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Combating climate risks

Combating climate risks: The future of insurance

Key Contacts

Natural disasters killed more than 10,000 people in 2018. They left millions more homeless. In the same year, natural catastrophe-related economic losses reached US$160 billion. The vast majority — 95 percent — of the registered events were weather related.

Adding further urgency to the issue, a recent report by the International Panel on Climate Changes spoke of the dire consequences for people, economies and ecosystems which would result from global warming exceeding 1.5 °C above pre-industrial levels. The World Economic Forum’s Global Risks Perceptions Survey 2018–19 revealed extreme weather events, failure on climate change mitigation and adaptation, and natural disasters as the three most likely risks of significant concern. No wonder climate change is rapidly rising up the public agenda.

It is also rocketing up the insurance agenda. Not just because natural disaster insurance claims are rising, but also because insurers are increasingly recognizing that the mid- to long-term outlook on climate change carries some massive risks.

Understanding the risks

Back in 2015, Mark Carney, Governor of the Bank of England, delivered a landmark speech in which he warned insurers that ‘the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors (including business, political, and technocratic authorities) — imposing a cost on future generations that the current generation has no direct incentive to fix’.

There are three channels through which climate risks could crystallize.

The first is the physical risks from extreme climate events, which include storms, heavy rain, flooding, drought and associated wildfires, and heat waves. It is hard to predict the changing intensity, frequency and concentration of these events such as clusters of typhoons. Insurers also struggle to foresee the indirect risks such as disruption to economic value chains.

The second class of risk is the transition risk; basically, the ‘unknowns’ about how the world will evolve towards a low carbon economy in terms of public policy, regulation, actual temperature change, social expectations and technological developments. That’s even more difficult to measure or price. And, given the slow progress on transition, the potential for a panicked, forceful policy response in a few years’ time — sparking a disorderly transition — is increasing.

The third class of risk is the liability risk. Recent estimates suggest that there have been close to 1,000 climate change related class action lawsuits filed in 25 countries. Rhode Island, for example, filed a suit that alleges 21 companies knowingly contributed to climate change and failed to adequately warn citizens about the risks posed by their products. Law suits are creating concerns for companies’ insurers.

It is not inconceivable that some insurers could suffer a triple loss: a large increase in director and officer liability insurance policy claims arising from failure to mitigate, adapt or disclose climate risks; a drop in asset value if they also invest in these companies; and litigation from policyholders who believe their insurers failed to fulfil their fiduciary duty to construct climate-resilient asset portfolios.

The industry takes the lead

The good news is that there are a number of initiatives to improve awareness and catalyze a response to climate-related risks. For example:

  • The Insurance Development Forum — an industry-led public/ private partnership that KPMG member firms support — is making great strides towards the more effective use of insurance and its related risk management capabilities to build greater climate resilience and protection for people, communities, businesses, and public institutions that are vulnerable to climate-related disasters and their associated economic shocks.
  • The UN Environment Programme’s Principles for Sustainable Insurance Initiative has been steadily increasing its focus on climate resilience, with leading insurers currently developing a new generation of forward-looking risk assessment tools to better understand the impacts of climate change on their business.
  • The multi-stakeholder InsuResilience Global Partnership for Climate and Disaster Risk Finance and Insurance Solutions aims to strengthen the resilience of developing countries and protect the lives and livelihoods of poor and vulnerable people against the impacts of disasters.

Yet, while industry and government efforts seem to be moving ahead, our view of the market suggests that most individual insurers still have a long way to go before they can confidently claim to be understanding, mitigating and managing their climate risks.

Start from within

There are a number of actions that insurers could take to improve the way they assess and manage the near and longer-term impacts of climate change.

One of the most important things insurers can do is to fully embed climate-related risks into their overall governance and risk management frameworks. This includes sharpening quantitative risk modeling (including scenario analysis) around perils impacted by climate change and measuring the potential for liability claims against high carbon emitter. The recommendations of the Financial Stability Board (FSB) Taskforce on Climate-related Financial Disclosures provide a helpful road map in this regard — spanning governance, strategy, risk management, as well as metrics and targets.

Insurers will want to consider whether their liabilities and investments are properly diversified to avoid excessive risk concentration. That may include tilting portfolios towards companies and industries which are relatively climate resilient and best positioned for the low carbon transition, and spreading regional exposure.

Insurers could also be taking action to drive greater awareness and response to climate change within their customer base and their markets. Just like some insurers offer lower home insurance premiums for home owners that install strong locks and robust alarm systems so, too, could businesses be offered lower premiums if they have taken the steps necessary to reduce their vulnerability and increase their preparedness for extreme climatic events.

There is also the opportunity for insurers to be more proactive in helping governments and municipalities improve resilience by using their experience, data and models to help enhance building codes and land zoning regulation. And they could be more forceful in encouraging their corporate and government policy holders to voluntarily adopt standardized climate-related financial disclosures.

Your future success depends on it

To be clear, the response to climate change is not only about moral and ethical responsibility for an existential threat to life. Insurers also have a business imperative to preserve their existing markets, policies and investments, and also to create new markets and green investments. Further, as insurers look to developing markets for the next round of growth, those countries’ greater exposure to climate-related risks will require insurers to better understand, quantify, and rigorously combat the impacts of climate change.

The reality is that there will likely be more climate-related regulation and legislation in the very near future. Insurers will have no choice but to act.

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