Rowan Douglas explains how the insurance industry can play a more critical role in combating climate change
Insurance sector communities have the invaluable expertise and resources required to address society’s climate challenges, but that experience is not fully understood or harnessed by the mainstream climate and resilience agenda. With COP26 drawing ever nearer, the insurance industry has a once-in-a-decade opportunity to recapture its historic role in social transition and gain a seat at the main table in Glasgow.
When the Paris Agreement was adopted by 196 nations in 2015, the annual COP meetings became the focal point of global efforts to tackle climate change. While some of the signatory nations have since made progress, it is still urgent that we cut emissions and adopt resilience strategies.
Like few other parts of the financial services sector, actuarial sciences have underpinned the social insurance systems that have enabled social transformations. Natural catastrophe modelling also has obvious applications within the climate challenge and highlights our industry’s unique ability to accurately price risk over the longer term.
It shouldn’t be surprising that an industry built upon the mathematical and philosophical foundations of the 18th-century Enlightenment is now well placed to provide assistance in the quantification of climate-related risks and the evaluation of the related choices and trade-offs.
Since the early 1990s, the insurance industry has revolutionised its mainstream assessment of climate-related risks and integrated this into its core pricing, risk controls, regulatory disclosure and capital management. A decade ago, led by Munich Re and in concert with public and academic partners, the industry created the Global Earthquake Model Foundation (GEMF), a global facility to assess the seismic risks to properties, infrastructure and wider assets.
The GEMF’s aim was to support better planning, building codes, investment, insurance and disaster responses to help save the millions of lives, livelihoods and assets that were at risk due to seismic activity. We now have the opportunity to emulate that ambition and provide a programme for building a global resilience model to support physical climate risk scenarios, stress testing and analysis for exposed communities, markets and assets.
Because climate resilience is the product of many factors, insurance is not a ‘silver-bullet’ solution. However, it is a necessary component because, when disaster strikes, the ability to rebuild homes, businesses, jobs and lives is central to economic recovery.
The global pandemic has demonstrated that risks are systemic and will cascade through an economy if left unchecked. It has become more widely acknowledged that the world has reached the critical threshold at which it must act on the climate change lessons learned in the insurance industry, which are worth sharing more broadly.
Through insurance, communal risks can be shared across public, private and mutual systems via premiums, taxation and hybrid systems. With sound scientific principles, economic sustainability and transparency to build upon, costs, payouts and incentives can be designed to support affordability, risk signalling, resilience and wider solidarity.
In conjunction with wider financial reforms and processes, we also need to ensure that companies and local and national governments have enough support to evaluate and formally manage their contingent climate risks and liabilities.
The history of physical, industrial and social transition has shown that changes need to occur at speed and across all economies. They will require the provision of public, private and mutual insurance (including hybrid approaches) to enable a financially, socially and politically viable process. This is not just about commercial insurance products and/or public services; it is about the adoption of ‘insurance thinking’ with regard to risk assessment and the creation of economically sustainable risk pricing and risk sharing mechanisms.
It is a mammoth task, but we don’t have to start from ground zero for insurance to play a role in achieving a net-zero and climate-resilient economy. There are organisational vehicles already in place to help speed us along this journey.
“When disaster strikes, the ability to rebuild homes, businesses, jobs and lives is central to economic recovery”
For example, the Insurance Development Forum (IDF), launched at COP21 in Paris, was created in recognition of the critical role that risk management plays in the response to climate change. The IDF is a unique international institution that brings together the private and public sectors to help countries build the resilience they need to limit physical, social and financial climate change impacts.
The global challenge of closing the ‘risk protection’ gap brought by climate change is at the heart of the IDF’s mandate, and it has already found success using its Tripartite Agreement project to support major sovereign and sub-sovereign programmes.
It is also engaged in the development of the Global Resilience Index (GRI), an open-access platform providing reference data, risk metrics, mapping and resilience evaluation tools. The GRI will not only help insurance coverage but can also play a critical role in targeting resources, including from the development finance institutions and in building resilience where it’s needed most. A GRI prototype will be ready by COP26, with a view to launching a full index next year.
Risk management and strategies
Disaster risk financing has risen up the agenda in recent months, with campaigners and insurers advocating for more attention from governments to manage risks before they become crises, with pre-arranged finance that can be deployed the moment disaster strikes.
Most catastrophes, such as earthquakes, wildfires, floods, droughts and disease outbreaks, are predictable. But the international crisis financing system only covers around 2% through pre-arranged funding, relying instead on humanitarian aid that can takes months to deliver, by which point the secondary impacts have turned the original disaster into an enduring crisis.
Willis Towers Watson (WTW) is working on innovative projects to develop climate and disaster risk strategies with the city of Medellin in Colombia to help its citizens recover more quickly from natural catastrophes, such as landslides and earthquakes. Alongside partners, MAR Fund and InsuResilience Solutions Fund, WTW is also participating in the world’s first multinational collaboration to design and implement parametric insurance to help restore the Mesoamerican Barrier Reef System, listed as endangered by the International Union for the Conservation of Nature, following hurricane damage.
This model of shared success, augmented by inclusive insurance and mainstream market expansion across many territories, provides the ideas and facilities to support the countries looking to protect their people and assets from the dangers of climate change.
Only by accounting for risk can we properly value resilience and align economic incentives with secure climate outcomes.
As major investors, underwriters and risk managers, insurers can play a leading role in enabling the wider finance, infrastructure and public sectors to implement the risk-informed rating systems, pricing and economic systems that will achieve the same outcomes for climate resilience.
A pivotal moment
COP26’s host city of Glasgow is also the ideal location to renew ambitions for the role of insurance at the outset of the green financial revolution; traditional economic models will need to be updated to incorporate the modern context, including the climate and environmental risks to capital and human wellbeing.
As we look to a period of unparalleled urgency and ubiquity, technical and environmental transitions, we should make sure to anticipate and create the insurance systems we will need, rather than delaying preparations until the risks, costs and losses reach crisis levels that will spur the necessary actions later on, when they will be less effective.
If we seize the opportunity, society may look back on COP26 as the pivotal moment in climate-financial history – in the same way we now look on COP21 for its influence on climate politics. November may also be remembered as the month the sleeping insurance sector awoke to fulfill its potential in helping quell today’s climate emergency.
As the providers of risk transfer solutions, insurance companies have always been ‘in the room’ for climate change discussions – but we are yet to fully sit at the main table where the historic solutions will be forged. COP26 is a strategic opportunity to finally and comprehensively take our seat.
Rowan Douglas is head of the Climate Resilience Hub at Willis Towers Watson, and the chair of the operating committee at the IDF