Oliver Schelske places nature-related risks within an actuarial context, and explains why it is so important for insurers to understand such risks
Our natural world is under threat. Species diversity is declining and ecosystems are being degraded – yet we remain dependent on nature for our prosperity and wellbeing. Threats to nature are therefore threats to humanity.
Nature losses can cause physical and transitional risks. The UN Sustainable Development Goals (SGDs) 14: Life below water and 15: Life on land are relevant to every other SDG. There is no longer any debate as to whether insurers or actuaries should assess risks that may emerge from natural losses – the question is how they should do so.
Physical and transitional risks
Corporation-related nature risks fall into a couple of categories. Companies that depend on nature, and produce in areas where ecosystem services are already reduced, are exposed to more production-related risks in the event of progressive pressure on ecosystem services than companies from sectors that are less dependent on ecosystem services, and/or that operate in areas where nature is less under pressure.
The materialisation of physical risks will lead to corresponding consequences for long-term competitiveness, cost structure, attractiveness to investors and lenders, job supply and tax payments. Furthermore, companies must comply with changing legal frameworks such as emission regulations or land use requirements. Non-compliance poses a liability risk and can lead to fines, compensation and other measures.
Transitional risks apply equally to long-term capital goods, consumer goods and financial products. Consumers increasingly prefer products whose low ecological footprints can be credibly and certifiably proven; providers that do not have such products may suffer sales losses or lose their attractiveness to investors and lenders.
When risks materialise
The challenge for insurers and actuaries is understanding and measuring stress on and within nature, and assessing how it might become relevant for property and life and health insurance. For example, natural flood barriers such as coral reefs, mangrove forests or wetlands lose their functionality if they are damaged. A degraded coral reef offers less protection from storm flooding, which increases risk to local coastal properties. Insurers therefore need a reliable and replicable way to capture risk associated with reef damage.
“Insurers should only support projects if strict, verifiable and independent environmental impact assessments are in place”
Another example is terrestrial habitats. If they are destroyed, altered or fragmented, the probability of contact with zoonotic pathogens can increase. Eroded or polluted soils limit agricultural output, the consequences of which include a less diverse diet, higher prices for input factors (such as in food processing) and shortages. Damaged or destroyed forests cannot produce the same levels of timber, while pollution and over-use affect the quality and quantity of fresh water.
Productivity losses and operational interruptions can increase over the medium-to-long term. In many countries, environmental damage has direct implications for local subsistence, and biodiversity loss also affects human populations directly. The effects of natural degradation on mental and physical human health are often underestimated. It has been proven that proximity to nature and time spent in nature increases wellbeing, and can lead to lower medical costs.
Although insurers may be able to cover different damages, they must regularly check the loss development. Only about a quarter of all global losses due to natural hazards are insured; for the uninsured, financial existence can be endangered if governments do not step in financially – on top of the personal suffering involved.
The role of science
Capturing the exact extent of nature-related risks is an evolving discipline. Current research uses input-output models, footprint and lifecycle analyses to determine the ecological consequences of a particular economic activity. Activities that lead to standardisation and communication of biodiversity and ecosystem services-related corporate data, as is the aim of the Taskforce on Nature-related Financial Disclosures, are very important. Because climate change impacts biodiversity, it is important to follow the Taskforce on Climate-related Financial Disclosures. An internationally recognised and scientifically supported framework for collecting and communicating this data supports consistency in the implementation of national initiatives.
It is also important to test such a survey framework across sectors, and to adapt it if necessary.
What we can do already
Even if spatial planning or infrastructure policy is made by governments, the insurance industry and actuaries can consider excluding support for economic activities that do harm in areas of importance for nature conservation. Risk management, asset management and underwriting can assist such exclusions.
In any case and also outside of these areas, insurers should only support major projects if strict, verifiable and independent environmental impact assessments are in place.To minimise nature-related risks, specific mandatory guidelines could be implemented for sectors that are particularly dependent on nature outside protected areas, or that have a particularly negative impact on nature.
“The problem of biodiversity loss can only be solved through the joint efforts of all actors”
Insurers can also consider how they can protect and insure natural capital. Construction risks, for example, can be insured in landscape restoration, such as forestry or wetlands – assuming that a neutral or positive effect on biodiversity has been previously tested and confirmed. Payments because of damage can also be linked to the improvement of the ecosystem, provided there is a clear link between damage and ecosystem function. Tropical storms, for example, can cause pollution of reefs or mangroves that protect the coast, as they bring dirt and debris that accumulates in the ecosystem and affects its species. Portions of the insurance payout can be used to support local groups that are cleaning up the ecosystem after a storm.
Biodiversity risks: An actuarial classification
Climate change and biodiversity loss are two sides of the same coin – the challenges of one cannot be solved without the other. The International Actuarial Association (IAA) Climate Task Force has applied its climate methodology to insurers and other financial institutions; if we are to frame biodiversity as an actuarial challenge, we can be inspired by this pioneering work. Table 1 applies IAA’s work on climate to biodiversity.
Ultimately, the problem of biodiversity loss and ecosystem service impairment is complex, globally and locally relevant, and spatially different. It can only be solved through the joint efforts of all actors. Due to its multifunctionality, a biodiversity policy must be cross-sectional. In other words, policies for agriculture, governmental infrastructure, energy, trade, spatial planning, housing and financial services must become ‘biodiversity and ecosystem services-friendly’.
Oliver Schelske is a director at Swiss Re Institute, Group Underwriting, and its natural assets and ESG research lead
