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The insurance industry and capital markets can mitigate some of the physical impacts of climate change, but infrastructure investment and regulation will be critical in reducing the underlying risk.

At the start of the coronavirus pandemic in Europe, when countries went into lockdown, a cartoon began making the rounds on social media. It showed a fictional city about to be engulfed by a tsunami, labelled Covid-19. Behind it was an even bigger wave, labelled “recession”, and behind that was a truly monster wave, labelled “climate change”.

The message was clear: the pandemic is a major test for governments, society and business, but there are more shocks to come and some – in particular, climate change – represent existential threats requiring urgent action.

A great deal has been written about the need for a clean, green recovery coming out of the global pandemic crisis. While much of the world’s attention is squarely focused on the immediate challenge of Covid-19 and a global recession, climate change has not gone away.

In the long run, climate inaction is likely to be the biggest risk of all. As this year’s World Economic Forum global risks report identifies, “failure of climate change mitigation” will be the biggest global threat (by severity of impact) over the next 10 years. It warned the near-term impacts of climate change add up to a “planetary emergency that will include loss of life, social and geopolitical tensions and negative economic impacts”.

Climate Week in September, is an appropriate time to reflect on the unprecedented scale of the climate change challenge and the role that the insurance sector can play in building resilience and helping to shape a greener future.

Lockdowns at national and local level, as well as the economic aspect of the crisis, have caused a global pause in air traffic and a reduction in commuting, power generation and other oil-intensive activities.

Extreme heat 
But while less carbon has been released in 2020 so far than in previous years, the amount of carbon that remains in our atmosphere continues to have an effect – and the consequences are increasingly clear to everyone. This year is already set to be the warmest or second-warmest on record, with extreme heat events in Australia, Siberia and the Arctic during the first six months of the year. 

An increasing number of insurers now recognise the historical claims record is no longer a reliable basis upon which to price and underwrite risk, as the climate continues to change. Complicating the picture is the fact there are also more assets at risk in many increasingly hazard-prone parts of the world, due to population growth, urbanisation and other macro trends.

According to S&P Global Ratings’ research, 60% of S&P 500 companies own assets that are at a “high risk” from the physical effects of climate change.

It is widely acknowledged by scientists from the Intergovernmental Panel on Climate Change that weather is likely to become more volatile in the future and that some natural catastrophes, including heat waves and floods, will become more frequent and more intense in many regions.

Attribution studies are beginning to assign a climate change footprint to events such as hurricanes, demonstrating how these storms are more powerful/intensifying – and hence more destructive – because the climate is changing (although debate continues over whether Atlantic windstorms are becoming more or less frequent).

A role for insurance 
With more assets at risk and a growing climate crisis, many catastrophe-exposed regions of the world remain under-insured. The “protection gap” – the widening gulf between the economic and insured losses stemming from natural hazards – has grown to $1.24trn, according to the Swiss Re Institute’s Resilience Index. 

This is an especially pressing issue in the developing world, with estimates more than 80% of the world’s most food-insecure people live in countries prone to natural hazards. But there is also significant underinsurance in many mature insurance markets, such as the US flood insurance market.

Use of risk financing and insurance can help countries and communities become more resilient. Here, the insurance industry can play a central role not only to contribute capital, but more importantly, essential skills such as risk modelling to understand and price risk; loss assessment as the first step in addressing the impact of catastrophes and, the know-how to build back better and increase resilience.

I believe the most effective way forward to shift our disaster response from reaction to prevention is a collaboration between governments, international organisations and the insurance industry.

The insurance industry should clearly be part of the solution, not just because of the re/insurance capacity it brings to bear, but also because of its extensive underwriting experience, risk modelling capabilities, risk expertise and claims insights, for the benefit of the wider community.

There are already a number of successful public-private partnerships, at both a country and regional level, seeking to improve societal resilience to climate shocks and offering innovative mechanisms to transfer more of the peak risks to the re/insurance and capital markets.

The insurance Development Forum (IDF), represents such a venture at a global scale, as a public/private partnership led by the insurance industry and supported by international organisations, namely the World Bank Group and the UN to optimise and extend the use of insurance and its related risk management capabilities to build greater resilience and protection for people, communities, businesses, and public institutions that are vulnerable to disasters and their associated economic shocks.

Risk-financing solutions 
Demand for risk financing solutions will continue to grow as the financial burden from climate change becomes more apparent, especially in countries still reeling from the impacts of Covid-19. Responding effectively to these needs will require collective political will to spark the action that is necessary.

The collaboration between the IDF, the UN Development Programme and Germany’s federal ministry for economic co-operation and development is one example of how private and public sectors can come together to improve disaster risk reduction strategies and help close the protection gap.

The tripartite initiative was established to accelerate risk management and financing solutions for 20 countries by 2025, with IDF members committing up to $5bn in total offered capacity to help reduce financial vulnerability to climate risks. It also contributes to the joint G7, G20 and V20 InsuResilience Vision 2025 to cover 500 million poor and vulnerable people against climate and disaster shocks by pre-arranged risk finance and insurance mechanisms.

The first project under the tripartite was recently launched in Peru to develop an insurance programme for the government’s more than 50,000 public schools, an effort between global reinsurers and the Peruvian Association of Insurers.

Public-private collaboration focused on increasing resilience begins with the identification of a country’s main risks and vulnerabilities, based on its strategic socio-economic priorities. These may be to protect valued public assets fundamental to the functioning of its economy, or to promote and protect development in key sectors such as roads and bridges, health, public housing or the agricultural sector.

With these insights, collaboration enables access to risk financing solutions, be it re/insurance cover for critical public infrastructure or the structuring of innovative catastrophe risk insurance pools. Examples of insurance risk pools include the CCRIF SPC in the Caribbean and ARC in Africa, which provide regional governments with immediate financial support post catastrophe loss, as well as supporting and funding long-term sustainable development.

Risk-pooling facilities are also being mooted as a potential model for insuring future pandemics. Systemic risks such as global pandemics will require government backstops and support if they are to be a success, using similar frameworks that have already been established in many countries for insuring terrorism risk.

To tackle the more immediate Covid-19 crisis, a public-private partnership (PPP) between the IFC, a subsidiary of the World Bank Group, and six global insurance companies has been set up to mobilise $2bn in credit capacity under the Managed Co-Lending Portfolio Program.

Looking ahead, PPPs will continue to play an important role as governments, business and society look for more effective risk mitigation and financing strategies to counter the threats posed by climate change. It is not just about the ability of the insurance industry and capital markets to absorb ever-increasing risk, but investment in reducing the underlying risk by building more resilient cities and infrastructure.

The risk is not just physical, it is also transitional and reputational, as governments work towards their Paris Agreement commitments and organisations look to build more sustainable business models, driven by a growing raft of stakeholder requirements and expectations set out to encourage and protect socio-economic development.

The Covid-19 crisis has illustrated how quickly business models can become obsolete in the face of catastrophe. Equally, the transition to a low-carbon economy, and lack of preparation for this, is likely to catch many off-guard.

Being “resilient” is as much about the ability to change and adapt, as it is about building more robust and sustainable societies and economies. The insurance industry itself must be ready to take the lead, make challenging decisions and adapt its own business models as it rises to the challenge.

Through the IDF, our goal is to encourage this action, to foster greater collaboration through PPPs and in other arenas, so that insurers can seize the opportunity to play their part in building and sustaining a more resilient future. 

Denis Duverne is chairman of Axa and the Insurance Development Forum.

This article was first published in Insurance Day.


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