Re/insurers adapt underwriting to better price climate risks

Appetites are changing in response to the growing environmental and significant business challenges posed by environmental factors, which in turn is mobilising insurers and reinsurers to reassess their own operations and increase efforts to demonstrate climate leadership.

This is according to a report by law firm Kennedys, which finds that the underwriting practices of (re)insurers are a major catalyst for change among businesses in the ongoing climate crisis.

The report considers the impact of climate change on insurers; how to mobilise insurance markets to mitigate climate risks; value chain risk arising from climate risk; and the growing trend of climate litigation risk.

John Bruce, partner, Kennedys said: “The growth in sustainability and climate-related issues impacts on all types of insurance policies for the simple reason that climate risks are a constant, growing concern.

”From an underwriting perspective, changes in practice will be required to price climate risks more accurately in the future.

“(Re)insurers (and the businesses they insure) that are ahead of the transformation game, like those at the forefront of the industrial revolution and the move to a digital economy, are much more likely to succeed.”

Environmental liability risks

The three main types of climate litigation being seen in the courts which bring Directors and Officers (D&O) and Errors and Omissions (E&O) insurance into focus, namely:

1. Lawsuits targeting states challenging the adequacy of climate policies.
2. Lawsuits targeting companies over their emissions of carbon dioxide, alleging climate-related harms.
3. Other litigation strategies including activist shareholder and employees, including with regard to misleading environmental promises (greenwashing) and non-disclosure of climate-related risks.

Within this already active, litigious landscape, Kennedys notes two major developments compounding pressure as companies transition towards sustainable practices.

First, a climate change ‘duty of care’ is owed by public and private actors, which is already being tested when establishing causation. As with the ‘duty of care’, shareholder activism is also on the rise and is set to drive a change in corporate behaviour.

Individuals and NGOs are increasingly using the court to try to achieve their objectives, including enforcing board responsibility with regard to corporate compliance with regulations, targets and broader environmental principles. Insured companies must, therefore, focus on improving their ESG regulatory frameworks.

Strategies for change

While the insurance sector has long taken steps in the right direction – for example, (re)insurers now make up 12 of the 26 members of the UN-Convened Net-Zero Asset Owner Alliance – many (re)insurers continue to identify climate risk as a significant business challenge.

Major risk types include physical risks, which manifest in the form of physical damage via natural catastrophes; transition risks as businesses make changes to meet carbon emission targets; and environmental liability which could result in losses related to physical or transitional risks related to climate change.

As the sector realises the transition towards environmental sustainability, overcoming these risks will be business critical. Therefore, insurers have begun to:

• Strengthen senior management accountability – senior (re)insurance business leaders will be expected to set the course in creating the right policies, incentives, and business culture for embedding climate risks, as corporate and insurance business leaders fall under pressure to transition from ‘brown’ to ‘green’ activities.

• Embed climate risks within solvency regimes – the need to make provision for future losses raises industry concerns that natural catastrophe modelling does not properly capture climate risks within the existing capital requirements framework, and longer climate risk horizons should be applied to balance sheets according to EIOPA guidance.

• Establish the right price for underwriting growing natural catastrophe risks – there is an inherent risk of mispricing natural catastrophe risks as the underwriting models need to be recalibrated; moving from the use of historical backward-looking data to a more forward-looking approach to risk assessments.

• Improve climate transparency and reporting – risk assessments are only as good as the risk models and the data available. Emerging climate risks may represent unchartered waters for (re)insurers, and historical data may not be as relevant or useful as weather conditions become more severe and uncharacteristic of the past. As a result, data required to price transition and physical risks may often be incomplete.

In addition to the sector’s vital risk management role, the industry is a major institutional investor, channelling billions of dollars of funding into public and private sector investments around the world via global capital markets.

The insurance sector has a significant role to play in ensuring those investments flow into business activities which support green transition.

Recommendations

The report makes the following six recommendations for (re)insurers to adopt, and to encourage their corporate clients to embrace to address climate risks and reduce the likelihood of environmental liability claims made against them:

1. Embed climate mitigation within governance changes and senior leadership
2. Advocate enhanced annual climate emissions disclosures, to include data on specific emissions sources and, in time, associated biodiversity risks
3. Develop extended net zero plans which consider climate impacts across the business value chain, incorporating sustainable procurement policies
4. Reduce emissions across the value chain by implementing and disclosing details of decarbonisation measures, ensuring that externally sourced inputs are aligned with business sustainability targets
5. Take steps to ensure conduct is fully compliant with objectives and insureds do not make misleading statements or pledges in the rush to adopt sustainable practices (greenwashing) – including a review of all consumer literature
6. Seize the opportunities in green technology, green building and renewable energy (which could represent a market worth more than £200bn by 2030) – rather than try to resist the inevitable transition towards long-term sustainability.

Deborah Newberry, director, corporate affairs, Kennedys said: “The evidence of climate action being taken in many countries is deeply encouraging. However, it is clear that all sectors have an important role to play in achieving further and substantial emissions reductions.

”Addressing the challenges of climate change requires true innovation – in institutions and organisations; understanding and thought; technology and leadership.

”In turn, the right policies, infrastructure and regulatory landscape are required to enable business to help meet the targets.”