Risky business: the role of insurance in addressing climate change

Risky business: the role of insurance in addressing climate change

While this summer in London might not have felt very balmy at all, last May was reportedly the warmest on record in the UK1 and globally, marking a year of record-high monthly temperatures.2 Things have been metaphorically heating up in the global political arena as well, with elections taking place in India, France, the UK of course, and the US in November. In this context of changing climate, both physical and political, world leaders will head to COP29 in Baku, Azerbaijan, in mid-November, to drive action on climate change. COP29 has been dubbed the “Finance COP” because it will focus on negotiating a new climate finance goal;3 and it will aim to be an “enabling COP” which will catalyse action on climate through mobilising people, finance, resources and solutions.4 Undoubtedly, a key solution, indeed a potential “great enabler” on climate action, is insurance.5

The global insurance market has been estimated to be worth over $6 trillion.6 Insurance is ubiquitous; many types of insurance are mandatory and its function as an effective risk transfer mechanism has long been recognised. These characteristics make insurance a key means of tackling the grave risks posed by climate change and facilitating a just transition, as well as a sector which is perfectly placed to grasp the commercial opportunities this offers.

The insurance industry can play a threefold role in the climate crisis, as:

1. a hub of knowledge, skills, data and capabilities on the assessment and evaluation of risk;

2. an enabler of the transfer, abatement and mitigation of, and adaptation to, risk; and

3. a driver of investment.

Three types of climate risk

As long as there have been risks, there has been insurance. Climate change is certainly one of, if not the greatest risk facing Planet Earth today. More so as it is closely intertwined with the risks of biodiversity loss and ecosystem degradation, as well as social and political risks. Climate change is set to exacerbate resource scarcity and uninhabitability of certain parts of the world, leading to mass migration and violent conflicts.

Climate risk itself is commonly classified into three types of risk, outlined in 2015 by then Governor of the Bank of England Mark Carney in his famous “Breaking the Tragedy of the Horizon” speech at Lloyd’s of London. In rallying the insurance industry to act on climate, Mr Carney posited the industry would need to face physical, transition and liability risks.

• Physical risks are the most immediate and obvious risks posed by climate change, namely the physical effects of a rise in temperatures such as desertification, melting of ice caps, sea level rise, increase of flooding and forest fires. These risks can lead to the widening of the so-called “protection gap” between areas and assets that are covered by insurance and those that are not, and the creation of “insurance deserts” where it is too costly and risky for insurers to provide cover. For instance, some insurers have stopped insuring parts of California and Florida, due to the increased risk of forest fires in the former and flooding in the latter,7 leaving the uninsured to bear those risks, and attracting criticism for failing to adapt their models to accelerating climate change.8

• Transition risks are occasioned by the shift away from a fossilfuel based economy to a net zero economy. Transition risks take the form, primarily, of stranded assets, meaning those assets such as coal mines, oil fields and the infrastructure which supports them, which will become obsolete as the world transitions away from fossil fuels. Transition risks also comprise devaluation of enterprises which continue to rely heavily on fossil fuels and/or carbon-intensive practices – including, for instance, the production of steel, concrete, or factory farming.

• Liability risks are the risks that companies face of being targeted by climate litigation. Over the past decade (broadly coinciding with the entry into force of the Paris Agreement), there has been a real surge in climate litigation, with an ever-greater variety of claimants bringing lawsuits against different defendants. From early “framework” or “administrative” cases brought mainly by environmental NGOs and individual plaintiffs against States in the Global North, challenging insufficient action on climate, climate litigation now spans the globe and is increasingly targeted at corporations – aiming to hold high emitters accountable for their role in causing climate change, questioning companies’ commitments on climate and their marketing practices (“greenwashing”), and taking issue with directors’ roles and responsibilities in the climate crisis.9

How the insurance sector manages to analyse and respond to these risks will determine how effectively it adapts to the climate crisis, maintains profitability and supports a just transition to net zero in line with States’ international commitments and companies’ strategies.

Insurance helps manage risk

At its heart, the fundamental purpose of insurance is to be “the ultimate community product”,10 providing protection to individuals and companies in times of need. The insurance sector has had to adapt and learn to remain relevant; weathering shocks and working with other societal actors to mitigate risks. In terms of promoting resilience, there is evidence that countries with greater penetration of insurance coverage have faster economic recoveries from catastrophes and rebuild with greater resilience to future disasters; reportedly, a 1% increase in insurance penetration can reduce the disaster recovery burden on taxpayers by up to 22%.11

The role which insurance can play in supporting the resilience of communities around the world is widely recognised and driven by multilateral organisations. For instance, the Access to Insurance Initiative (aii) (the implementation arm of the International Association of Insurance Supervisors (IAIS)), notes insurance’s role in protecting people and assets and in supporting many of the United Nations’ Sustainable Development Goals.12 In 2012, the UN Environment Programme Finance Initiative (UNEP FI) launched the Principles for Sustainable Insurance (PSI), the largest collaborative initiative between the UN and the insurance industry, to work on solutions including sustainable insurance facilities, net zero and naturepositive insurance. The Insurance Development Forum, a publicprivate partnership between the insurance industry and international organisations, further supports projects around the world to improve tracking of risk and build resilient communities,13 including by promoting pre-arranged financing for disaster-prone areas and initiatives like the Global Risk Monitoring Alliance.14

