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Climate change: Now’s the time to look outside, to take action within

Climate change: Now’s the time to look outside, to take action within

Tom Herbstein, Programme Manager, ClimateWise, Cambridge Institute for Sustainability Leadership

14 September 2016


In September 2015 Mark Carney, the Governor of the Bank of England, gave a ground-breaking, and since much-debated, speech at Lloyd’s on the threat climate change presents the financial markets. He proclaimed that “Climate change is the Tragedy of the Horizon”, classing it as a “mega risk”. Coming from the governor of a central bank, not least the Bank of England, Carney’s speech has ensured that the topic of climate change has now been firmly placed on the boardroom tables across the financial centres of the world.

Earlier that same month, political leaders met in New York City to officially launch the United Nations Sustainable Development Goals which, until 2030, will frame the global response to society’s biggest challenges, including hunger, poverty, health and threats to the environment. Later that year, in December, global leaders met again, this time for COP21 in Paris, where they worked on a clear international framework to avoid the threat of climate change and signalled the much-needed transition to a low carbon, climate-resilient future.

Together, these reinforce how sustainable development is not only an ethical or moral issue, but increasingly an economic one – both in terms of the future risks and rewards it presents. The actual number of catastrophic events has grown from an average of 40 in the 1970s, to almost 200 today, while the frequency of weather-related catastrophes such as windstorms and floods has increased six-fold since the 1950s. Economically, the cost of natural disasters has increased eight-fold since the 1970s, up from an annual average of $5 billion to over $40 billion by 2010.  [Possible graphic]. In total, the World Meteorological Organization (WMO) has estimated that the 8,835 climate-related catastrophes, between 1971 and 2014, claimed 1.94 million lives and cost the global economy $2.4 trillion.

This has all led the World Economic Forum 2015 Global Risks Survey to identify a failure of climate adaptation as one of the top four high-impact, high-likelihood risks, alongside water crises, under-/unemployment and interstate conflict. Strikingly, as the Governor of the Bank of England himself stated:“Once climate change becomes a defining issue for financial stability, it may already be too late”.

What does this mean for the insurance industry?

Climate change is generally accepted as presenting the insurance industry with unprecedented levels of risk. A recent report authored by Sir David King (the UK Foreign Secretary’s Special Representative for Climate Change), entitled Climate Change, A Risk Assessment, noted how, with just one metre of global sea level rise, what is today a ‘100-year flood’ will become about 40 times more likely in Shanghai, 200 times more likely in New York and 1,000 times more likely in Kolkata. With some estimates even predicting that current modelled losses could be undervalued by as much as 50 per cent, should recent weather trends prove indicative of the new normal, there is good cause for insurers to be concerned.

Besides general insurance, climate change could also lead to a sharp upswing in morbidity and mortality linked to rising exposure to disease and pandemics. A recent Lancet study even concluded that tackling climate change offers the “greatest opportunity for global health” over the course of the 21st century.

Already, many climate-related risks are impacting insurers balance sheets with nine of the top ten most costly floods all having occurred over the past ten years. The 2011 Thailand floods, for example, caused an estimated loss of $15-20 billion as they impacted global parts suppliers including Ford, Toyota, Dell, Cisco and Honda.

The insurance industry needs to look outside, to take action within

As the probability of extreme events increases, it will become more difficult to insure against them – and at levels that may remain affordable for customers. This could not only undermine the viability of commercial insurance but also lead to a society less prepared for the future shocks of climate change.

Consequently, there is a need for a broader and more societally focused response by insurance to both the causes and impacts of climate change. Such a response would acknowledge that the resilience of insurance is inherently tied to the society within which it exists, and vice-versa. What’s more, it would help extend the role of insurance, as society’s risk manager, beyond the financial risk transfer mechanism role it currently plays. This was reinforced in a recent Cambridge Institute for Sustainability Leadership (CISL) report – Insurance Regulation for Sustainable Development – that highlighted how access to insurance is a crucial feature in sustainable development.

Mark Carney, in his speech, also called for improvements in risk modelling to be unrelenting as the frequency patterns of loss and severity change, and for the extension of new models of insurance to new markets to bring a focus on new, unanticipated risks.

