Climate Change: It's time for Insurers to take action!

Introduction

Climate and Sustainability are increasingly at the forefront of the financial service industry. ESG (Environmental, Social and Governance) has been a yardstick in the industry to evaluate the extent to which financial institutions work on behalf of social goals. ESG reporting is mainly linked to banking and investment management companies rather than insurance companies, as they have direct control over the money they lend or invest into various industries. The insurance industry has been viewed as a service to absorb financial shocks.

A broader reporting of sustainability will be required in the coming years. it is high time for insurers to start thinking about the metrics and infrastructure to reliably report the progress on critical socio-environmental issues such as carbon footprint and inclusion practices etc. In the UK, it's already mandatory to include TCFD (Task Force on Climate-related Financial Disclosure) reporting for large UK companies and financial institutions. In the US, the SEC has proposed a rule change that would require companies to include specific climate-related disclosure, including their greenhouse emissions along with those of their supply chain information and climate-related risks that are reasonably likely to have a material impact on their businesses.

Greenhouse gases have been the key driver of climate change since the mid-20th century. The world has recognised the importance of climate change. At the COP 21(Conference of the Parties, UN initiative) in Paris, it agreed to limit global warming to below 2 degrees, preferably to 1.5 degrees Celsius, compared to pre-industrial levels. To achieve this long-term temperature goal, countries aim to reach the global peaking of greenhouse gas emissions as soon as possible to achieve a climate-neutral world by 2050. According to the Intergovernmental Panel on Climate Change (IPCC), to achieve a trajectory of a 1.5°C or net-zero future by 2050, the world needs to have halved emissions by 2030.

The net-zero transitions will prevent the build-up of physical risks and reduce the impacts of climate change. Since adopting the Paris Agreement, governments, businesses, NGOs, and individuals are paying attention to the climate change agenda. However, the progress has not been fast enough.

Significant transformations are required to the system, which produces the emissions to achieve net-zero. This will impact the industries in the power, mobility, building, agriculture, forestry and other land use and waste. We can expect a significant shift in asset values and higher costs for doing business in specific sectors. And there will be a need for the transition of workers, communities, and cities as well.

A coordinated effort by all stakeholders is required for an orderly transition. This will be shaped by government policies, technological innovations, and market sentiments. Government and Industries need to work together to address these climate challenges. Businesses must invest in new technologies and innovative business models to drive deep decarbonisation.

What should the Insurance industry focus on now?

While talking about ESG, Climate Change often comes first as the Insurance industry has been focussing on climate risk and climate change. The insurance industry is already underwriting some physical risks like hurricanes, floods, wildfires, etc., helping to survive climate change disasters and speeding up the recovery in the event of a disaster. Life and Health insurers are providing necessary protection through their protection, pension, and Savings portfolios. Insurers can influence public behaviour given their services to businesses and individuals.

The insurers were focusing on their operations and investment management portfolio so far as part of the sustainability agenda. According to NZIA ¹(Net Zero Insurance Alliance, an UN-convened and member-led alliance consisting of 20 leading insurers), the insurance industry is now seen as an enabler of economic activities, and it is essential to look at the assets and activities being insured and their impacts on the environment and society. The attention for insurers is now progressed from operations and investments to underwriting.

The insurance industry should play a broader role in these changing scenarios by looking beyond traditional risk models and offering innovative, sustainable, and technology-driven solutions to address these challenges. The areas insurers should focus on are:

• Commitments to Paris Agreement in their operation

Insurers must meet the Paris agreement's targets by committing to the Achieve GHG reductions required to complete a 1.5 degree C in insurance activities via long-term net-zero (2050) and interim targets. The targets should cover both direct greenhouse gas (GHG) emissions (Scopes 1)² and indirect emissions from purchased electricity or other forms of energy (scope 2). In addition, insurers would be required to disclose GHG emissions that are part of their value chain (Scope 3). The most relevant areas for insurers are their investments, underwriting portfolio, claim handling process, and associated supply chain. Many insurers have embarked on sustainable claim processing by considering the environmental and social impact of the claim they are processing and minimising that impact. Using ESG factors when deciding the long-term investments is becoming a top priority for insurers.

There are no global standards yet to measure insurance-associated emissions. The NZIA is developing technical guidance for measuring insurance-associated emissions and science-based targets aligning to the principles of Glasgow Financial Alliance for Net Zero:

• Achieving net-zero commitments in their operation,
• Engagement and stewardship with the client to reach net-zero
• Sustainable business practices
• Disclosing activities to stakeholders

When this methodology is published in the later part of 2022, the Insurance industry needs to leverage data from various sources to substantiate their reporting requirements.

• A new way of underwriting

Climate change will manifest new hazards, requiring new underwriting solutions. Traditional models need to be amended as past loss experience will not predict the future. An additional set of climate-related data need to consider for underwriting. Obligations will change, requiring new techniques for portfolio management. Underwriting will become more strategic for insurance companies.

