exposure, analysis of how vulnerability may change in the future is also needed, but not directly addressed in the work presented in this report.”
On the topic of data, the report noted that it “is less consistently available for transition risks, with the industry switching between quantitative and qualitative approaches for this risk category. Litigation risk analysis is generally more qualitative, and many market participants are not yet consistently going beyond monitoring legal cases.”
In the future, the report notes that a more integrated approach to the insurance industry’s management of climate change risks will have to tackle four concerns: the steep analytical sophistication of climate change risks, the potential systematic impact of cross-business and cross-geographical climate risk, increased focus on the impacts on life and health insurance and the impact of these risks on the insurance and investment portfolios.