How to insure a warming world

What effect will climate change have on the insurance industry, and what can insurers do to mitigate climate risk? Participants in part two of this roundtable from InsuranceERM and DWS discuss the strategic transformations that are needed, and the influence of voluntary and regulatory initiatives on this process

Climate risk for a general insurer

Otto Bedford: As a general (non-life) insurer, one way you avoid the risk of a changing climate is writing short-term contracts. But in life insurance, you are forced to think much longer-term. How do you deal with the fact that the data you have is not applicable in five years' time?

Zelda Bentham: It is something we are very conscious of. There is also going to be a huge issue if the transition risks' impact on assets kick in before the physical impacts on the liabilities side, as this may mean that insurers are not as easily able to pay out the liabilities.

Christopher Cundy: Will the world be uninsurable with a temperature rise of four degrees? Or do you side with Warren Buffett and think more catastrophes will create more business for re/insurers?

Tom Herbstein: Warren Buffett's comment did surprise me, from someone that prides himself as a long-term investor. If the industry continues to simply re-price risk, in some markets insurance could become unaffordable. A focus on resilience will help to manage that.

The financial markets will face risk either way. If we go to a four-degree world, there is going to be a tremendous amount of physical risk exposure to manage. If we 'save the world', we are going to have less physical risk, but far more transition risk to manage.

From my perspective, I hope we have a lot of future transition risk to deal with as that would be a sign that we are moving in the right directions. However, physical risk undoubtedly captures people's attention more.

Otto Bedford: There might be an increase in the need for government-backed insurance pools, like the UK's Flood Re or US National Flood Insurance Program, because you are going to end up with pockets of uninsurable areas. If it is not a government scheme, it will be the government forcing the commercial industry to cross-subsidise by saying: 'If you want to write any of this, you have to write all of it.'

Also, in our own products, we will have to find ways to identify the risks and then credit people for taking actions to avoid them. The trouble is, we are in such a soft market at the moment, that it's hard to implement charging more for the people that do nothing.

Zelda Bentham: The insurance sector needs to get better at helping people take more responsibility for the risks themselves. In our Canadian commercial property underwriting business, provision of cover provides up to 10% of the loss of damage to make their property more resilient. It could be used for hurricane clips to secure the roof to the walls, anchors to hold the walls to the foundation or improve the type of roofing in hail-prone areas to more hail-resistant products. If the measures mean losses are minimised over a five-year period, then it has mitigated the risk and benefits both customer and insurer.

Otto Bedford: If governments could just make it mandatory that anything rebuilt with insurance money has to be rebuilt properly, it would be marvellous!

Rowan Douglas: We need to create a structural change in the way that governments view the insurance industry. It has happened before with urban fire: in the 1870s in the US – when bigger, industrialised cities were burning down – insurers said 'this is not sustainable unless we do certain things'. Effectively insurance became mandatory, because capital providers required it, but insurers then required governments to impose building codes, zoning laws and fire departments.

Now, governments have worked out there is a tremendous global pool of capital that can be brought to bear on these risks, and there is a desire to use the institution of insurance to crack big social or economic problems. Climate sustainability is going to drive wider changes, but we as an industry have got to be prepared to engage in that dialogue.

But the bigger picture is, if global temperatures rise four degrees, it is not really the direct physical risks to property that I am particularly worried about. What will be the effects on global agriculture and food production? Or on migration?

Tom Herbstein: What then should the insurance industry of the future look like? Will it be one that focuses primarily on financial risk transfer, or is it one that becomes much broader and where financing of disasters plays just one part?

Rowan Douglas: That is what the industry has always done. I know in most specific examples of property risk now they are not doing that. But it was the insurance sector that made the electric system of the world safe, through the underwriters' laboratories. We have, broadly speaking, safe cars and safe road layouts, because there was an economic agent called the insurance industry which demanded those things.

Otto Bedford: With all the mergers and acquisitions leading to fewer, bigger players, I wonder if it will be easier for the industry to talk with a unified voice?

