What role could insurers play in the much-needed transition to a low-carbon economy? Travis Elsum investigates
Last year was a watershed in the climate change narrative - the UK parliament declared a climate emergency, schoolchildren marched en masse and devastating wildfires raged across multiple countries. The enormity of the challenge we face, and the grave consequences of any failure to arrest it, sunk in.
Global annual CO2 emissions need to halve by the end of this decade and then reach net-zero by 2050 in order to limit the increase in global average temperatures to 1.5°C. Conversely, though, emissions have increased by 4% since the Paris Agreement was struck in 2015 - and are showing no sign of falling. For every year of delay the bar is raised, with deeper net negative emissions required in the future.
The climate change problem is so pervasive and complex that it will not be solved by one person or breakthrough technology. Halting it will require an almost complete rewiring of the global economy - a co-ordinated effort from governments, experts and organisations across sectors.
Long-term investors such as insurers, pension funds and other financial companies have a major role to play. Their actions can influence whether sustainable technologies will supplant fossil fuels.
Reasons for supporting the transition
Supporting the transition to a low-carbon economy sits squarely within the corporate social responsibility of insurers and other financial companies. It is no longer enough to solely exist to create shareholder value - companies are increasingly expected to play a more beneficent role in society. Similarly, employees are less likely to connect with the traditional goals of churning out ever more widgets. They are searching for something more - to make a difference.
Last year, the Business Roundtable released a statement on the purpose of a corporation (bit.ly/2GhLhMo) - signed by almost 200 US companies - which commits to supporting a wider range of stakeholders and adopting sustainable practices. While a degree of scepticism is healthy, many insurers are already practising these principles. L&G's CEO Nigel Wilson, for example, has championed and embedded inclusive capitalism, whereby shareholder value is generated through products, initiatives and investments that also have broader social and environmental benefits.
There is another, perhaps more compelling reason to support the transition - the bottom line. Addressing climate change will drive unprecedented rates of change in the energy, transportation and food sectors, potentially stranding billions of pounds' worth of assets. Insurers that do not engage will be poorly equipped to manage risks and seize opportunities. It is the equivalent of investing in Kodak film during the rise of the digital camera.
Bank of England governor Mark Carney has been vocal in warning companies about the significant financial consequences of not paying heed to transition risks. Actuaries will play an essential role in helping insurers and other financial companies better understand these risks.
How to support the transition
Insurers can support a smoother transition by investing in sustainable infrastructure, influencing heavy emitters and, if necessary, divesting. They can also offer and promote new sustainable products.
Insurers can use their own assets to invest directly in sustainable infrastructure and technology. The lengthy investment horizons and typically stable payoff associated with these assets are well suited to long-term investors.
Several insurers have set ambitious targets for sustainable investments. AXA is targeting 24bn of green investments by 2023, including infrastructure and real estate. Aviva has already invested £3bn in low-carbon infrastructure since 2015, exceeding its own target two years early.
Engage and influence
Insurers, pension funds and other financial companies own or manage trillions of pounds of assets. They can use these to engage with and influence companies on climate change. Forming coalitions can further increase their influence.
The Climate Action 100+ group (bit.ly/2Pqy8WU) is a notable example, representing more than 370 investors with over US$35trn assets under management. The group aims to influence the largest corporate emitters to align with the objectives of the Paris Agreement. It has successfully co-filed a number of climate-driven shareholder resolutions.
The level of climate change engagement varies significantly across the sector. An InfluenceMap report (bit.ly/35qxNJj) on asset managers found that Allianz, AXA, L&G and UBS led on climate engagement, while large US-based managers trailed. In particular, BlackRock voted against 89% of climate-driven resolutions.
There may ultimately be a limit to the power of investors to influence heavy emitters, especially in the US. The US Securities and Exchange Commission
set a precedent by granting ExxonMobil's request to block a climate change-related shareholder resolution on the grounds that it amounted to micromanagement.
Divesting or restricting services can be effective where engagement fails and for investments that are inherently incompatible with the Paris Agreement, such as new coal mines and coal-fired power stations. Divestment adversely impacts the valuations and funding costs of target companies. General insurers and reinsurers can further affect the viability of new projects through the restriction of cover.
The 2019 Unfriend Coal scorecard found that reinsurers representing almost 50% of the market have either ended or limited their coverage of coal projects, while 35 insurers and reinsurers have adopted coal divestment policies. Swiss Re achieved the top score on restricting insurance and divestment. These initiatives appear to be having an effect, or at least provoking a reaction, with Australian prime minister Scott Morrison - who, as Treasurer of Australia, brought a lump of coal into parliament - reportedly exploring ways to ban such practices.
Wider divestment strategies are more complex. Divesting from emissions-intensive sectors can reduce the time-zero emissions intensity of a portfolio, but may not recognise and support companies that plan to transition to a low-carbon business model. Further, insurers and pension funds may be reluctant to tilt towards green investments due to concerns around impacts on tracking error and diversification.
Actuaries are well placed to help insurers and pension funds consider forward-looking climate-related factors in asset allocation decisions using scenario analysis.
Demand for sustainable investments has driven a surge in the growth of investment funds that consider environmental, social and governance (ESG) factors. This is set to continue as campaigns such as Make My Money Matter (bit.ly/35sfB1I) encourage people to invest their pension sustainably.
Investors' ESG preferences are likely to become stronger and more nuanced over time, creating demand for a wider range of ESG funds. For example, some investors may opt for a portfolio aligned with the Paris Agreement, while others may seek to exclude fossil fuel investments altogether.
Innovative solutions will also be needed to help individuals finance and insure new zero-carbon technology at home. A wealth of opportunities willbe available as insurers embrace this decisive decade.
Travis Elsum is group internal model controller at Legal & General.