Where next for sustainable insurance? Five priorities for the next decade

Back in the 1970s, the Munich Reinsurance Company published its first assessments of the dangers of climate change. The company warned that rising greenhouse gas emissions would alter global systems and could lead to more floods, storms and droughts. Publishing risk assessments was initially a rather novel form of public engagement in an otherwise traditional and somewhat old-fashioned sector – but it is now widespread.

Today, an increasing number of players in the insurance sector are not just aware of the risks that environmental change brings but are also changing their practices in terms of both underwriting and investment. Under the banner of ‘sustainable insurance’, a growing number of companies have pledged to be a responsible corporate citizen and ensure that they and their clients can prosper, today and in the future.

The insurance industry undoubtedly has an important role to play in achieving environmental sustainability. In this commentary we review how both the sector and its partners could build on the growing momentum and overcome the continuing barriers to deep implementation of sustainable insurance practices over the coming decade.

Heading for an uninsurable world?

Climate change undoubtedly presents one of the biggest challenges for insurers, their clients and society as a whole. The recent Special Report on 1.5 degrees by the Intergovernmental Panel on Climate Change states that expected net present value of damages from 2°C of warming are expected to be US$64 trillion by 2100. Insured losses in 2017 in the US were the highest on record, at $138 billion, due to the major hurricanes and other weather events last year that experts link to climate change. This may be just a small indication of what the future could hold. Certainly beyond 3°C of global warming, leading insurance figures now believe, many parts of the world may become largely uninsurable.

Risks to society bring opportunities as well as challenges to the industry and insurers are a vital line of defence for organisations and people when they face threats. However, insurability is not limitless and comes at a price. Any damages to insured assets require pay-outs and, other things being equal, push premiums upwards. But not only this: the industry’s balance sheets and profitability are also highly exposed to risk trends.

Society’s risk manager

The insurance industry is a key part of the financial system. Globally, it manages over $30 trillion in assets, acts as an important guardian of wealth and as a financier of economic growth. All the while the industry helps to spread and smooth risks for millions of individuals, businesses and governments. Its role as society’s risk manager goes back a long way, and it has led to significant improvements in safety standards and accident reduction, for example in fire risk and road safety.

It is therefore natural that insurance companies pay considerable attention to the risks and threats coming down the track. Indeed, a core role for insurance as society’s risk manager is to raise red flags and challenge the rest of the system to change course before threats become unmanageable.

Initiatives such as the UN Environment Finance Initiative’s Principles for Sustainable Insurance (PSI) and the Cambridge Institute for Sustainability Leadership’s ClimateWise provide guidance to companies on how to make sustainability a key component across their businesses, helping to raise the bar for sector practice. Indeed, there are promising examples on both the asset and underwriting sides of the industry.

In terms of climate change, insurers can be important agents in both mitigation of emissions and adaptation to climate impacts by directing capital to these areas. In addition, their underwriting and advisory functions can be further leveraged to encourage positive action on climate change by influencing the behaviour of individuals, businesses and governments.

Beyond the climate arena, insurers can also contribute more broadly to the Sustainable Development Goals (SDGs) by deploying expertise and resources in other priority areas. Recent examples include improving health by divesting from tobacco stocks or protecting the oceans by restricting insurance to prevent illegal fishing.

Sustainable insurance is also no longer simply a matter for the sector itself. Regulators, policymakers and insurance customers all play a part. Central banks and insurance regulators are now incorporating climate risks into the way they supervise insurance firms from a prudential perspective. Alongside the PSI, the Sustainable Insurance Forum (SIF) sees regulators and supervisors from 18 national, international and, in the United States, state-level bodies come together to discuss experiences and responses to environmental, social and governance issues. In July this year, the SIF, together with the Basel-based International Association of Insurance Supervisors (IAIS), produced the world’s first assessment of why supervisors should connect climate change with their core mandate of ensuring firms as safe and sound, and how they can do this.

