This year, 2023, marks a significant shift in discussing the intersection between politics and business. This was evident at the World Economic Forum in Davos, where regulators and industry leaders outlined key objectives to revitalise the global economy and promote sustainable development in an increasingly turbulent and fragmented world.
Sustainability regulation around the world provides the necessary checks and balances for financial markets, whose logic is often embedded in oscillating behaviour-driven choices. Although the number of ESG policy interventions restores optimism in the pace of transition, there are fears among captains of industry about the failure to keep carbon emissions and climate change reduction targets on track. In many contexts, regulators are being urged to rise to the challenge of providing market certainty and clarity while not stifling innovation and entrepreneurship.
The United Nations Secretary-General, Antonio Guterres, has repeatedly urged businesses to reach net zero greenhouse gas emissions by 2050. During a meeting on the potential contribution of the shipping industry to carbon emissions in London Mr. Guterres urged decarbonisation efforts to move faster.
Shipping, which transports around 90% of world trade and accounts for nearly 3% of the world’s carbon dioxide emissions, is facing calls from environmentalists and investors to deliver more concrete action – including a carbon levy.
“I urge you to leave London having agreed a greenhouse gas strategy that commits the sector to net zero emissions by 2050 at the latest,” Guterres said in an address.
Member-countries of the U.N.’s shipping agency, the International Maritime Organisation (IMO), have so far pledged to reduce greenhouse gas emissions from ships by 2050; a commitment that is below EU and U.S. plans to reach zero net emissions by that date. To the extent that the shipping industry constitutes one of the biggest clients of insurance, it makes climate change failure more serious for the global economy.
Insurance and climate change
Studies are indicating that the growing trend of insurers abandoning high-risk markets due to climate change not only threatens to disrupt the insurance business, but also the financial ecosystems. The universal core function of any insurance firm is their ability to identify, manage and price long-term risks.
However, with extreme weather events like flooding, hurricanes, droughts and wildfires on the rise, climate change is fast becoming one of the biggest risks facing the insurance sector, not only in developed countries but also in poor countries that have been heavily impacted by climate change and carbon emissions. In some of these poor countries, including Ghana, climate has changed the weather and rainfall pattern, with dire consequences for agriculture and business. With many global insurance brands like Allianz operating in some developing countries, their operations could be negatively impacted in future.
Risk barometer
In the Allianz Risk Barometer 2023, it is noted that businesses continue to experience significant disruption around the world after COVID-19. The pandemic brought massive shocks to business models, creating global shortages, delays and higher prices. Unsurprisingly, business interruption and supply chain disruption rank as the second-top risk in this year’s Allianz Risk Barometer (34%). It is second only to cyber incidents (by just a few votes, also on 34%), whose top position reflects the importance of today’s digital economy, the evolving threat from extortion, as well as geopolitical rivalries and conflicts increasingly being played out in cyber space.
A 2021 BlackRock study found that 95% of insurers representing US$27trillion in assets believe climate change will have a significant impact on portfolio construction in the near-term. A similar study by McKinsey research found that the value at stake from climate-induced hazards could increase from around 2% of global GDP to over 4% by 2050.
For instance, in May 2023 the US insurance giant State Farm announced plans to halt the sale of new home insurance policies in California – citing “rapidly growing catastrophe exposure” as one of its main reasons for stepping back from the market.
It is believed that State Farm is not the only insurance company to be harbouring such plans, as a number of insurance firms are reportedly pulling back from regions that are worse-hit by the negative effects of climate change and high carbon emissions which are creating adverse business conditions.
In fact, many financial and economic experts are increasingly worried about the impact of climate change on the balance of financial ecosystems posing detrimental knock-on effects for banks, investors, policymakers, companies and citizens. Whereas every sector of an economy was potentially insurable, that is no longer case in a fast-changing and unpredictable global environment.
“Climate change is a huge financial risk to insurers,” says Steven Rothstein – Founding Managing Director of the Ceres Accelerator for Sustainable Capital Markets – in a recent interview with ESG Investor blogger Emmy Hawker. The Executive Director of Hanssen Global UK & Ghana Ltd. – a partner of Microsoft Network and Allianz Insurance, Thomas William Jefferson Cook Dankwah, adds that climate change is an emerging risk that businesses, especially those in the extractives and insurance sectors, need to take seriously.
Blessings and curses
The irony is that despite wanting to protect themselves from climate-related financial risks, many insurers continue to underwrite fossil fuel production and other carbon-intensive activities; thus further contributing to global warming. The climate crisis is posing obvious, inherent challenges to the insurance industry.
“The insurance industry possesses both a curse and a blessing,” says Sylvain Vanston, Executive Director-Climate Investment Research at MSCI. It allows for annual repricing of premiums and reinsurance markets, which enables risk reassessments based on recent events. Unfortunately, this can sometimes limit the industry’s long-term perspective.
