The Fight for Sustainability

It is no secret that climate change has been altering the way that industries operate. This is not only true for direct contributors; financial institutions need to be part of the conversation of setting metrics and decarbonisation targets. Therefore, leaders in insurance sustainability will inevitably shape the insurance market over the next couple of decades. So, what is the problem with sustainability in insurance? Why have we not reached net-zero, and what are the hurdles for enterprises? Let’s explore the key challenges that organisations will face on their journey to net-zero.

Assets

In insurance, often the first thing that springs to mind when a sustainable strategy is mentioned is an insurers asset portfolio. As an industry we want to be more conscious of the assets we hold, the activities we fund, and their impact on the environment and society. Unfortunately, this may not be as easy as not investing directly in oil, as investing in government bonds or innocuous private assets, may inadvertently lead to supporting inefficient industries, dependent on the political climate and supply chains.

Given the billions of pounds in insurance companies, where they choose to invest has a direct impact on global economies, hence insurance companies have a unique ability to encourage sustainability across markets, through making ethical investment decisions.

The problem is that there is no golden ribbon for early adopters. An insurers performance has traditionally been measured by their profits for both shareholders and policyholders. Aligning their investment policy to sustainable goals, may not be the optimal portfolio for profitability. Without an industry led approach, an insurer that attempts to jump to the finish line may appear to be a poor investment for shareholders, and unit-linked policies may not appear desirable when compared to competitors.   

The Net-Zero Asset Owner Association (NZAOA) was formed in 2019 to lead the industry with issues stemming from carbon impact related to asset portfolios. Their second edition Target Setting Protocol can be found here: NZAOA-Target-Setting-Protocol-Second-Edition.pdf (unepfi.org)

Liabilities

A newer sustainability issue, which was highlighted at last year’s COP26, was that of sustainable underwriting. In fact, the Net-Zero Insurance Alliance (NZIA) was set up to specifically tackle this issue. So, how do our underwriting practices impact sustainability?

Immediately, we should frame what products will have the greatest impact to sustainability. Insurers writing an individual life insurance policy needn’t worry. In fact, I would narrow our scope to largely general insurance companies, group protection policies, and group pension arrangements.

An insurer could limit their exposure to emissions by avoiding underwriting enterprises with a negative environmental impact. This definition could be limited to underwriting activities related to a poor environmental impact, or all insurance sold to an organisation deemed to have a low sustainability rating.

The NZIA has outlined their methodology. Insurers should reduce the proportion of commercial lines that are not following the Science Based Targets approach laid out by the Science Based Targets Initiative (SBTI).  A key element of this methodology is that historically insurers have focused on the adaption to physical effects of climate change, rather than the mitigation through a proactive decarbonisation agenda. The NZIA guidance was published as a white paper in April: Insuring-the-net-zero-transition.pdf (unepfi.org)

The SBTI have issued guidance to carbon intensive industries such as Aluminium, Aviation, Oil, and Gas. They have also issued guidance for Financial Institutions: Net-zero for financial institutions - Science Based Targets

General insurance covers a wide range of products – we will focus on the largest UK product. Motor insurance is a great example of an product type where underwriting a large volume of business, has a direct impact to the environment. It could be that we encourage a wider adoption of electric vehicles, that insurers attempt to limit the proportion of non-electric vehicles that they underwrite, or that insurers encourage the public to use lower emission alternatives, such as public transport. These are a few of the examples that the Net-Zero Insurance Alliance has outlined as potential ways insurers could commit to reducing their carbon impact through their underwriting processes and business practices.

Operational Sustainability

One last view is the environmental factors that should be considered from day to day running of the insurer. This could include energy consumed from office space, disposable coffee cups, petrol from employee commutes, long-distance business travel, laptops left on overnight… the list goes on.

The point here is that whilst deciding upon Asset and Liability strategies that will make a positive environmental impact, insurers can introspectively analyse their own operation for actions that they can take to be closer to net-zero. One of the biggest examples, stemming from recent years, is the reduction in commute and office space required from a remote/hybrid working location.

Another area to consider is how extreme temperatures, and extreme weather, will affect the claims experience of your portfolio. Extreme temperatures tend to increase mortality and extreme weather will increase claims on property. A great quantitative analysis of how climate change may affect mortality rates was published by 4most in the latest The Actuary magazine: Boiling point: the effect of rising temperatures on future mortality | The Actuary

The Future

A big factor of how insurers will react to the increasing needs to be environmentally conscious will be the steering of committees, such as the NZIA and the NZAOA, who are part of the wider Principals for Sustainable Insurance (PSI) group. Around COP27, there has been a serious of events, from the PSI, focussing of different pieces of the puzzle. You can find these talks here: PSI COP27 Sustainable Insurance Series – United Nations Environment – Finance Initiative (unepfi.org)

The PSI and SBTI are working closely together to ensure insurers have a clear roadmap to net-zero. We will also see involvement and alignment with the Partnership for Carbon Accounting Financials (PCAF) who are developing the first global standard to measure insurance-associated emissions. Their initial version of the standard is primarily focussed on financial emissions that stem from lending and investment portfolios. There is expectation that PCAF and NZIA are working on extending the material to include underwriting portfolios. The goal of the standard is to empower insurers to decarbonise their asset/liability portfolios through target setting, scenario analysis and strategy development. Learn more about their efforts here: The Global GHG Accounting and Reporting Standard for the Financial Industry | PCAF (carbonaccountingfinancials.com)

Many of the targets are set for between 2030 and 2050. To reach these targets, we need to drive conversation now.