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Climate change: a galvanising force in insurance ESG

Insurer Solutions Climate Risk Series

Climate Quantified|Insurance Consulting and Technology
Climate and Resilience Hub|Climate Risk and Resilience|Insurer Solutions

By Adhiraj Maitra , Elke Vagenende and Gareth Sutcliffe | November 19, 2020

In 2020, environmental threats dominated issues on senior leaders’ agendas for the first time in the history of the World Economic Forum’s (WEF) Global Risk Report. Climate considerations, while naturally and closely aligned with the ‘E’ of ESG (environmental, social, governance) approaches, will increasingly need to straddle insurers’ broader ESG thinking and policies.

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About this series

Insurers increasingly find themselves being pushed to the front of the queue for meaningful action on climate risk and resilience. As the articles in this special Insurer Solutions climate risk series demonstrate, a strategic response is required that will need to consider the breadth of an insurance business across people, risk and capital.

The WEF report headline alone is a further sign, if one were needed, that the global challenge of achieving a just and orderly transition to a low carbon, climate resilient economy dictates that climate considerations are pivotal to mainstream financial decision-making across the public and private sectors.

And as climate change has shifted from being seen as ‘society’s problem’, or perhaps a moral issue, financial services businesses, including insurers, have very quickly found themselves thrust into the role of corporate catalysts for change as part of a wider ESG agenda.

From the types of policies and sectors insurers underwrite, how they make investment returns, how resilient the business itself is to physical, transition and liability risks (see below), how they assess and disclose climate risks, how they reward people, and their attractiveness and fairness as an employer – all increasingly are viewed by stakeholders through a climate lens (see ‘Series Insights’). And all are becoming crucial factors in the wider ESG rating an insurer can achieve.

To more fully understand why there has been such a significant shift in the framing of ESG objectives, it is useful to understand current views of the science.


The science landscape

2020 represents a fundamental fork in the climate change road. The actions we take now, and in the coming years, may well determine the future of the world’s climate system. Views on how extreme weather events will change in a warmer world vary, depending on the type of event and its individual characteristics. This is where modelling future climate scenarios using state of the art scientific knowledge can play a key role in strategic planning and risk management processes.

While a 2°C increase in temperature may not seem important, it’s worth bearing in mind that for the last 10,000 years, it’s the relative climate stability of +/- 1°C that has, at least in part, been the foundation of our collective progress today: a climatically stable nursery for civilizations to grow. Beyond 2°C, or even 1.5°C according to a recent IPCC (Intergovernmental Panel on Climate Change) report1, we are going in to uncharted territory with increasing risk of climate tipping points.

There has been a significant and rapid increase in concentrations of atmospheric carbon dioxide (CO2), especially since the 1970s, reaching levels unprecedented for at least 800,000 years, during which time we’ve been through many ice ages and warm periods (inter-glacials, such as our pre-industrial climate). In fact, palaeoclimatological evidence shows that the last time CO2 concentration was this high was at least 3 million years ago. Temperatures were two or three degrees higher than pre-industrial climate and seas were 15 to 25 metres higher.

CO2 is a greenhouse gas that acts like a thermal blanket around the Earth, and it’s getting thicker every year. In response, our planet is warming, sea levels are rising and weather patterns are changing. The rapid increase in CO2 takes time to exert these impacts on the planet, and so the emissions produced already will continue to affect our climate for centuries to come. If we continue along a similar pathway – continuing to increase carbon emissions – global temperatures could rise over 4°C by the end of the century, and this has been quoted by some as being an uninsurable world2.

Graph showing 2100 global warming projection
Figure 1. The science landscape

Source: Climate Action Tracker – September 2020. © Climate Analytics and NewClimate Institute (see also https://climateactiontracker.org/global/temperatures/)

If we are to keep global temperatures to ‘well below 2°C’, the guardrail which scientists view as important to reduce the risks of severe, irreversible and pervasive changes in our climate, we need to make substantial and sustained reductions in the rate of emissions and reach ‘net zero’.


Plenty of sticks - but carrots too

What this all means is that if your senior executives haven’t been pressed about your company performance through a climate-focused ESG lens already, then rest assured it is coming, and coming soon. Indeed, it’s likely that money will increasingly follow those companies with the highest proven ESG credentials, as recognition of the systemic nature of issues such as climate change and a plan to manage them increasingly become key indicators of appropriate risk management and investment worthiness.

Indeed, events that would have seemed unimaginable only a few years ago, such as the Chairman and CEO of BlackRock discussing climate risk and referring to a fundamental reshaping of finance3, are now becoming the norm.

In July 2020, BlackRock announced it had identified 244 companies that were making insufficient progress on climate risk. 53 had voting action taken against them on climate issues, and 191 were warned they would risk voting action against management in 2021 if they do not make significant progress.


Source: BlackRock4

And as outlined in our article on the evolving regulatory and policy landscape , 2020 has been a particularly active year for climate-related announcements affecting the UK insurance sector – including the Prudential Regulation Authority’s ‘Dear CEO’ letter, the Financial Conduct Authority consultation, further details of the Bank of England’s climate stress test proposals and the recent opening of an EIOPA consultation on the inclusion of climate risks in companies’ Solvency II ORSA (Own Risk and Solvency Assessment) reports – with more potentially future-defining events on the horizon. (Note: on 9 November, the UK joint regulator and government Taskforce for Climate-related Financial Disclosures (TCFD) Taskforce published an interim report and accompanying roadmap signalling the intention to make TCFD-aligned disclosures mandatory across the economy by 2025, with a significant portion of mandatory requirements in place by 2023)5.

