According to a report entitled ‘Global Climate 500 Index 2016-Insurance Sector Analysis’ published by the Asset Owner’s Disclosure Project earlier this month, insurance companies currently manage one third of the global investment capital, with their actions having a significant impact on the global economy. Climate change poses a significant threat to the insurance industry from two perspectives – higher costs from claims related to the physical impacts of climate change and the knock-on costs associated with disruption to global supply chains. The report examines the capabilities for insurance companies and pension funds to manage climate change risk, and the findings were clear – pension funds significantly outperform insurance companies in this capacity.
Climate change risk is now a mainstream issue for institutional investors worldwide. Last year, Chairman of the International Financial Stability Board (FSB) Mark Carney warned investors they could face huge losses from climate action that could render significant reserves of fossil fuels stranded assets. Insurance companies’ lack of asset class diversification means that they are exposed to the climate capacity of ratings agencies that are only starting to reassess the risk that climate change represents. For as long as only a few insurance companies act on climate change risk, there is a danger of a systemic failure that could have catastrophic effects on the wider economy.
One in eight insurance companies are taking tangible action to manage climate risk in their portfolio compared to one in four pension funds
The Asset Owner’s Disclosure Project report focuses on 116 insurance companies with US$15.3 trillion of investments and compares their performance in managing climate risk with that of 324 pension funds (US$15.9 trillion of investment). Each insurance company and pension fund was asked 41 questions covering the following three keys areas assessing their capability to manage portfolio climate risk:
1.Engagement – how are they influencing the transition to a low- carbon economy by actively engaging with the stakeholders within and outside the investment chain (including their members or clients, investment consultants, asset managers and regulators)
2. Portfolio carbon risk management – how effectively asset owners are measuring, monitoring and managing climate change risks within their portfolios
3. Low-carbon investment – the dollar value they have invested in low-carbon assets
The findings of the report revealed significant differences in terms of managing climate change risk, namely:
- One in eight insurance companies are taking tangible action to manage climate risk in their portfolio compared to one in four pension funds
- 1% of insurers consider the risks of stranded assets compared with 6% of pension funds
- 8% of insurers have staff dedicated to integrating climate risks into the investment process, compared with 16% of pension funds
- US$30 billion of insurance assets on the Global Climate 500 Index are in low-carbon investments compared to US$93 billion of pension funds
- European insurance companies outperform their counterparts in the Americas (including US and Canada) and Asia Pacific (including Japan and China) with respect to climate change risk management
The AODP report has really opened my eyes to the sheer size of the education task ahead of the global insurance community to better manage climate change risks. I believe the results of this report present an ideal opportunity for the broader business community (which obviously includes insurers) to collaborate and share their knowledge in order to educate companies across the global private sector regarding the opportunities that effective climate change management can bring. In a previous article entitled ‘Collaboration and knowledge sharing are critical to climate change adaptation for European cities’ I highlighted the importance of collaboration and knowledge sharing in finding and communicating climate change adaptation strategies. If collaboration and knowledge sharing can be effective in terms of adaptation for European cities I can’t see why they wouldn’t work with climate change risk management in the insurance sector. I think the Paris Climate Change conference in December last year was an ideal example of what can be achieved when parties from across the world collaborate on climate change which is a matter of international significance.
The sheer size of the investment held by the global insurance sector can (and should) be allocated to partly financing the global transition to a low carbon economy. This can make a significant difference as other sectors are likely to have more confidence in investing some of the funds at their disposal in the global fight against climate change. In addition to this flow on effect, such investment from the insurance sector could bring an end to pension funds outperforming insurance companies in managing climate change risk.
The insurance sector has an important part to play in managing and mitigating the impacts climate change. It holds billions of dollars of investments globally for which it needs to exercise due diligence to ensure those investments are not put at undue risk on a daily basis. The insurance sector also offers to protect the assets and operations of businesses and individuals around the world from a range of possible adverse outcomes, therefore reducing the exposure of those assets and operations to risks – climate change being one. With the insurance sector offering businesses and individuals protection, it has a responsibility to understand and manage climate change risks, with failure to do so presenting a real issue for the future of the industry and the people relying on its services.