A renewed sense of purpose: the path to a net zero insurance industry

Whilst the past year has been littered with uncertainty, something that has become ever more apparent is the conviction amongst insurers that sustainability has evolved beyond altruism into a new business imperative.

A potent mix of strong external market forces and shifting internal culture dynamics has elevated sustainability to the very top of the insurance sectors ‘to-do’ list. The World Economic Forum this year once again placed environmental degradation as the highest long-term risk facing the global economy, identifying climate action failure as the most impactful risk, illustrating the gravity of the issue facing the industry.

As a market heavily impacted by the physical effects arising from both chronic and acute environmental impacts, insurance will undoubtably be one of the industries most affected by climate change. Hence, it is incumbent on industry practitioners to respond with a unified approach of mitigating the risks whilst embracing the drive towards a more sustainable future.

The third day of Guernsey Finance’s 2021 Sustainable Finance Week was rooted in the drive towards sustainability within the insurance sector.

Dr Phil Klotzbach, Research Scientist at Colorado State University, explained during his keynote speech that the insurance sector plays a critical role in the transition to a low-carbon, resilient and sustainable global economy, both in terms of the risks it covers and the investments it makes.

Guernsey Finance takes a similar view – in May 2021 it published the worlds first insurance-specific ESG framework, designed to aid Guernsey-domiciled insurance firms to better manage ESG opportunities and risks.

Whilst we are a long way from agreement on a single standard for ESG in the insurance space, the framework is an important first step on the journey towards ensuring that ESG is at the very heart of governance structures across the industry. Guernsey’s framework enables Guernsey-based insurers to self-certify and work is already underway to create a kitemark through a third-party accreditation process.

Meredith Jones, Head of ESG & Responsible Investing at Aon, said the insurance industry was now recognising its role in the sustainable finance movement. Best practice is slowly developing across the industry as more insurers look to better understand climate and broader environmental risk.

Panellists pointed out that risk assessments for the physical and transitional impact of climate change can be a challenge as the time horizons are so much longer than the traditional time frame of five years or so. Long term climate risks are expected to crystallise at around the 30-year mark, while medium term risks sit around 10-15 years. Getting a firm to buy into these extended risk management horizons demands a cultural shift.

Martin Massey, Managing Director at OneRisk Consulting and Chair of the Climate Change Committee at the Institute of Risk Management, added that regulators are increasing the pressure on climate risk and there’s a significant amount of work to be done to meet PRA and FCA expectations that insurers have fully embedded their approaches to managing climate-related financial risks by the end of the year.

Ever present throughout the climate risk conversation is how one goes about incorporating this into investment portfolios. Jutta Kath, CEO & Founder of Uni-Kath, likened the process to that of peeling back the layers of an onion. Kath contends that ESG cannot be viewed as a single endeavour, rather each element has to be comprehensively and individually assessed when investing with a sustainable purpose. Conversation turned to the ESG data gap, with panellists unanimously arriving at the conclusion that better data is needed to build truly sustainable portfolios.

Discussing the innovation needed to foster better ESG alignment across the insurance industry, Adam Bornstein, Lead, Innovation Finance & Systems Change at the Danish Red Cross, spoke of the world’s first humanitarian catastrophe bond covering pure volcanic eruption, sponsored by the Danish Red Cross and developed using a Guernsey insurance-linked securities (ILS) structure. The catastrophe bond covers the risk of eruption of 10 volcanoes across three continents and raised $3 million from specialist cat bond investors, with the capital set to be used to support humanitarian aid in the aftermath of an eruption. Bornstein noted that more needed to be done in this regard.

Meredith Jones spoke of the protection gap when it comes disaster and catastrophe cover. Aon’s latest annual catastrophe report highlights that the catastrophe protection gap reached 64% in 2020 as roughly $171bn of natural disaster and severe weather losses were not covered by insurance and reinsurance. Jones eluded to the abundantly clear fact that as an industry, insurers need to address the protection gap as a priority.

Next up for discussion was the prevalence of net zero commitments across the market with Ben Snook, Senior Listings Manager at The International Stock Exchange, headquartered in Guernsey, raising concern over the wide-ranging interpretations of what ‘net-zero’ actually means. Kate Storey, Partner at Walkers, agreed noting that the latitude of what success looks like could be a thorn in the side of those who have made opaque commitments.

Paul Sykes, Managing Director at Aon Insurance Managers, looked to the future in his closing speech. In what had been a day of intense discussion on the role of the insurance sector within the sustainable finance sphere, it was a befitting close to hear of the resiliency with which the industry has responded to previous challenges and that the sector as a whole, while not quite yet there, is well on its way to a sustainable future.

This article first appear in the Financial Times, June 2021.