Climate change and its long-term implications have a serious and tangible impact on companies. According to NOAA's National Centers for Environmental Information, the United States alone has sustained 341 weather and climate disasters since 1980 in which total damages reached at least $1 billion. The total cost of these disasters was $2.475 trillion.
As the severity of the climate crisis intensifies, companies are becoming more susceptible to vulnerabilities including physical risks arising from extreme weather events, technology threats, global market and economic uncertainty, and brand/reputational risks.
These issues are of significant concern for the insurance industry, whose purpose is centered around pooling and managing risks. The industry is facing an immense amount of pressure across stakeholders, from employees and customers to regulators and investors, to take proactive steps to mitigate and help the world adapt to the impacts of climate change. This is a major challenge for insurers—according to a PwC study, 85% of global insurers believe environmental, social and governance (ESG) will impact all functions of their business. Not only are insurers trying to determine the many ways climate change affects them and how to manage those impacts, they are also trying to figure out how to help their policyholders manage related risks.
Insuring the Green Transition
The insurance industry has an important role to play in mitigating the worst potential impacts of climate change. The transition to a low carbon economy requires massive investments in new technologies that are at various stages of maturity and should be tested, proven (or abandoned), and scaled up to meet the size of the challenge very rapidly. This will require vast amounts of capital to fund research and development and, ultimately, deployment of the most viable solutions—all of which comes with risk.
Uniquely positioned to help fund this risk-taking venture, insurers have an opportunity to work with the capital markets to prioritize green investments. Insurers who aggressively embrace the challenge have an opportunity to be part of the climate solution, while opening new markets and sources of revenue.
Protecting Vulnerable Populations
Insurers can also play a role in climate change adaptation. If the world is unable to transition to a low-carbon economy, or is unable to do so quickly enough, the climate science community predicts dire consequences for humankind. While we often speak about climate change in sweeping terms with visions of wildfires, floods and droughts engulfing the planet, the physical impacts of climate change are expected to be more nuanced and localized. The most vulnerable populations are likely to be those who have the least economic resilience—the poor, the isolated, and the historically racially/ethnically diverse communities.
The insurance industry can help spread the risk of high-impact, low-likelihood events across a broad pool of individual exposures. Some insurers are stepping up to provide more coverage. Rather than leaning on policy exclusions related to environmental impacts, many in the industry are rethinking what they do and do not cover. And instead of exiting markets that will likely be highly impacted by climate change, some insurers are working creatively to increase risk pooling. Entirely new products, specifically tailored to the needs of a high-carbon, volatile world, are being created.
With all of this comes the need to adequately underwrite and price such products, applying the same rigor and risk management diligence that is the foundation of the industry. It may mean working with new partners, governments, industry groups and others to create the conditions necessary for this important work to be done. The case for this is not reliant on altruism—there can be financial rewards for those who innovate and act aggressively to drive change.
Adjusting Operations and Standards
Beyond the strategic role that insurers play in the climate crisis, it is important to remember that insurers are facing the same pressures to measure and disclose their climate-related risks as other companies. In another PwC study, 80% of investors said they believe how a company manages ESG risk is an important factor in investment decision-making. The management and identification of ESG factors in investment decision making were identified as the single largest area of impact, followed by integration of these factors into risk and internal audit, and underwriting practices.
Amid growing regulations and stakeholder demands, climate risk modeling tools can aid in developing a strategy for understanding and disclosing stakeholders’ risks and opportunities related to climate change. It is imperative that insurance companies accurately measure their clients’ physical and transition risks associated with climate change through their risk management tools and apply it to their underwriting. What are these types of risks?
Physical risks are associated with extreme weather events such as floods, hurricanes, storms and wildfires. While managing such risks is not new for the insurance industry, the growing frequency and severity of these events due to the impact of climate change has increased the focus.
Transition risks are associated with changes in policy, such as a carbon tax, or changes to markets. Measuring and managing transition risk is less intuitive and more likely to require that new tools and processes be identified and implemented.
Accounting for climate-related physical and transition risks is absolutely critical if insurers are to take any of the actions outlined above to increase their participation in the climate-change ecosystem. And even for those insurers who choose not to do so, this is simply good business and becoming “table stakes” in the eyes of investors and regulators.
For example, as a result of investor concerns, the SEC has proposed climate disclosure requirements that mandate companies to demonstrate how they are managing climate-related issues. More specifically, the policy requires publicly traded companies to disclose their greenhouse gas (GHG) emissions and business risks impacted by climate change. To comply with the pending regulation, senior management and the board need to develop an overarching strategy on climate disclosures and risk management to identify what risks are material for the company’s financial statements and align with its business strategy. This involves setting clear disclosure objectives, defining key metrics, identifying underlying data sources and embedding climate-related information into data governance models and management processes.
Managing Risks and Opportunities
As climate change shifts regulations and stakeholder expectations, insurers should be prepared to shift as well to help meet client needs and protect assets. There is a real opportunity for the insurance industry to claim its seat at the table and become a leader in climate change mitigation and adaptation.
By leveraging climate risk modeling tools, insurers can generate accurate insights to inform their business strategy and offer transparency for both investors and regulators. Taking this approach can help organizations grow and maintain vitality amid uncertain conditions.