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) has also stimulated new activity by the insurance sector to deepen its existing work on risk modelling in the new context of scenario planning. Importantly, the new wave of reporting that will result in response to the TCFD’s recommendations will not just be used by the sector’s investors, but also by the regulatory community as it seeks to understand overall systemic risk.

The road ahead for sustainable insurance

This momentum is impressive, with actions now taking place that were unthinkable just a few years ago. Yet while the commitment is underpinned by clear action by some insurers, a ‘business as usual’ approach is still widespread when it comes to addressing sustainability challenges. A significant barrier to the deep implementation of sustainable insurance practices lies in the nature of insurance companies themselves: large firms typically have short-term time horizons, capacity constraints, misaligned incentives and other barriers to strategic repositioning.

The good news is that serving the delivery of the SDGs could be a major driver of growth for insurance coverage worldwide. But if the sector and its stakeholders do not rise to the scale and urgency of the challenge, the sector’s traditional business model could be exposed to growing constraints as inequality and climate disruption narrow the market. A new generation of leadership is required to place climate resilience and sustainable development at the heart of the insurance business model. As insurers and reinsurers have both sticks and carrots in their toolbox that can help society to shift to a more sustainable pathway, they are well placed to play this catalyst role.

The Grantham Research Institute is actively working with the industry and policymakers to address these issues, based on a decade of research experience and engagement, ranging from sustainable flood insurance to testing pre-event flood risk reduction strategies at community level, investing in a just transition, understanding litigation risks and the role of risk transfer in driving climate resilience in developing countries. Progress has clearly been made in many areas, with genuine efforts from some industry leaders to internalise sustainability and demonstrate that this is good for their business, clients and society. But at the same time there are challenges that have not been resolved, and which will require joint efforts to address.

Strategic questions for the industry and its partners

We see five clusters of strategic questions that need to inform the next phase of the sustainable insurance journey:

  1. Closing the protection and resilience gap: In many parts of the world access to insurance is not available, or the existing products are not meeting the needs of those most vulnerable to current and future risk. How can the industry build trust, capacity and long-term solutions where no markets currently exist or where rising risks threaten the availability of insurance?
  2. ‘Building back better’: After climate shocks, why are not all insurance repairs conducted with a low-carbon and climate-resilient future in mind? There are commitments on doing this both for the residential and industrial insurance business sides, but has this led to a real transformation?
  3. Investing in sustainable assets: How can the industry address the disconnect between risk know-how on the underwriting side and investment decisions on the asset side? In other words – why are insurers still funding projects that they would not insure, whether on health, social or environmental grounds? How can insurers play a market-shaping role in terms of driving demand for green and sustainable assets, not least for sovereign bonds, often the largest asset class?
  4. Make resilience an investable proposition: Why are we not able to attach monetary returns to investments in resilience? There is growing interest in generating returns from investments in resilience and climate adaptation but a good formula is still missing.
  5. Engaging with clients and customers through better risk signalling: How could insurers set out requirements for their clients to demonstrate sustainable behaviour? Insurers can fill a void in terms of engaging with companies and governments in locations in which they invest or which they underwrite – can this help to encourage prioritisation of climate change and other sustainability concerns in planning and policymaking? How can insurers use risk signalling to inform other sectors and governments about the urgency of changing to more sustainable practices and policies?

Many of these questions are not new, and they do not have simple answers. But the industry, its regulators, and policymakers need to respond if they take their role as society’s risk manager and agent of change at all seriously. Barriers exist – be it lack of appetite from customers, regulatory constraints, or short-termism – but as the many good examples from across the industry show, they are not insurmountable.

Time is starting to run out, however. The urgency of strategic action on climate and wider sustainability is growing – not driven by altruistic motives, but out of concern about business’s own longevity.

The views in this commentary are those of the authors and do not necessarily represent those of the Grantham Research Institute.