The insurance sector has adopted the ESG targets with every company developing an ESG strategy. The sector is particularly affected by climate change, since a rise in temperature means more energy in the atmosphere and thus more natural catastrophes (Nat Cat) such as storms, tornadoes, and floods.

When the average baby boomers – now at around retirement age – look back on global threats that occurred during their lifetime, they will be happy to have survived the danger of mass extinction by nuclear warfare and nuclear catas­trophes, cancer and pulmonary diseases due to air pollution and acid rain or IT breakdowns or even mass diseases.

It is thanks to mankind’s spirit of invention and unwavering determination that these threats were overcome, challenges tackled, and problems solved. For the average baby boomer, the fear of global warming and population growth has been equally present during all this time. Still, there is no solution in sight yet, despite good intentions and declarations made at big conferences.

Global warming has already turned into climate change, accompanied by temperature increases and drastic events: atmospheric phenomena, windstorms, heavy rainfalls, snow blizzards, desertification, wildfires or the slow but steady rise of sea levels. Leading industrial nations, the EU, and even the USA now seem to be willing to act. According to the new Paris Agreement1, the global temperature shall be kept at 1.5° C above pre-industrial era levels. Better education and social perspectives are aimed at contributing to a slowdown in demographic growth and solutions to feed the world’s population in a healthier and more sustainable way.

Green targets

These targets have been included in the scope of ESG measures introduced by both the European Union and the new Biden Administration. The EU has implemented the Taxonomy Regulation that demands a commitment and a special legislation to decarbonise and clean up Europe until 2050 from all member states based on the following objectives:

  • climate change mitigation
  • climate change adaptation
  • sustainable use and protection of water and marine resources
  • transition to a circular economy, waste prevention and recycling
  • pollution prevention and control
  • protection of healthy ecosystems

It is obvious that these targets can only be reached if everyone – citizens, enterprises, decision makers, and authorities – changes one´s behaviour. Whether this requires huge technical innovations or less consumerism remains to be seen. We will probably need both.

The role of the insurance sector

The insurance sector has adopted the ESG targets with every company developing an ESG strategy. The sector is particularly affected by climate change, since a rise in temperature means more energy in the atmosphere and thus more natural catastrophes (Nat Cat) such as storms, tornadoes, and floods. The average cost of insured claims due to Nat Cat currently amounts to about 70 billion USD per year, with peaks exceeding the 100 billion USD mark. Reinsurer Munich Re expects claims to soon reach the “mid-three-digit million Euro range”. The growing percentage of Nat Cat claims because of atmospheric events increasingly depletes the premium generated in the entire property insurance portfolio, leaving less room for paying classical fire and explosion claims. The answer may be to increase the total premium.
Nonetheless, once a certain point is reached, the risk becomes uninsurable – as we have seen with the pandemic risk. Another example are the wildfires, seen in many regions this summer and caused by another climatic scenario – drought due to stable high-pressure areas and a disturbance in the global wind circulation system.
 
Insurers are challenged to pursue their own sustainability policy, using three methods of leverage:

  • their own corporate behaviour,
  • their investment policy,
  • and their underwriting policy.

The first focuses on infrastructure (office buildings, car parks) and digitisation (less office space and business travels, working from home, which may enhance social governance as well). The second will result in huge support for innovation projects and green measures taken by both public and private business as insurers have to invest their reserves to be able to pay future claims. The decision where to place this money has to be driven by security aspects (for this reason there is a relatively big share of public investment) and with a long-time perspective in mind.

Added to this is the increasing focus put on sustainability and the ethical value of projects, measures taken, and targets set by companies or public entities for creating financial products for clients and for placing the insurer’s own assets.

Ecological underwriting

For the insurer as a risk carrier the underwriting policy plays a major role with regard to the sustainability strategy as mentioned above. In an effort to contribute to decarbonisation targets, major insurers have taken the first steps by deciding to stop the underwriting of coal risks in their entirety (production, refining, fuelling, transport). The newly founded Net-Zero Insurance Alliance will provide new industry leadership to carbon-neutral underwriting.
 
Besides the ban on coal, other bans, for example on excessive meat production, soya or palm oil farming, could follow suit. At the same time, green companies could be encouraged with a higher insurance capacity at a better price or a bonus for new installations that increase sustainability.

However, insurers as risk carriers always look at the so-called quality of the risk, i.e. at the (mathematical) probability of loss linked to the risk. For instance, when considering to offer a client a panels on the home´s roof, the insurer, although he may be happy that the client is taking this step, must calculate which one of the two heating methods would cause less claims.

This causes a dilemma because not all innovations will produce better results for the client’s risk portfolio. Statistics about fire claims caused by (bad quality) solar panels or by car batteries prove the point. The technical hull premium for a fully electrical vehicle must be higher than that of a traditional car of comparable size. Then there is the old underwriting principle: Do not insure prototypes! No one knows whether they are harmless or not. At this point in time, insurers face the predicament of either bad experiences or none at all with fires and Nat Cat risks of solar panels and windmills, new food production methods, crop Nat Cat exposure, and so forth.

Risk engineering is the key

The solution to overcome this dilemma and foster new, green industries and insure new risks at an acceptable price is called risk engineering and risk dialogue. A close investigation of new projects, technical procedures and industrial sites should enable insurers to find a good balance between the opportunities and risks presented by new technologies. The results may indeed be positive – for instance, when old coal furnaces are replaced with electricity generated by wind farms, when explosive chemical processes become obsolete and undesirable, or when human factor risks are reduced because excessive overtime working has been banned.

Finding the right balance between opportunities and risks will be the focus of new, so-called ecological underwriting. Purely price driven underwriting will cease to exist as better risk concepts, evaluations, and simulations mirror a company’s changing situation. By giving clients coverage for new risks, insurers will contribute to reaching the ESG targets set for the entire economy.

The broker’s role is changing as well. In the past, the broker was a service provider who advised clients about existing insurance solutions and negotiated the best cover and price. He is now increasingly involved as risk manager and risk engineer in his clients’ change management projects. More than ever, the broker will focus on mediating between his innovative clients and conservative insurers. They, however, are now more open-minded when it comes to contributing to the success of green progress.

Globally, the initiatives to prevent climate change present an opportunity to invest the money generated in the past few years. The outlook is optimistic as new and innovative industrial methods add tremendous value to finding new ways of tackling climate change.

The article is written by Andreas Krebs.

Paul Spittau

Head of Group Carrier Relations & Insurance Mediation

T +43 664 537 17 42

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