Insurance underwriting matters more than you think
Insurance companies are the financial institutions that are hit first by the climate and nature crises. But they also have enormous leverage to prevent this twin crisis from spiralling out of control.
By Regula Hess, Senior Advisor Sustainable Finance Team WWF Switzerland, and co-author of the report.
Insurance companies are vulnerable to natural catastrophes especially those insuring weather-related risks or environmental liability. Most directly, insurance companies are affected by the rising costs of natural disasters. Swiss Re estimates the economic costs of global natural catastrophes in 2022 at US$ 275 billion, a 32% increase from the previous 10-year average. Before these losses hit banks and the wider financial system, insurance companies absorb damages so that companies do not default on their loans. At the same time, insurance companies are exposed to increasing climate and nature-related risks on the investment side. Hence, insurance companies are taking up a front-seat in the climate and nature crisis.
Currently, insurance companies mostly manage these risks by increasing premiums, reducing coverage, or exiting markets as is the case in California (wildfires) or Louisiana, Texas and Florida (hurricanes and floods). Yet, the challenges of affordability and increasing uncertainty about the severity and frequencies of these weather-related events render these strategies less and less effective to cope with the climate and nature crises. As Thomas Buberl, CEO AXA Group, once famously said, a 4-degree world is not insurable anymore.
Luckily, insurance companies have another strategy at their fingertips to secure the future of their business and the well-being of humans and the planet. They can use their power as underwriters, institutional investors, and important stakeholders to catalyze a green, fast and fair transition. A new report published by WWF Switzerland and co-authored by Deloitte Switzerland explores the levers that insurance companies have in their underwriting business to reduce their negative impacts on climate and biodiversity and how they can become part of the solution. The report structures these levers around three central questions: WHAT is insured? HOW is it insured and WHAT ELSE insurance companies can do.
WHAT? The economic activities that an insurer chooses to underwrite or not
Insurance companies are crucial enablers within the economy. They made the first industrial revolution succeed by insuring boats, railways, or large mills and factories, notably against the risk of fire. Similarly, large investments are rarely feasible today without insurance companies absorbing important risks. More so, for most large projects including mortgages, insurance coverage is a precondition for financing and/or obtaining permits. By continuing to cover new coal- fired plants, mining activities in protected areas or vessels involved in illegal fishing, insurance companies play a key role in cementing the unsustainable status quo. They need to turn away from insuring harmful economic activities and implement serious engagement-, exclusion-, and phase-out policies that are aligned with global climate and biodiversity goals.
The transition towards a sustainable economy offers immense business opportunities. Insurance companies can develop new products and services that allow scaling-up green technologies and products. For example, renewable energy, mass timer constructions or recycling facilities come with different, often less attractive risk profiles compared to their non-sustainable alternatives. Insurance companies can leverage this opportunity with tailored products in these growing market segments, thereby helping breakthrough innovation unfold. In the case of the German wind industry for example, insurance companies supported the development of more resilient wind-mills or the manuals to correctly maintain them. Similarly, they can promote nature-based solutions by providing coverage for the building process or insuring existing natural assets against threats. An example is the reinsurance of the restoration of canals in Kochi, India. The canals currently flood periodically, and are polluted. Restoration includes planting mangroves, constructing wetlands, and using porous surfaces for canal walls to offer greater flood protection, reduce water pollution and mitigate urban heat.
HOW? Product design and claims management
Insurance products usually create incentives that steer the policyholder’s behavior in a particular direction. For instance, an environmental insurance liability product with inadequate terms and conditions may lead to a riskier behavior by insured people and companies, thus increasing the risk of environmental pollution. Therefore, insurance needs to cleverly design products to prevent pollution e.g., in the case of insuring mines or chemical plants.
Similarly, insurance companies can use product design and claims management to encourage sustainable behavior from their clients. For example, they could provide monetary incentives for driving less, facilitating the transition to regenerative or organic agriculture, or for making energy-saving home improvements.
Also, as insurance companies are paying trillions for claims, they need to ensure these claims follow sustainable consumption patterns. A circular economy should be the foundation of claims management, favoring, for instance, repairing goods over replacing them and replacing products with long-lasting alternatives. Moreover, the concept of building back better can lift everyone up by replacing houses or machines with the newest, most sustainable version.
WHAT ELSE? Supportive activities
As a multi-trillion industry with millions of employees having nearly all companies and many individuals as their clients, insurance companies are the drumbeat of the economy. They are powerful stakeholders for companies and public authorities, and they should leverage that position for positive change. For instance, they should use the wealth of data at their disposal to help policymakers understand the risk of the climate and biodiversity crises and advocate for stringent environment policies and for fiscal incentives that are aligned with global climate and biodiversity goals.
In a nutshell, it is in the self-interest of insurance companies to reduce the risks from the climate and biodiversity crises by becoming a catalyst of the transition to a sustainable economy and financial system.
The report targets the insurance sector, its clients and investors, policymakers and financial supervisors offering recommendations to facilitate implementation. If you wish to learn more about the report, please register for our public webinar on September 26 , join us at one of the public events listed here or get in touch.
