Date posted: 01/12/2016 6 min read

Climate change challenges the insurance industry

Climate change, business and the insurance industry

In brief

  • What will the path to a low carbon future look like for the mining-focused Australian economy?
  • Insurance companies and investors grapple with the challenge of shifting to a low carbon economy
  • A4S Accounting Bodies Network calls for determination and political will to achieve a low carbon, sustainable future

By Steve Lewis 
Photography by Toby Zerna

When a series of deadly storms swept Australia’s eastern coast in mid-June — devastating four States and causing an estimated A$235m in damages — it brought the impact of climate change into sharp focus.

More than 32,000 insurance claims were filed while the nightly news showed multi-million-dollar properties on Sydney’s northern shores perched precariously above beaches eroded of their sands.

It was a most graphic demonstration of the threat posed by rising sea levels to island nations like Australia and New Zealand.

It was also another stark reminder to the insurance sector that climate change is a reality that will have a significant, although as yet unquantifiable, impact on policy premiums.

Climate change is having an impact on our way of life. It is impacting on the insurance sector, indeed the broader business and investment community.

Around the world, governments are responding to human induced climate change with a raft of policies, although in Australia the track record of successive federal governments has been mixed and characterised by partisanship.

Across the Tasman, the New Zealand government hasn’t been idle in addressing the threat of rising seas. In November 2015, the Parliamentary Commission for the Environment produced a hard-hitting report, simply titled Preparing New Zealand for Rising Sea Levels.

Pulling no punches, Commissioner Jan Wright suggested that entire communities may need to be uprooted as she identified 9,000 homes that lie just 50cm above spring king tides.

“Continued sea level rise is not something that might happen — it is already happening, will accelerate, and will continue for the indefinite future,” Dr Wright wrote.

Exquisitely timed, Dr Wright’s report was published just weeks before world leaders flew into Paris last December to hammer out a new global agreement on climate change, the so-called COP 21. Around 180 nations signed up to COP 21, which aims to ‘hold the increase in global average temperatures below 2C above pre-industrial levels”.

In policy terms, Australia and New Zealand were closely aligned. Australia pledged to reduce emissions to 26-28 per cent of 2005 levels by 2030. New Zealand’s pledge was 30 per cent.

A quiet revolution is taking place on both sides of the Tasman as insurance companies and the broader investment community grapple with the challenge of shifting to a low carbon economy.

Insurance industry leads

Insurers are “investing heavily in improving their modelling” of the risk posed by climate change-related events, says Tom Herbstein from the Cambridge Institute for Sustainability Leadership (CISL). He adds the caveat that these models “are only ‘directionally correct’ and thus far from accurate.

“The challenge lies in understanding the nature and impact of low-frequency risks such as, for example, 1-in-250 year weather events. It is much easier to understand other low-probability events such as earthquakes, given the geological record that is often left behind,” he says.

To help with the transition to a low- or zero-carbon future, the CISL has initiated ClimateWise, a global network of leading insurers, reinsurers, brokers and industry service providers. The platform is designed to try and help insurers encourage the transition to a low carbon economy. For instance, ClimateWise is urging insurers to actually rate businesses on how they contribute to climate risk (the greater the level of emissions, the higher the risk) and to create business models that incentivise low-carbon behaviour.

Campbell Fuller, the Insurance Council of Australia’s (ICA) general manager of communications and media relations, says that the sector is still working out how best to “price” premiums to reflect the climate change challenge. Insurers closely monitor scientific reports on climate and weather trends. Each insurer has developed its own response to concerns about climate change, Fuller says. But — and this is a significant caveat — the ICA is not able to estimate what influence climate change may be having on insurance claims.

The ICA, he says, keeps a comprehensive database that lists catastrophes it has declared over the past 40 years. This has been analysed to determine whether events are becoming more intense or frequent. However, the extent to which climate change is contributing to greater natural disaster losses “is being obscured by the influence of population rises, expanded development and increased building costs”.

While the ICA argues that the climate change threat is not impacting on premiums, it also says that it will be up to governments to underwrite more of the risk posed by erratic weather patterns. “Insurance cannot change underlying risk. Governments must therefore protect communities from known and predicted hazards,” Fuller says.

But the insurance industry is also working out how best to model the impact of climate change and how to measure its impact on future business settings.

