Climate change is widely accepted as posing many risks to businesses, including physical risk, regulatory risk, reputational risk, structural risk and liability risk. The acuity of each risk varies across sectors, with the insurance industry expecting physical risk to be its biggest challenge.
The issue of assessing risk was the topic of a November, 2011 panel at the International Emissions Trading Association (IETA) Fall Symposium on Climate Change and Business Risk. In addition to discussing general climate risks, panellists probed an interesting and inconspicuous aspect of climate change risk. In the insurance industry, companies manage their own risks and through the insurance market, negotiate the price of the risks clients chose to insure against. In turn, insurance providers and the insured face direct climate risk to their operations as well as the indirect risk associated with insurance packages.
In a first-of-its-kind report, sustainability-focused think tank Ceres found broad consensus from insurers that climate change will affect extreme weather events. However, the sector has largely not adopted formal policies. Only one in eight companies have a climate risk management structure, even though natural catastrophe losses in 2011 were 40% higher at the time of publication than in 2010.
The study’s author, Sharlene Leurig, suggests that the industry is looking “backward” when pricing climate change risk, using historic models that do not capture how risks are changing. Subsequent risk assessments threaten the balance sheets of the companies themselves and shareholder value. Leurig recommends insurance companies work to develop forward-facing scenarios as well as exploring insurance-linked securities, catastrophe bonds and adapted capital allocation.
Small-scale, formalized climate change insurance is an emerging business with some reputable participants. For example, the World Bank’s Multilateral Investment Guarantee Agency provides insurance coverage for greenhouse gas reduction schemes for Clean Development Mechanism (CDM) projects. Coverage accounts for the risk of non-delivery of CDM credits. The model can be extended to cover the risk associated with non-delivery of credits or offsets in other carbon pricing systems (Alberta’s Specified Gas Emitters Regulation, the upcoming Western Climate Initiative). Innovative climate insurance solutions offer vanguard opportunities for insurance providers, and risk management tools for insurance clients.
