The critical role of insurers in the net zero pathway

This blog was initially published in Spanish on the Social Investor website here.

The insurance sector plays a key role in the energy transition both in terms of who and how they write policies and as investors. And they have sustainability challenges.

At a time of great social and economic uncertainty, the insurance sector is taking on a greater role in achieving the transition to a greener and more inclusive economy.

Climate disasters in 2021, such as floods in Australia, Europe, Canada and South Sudan, hurricanes in the United States, China and India, fires and heat waves in the United States, droughts in Africa and Latin America… have been a litmus test for the sector worldwide.

According to Swiss Re Group estimates, some USD 270 billion in losses were attributable to natural catastrophes. Of this sum, less than half, $111 billion, was insured and represented the fourth highest pay-out since Swiss Re Institute, the insurer’s research arm, began keeping records in 1970. Is this an exceptional occurrence or the new normal?

Unfortunately, it seems to be a fact of life, increasing in frequency and severity. The World Meteorological Organisation reports that floods, heat waves and forest fires have increased fivefold in the last 50 years, resulting in incalculable environmental costs, in addition to the loss of more than 2 million lives, and an economic impact of more than $3.64 trillion.

With this data, and with the current trends in mind, insurers are reformulating pricing models to accommodate these events.

Repeated and increasing natural catastrophes significantly increase the risks on protected assets, also increasing the cost of coverage and policy premiums.

According to KPMG, this situation may lead to a failure of the model, amid regulatory restrictions, rising premiums and doubts that individuals and organisations can afford insurance in increasingly disaster-prone areas where premiums have risen exponentially, as is already the case in the United States.

According to Capgemini, over the past four years, approximately 340,000 customers in fire-prone areas of the United States have been defined as “uninsurable” by most large insurers.

This is a decision made on the basis of the simple risk-benefit equation, but does it take into account the impact on customers and society resulting from the insurer’s actions? It should not be forgotten that insurance protection is a prerequisite for many activities of companies, financial markets participants and households.

Actions of this kind call into question the credibility of the overall purpose of insurers: to take risks to meet the needs of people and organisations when they are needed, thus contributing to social and economic progress.

Companies should identify, manage and communicate the negative impacts of their decisions, not avoid them or put barriers.

How can insurers reframe their role and impact, both as risk managers and institutional investors, at a time of transition such as now?

They are certainly in a unique position to, in addition to acting as a traditional risk “prevention provider”, become a contributor of comprehensive ESG management. In other words, in addition to protecting, they can drive the transition to a more sustainable economy.

Because of their influence, prestige, financial capital, experience, and the data they manage, they can work with insured and invested organisations to improve their resilience to socio-environmental events, while also improving the efficiency and profitability of the insurer itself.

Sustainability remains a challenge

However, in order to play this role, they need to have an adequate and up-to-date estimation of ESG risks; analyse and monitor the potential social and environmental impacts on companies and, conversely, of companies on the environment and society; design mitigation or compensation measures; and, finally, provide timely, two-way, accessible and clear communication.

Unfortunately, most insurance companies still show poor internal management in the area of sustainability: 50 of the 66 MSCI World insurers are excluded from the MSCI World SRI because of their low ratings.

Although there are differences between regions, it is significant that for 92 percent of US insurers surveyed by Conning, corporate reputation was the main reason for incorporating ESG factors into their investment decisions and that 79 percent had only recently incorporated it, less than two years ago.

There is a great deal of imbalance in the management of ESG factors, with the environmental aspect being the most worked on. Strict regulation, litigation risks and social pressure are driving the focus on this area, although it is still at a very early stage:

• Major insurers and reinsurers announced at COP26 the formation of the Net-Zero Insurance Alliance, committing their portfolios to achieve greenhouse gas emissions neutrality by 2050. This can create a ripple effect across all sectors, especially if science-based targets are in place. Clearly, the challenge is to move from commitment to action, measuring and communicating the impact and progress of this strategy.
• A growing number of insurers will restrict coverage for companies that build or operate coal mines and plants. This is a first move that focuses on exclusion, but does not address the problem or the consequences of restriction. It should be complemented by actions aimed at achieving the transition of activity of the insured.
• New products are appearing in the form of discounted insurance plans for customers who are adopting sustainable practices to reduce energy and resource consumption. These include discounts for driving more responsibly, for insuring hybrid cars, or for insuring efficient buildings or those that generate renewable energy, among others.

However, the S aspects should not be neglected. Social issues have also become more relevant since the #MeToo and Black Lives Matters movements, which shift the focus to aspects of diversity, equity and inclusion. In addition, cybersecurity and the constant disruptions in supply chains call for greater prominence of social issues.

It is true that the current context is plagued by major challenges that entail risks from an ESG perspective: pandemic outbreaks, inflation, geopolitical conflicts, energy transition, social manifestations, new technologies…, but, at the same time, all these challenges reinforce the need for insurance.

The sector thus becomes a key lever for the recovery and transformation of the economy, industry and society. Depending on how the management of ESG factors is incorporated, both in insurance and in investments, this transformation will be more sustainable and therefore more resilient.

In the words of Pilar González de Frutos, president of Unespa, “a solid insurance sector guarantees the mitigation of any economic impact and puts the economy in a better position to face challenges”.