Insurers must wake up to the risks of climate change and back the low-carbon economy
Climate change poses a double threat to the insurance industry. It faces mounting costs from claims relating to the physical impacts of climate change and knock-on events such as the disruption of global supply chains. At the same time, the investment portfolios that enable it to meet claims are themselves exposed to climate risks in the transition to the low-carbon economy.
Speaking to insurers last year, Mark Carney, Governor of the Bank of England and Chairman of the international Financial Stability Board, warned that investors face “potentially huge” losses from climate action that could leave vast reserves of fossil fuels as worthless stranded assets.
Climate risk is now a mainstream issue for institutional investors. The FSB has set up a task force chaired by former New York Mayor Michael Bloomberg which will make recommendations to the G20 on how asset owners, the companies they invest in and financial intermediaries should report the potential impact of climate change on their
The global commitment to limit climate change to two degrees also presents asset owners with new opportunities. In the same “Tragedy of the Horizon” speech Governor Carney observed: “Financing the de-carbonisation of our economy is a major opportunity for insurers as long-term investors.”
AODP’s annual Global Climate 500 Index rates the world’s 500 largest asset owners on their success at managing climate risk in their portfolios, grading them from AAA to D, while “laggards” taking no action are rated X. It reveals that as a group the world’s biggest insurers are ignoring warnings on climate risk and lagging behind pension funds on the three key capabilities required to protect their portfolios: risk management, engagement and lowcarbon investment.
Insurers are way behind pension
funds in protecting their portfolios
from climate risk. Only one in eight
is taking tangible action compared
with one in four pension funds.
This special report focuses on 116 insurers with $15.3 trillion of investments and compares their performance with 324 pension funds with $15.9 trillion. These two groups account for over 80% of the $38 trillion of assets covered by the Index.
The Index identifies 31 asset owners who are leaders on managing climate risk, rated A+.
They include 26 pension funds, but just one insurer, Aviva. Across the Index just 14 insurers, one in eight, are taking tangible action to manage climate risk in their portfolios, rated C+, compared with one in four pension funds.
Insurers perform worst on their
core competency, managing risk.
Just 1% consider the risks of
Insurers perform worst and lag furthest behind pension funds on what should be their core competency: risk management. While they may be considering the effects of climate change on their liabilities, the vast majority of insurers are overlooking the impact of the low-carbon transition on their investment portfolio. Just 1% consider the risks of stranded assets, compared with 6% of pension funds.
They also underperform on engagement. Only 8% of insurers have staff dedicated to integrating climate risk into the investment process, half as many as pension funds.
Just $30 billion of insurance assets on the Index are in low-carbon investments compared with $93 billion of pension assets. Among those asset owners who disclose low carbon investments, on average these represent just 0.8% of insurance portfolios but 3.5% of pension portfolios.
Insurers are exposed to additional risk because generally their asset allocation is far more
concentrated into fixed income than pension funds. This leaves them exposed to the climate capacity of ratings agencies who are only starting to reassess this risk. Such exposure can have major consequences for the whole financial system as identified by the FSB after the sub-prime mortgage crisis. Insurers’ lack of asset class diversification also means that company engagement is restricted to a minimum although their direct company risk is retained through corporate bond risk.
The Index also reveals big differences between regional markets. European insurers outperform insurers in the Americas and Asia Pacific on risk management, low carbon investment and engagement, and they make up 11 of the 14 insurers taking tangible action on climate change. However, a quarter of European insurers are doing nothing, with $730 billion completely unprotected, 10% of regional insurance assets.
In the Americas, three in five insurers (61%) are taking no action on climate change putting $954 billion at risk, nearly a third (32%) of regional sector assets.
In Asia Pacific nearly half the market (44%) is taking no action, putting $2.5 trillion at risk, more than half of regional assets (52%).
Most asset owners are only starting to get to grips with the huge implications of climate change for their investments and far more action is needed across the board, but there can be little excuse for the world’s biggest insurers to lag so far behind pension funds. By failing to protect their investments they are threatening their long-term capacity to cover future claims and placing the security of millions of clients at risk.
As long as few insurers take action
on climate risk, there is a danger of
a systemic failure which could have
catastrophic effects on the wider
Insurers manage a third of the world’s investment capital, so their actions can have a profound impact on the global economy. As long as few insurers take action on climate risk, there is a danger of a systemic failure which could have catastrophic effects on the
wider economy. Conversely, by investing just a fraction of their portfolios in low carbon assets, insurers could play a key role in the transition to a low carbon economy and battle against climate change.
The Paris Climate Summit signalled the end of the fossil fuel age by pledging to limit warming to a maximum two degrees. The insurance industry now needs to wake up to the real risks of climate change, take urgent action to protect its trillions of dollars of investments, and in so doing help finance a smooth transition to a low-carbon economy.