Climate Change and the Insurance Sector
The intensification of climate change is affecting an increasing number of economic sectors. However, the impact of climate risks has not been uniform across economic activities or between companies engaged in similar activities. In this context, the insurance sector stands out for its potential to increase the climate resilience of businesses and society as a whole.
What is the relationship between climate change and the insurance sector?
Insurance companies offer products that allow individuals to protect themselves against extreme events at a low cost. They are able to do this because a sufficiently large number of homogeneous risks grouped together produce relatively predictable aggregate behaviour (LESTER, 2009).
Therefore, the main activity of insurance companies is to accept insurable risks, manage them, and provide compensation for possible losses. Because of this ability to absorb risk, insurers play a key role in the transition to a low-carbon economy by helping citizens, businesses and governments to protect themselves against the material damage caused by global warming.
As the climate risks increase, it is possible that the demand for insurance will also increase as economic agents seek to protect themselves against adverse situations. Other opportunities may arise in the infrastructure sectors, as this is a fundamental investment for climate adaptation – and they will generally require Engineering Insurance and Guarantee Insurance. Other types of insurance, such as Material Damage and Loss of Profits, are interesting alternatives for companies whose activities may be disrupted by climatic events.
However, these opportunities do not come without cost. In some cases, it is possible that as climate risks increase, insurance for certain risks or geographies may become less accessible if claims rise faster than premiums. In this case, the risk protection gap would widen, leaving people, businesses and governments more exposed to the impacts of climate change.
The ability to provide business lines such as guarantees and loans to carbon-intensive sectors could also be significantly affected by the adoption of more ambitious climate policies. In addition, regulators are increasingly demanding transparency on the climate impact of insurance companies, as advocated in Circular 666 of the Superintendence of Private Insurance (SUSEP), the sector’s regulator. As a result, insurers need to manage transition risks as well as monitor the physical risks of climate change.
Financed emissions and insured emissions
In this sense, one tool for measuring exposure to transition risks is to calculate financed emissions and insured emissions. For financed emissions, transition risks can be perceived more directly, as the assets invested by insurers may be subject to price changes as a result of regulatory or technological changes, such as carbon pricing. A change in the price of these assets could alter insurers’ reserving, profitability and capital structure.
Insured emissions, on the other hand, indicate the exposure of businesses to highly polluting, carbon-intensive companies and sectors. As the transition to a low-carbon economy takes place, these lines of business may be affected due to stranded assets or technological changes. Through carbon accounting, insurers can identify which sectors and companies in their portfolios require more sophisticated solutions to advance decarbonisation, and thus play an active role in their transition. Some opportunities may arise with companies with high emissions intensity, where insurers can offer Performance Insurance for decarbonisation projects.
Why estimate financed and insured emissions?
The Partnership for Carbon Accounting in Financials (PCAF) provides methodologies for estimating financed and insured emissions. The data obtained from the calculation can be used to measure, monitor and manage the transition risks of insurers’ portfolios and to disclose them to regulators, such as SUSEP, and other stakeholders through reports to the Carbon Disclosure Project (CDP) and in line with the Task Force on Climate-Related Financial Disclosures (TCFD). By estimating financed and insured emissions, insurers can measure the transition risk exposure of their investment and insurance portfolios and identify potential improvements in risk exposure as well as opportunities within specific sectors and clients.
Admittedly, there are still some limitations in estimating these emissions, mainly due to the difficulty in finding and standardising data in the industry. However, this difficulty in obtaining data is already an indicator of uncertainty for institutions: the more difficult it is to obtain emissions data from clients, the more disorderly the transition of these portfolio companies to a low-carbon economy tends to be.
A fundamental step in analysing insurers’ transition risks is therefore the calculation of financed and insured emissions. The initial difficulties in collecting and processing the data will be overcome as the operational teams learn, as clients get involved and, above all, as regulatory progress requires inventories from companies in the real economy, i.e. insurers’ clients, allowing them to further advance in their climate management. The benefits of being ahead of the competition in climate management can be seen in the advantage of being at the forefront and taking advantage of the opportunities offered by mapping the emissions of clients and the assets of institutions. The role of the insurance sector in the transition to a low-carbon economy is clear and the tools to fulfil this role are evolving rapidly. It is therefore to be hoped that companies in the sector will increasingly engage with this agenda, seize the opportunities and contribute to a more resilient economy protected from the impacts of climate change.
Bruna Araújo
