2021 has seen ESG become a priority topic for many insurers, who have already taken significant steps to commit to more ethical and sustainable practices. Whilst environmental, social and governance regulation has been progressing for the past decade, the pandemic has accelerated the drive to a more sustainable corporate world.

There has been a notable shift in expectations of investors, regulators and other stakeholders and now, insurers in all sectors have a greater focus on business continuity, employee health and safety and the environment. Ongoing regulatory developments in the UK, Europe and worldwide – such as TCFD disclosures, Climate Financial Risk Forum (CFRF) guidance, Sustainable Finance Disclosure Regulation (SFDR) disclosures and the Taxonomy Regulation – have all increased the need for firms to proactively take responsibility for the decisions that they make and the steps that they take which will affect both the environment and society.

Indeed, two of the key areas of focus at COP26 were to mitigate the impact of climate change and to build societal resilience against such impact. The objective being to reduce emissions and agree on international commitments to secure global net zero by 2050.

The insurance industry has been significantly affected by climate and environmental change, and insurers play a major role in identifying and measuring climate risk and in financing the move to a low carbon economy. Remaining competitive whilst focusing on environmental and social duties means that insurers have to continuously adapt and innovate.

Industry initiatives

The UN Convened Net-Zero Asset Owner Alliance (NZAOA) is an international group of 61 institutional investors delivering on a commitment to transition their investment portfolios to net zero by 2050. NZAOA was initiated by Allianz and Swiss Re at the beginning of 2019 and has since added a number of leading global insurers as members. Although NZAOA is driven by the insurance industry, it does not cover the liability side and includes other investors as members.

The liability side is the focus of the recently founded Net-Zero Insurance Alliance (NZIA), a net zero initiative dedicated to the industry launched by AXA and the United Nations Environmental Programme Finance Initiative (UNEP FI). NZIA brings together fifteen of the world’s leading insurers and reinsurers to play their part in accelerating the transition to net-zero emissions economies. They are committing to individually transition their underwriting portfolios to net-zero greenhouse gas (GHG) emissions by 2050, consistent with a maximum temperature rise of 1.5°C above pre-industrial levels by 2100.

As risk managers, insurers and investors, the insurance industry plays a key role in supporting the transition to a resilient net-zero emissions economy. Climate change-related physical and transition risks are relevant to both the insurance and investment portfolios of insurers – for firms, financial risks emerge through two primary channels, or ‘risk factors’: physical and transition. Physical risks from climate change arise from a number of factors and relate to specific weather events (such as heatwaves, floods, wildfires and storms) and longer-term shifts in the climate (such as changes in precipitation, extreme weather variability, sea level rise, and rising mean temperatures). Transition risks can arise from the process of adjustment towards a low-carbon economy. A range of factors influence this adjustment, including climate-related developments in policy and regulation, the emergence of disruptive technology or business models, shifting sentiment and societal preferences, or evolving evidence, frameworks and legal interpretations.

In addition to physical and transition risks, it is worth noting that liability risks may occur from people or businesses seeking compensation for losses they may have suffered from the physical or transition risks outlined above ie ‘if future generations do suffer from severe climate change, who will they hold responsible?’.

For insurers, these risks will ultimately manifest in forms such as increasing underwriting, reserving, credit, or market risk and firms are ever more aware of the need to adapt or even reinvent their practices to mitigate these risks.

Climate data – adapting and innovating

Identifying and managing risks form the core of the insurance industry and a key question firms are asking is how technology can advance their ESG profile. We are seeing technology used in a huge variety of new ways from using satellite imagery and machine learning to understand natural resource management which ultimately guides firms’ sustainable practices, to providing credit insurance in the renewable energy sector.

New environmental data sources with better capabilities to predict loss will continue to be a crucial component to help the industry and the wider financial services community transform their operations. Insurers have, for certain risks, historically leveraged data on an annual basis but for climate change, in order to prevent loss, the data needs to be as close to real time as possible. The use of satellite imagery as a catastrophic event is unfolding in order to capture every detail of that event allows insurers to process claims within days of a catastrophic event. The combination of satellite, aerial, and other imagery with AI processing allows firms to assess loss damages almost instantly.

Increasingly advanced technology provides insurers with access to granular information on properties, topography, weather, and environmental conditions which will ultimately enable firms to better quantify risks, price policies, and settle claims.

For climate risk, historical data is becoming less effective in predicting future risk given the rapid acceleration of climate change over the past decade. New real-time data sources for example, wind speed, temperature, rainfall, etc., analysed via artificial intelligence will continue to increase the efficiency and accuracy of predicting expected losses in the future.

The ‘Green Recovery’

ESG means firms need to do more than just embed ethical and social principles into their business plan; it’s more than just corporate strategy. Ultimately ESG needs to underpin a firm’s vision and help set the direction the firm takes. The availability of new platforms providing alternative and specialised forms of insurance serve to indicate how rapidly the market is changing and how the ‘traditional’ insurance model is evolving.

We have seen firms now commit and sign up for the business ambition pledge to limit global temperature increases to under 1.5 degrees centigrade and to cut carbon intensity in equity bond investments, as well as reducing emissions from their own operations. Some firms are making huge commitments to eradicate their carbon footprint entirely within the next 20 years and have goals to cut emissions from their investments by up to 60 per cent within the next 10 years. Firms are actively removing coal-based assets from their portfolios and taking further steps to increase investment in renewable and social infrastructure.

Firms need to continue to assess the financial risks from climate change, and to be able to address and oversee these risks within their overall business strategy and risk appetite. They need to have clear roles and responsibilities for the board and its relevant sub-committees in managing these risks.

The clear message for insurers is that they will have to adapt to the ESG framework and continue to innovate to remain competitive.