IN A NUTSHELL: Climate change has led to insurance companies rethinking how they do business. As a large-scale investor, the industry can take the lead by prioritising sustainable investments. In this way, insurance companies ensure their own as well as the planet’s future.
Although the insurance industry has a fairly small footprint, climate change is having a huge impact on its business model. As the world tackles climate change, the industry, as an investor, is in a unique position to drive change that will benefit its bottom line and society as a whole. Retirement funds as large-scale investors can glean insights from the industry.
Most of us understand the impact of the physical risks of climate change on the industry, i.e. the large-scale damage to property, infrastructure and supply chains due to extreme weather events. In this context, the industry has had to adapt quickly. It has to re-evaluate its underwriting risk when it comes to disaster-prone areas as well as its traditional assessment models. In the past, these models were based on historical data, which cannot keep up with the current changing climate. Some insurance companies are coming up with innovative solutions by developing predictive tools that model the financial impacts of climate change across various climatic scenarios.
Example of a climate predictive tool
What is underwriting risk?
Insurance companies provide insurance for various businesses or projects. This process is known as underwriting. It can also be referred to as “underwriting liabilities”. These ventures come with inherent risks. In terms of sustainability, these risks include excessive unforeseen claims due to extreme weather, as well as claims against their clients for contributing to climate change.
Insurance companies also have to rethink their client base. Without insurance, fossil fuel companies cannot dig new coal mines or expand oil and gas production. To what extent can they still, if at all, insure fossil fuel-heavy industries that ultimately cause these weather events? In fact, according to the Insure Our Future campaign, 45 companies worldwide have committed to end or restrict underwriting for coal projects and 18 have committed to end or restrict underwriting for new oil and gas projects.
While some insurance companies no longer underwrite carbon-intensive industries, others opt to support clients in their net-zero journey. Some change their product offering to incentivise their clients to replace “dirty assets” with green replacements to speed up the move to a carbon-neutral economy, reports the law firm Norton Rose Fulbright in their Climate change and sustainability disputes report.
The insurance industry is the custodian of vast amounts of capital for its beneficiaries. According to Statista, the assets of insurance companies in South Africa amounted to USD238 billion in 2022. As an investor, the industry can drive change by investing in companies that prioritise sustainability and uphold ESG principles.
This is not just an altruistic matter but is also necessary to future-proof the business. Like any business, insurance companies must consider their bottom line. The company’s assets and investments must balance out its underwriting liabilities. As the world transitions to a climate-friendly future, carbon-intensive companies may suffer under carbon taxation and ultimately become a stranded asset for the insurance company.
Retirement funds are also custodians of capital and by staying abreast of movements in the insurance industry trustees can gain insights into how to future-proof their beneficiaries’ investments.
Principles for Sustainable Insurance (PSI)
The PSI is a global framework for the insurance industry to address ESG risks and opportunities. The framework was created by the United Nations Environment Programme and currently has 159 signatories worldwide.
What is ESG?
Environmental, Social, and Governance (ESG) concerns have been on the rise over the past few years. ESG is underscored by the belief that the long-term sustainability of a company extends beyond profitability. A company also has a responsibility to consider its impact on ESG factors in the way it operates. In terms of the insurance industry, ESG factors should be integrated into the risk assessment and the underwriting process.
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