In particular, there is the United Nations Climate Change Conference COP26 meeting, held over from this year to next in Glasgow, at which international pressure for action on reducing carbon emissions is expected to further grow. Meanwhile, initiatives such as the Coalition for Climate Resilient Investment, which has the backing of major financial institutions around the world, are taking aim at the pricing of climate risks and climate resilience in investment decision-making.

Add to this evolving landscape the idea that COVID-19 may accelerate the broader appetite towards ESG as financial markets look to build resilience to systemic risks, and there is an even stronger case for enhancing ESG response.

Doing nothing is therefore not a viable option. But it’s not all a matter of compliance and enforcement ‘sticks’.

From an investment point of view, for example, there is already substantial evidence of the risk-adjusted return benefits of more sustainable portfolios. Many studies rightly focus on the long-term6, but there has also been no shortage of headlines highlighting how well ESG-orientated strategies have performed in recent years and during the current pandemic too7. More broadly, there’s a strong argument that companies that embrace ESG, including the climate aspects of it, will be better prepared for the likes of mandatory climate disclosures in due course and reap the financial and reputational benefits in the meantime.

Which brings us to what are insurers dealing with.

The current ESG landscape: a framework for climate-related financial risks

As the worlds of ESG, climate science and finance have come together in recent years, a new language of climate-related financial risk and disclosure has developed.

A framework based on physical, transition, and liability financial risks from climate change, as first set out in a report by the Bank of England in 20158, has become the common climate dictionary.


  • Physical risks are the direct risks to infrastructure, premises and supply chains that arise from extreme and adverse weather and the economic losses that result. This is where the use of the IPCC scenarios is incredibly useful because they give an evidence-based frame to consider possible futures for risk assessment, asset management and capital expenditure.
  • Transition risks are the legal, technology, market and reputation costs linked to how organizations adapt to, and the speed at which they adapt to, lower carbon and climate resilient economies, such as a shift to alternative sources of energy or more sustainable forms of transport.
  • Liability risks are the legal costs and damages that result from failing to meet responsibilities for climate risks. These risks could arise from a failure to adapt, mitigate or disclose the financial risks from climate change.

In many ways, these risks are not new per se; they translate into existing categories of financial risk such as credit, market, business, operation and legal risks that insurers have been managing effectively for many years. But as new sources of financial risk, they do present new challenges, not least the need for more extensive modelling of the natural world and developing a much more granular understanding of the transition to a ‘net zero’ future.

Dealing with climate change is a responsibility we all share – we believe we all are the ‘they’ who must act.”

Rowan Douglas | Head of the Willis Towers Watson Climate and Resilience Hub

Multi-dimensional challenge

There is no off-the-shelf solution to tackling them. To respond effectively to the various drivers for action, be they regulation, investors, employees or consumer activism, organisations will need to act in several areas, such as:

  • Assessment and quantification of climate risks and opportunities
  • Transition and resilience planning
  • Financial reporting and disclosure
  • Investment and underwriting strategy and its implementation
  • Budgeting and capital management
  • Risk hedging and transfer
  • Human capital: talent, rewards and culture alignment, non-executive director responsibilities, pensions management, corporate governance

Reflecting this diversity of drivers, responding effectively and taking a strategic approach will be truly multi-dimensional and will require solutions to managing people, policy, risk and capital that not only continue to create opportunities to make future profits but which mitigate against activities and events that could have a detrimental effect on reputation and value – or even the sustainability of a business.

For most organisations, an essential first step will be to quantify how they will be affected by, and can affect, the climate change trajectory. To do so, and as our recent TCFD readiness survey showed, the biggest obstacles that most companies, including those in the financial sector, seem likely to face revolve around climate-related data, analytics and metrics selection in order to understand and report on their position.

Even where insurers are perhaps comfortable with their natural catastrophe modelling capability, the need to develop transition scenarios based on longer-term climate projections will pose completely different challenges.

It’s likely to be one of many as climate change continues to test insurers’ full range of ESG credentials in the years to come.


Footnotes

1https://www.ipcc.ch/sr15/
2https://www-axa-com.cdn.axa-contento-118412.eu/www-axa-com%2Ff5520897-b5a6-40f3-90bd-d5b1bf7f271b_climatesummit_ceospeech_va.pdf 3https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
4https://www.blackrock.com/corporate/literature/publication/our-commitment-to-sustainability-exec-summary-en.pdf
5https://www.gov.uk/government/publications/uk-joint-regulator-and-government-tcfd-taskforce-interim-report-and-roadmap
6https://www.willistowerswatson.com/en-GB/insights/2018/02/sustainable-investment-show-me-the-evidence
7https://responsibleinvestment.org/wp-content/uploads/2020/07/RIAA-Briefing-Note-COVID-19-and-performance-of-responsible-investments.pdf
8https://www.bankofengland.co.uk/climate-change

Authors

Adhiraj Maitra
Director, Insurance Climate Risk

Elke Vagenende
Head of FINEX Western Europe

Gareth Sutcliffe
Head of Insurance Investment Team

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