Insurance has many resources to lend to these efforts. It already has a long track record as risk managers partnering with governments, themselves keen to avoid being the insurer of last resort. With over $27 trillion of invested assets, the industry has significant potential to positively engage the transition to a low carbon, climate-resilient economy.

However, such responses will require insurers to start engaging climate risk outside of the normal insurer-client relationship and to become more systemically focused in their response to climate change in a way that acknowledges the long-term resilience of the insurance industry as inherently tied to that of the communities within which it underwrites.

And the regulators are getting concerned

A report, launched by the UK Prudential Regulatory Authority (PRA) in September 2015, and entitled ‘The impact of climate change on the UK insurance sector’ provides one of the first examples of an insurance regulator examining the direct impact climate change could have on the insurance industry and its customers.

The report found that insurance is well placed to deal with the risks of climate change over the short term but highlights a number of long-term challenges that the industry (and its regulators) will need to address. These risks insurance will face stem from the physical impacts of climate change, the societal transition to a low carbon, climate-resilient future, and the threat of liability. These longer term risks could have severe impacts for insurance and its policyholders.

The PRA’s report also highlighted a number of opportunities for supporting the transition to a low carbon, climate-resilient economy. This includes the development of new insurance products, playing a more active role as institutional investors and in assuming a greater leadership role.

In response to the PRA’s report, the leaders of 15 ClimateWise member companies – the insurance industry leadership group facilitated by the Cambridge Institute for Sustainability Leadership – including Aviva, Lloyd’s, RSA and Zurich – welcomed, in an open letter published in the Financial Times in October, the attempt by a central regulator to consider the impacts of climate change. They reiterated their own commitment to taking action and called for a more enabling regulatory environment that will allow them to respond more systemically, by helping to align their investment, risk management and underwriting capabilities in response to climate change risk.

Facilitating the transition

ClimateWise members have been collaboratively exploring many of the issues raised by the PRA, focusing in particular on how insurers can actively enhance resilience to climate change. This includes how the industry can work directly with global cities to support them to become more climate resilient and how to align their investment activities with the types of investments that could benefit underwriting while generating investment returns. Investments in infrastructure, that can enhance climate resilience, are one example.

Such efforts are not going unnoticed. Companies in the CDP Climate Leadership Index, for example, have outperformed the Bloomberg World Index of top companies by over 9 per cent for the past four years. Even rating agencies like Standard & Poor’s now claim that insurers, actively responding to climate risk, have the potential to improve operating performance.

Besides this, insurers actively supporting society to control its risk exposure, will not only contribute to the stability of their own future markets by maintaining insurability but will also help to build better and closer relationships with key stakeholders like governments, regulators and customers. As the need for a collaborative response to climate change grows, such relationships will become ever more important, as the PRA report reinforced.

What happens next?

Reflecting on the insurance industry’s role in responding to climate change, Maurice Tulloch, Chair of ClimateWise and CEO of Aviva UK, last year stated that “as COP21 approaches, it’s more important than ever that we rally around a clear and coordinated message of what the industry’s contribution to the challenge of climate change is and the desired outcome we want to see from Paris.” He added: “Put simply, a deal in Paris represents the largest combined health, life, liability and general insurance contract the world could ever sign up to. The risks from not reaching an agreement are incalculable.”

However, regardless of the outcome of last year’s Paris negotiations, insurance will continue to face the reality of a society increasingly vulnerable to climate risks. This is why it is crucial to make insurers’ collective voice on this systemic risk ever more prominent by encouraging participation in leadership platforms like ClimateWise that are active in coordinating an industry response and engaging with regulators around climate change.

All parts of the insurance industry have a role to play in supporting the global transition to a low carbon, climate-resilient economy. However, only a response by the industry that reflects the global nature and impact of climate change and that promotes novel, innovative and collaborative solutions, can ensure that the markets of today remain insurable ones in the future.


This piece was first published in print in The Journal, October 2015 (subscription required).

 

About the author

Tom Herbstein 100x100px

Tom Herbstein is the Programme Manager of ClimateWise, an industry initiative of global insurance companies who share a common concern and a willingness to help identify, and realise, a collaborative response to climate change. ClimateWise is facilitated by the Cambridge Institute for Sustainability Leadership.

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Articles on the blog written by employees of the University of Cambridge Institute for Sustainability Leadership (CISL) do not necessarily represent the views of, or endorsement by, the Institute or the wider University of Cambridge.