Insurance cannot change underlying risk. Governments must therefore protect communities from known and predicted hazards.
Campbell Fuller, General manager of communications and media relations, the Insurance Council of Australia’s (ICA)

Low carbon future

A major question for an economy like Australia’s — still heavily reliant on mining coal and other fossil fuels — is what will this path to a low carbon future look like?

Some of the nation’s biggest emitters — such as AGL, which outlined a new greenhouse gas policy in April 2015 — have publicly promised measures to reduce their carbon footprint. But what about the laggards, the big polluters who refuse to go down the low-carbon road?

According to the CISL’s Herbstein, the global insurance industry is “starting to increase premiums for some companies that are still to transition towards a low-carbon business model”. This he adds is more as a consequence of their increased risk profile (for example, liability risk) rather than as a means of encouraging them to transition to a low carbon economy.

Within the usually staid insurance sector, there are signs that individual firms are starting to reduce investment exposure to “high risk assets” within their investment portfolios — based on concerns around “stranded assets” and other increasingly unviable investments, such as coal. AXA, Aviva and Zurich have all made significant announcements to this effect.

The Climate Institute Deputy Chief Executive Erwin Jackson believes it’s more than just the insurance sector that is influencing these decisions.

General investors are starting to mainstream climate risk assessment in the decisions they make and are asking companies to demonstrate how they are resilient in a world accelerating moves to clean energy, Jackson argues.

Those companies and countries that have “credible climate change plans will gain competitive advantage in a world switching to clean energy”, he says.

Responding to risk

But how is this manifesting itself, particularly in countries like Australia and New Zealand where the corporate culture is conservative and many boardrooms default to the status quo? “In the first instance, there is a growing drive to ensure companies are disclosing the carbon and climate risks they face,” Jackson says.

“This is not happening just at an investor level. Financial regulators are also engaging. One example of this is the taskforce established under the G20’s Financial Stability Board to develop voluntary global standards for carbon and climate disclosure.”

We are also starting to see the first signs of legal interventions against companies for failing to disclose their internal assessments of climate change. And other areas such as liability risks for directors and their insurers is a new emerging frontier.

That is a new dynamic that is exercising the minds of insurers, even as they try to determine how best to respond to the threat — and higher costs — of damaging weather events, such as the recent storms along Australia’s east coast.

Emma Herd, chief executive of the Investor Group on Climate Change, is adamant that the Paris agreement is impacting on investor sentiment.

“The Paris agreement has sent an incredibly strong market signal to the investment community that carbon constraints will continue to tighten and that policy responses will continue to tighten,” Herd says. But have we reached a tipping point yet where investors will shy away from investment in big polluting corporations?

Herd suggests the response will be more nuanced.

“It is a mistake to look at investor appetite and interest solely in terms of dollars invested in Australian or New Zealand clean-tech projects. That (investor) conservatism also translates into conservatism in managing carbon risk, so it’s not just about dollars invested in new exciting projects.“

It’s also about how investors are seeking to manage down the risk in their existing portfolios related to carbon regulatory settings, and also physical risk and adaptation risk.”

Steve Lewis is an author, journalist and senior adviser with Newgate Communications.

This article was first published in the September 2016 issue of Acuity magazine.

Accounting body CEOs call for low carbon future

  • An open letter to world leaders

    The global accountancy profession urged world leaders to demonstrate determination and political will in order to achieve a low carbon, sustainable future.

    In an open letter to world leaders ahead of the COP 21 Climate Change meeting, chief executives of the accounting bodies representing one million accountants worldwide, asked governments to:

    1. Commit to an agreement in Paris that provides a clear signal that governments will act to achieve a low carbon, sustainable future.
    2. Put in place a framework that sets out necessary government actions, reduces uncertainty and enables investors, businesses and others to make informed decisions that are consistent with this aim.
  • Accounting community addresses climate change

    The 12 accountancy bodies, all members of the A4S Accounting Bodies Network (ABN), commit to a set of principles that support action by the accounting community to address climate change. In particular, through these principles we commit to:

    • Equip accountants with the skills, knowledge and behaviours needed to support their organisation’s response to climate change by incorporating into training and professional education, driving thought leadership, and working with others to accelerate learning and progress.
    • Influence and inform our membership to understand the implications of climate change, and how approaches such as the adoption of integrated reporting can support an effective response.

    The transcript of the full letter and signatories can be found here