Rowan Douglas: The consolidation may help. But the challenge for the industry is, in a sense, no longer risk, and it is no longer capital – apart from having too much of it. The challenge is growth and this huge level of underinsured populations and assets, even in developed countries, let alone developing ones.

Almost all insurance is bought because people have to, so the only way we are going to get structural growth is to convince governments that, to manage societal risks, they need to encourage, or even compel, people to have insurance.

The other side is our investment capital: we have the ability to drive investment capital into some areas that governments really want.

Asset strategies

Christopher Cundy: Let us stick on that point about what asset management can do in this space. Do insurers need to divest from firms that pose big climate risks?

Michael Lewis: You can do it on a case-by-case basis, but saying you should get out of fossil fuels is not the best approach. These companies are actually changing themselves, and they are going to be needed in the transition to a low carbon economy.

However, asset managers are moving away from 'do no harm' into 'doing good' in terms of their ESG investment process. As a result, they are increasingly screening their assets to see whether they are aligned to the UN Sustainable Development Goals, for example. But you have to be rigorous in your approach and as an asset manager must not over-promise on what they are doing.

Zelda Bentham: The other tool that underwriters and asset managers can use in this space is TCFD (Task Force on Climate-related Financial Disclosures) – if it is taken seriously, if it produces decision-useful information, and if insurance companies and asset managers use the information appropriately.

I think that will come over time and hopefully it will be voluntary – but to capture all companies it will probably have to be mandatory.

Tom Herbstein: There are strategic benefits and opportunities of staying invested in companies and working with them to decarbonise, but there is also the very real risk – portfolio risk, material financial risk – of a sudden transition.

We are in a carbon bubble and it will burst at some point, likely before the 2040 global warming limit set in the Paris climate agreement that many governments are aligning to.

Michael Lewis: The asset management community is introducing products that try to eliminate that sort of exposure. For example, we have created low-carbon ETFs where the carbon footprint is something in the order of 80% lower than a typical ESG fund.

Zelda Bentham: New products are fine, but it is the existing products that hold the risk, is it not? How do we make sure those risks are taken into account by the mainstream fund? That is more of a challenge. I think it will be slower to implement, but it has to happen at some point.

Regulatory push

Christopher Cundy: Is there any regulation or initiative on the horizon that will influence insurance companies or asset managers in this regard?

Zelda Bentham: The TCFD is probably one of the front-runners. Two thirds of the G20 are looking at it. Most governments would prefer it to be voluntary to start with, but the UK's Environmental Audit Committee have called for it to be mandatory by 2025.

Tom Herbstein: Whether it's the TCFD or the High-Level Expert Group on Sustainable Finance (HLEG) or the UK Green Finance Taskforce, just to name a few – there is a tremendous amount going on, and it really feels like an exciting time to be in sustainable finance.

ClimateWise is working on two projects: one looking at geographic concentration of risk within portfolios, mainly real estate; and the second is contributing to the transition risk conversation. We have just published a summary document on an open-source model looking at transition risk, on infrastructure assets initially.

Christopher Cundy: Is there anything that your boards are beginning to pick up on?

Michael Lewis: The EU action plan will be a major clarification of the investor duties as it relates to sustainable finance. Another is looking at green discounting factors – the pricing of brown versus green assets as well as the need to understand the sustainability interests and preferences of our clients and the need to explain how sustainability considerations are incorporated into our investment products.

Zelda Bentham: For us as a pension provider, it's the DWP [Department for Work and Pensions] and FCA [Financial Conduct Authority] responses to the Law Commission on how trustees and pension providers mirror the values of customers and take into account climate risk in the way that they provide pensions.

Vincent Huck: What do you think of the EU's plans to create a sustainable taxonomy, and introduce green labelling of financial products?

Michael Lewis: I am in favour. I will be interested to see how we define 'green' and 'brown' as I think this will be very challenging, but we have got to start somewhere.

Zelda Bentham: Being able to highlight whether a product or investment meets a particular standard is great. The challenge will be that it makes it more niche, rather than it being something that all investments take account of. Does putting a label on a product mean the rest are not doing anything?

To read part one of this roundtable click here.