To respond to heightened needs for protection driven by climate change, insurers are increasingly using innovative instruments such as parametric insurance. This type of insurance, which pays out to policyholders once certain conditions are met, such as excessive heat or rainfall, can help manage those risks before damage (for instance, lost crops) materialises. For instance, insurer Allianz has recently developed a parametric insurance product to help farmers in Colombia protect their crops against risks of excessive or insufficient rain;15 while in India, parametric insurance has supported women workers during extreme heatwaves;16 and in Mexico, it has protected the Mesoamerican Reef from the risk of destruction by hurricane.17

Insurance policy wording can disincentivise environmentally damaging behaviour. For example, the Lloyd’s Market Association (LMA) has introduced a model climate change exclusion clause to avoid policyholders being compensated for liability arising out of claims that they have caused or contributed to climate change and its consequences.18 The LMA also published a clause to exclude provision of insurance to vessels engaged in illegal, unreported and unregulated fishing,19 a practice which is seriously detrimental to marine environments. Lastly, insurance is crucial in de-risking new projects to support the energy transition, such as renewable energy production facilities and carbon removal projects, with specialist insurers such as carbon market insurer Kita focusing on this work.20 New research shows that over half of the $19 trillion committed to financing the climate transition to 2030 will require additional insurance coverage.21

Insurers are key institutional investors

Insurers invest the funds (premiums) they receive through the sale of policies to protect their value against inflation. In 2021, the total assets of insurance companies worldwide amounted to approximately $40 trillion.22 Investment is a vital aspect of insurers’ activities, as well as a crucial means to support the transition to net

zero; some estimate that spending on physical assets alone would need to amount to around $9 billion per year to achieve net zero by 2050.23

Insurers can play a key role through impact investment and stewardship, for instance, by implementing the UN’s Principles for Responsible Investment (PRI).24 Many PRI signatories are insurance companies, and re/insurers are considering portfolio strategies that increasingly integrate climate change considerations, including investing in green, resilient, transition and catastrophe bonds.25

Many insurers are part of a growing network of alliances (such as Climate Action 100+ and the Net-Zero Asset Manager Alliance) for investing at scale in resilient low-carbon business models.26

Investment is also becoming more transparent, with climate risk assessment and related disclosures gaining momentum among financial services regulators and standard setting bodies such as the International Association of Insurance Supervisors (IAIS), the Sustainable Insurance Forum (SIF), the Network for Greening the Financial System (NGFS), the European Insurance and Occupational Pension Authorities (EIOPA) and the Prudential Regulation Authority (PRA) at the BoE.

The role of lawyers in climate and insurance

Lawyers have an important role to play in this space, either within, or working with the insurance industry, by:

• Developing and advising on contractual wording, including through possible cooperation with external organisations like The Chancery Lane Project;

• Supporting insurers’ claims processes and working with insurers and policyholders in the delivery and use of new solutions;

• Advising on liability risks; and

• Providing thought leadership and training.

Bringing together legal and risk expertise will be essential in addressing climate change and its effects, building resilience and improving the sustainability of communities and businesses; recognising that taking these considerations into account is not only a moral duty, but a business imperative. 

Lucia Williams

(Senior Associate, Clyde & Co)

1 Warm May and spring for the UK - Met Office, 3 June 2024

2 S Younger, NASA Analysis Confirms a Year of Monthly Temperature Records - NASA, 11 June 2024

3 G Swaby, C Thangata, K Zoysa What Climate-vulnerable Countries Need on the Road to COP29 | World Resources Institute (wri.org) 16 May 2024

4 C McNally, Countdown to COP29: Negotiators and scientists meet to raise global ambition | Imperial News | Imperial College London 2 July 2024

5 F Arnold-Dwyer, Insurance as the great enabler (Dr Franziska Arnold Dwyer) - FOIL Newsstand - Powered by Lexology, 10 April 2024. See also: F Arnold-Dwyer, 

   Insurance Climate Change and The Law, 2024

6 Global insurance industry - statistics & facts | Statista

7 Why insurance companies are pulling out of California and Florida, and how to fix some of the underlying problems (theconversation.com)

8 The uninsurable world: how the insurance industry fell behind on climate change (ft.com), 2 June 2024

9 See: Global trends in climate change litigation: 2024 snapshot - Grantham Research Institute on climate change and the environment (lse.ac.uk), 27 June 2024

10 Insurance as a force for good (With Rowan Douglas) | RPC, 25 April 2024

11 About | Insurance Development Forum (theidf.org)

12 Insurance and the Sustainable Development Goals | Access to Insurance Initiative (a2ii.org)

13 Mission, Vision, History - Insurance Development Forum (insdevforum.org)

14 See: PRESS RELEASE: COP26: IDF and V20 Announce Partnership in Risk Understanding to Build Global Resilience to Climate Risk; IDF Announces other Multi-Partner 

     Resilience Actions - Insurance Development Forum (insdevforum.org); GRMA - Homepage

15 Allianz develops parametric solution to support Colombian farmers battling climate change - Reinsurance News

16 Insurance programme helps in tackling heatwave conditions (pirainc.com)

17 How insurance is protecting the world’s second biggest coral reef | Swiss Re, 16 September 2021

18 LMA21-041-DP (lmalloyds.com)

19 Marine Insurers Prevented From Doing Business With Vessels Fishing Illegally (tm-tracking.org)

20 Kita

21 Insurance Critical to Mobilising Climate Transition Investment (howdengroup.com)

22 Assets of global insurance companies | Statista

23 The net-zero transition: Its cost and benefits | Sustainability | McKinsey & Company

24 What are the Principles for Responsible Investment? | PRI Web Page | PRI (unpri.org)

25  Climate Change Risk Assessment for the Insurance Industry | The Geneva Association, Feb 2021, p. 11

26  Id. pp. 11-12