By Kareline Daguer, Director, PwC
So what is the role of the insurance and reinsurance industry in the midst of this unfolding drama? Insurers are cautious and, I would say, conservative players. However, climate change presents a number of challenges that potentially put the insurance industry in a special place:
A place that can ensure the industry’s own survival but also give it a pivotal role in driving adaptation and risk mitigation across the society. I believe there are three key aspects to the roles that insurers can play in this challenge.
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First, it is estimated the insurance industry manages USD30 trillion of global assets, resulting in a leading role when it comes to investing in assets whilst transitioning to a low carbon economy. It’s an area that has attracted regulators’ attention - in just a few days’ time life insurers in the UK will have to spell out to the Prudential Regulation Authority (PRA) their plans on climate change risk and provide stress test results that include three blunt scenarios of transition or drastic temperature rises. Obviously, this attention focuses squarely on regulators’ concerns about insurers viability in these extreme events but it says very little about the power of insurers to influence events. The insurers’ ability to invest in the low carbon economy and their willingness to do so on a bigger scale can make a significant difference to the path ahead. At the moment it is estimated insurers invest less than 1% of their portfolios in investments that support the low carbon transition. Some large international insurers have started to challenge policymakers to unlock more opportunities to invest in for example clean infrastructure. The push and pull influence of insurers as investors who are in turn heavily regulated makes for a complex dynamic. In this case a collaborative approach between industry and policymakers with the objective of taking bolder action to meet the goals of the Paris agreement should be the way forward.
These actions can include appropriate consideration of the impact of fossil fuel subsidies, use of tax mechanisms and potentially mandating more transparency and better disclosure on climate change impact along the lines of the Task Force on Climate related Financial Disclosures (TCFD) recommendations.
Secondly, insurance is about measuring and managing risk. Very few outside governmental or scientific institutions have the expertise and ability to invest in risk modelling and data analytics to quantify what might happen in the next few years like insurers do. Some insurers are starting to integrate climate change risk across their group-wide risk management practices. We can’t manage what we can’t measure, therefore modelling and measuring efforts are essential in pricing risks correctly. The right approach to risk and modelling can influence and accelerate adaptation and mitigation. In a number of developing island countries where disaster liquidity instruments and protection could be very valuable, the discussion with insurers and reinsurers about measuring and pricing their risk has in turn led to a better understanding of a range of preventative measures. These can range from building defences and levees where it matters or allowing mangroves on coastlines to become more resilient to tidal surges or tsunamis. Also, once disaster strikes many are calling for a link between insurers and building regulators to encourage building back better through buildings that will be more resilient to disaster in the case of a future event. This leads us to the third aspect where insurers can excel which is product innovation resulting from climate change.
Some large insurers are starting to develop a new generation of climate-supportive products and services. These can range from life and pensions products that actively focus on a more climate aware investment profile to non-life products where collaboration with governments and other institutions is necessary to avoid insurers withdrawing from high risk areas of the market (like Flood Re in the UK). Some of the innovations can actually work in tandem with new technology to allow a more preventative approach to disasters through for example the use of parametric insurance, commonly used in agriculture. Again, the use of parameters that act as triggers requires a lot of modelling and data analysis to ensure incentives are not misaligned and create moral hazard. As an example, some drought insurance products in Africa now use levels of green/yellowing on the landscape (measured through satellite images) to trigger payments. These disasters are slow and gradual and therefore early payments and food aid can prevent the worse consequences of a famine, also allowing to improve the logistical response to the event.
Insurers can be proactive and take climate change and its related risks as an opportunity or only focus on adapting to the changes that will no doubt come. Playing an active role will require efforts to educate customers, policymakers and other stakeholders and highlighting the valuable advice insurers can provide on climate adaptation and mitigation. This effort should pay off, not just for insurers but more importantly for wider society and its most vulnerable members who might stand a chance to have better and more timely protection against disasters resulting from climate change.
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