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Highlights
- The insurance industry worldwide is set to play a pivotal role in the transition to a low-carbon economy.
- To ensure a just net-zero transition, insurers must address protection gaps as they navigate climate risks.
- They can do so by embracing product innovation, reimagining risk assessment, and making sustainable investments.
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Introduction
The global insurance industry is playing a crucial role in the transition to a low-carbon economy.
It is helping communities adapt to and mitigate the effects of climate change. Communities vary in their levels of vulnerability to climate risks, emphasizing the need for a just net-zero transition that ensures no one is left behind in the decarbonization journey. Insurers must address protection gaps, which are uninsured losses influenced by factors such as premium affordability, as they navigate climate risks. The insurance industry can play a pivotal role in facilitating a just transition to net-zero in three ways: innovating products that integrate environmental, social, and governance (ESG) factors, improving underwriting and risk information capacities and making responsible and impactful investments to decarbonize the global economy and enable communities to deal with climate change.
Adopt product innovation
Insurers must drive decarbonization through product innovation.
They must help businesses and communities cope with physical and transition risks. For instance, parametric insurance or index-based cover pays a predetermined amount to policyholders based on the magnitude of a specific event, as opposed to the magnitude of losses in a traditional indemnity policy. This product has been gaining traction as it delivers quick and guaranteed payouts for climate disasters. It operates on predefined triggers, eliminating the need for claims assessments.
Other innovative product structures include double triggers and usage-based products. Insurance companies are funding research that shows, for example, that protecting and restoring mangrove forests can build community resilience in the wake of coastal flooding, which impacts 15 million people. Cost-benefit analysis in the Caribbean region, which includes Florida, shows that this nature-based approach to financing can save $65 billion. Further analysis is being conducted to determine the cost of protecting mangroves to develop policy threshold limits for parametric-indemnity payouts. Similarly, in 2019, the first coral reef insurance policy was developed to protect and preserve reefs in Mexico. Since then, public and private partners have worked to develop the Mesoamerican Reef Fund (MAR), which has extended the reach of parametric insurance from Mexico to Honduras.
To scale up these innovative insurance products, insurers must adopt a two-pronged approach. First, they must assess their exposure to climate-related risks and then adopt nature-based strategies for insurance or reinsurance. This entails updating underwriting and risk assessment models.
Revamp risk assessment
A timely and just net-zero transition would require capital allocation and insuring low-carbon solutions.
For instance, insurers must underwrite risks for solutions such as carbon capture and sequestration (CCS) and carbon-infused cement. Often, insurers struggle with assessing long-term liabilities due to climate, environmental, regulatory, social, and market risks associated with these solutions. To understand and price these risks and help accelerate the testing and deployment of such solutions, insurers must advance their risk advisory capacities. This would allow them to ensure long-term price stability of premiums. Additionally, insurers must leverage their risk assessment and management expertise to promote transparent policies among stakeholders in the value chain. This will help achieve gradual emission reductions.
Invest sustainably
The International Energy Agency emphasizes sustainable investments.
It estimates that global clean energy investments need to triple by 2030 for the global community to achieve net-zero emissions by 2050. As asset owners and institutional investors, insurers can do more than divest from fossil fuels. They can redirect capital toward nature-friendly and socially sustainable products, companies, and solutions. In the US, joining platforms such as the Principles for Responsible Insurance, Net Zero Asset Owners Alliance, and the Net Zero Insurance Alliance will help insurers demonstrate commitment, transparency, and accountability, helping them catch up with EU and UK counterparts.
Data consistency is crucial for redirecting capital to sustainable investments. However, currently ESG data lacks standardization. Additionally, companies may excel in the environmental aspects of ESG but struggle in the social aspects. For instance, a solar firm might have a high environmental score as it provides green energy, but its social score could be low due to questionable labor practices in its component factories. Insurers also face data accessibility challenges when outsourcing investments to multiple asset managers. These managers often use different sustainability assessment methods, resulting in inconsistent information across asset classes. To address this, investment managers should develop proprietary ESG measurement tools for investing in various assets.
Despite data inconsistencies and greenwashing claims, insurers and their investment managers can conduct rigorous ESG due diligence to support just energy transition investments. This can be backed by an advisory approach and artificial intelligence and machine learning technologies.
Enable just transition
Insurers must incorporate just transition considerations to avoid widening the insurance protection gap.
This gap can occur due to coverage restrictions or when the industry’s innovation of protection products and risk advisory services lags behind the demands of the transitioning economy. For instance, only 25% of climate-related catastrophe losses are currently insured in the EU. The percentage of uninsured losses could increase in the medium to long term as repricing of insurance contracts in response to increasingly frequent and intense climate disasters may lead to such insurance becoming unaffordable.
In conclusion, insurance companies in the US market are proactively leveraging opportunities to invest in the transition to a low-carbon circular economy. However, the industry must ensure that climate and social justice goals are achieved in a transparent and accountable manner.
