Sustainability in insurance
Sustainability in insurance
The insurance sector is heavily impacted by the E, S and G aspects underlying what Sustainability is all about. And the fact that insurance companies are subject to stricter ESG regulation (a.o. the EU Sustainable Finance package) is only a small part of this enormous challenge. But at the same time Sustainability offers a huge opportunity. In this article we explore what sustainability has to do with insurance. And how insurers can and should transform their business model to integrate these different aspects .
The goal of net zero is the greatest commercial opportunity of our time (Mark Carney)
Let’s start from the definition of sustainability that often incorporates three key elements: economic, social, and environmental sustainability. Economic sustainability refers to the financial stability and profitability of a business. Social sustainability involves the fair treatment of employees and the positive impact a business has on the wider community. Environmental sustainability involves reducing the negative impact a business has on the environment, such as reducing waste, conserving natural resources, and reducing greenhouse gas emissions.
Insurance plays a crucial role in all three aspects : by providing financial protection against potential risks and losses, as a significant asset owner and through engagement with its customers across the entire society and economy. By pooling resources and spreading risks among a large group of people, insurance helps individuals and businesses manage uncertainty and financial instability. Few sectors take such a long-term view as insurance. Insurance helps to create the stability and security individuals and businesses need to plan for a sustainable future and invest in new opportunities.
The current climate crisis and the damage that is being done to our planet, caused by or stemming from climate change, implies an increase in natural disasters (see table below) and leads to enhanced claims in property and life. And apart from the human impact, this translates into financial costs that can jeopardize the very survival of the insurance business.
Table 1: A few statistics for Belgium.
- Belgium is at 1.5C warming already as Europe is warming up twice faster than the rest of the world (Link).
- By 2030 we could experience 17cm sea level rise, which could cause inland flooding until Gent (Link).
- Largest physical risk exposures for Belgian insurers are windstorm and flood with 0.4 Trillion Euro each (Link).
- In the summer of 2022, we saw such a strong drought and precipitation deficit that normally occurs once in 50 years (Link).
All of these pose greater risks for life and non-life insurance products and lead to more claims than ever before.
How can sustainability become part of an insurer’s way of doing business?
By transforming their business and organizational culture. Insurers have three main roles in the society and overall economy, and sustainability should be embedded in every one of these roles
Insurers are huge institutional investors. They collect premiums and invest them (directly or indirectly) in financial instruments to ensure long term returns. Behind these financial instruments, are real companies and businesses, and so the choice insurers make every day where to put their money in (or not) literally moves money around in the economy and can have an enormous impact on
- The Environment (i.e. the fight against climate change),
- Social aspects (i.e. illegal employment, child labour, equal pay, anti-corruption, etc.) and
- The Governance of these businesses (i.e. independence, long-term decision-making, remuneration issues on board level, diversity, equity, inclusion, etc.).
Depending on the ambition level of the insurer, being an active shareholder (directly or through proxy voting) in the General Assemblees of the investee companies can be an opportunity. Over the last years a big emphasis is being put on climate finance and financing sustainable transition. And not only in the EU’s Green Deal. Various alliances support that idea, including the UN-Convened Net-Zero Asset Owner Alliance and Net-Zero Insurance Alliance. These are member-led initiatives committed to transitioning respectively their investment and underwriting portfolios to net zero GHG emissions by 2050.
To support investors/insurers in their investment choices, many data providers are developing very granular sustainability related data and/or aggregated ESG ratings. The data collection and management process is a huge challenge, and therefore often too much focus is being put on the ESG ratings itself. And although these ratings can definitely complement and be very valuable in an existing Investment Strategy and due diligence approach, overreliance on these ratings can lead to misleading results. ESG performance is simply still difficult to measure, and different providers define ESG in a different way and prioritize underlying factors differently. So before integrating these ESG ratings in your decision making process, make sure you fully understand who is calculating them and on the basis of what underlying elements.
The role of insurers as Underwriters is to provide society financial protection against potential risks and losses. Insurers therefore analyze, measure and price risks and integrate them in their underwriting policies and policy wordings. Factors that are typically taking into account are the likelihood and potential cost of the loss, as well as historical data on claims and losses. And these are precisely the factors that due to the accelerating climate change are moving targets. The frequency and severity of natural disasters such as hurricanes, floods, wildfires increase, the likelihood and cost of claims also increase. And on top of that, there are no reliable historical data (no experience pricing) available for many of the natural disasters as these are new types of physical risks, like the rising sea-level. So to be able to continue to measure and accurately price risks, insurers are going to have to use alternative methodologies (forward looking) that are designed to anticipate the impact of future events. One example could be scenario analysis that creates hypothetical scenarios based on different assumptions about future events to estimate the impact of these scenarios on potential losses. Another example could be predictive analytics based on data and artificial intelligence techniques to analyse historical data and identify trends and patterns that may indicate future risks and eventually predict future losses.
But apart from measuring and pricing risk, insurers are more and more taking up their responsibility in also managing the risk, i.e. play an active role in preventing the risk from materializing or limiting the damage when the risk occurs. That is in the end a win-win for both the insurer (low or no claims to pay) and the insured (no damage occurred). How can they do that? Insurers can steer customer behaviour through product innovation, net-zero underwriting and sustainable claims management. That is obviously not an easy thing to do as, in the current market environment, customers are also very price sensitive. But as mentioned, with the right incentives (and some out of the box thinking) this is the way forward, as the multiple examples in Table 2 and 3 show.
A bit more advanced would be for insurers to start working together with the businesses they insure on e.g. decarbonization trajectories or to focus in their underwriting policy on (“derisking”) emerging start-ups, and other innovative technologies that are on a mission to fight climate change and/or to protect the planet.
As Operators insurers are just like other businesses. They are taking care of calculating their own emissions and emissions of their suppliers to reduce them and get to net-zero. They are looking into sustainability certifications of their offices or invested buildings (f.i. PPS schoolBuildings and seniorhomes). They are managing their waste, the home-work traffic by public transport or improving the homeworking conditions, the energy and papercost on their IT-infrastructure, usage of energy and water, indoor air quality, decarbonizing their fleets, etc. They are also taking care of their own employees and the employees in the outsourced activities (i.e. cleaning, building, archivage…). Here Diversity, Equity and Inclusion (DEI) are very important. As well as linking executive and employee pay to ESG objectives. This is one of the most progressive measures taken lately by the businesses. And it showcases a way forward to truly integrate sustainability in daily decision-making. And some organisations look beyond this too. They are looking into ways to support and develop local communities through philanthropy, public-private projects and partnerships and local nature-restoration projects.
In a crisis such as the one on climate change, we all need to step up and be part of the solution to transition to a sustainable future. Insurers hold a key role here and have the power to impact climate action in many different ways. And to conclude on the same note as we started off, this might be “the largest commercial opportunity of our time”, to cite Mark Carney again. Enhanced reputation, increase in market share, new markets opening up, improved claims ratio through changed customer behaviour and incentivized preventive measures, etc …