Articles - Role of Insurance on Climate Risk and Sustainability

Following a speech I gave on ESG and Sustainability, I was asked by a colleague to address an issue as close to my heart: The role of Insurance on Sustainability and Climate risk in this column. There is consensus that, in line with what Larry Fink expressed in his 2019 Dear CEO letter, long term strategies of financial institutions must encompass value creation for all their stakeholders, rather than focusing only on shareholders.

 By Carlos Montalvo is a Partner at PwC heading the European Insurance Regulatory practice. Previously, he was EIOPA’s Executive Director until 2016.

 One could consider happy employees and customers as the brain and lungs of any business, while good return to shareholders is the blood, and Social purpose the business’ heart, all are necessary and interconnected.

 How can then sustainability be successfully embedded in a business, its purpose and mindset?

 Firstly, regardless of the long term focus that Sustainability implies, progress has to start with short term tasks. Reorienting capital flows towards more sustainable investments, one of the objectives of the Commission Action Plan on sustainable finance, entails a risk: Whilst investing in “green” makes full sense, as it does an underlying taxonomy to help us all speak the same language, not all “Green” investmentswill make similar sense from a risk-return view point, and regulatory incentives should not hide that fact.

 The temptation to reduce or relax due diligence on “green assets”, in particular where backed by regulatory incentives remains a high risk, albeit a known one. In my view, there is a clear precedent regarding regulatory treatment of infrastructures under Solvency II. The outcome of the approach taken has not met expectations. Shall we be able to take the right lessons, when it comes to setting proper incentives for green assets?

 Secondly, the traditional approach to risk management has been over-reliant on past experience (rear mirror approach), and this will not work when it comes to Climate change, where once in a century is becoming the new normal. Here, the role of the regulator, “enhancing awareness” of risks stemming from climate change (e.g. via stress tests), must be combined with a holistic approach by firms, in terms of risk taking and managing, assets holding and risk appetite, both for direct as well as transition risks. Interestingly enough, this has the potential to accelerate the transformation of insurance businesses, from mere risk taking to managing those risks.

 If we move from risk management to governance, I have been confronted with a number of insurers, belonging to large groups, saying that ESG and sustainability are issues addressed at group level, rather than at their own legal entity. The former regulator in me kicks in, and wonders, whether I would accept a similar response on investment policies and risks…

 My response to it makes me think that we are not there yet.

 There is another issue worth raising, due to its impact on people: the Protection Gap, and the fact that (counterintuitively) it has increased in the last 20 years, both in developing countries and in developed ones. This is an area of great opportunity particularly for insurers, let’s not make it a lost one. An opportunity to enhance resilience to Climate risk via management of claims, underwriting and pricing processes, making steps to reduce the probability and impact of the next catastrophe, thus better protecting people. Yes, ladies and gents, Insurance can and should go beyond its mere role as institutional investor and embrace its very unique value proposition as business. The way Japanese society acknowledged the role of its insurers following the Fukushima catastrophe, shows us the way forward.

 We have been talking about incentives, awareness and opportunities for Insurance around Climate risk and Sustainability. Let me share an idea that I hope merits your attention: How about, when it comes to discussing incentives, moving out of the traditional focus on capital requirements and look at the possibilities that resilience and building back better and safer brings to Society in terms of preparedness and reduction of the next hit? Recognizing such investments on pre-emption in the capital position of insurers not via (artificially) reduced requirements, but through effective recognition of them as risk mitigation techniques, could bring the right type of incentives. To be candid, the former regulator in me likes the idea!

 When it comes to sustainability firms have a lot to do but even more to play for - there are opportunities to be taken by those who recognise them.


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