A 2020 report published by Aon noted that natural disasters caused US$3trillion in economic damages between 2009 and 2019, and cost insurers US$845billion – well above levels seen a decade prior. Swiss Re said that insured natural catastrophe losses hit US$110billion in 2021. Research also shows that limiting global warming to 1.5°C has the potential to save upward of US$20trillion in damages globally, whereas exceeding 2°C could lead to losses in the hundreds of trillions.
Pressure on governments
Without the active involvement of insurers to bear some of the risks, the cost of doing business – especially in developing countries like Ghana – will increase. Reports suggest that only a quarter of climate-related catastrophe losses in the EU are currently insured. According to a paper published by the European Insurance and Occupational Pensions Authority (EIOPA), this gap could widen in the medium- to long-term because of climate change events; which may lead to insurance becoming unaffordable.
This trend could increase the burden on governments, in terms of both macroeconomic risks and fiscal spending, to cover uninsured losses. The trend could also raise government debt burdens, increase economic divergence, pose financial stability risks and reduce credit provision in countries with large banking sector exposures to catastrophe-risk events. There is also the risk of creating poverty traps, whereby segments of the population are simply unable to secure insurance and are therefore exposed to huge risks.
Global transitions
Given the above scenarios, it is crucial that as a cornerstone of the finance sector insurers should be supporting the global transition to net zero greenhouse gas (GHG) emissions.
One best practice is that of Varma Pension Insurance Company, a Finland-based insurer that identifies industries which offer both opportunities for emissions reductions through their business and an ability to adapt to climate change. These companies span oil and gas, electricity and heat production, metals and mining, construction materials, transportation, paper and forest products, and chemicals. Varma further plans to reduce its investment portfolio emissions by 25% by 2025 across all asset classes, and 50% by 2030 compared to 2021 levels.
However, the 2023 annual general meeting (AGM) revealed a commitment to net-zero emissions by many large insurance companies is falling below targets.
Renewable energy
Climate change advocates, like NGOs and environmental social governance stakeholders, argue that the way forward for the insurance sector is to end its support of fossil fuel production. Rather, they should promote renewable energy and other low-carbon projects. The US insurance industry alone had US$582billion invested in some combination of oil, gas, coal, utilities and other fossil fuel-related activities as of year-end 2019.
This means that some insurers have continually undermined their own markets by investing in and underwriting fossil fuels. Moving forward, insurers should adopt a precautionary approach and consider reducing their financed and insured emissions in line with science-based targets.
The notion is that if more insurers refuse to cover fossil fuel projects, it will become difficult for companies to “build their climate bombs”, as this will mean higher prices and more risks to cover. Without insurers and their all-risks coverage, a fossil fuel project cannot be built. For instance, in a bid to become the UK’s biggest renewable energy insurer by 2027, Aviva now offers insurance for offshore and onshore wind, solar power, electric vehicle-charging points, and battery energy storage systems across the UK, US and Europe.
These potential innovations/solutions could encourage investments and accelerate market entry for new technologies. This solution can also provide buyers and investors with a safety net in case of warranty issues or insolvency on the side of an original equipment manufacturer.
Climate litigation
Another incentive for insurers to untangle themselves from fossil fuels is the risk of increased climate litigation in host communities. The issue at stake is that if insurers refuse to absorb the costs of climate catastrophes in high-risk markets, government alone cannot bear the cost. The simple answer is that the polluters should pay, or risk more climate lawsuits filed against fossil fuel companies.
Besides, insurers may feel increasingly inclined to take fossil fuel companies to court to cover the mounting costs of climate-related catastrophes; but there are concerns that by continually supporting the fossil fuel industry, insurers are at risk of becoming exposed to litigation. For instance, if a firm insures the liabilities of a fossil fuel company that is facing lawsuits over its contribution to climate change, that insurer may need to pay up for the damages and political costs.
Last year, Aloha Petroleum – a subsidiary of US-based Sunoco – filed a claim against AIG’s National Union Fire Insurance Company, arguing that the insurer had failed to protect Aloha from the costs of defending against climate-related claims made by local governments in Hawaii.
The UN Environment Programme has previously said that insurance firms were not being rigorous enough in their assessments of exposure to climate litigation risks. Also, the US Department of the Treasury has also warned that insurers face significant litigation risks due to the climate policies they issue, as well as failure to address exposure to climate calamities.
In a nutshell, the longer we allow the fossil fuel industry and its supporters in the insurance sector to delay the transition, the more painful and chaotic global decarbonisation will become. If we continue the current trend, then the world will become uninsurable sooner rather than later.
Reference
Hawker, E. 2023. ‘Is the World Headed for an Uninsurable Future?’ – ESG Investor.
