Is now the time for insurance companies to take a more proactive approach in the accounting of climate risks across their balance sheets?
The world has been given a stark warning. If we are to secure a habitable future for life on Earth, we must act swiftly and collectively in halving greenhouse gas emissions by the mid-2030s to limit the rise in global temperature to under 1.5°C above pre-industrial levels. As this warning has been issued by the world’s leading group of climate experts, in the guise of the United Nations’ Intergovernmental Panel on Climate Change (IPCC), it is one that should certainly be heeded.
Of course, it is the fossil fuel producers and the large-scale industrial emitters of greenhouse gas emissions who are expected to and must lead the charge of this mammoth decarbonizing effort. But there is another category of global business that has a surprisingly central role to play in this call to action: the insurance sector.
Insurers have a unique connection to climate change. Unlike any other sector, climate change risk affects the entire insurance balance sheet. The liability side is most obviously exposed to financial risks associated with extreme weather events, as well as directors’ liability for certain underwriters. The asset side can, and needs to be positioned to manage and mitigate the catastrophic effects that it could have on the economy and society.
For these reasons, the long-term viability and financial success of many insurance companies is becoming increasingly anchored to climate change. This is a call to action for insurers to not only centralize climate change within their risk assessment processes but also leverage their unique position as key institutional investors in global capital markets to spur the drive towards decarbonization through their asset portfolio.
On the liabilities side, while insurance companies have factored past climate risk trends into their underwriting decisions on the back of an astounding increase in extreme and destructive weather events, they have been far slower to factor in long-term climate risks in their underwriting portfolios.
This should hardly come as a surprise as one of the factors that has ensured the enduring success of the insurance sector over the centuries is its fundamentally staid nature. It has, historically, been slow to enact change to many aspects of its business to adapt to the shifting socio-economic context within which it operates.
As a result, despite their deeply entrenched expertise in risk pooling, many insurers still have some way to go in getting to grips with how climate change will affect their business models in the medium to long term.
Noting the slow pace of adaptation, the UK’s Prudential Regulation Authority (PRA) has provided guidance, through the Supervisory Statement SS3/19, on how the banking and insurance sectors should embed the management of climate financial risks. While we understand that the PRA is already incorporating expectations on the adoption of SS3/19 into conversations with regulated firms, we note that there is still a competitive advantage to be gained from moving fast. This is an area which will only increase in importance.
With mandatory risk assessments and disclosures possibly on the horizon, it is now an opportune time for insurers to take a more proactive approach in the accounting of this risk across their balance sheets. Not only will this mean that insurers are not caught on the back foot, it will also ensure that they are playing a far more meaningful role in solving the world’s greatest challenge. And given the ‘ticking timebomb’ that is the climate, we all, including insurers, have a moral obligation to ensure we mitigate the risk as best we can.