Insuretech companies like Kettle and Zesty.ai are analysing enormous amounts of geospatial imagery, location-specific data, and weather data to predict future wildfire patterns and wildfire risk to individual properties in California state in the US and underwrite the properties.

Insurers can also work with governments and regulators to incentivise companies to embed sustainability into their operations. For example, the underwriting of assets that are harmful to the environment can be restricted. Major insurers have already announced their plan to reduce their underwriting capacity for fossil fuels over a period.

• New products and services

The low-carbon transition creates demand for new sustainable goods and services worth trillions of dollars across all sectors. This is an opportunity for insurers to offer innovative insurance and reinsurance products for low-emission technologies and nature-based solutions.

For example, Insuretech start-up Kita is planning to offer insurance products that guarantee the quality and delivery of carbon units from buyers and sellers. Arbol provides insurance solutions for climate-related risks from rain, wind, snow etc.

• Use of digital technologies

Data will play a key role in the journey to net-zero transition and reporting. Digital technologies like smart meters, supercomputers, AI etc., would enable emission monitoring and the creation of data-driven applications and services related to emission savings across sectors.

• Artificial Intelligence (AI ): AI is already playing a pivotal role in the IT landscape of insurers in underwriting, claim processing, fraud detections, etc.AI has immense potential in tackling climate change (its carbon footprint has an associated cost too). AI algorithms can optimise energy use in factories, homes, and offices, optimise travel and strengthen climate change prediction whilst limiting the impacts. AI will be widely used to predict and determine the effect of devastation from storms, wildfires, and droughts.
• Internet of Things (IoT): IoT also is an important technology linked to insurers as it can send and receive data from various elements from remote locations to monitor and analyse climate data. It is already embedded in many products related to connected cars, healthcare, etc. Its smart connectivity also will enable energy networks and consumers to be more energy-efficient, intelligent traffic management, building smart cities and efficient mobility solutions. Insurers can also monitor the health of insured items through IoT and offer incentives and rewards to their customers based on the preventive measures they are taking. Availability of continuous data from IoT devices will enable the digital twin of the insured item, which will help prevent damages before they occur.
• Blockchain: The digitally distributed and decentralised ledger technology can ensure increased transparency and easily trace transactions. Smart contracts can be used to develop globally accessible systems, directly rewarding companies and individuals for participating in sustainable practices. Smart contracts also can interact with real-world data to make it possible to automatically pay-out insurance claims for parametric insurances. For example, insurance projects like Arbol and Etherisc offer smart contract-powered crop insurance to farmers globally. Pay-out will be made automatically if the actual weather data reaches a threshold. Lemonade Insurance also announced a similar project recently. Blockchain also can be used for tokenised carbon credit. The data from an IoT device or a satellite can be used to get meaningful data on reforestation to create carbon credit. Some of the earlier public blockchain networks are known for their high energy consumption. The new generation of proof of stake networks is consuming less energy.
• Virtual Reality (VR): VR can demonstrate the visual experience of the effects of climate change that would help educate the people and bring awareness to society. The recent discussion on Metaverse and its ability to provide an immersive experience is one of the developing areas to watch.
• Collecting, storing and processing of large volume of data will be a crucial requirement for the future, which requires large-scale computing capabilities. Insurers need to keep track of the developments in computing capabilities like Quantum Computing.

Some of the above technologies are energy-consuming and need to be implemented based on the evaluation of the net effect. Insurers should also consider these technologies and advise their supply chain network.

• Collaboration with broader ecosystems

Engagement with governments, regulators, and customers is one of the important ways for insurers to drive the climate agenda. This will help them develop new insurance products and services to support the net-zero transition. Insurers working individually or through associations can influence the government in necessary policy measures that affect the consumers to switch out of the high carbon-intensive activities. E.g., Changing fossil fuel subsidies, developing new building codes, promoting electric vehicles etc. Insurers also can reduce the capacity to insure high carbon industries. Insurers can also share the critical claims data to improve the insured items like cars and buildings. Tesla recently announced that it uses claims data from its insurance business to improve its vehicle.

In summary

All businesses, including insurance, are responsible for implementing sustainable business practices and responding to evolving public and government expectations on climate change. Insurance companies must consider floating innovative products to reduce the insurance gap and address the new risks that will arise due to the transition from a high-carbon economy to a low-carbon economy. They should leverage AI, Blockchain, and IoT technologies to better risk underwriting, improve claims management, and predict and prevent/limit climate-related catastrophes. Insurers must also collaborate with communities, government, and global NGOs to shape the policies and guidelines to address these sustainability challenges.

Insurers had demonstrated their collaborative spirit in a place like London Market, where a consortium could underwrite complex risks. It is time again for industry collaboration to address the man-made catastrophe, climate change.

Oliver Wyman has extensive climate and sustainability expertise; you can find more details at https://www.oliverwyman.com/our-expertise/capabilities/climate-sustainability.html.

[1] https://www.unepfi.org/net-zero-insurance/

[2] https://ghgprotocol.org