In a recent speech to Lloyd's of London, the Prince of Wales told the insurance market “We have never needed you more than we need you today”, urging insurers to do their part to help with the transition to a low carbon world. He said that there would need to be a seismic shift in investment to new technologies, and that “if there is one insurance policy we need, it’s the one that guarantees the survival of the natural systems that sustain all life on earth.”
The Prince stopped short of mentioning any specific ways in which the insurance industry might help guarantee the survival of the natural world. The focus of his brief speech was on assisting with new technologies rather than working against those that contribute to climate change.
Increasingly, however, others are less circumspect. Climate change activists, frustrated at a lack of progress from targeting large emitters directly, are targeting insurers and other financial services firms that provide services to emitters. Large financial services firms are generally more susceptible to threats to their brand and other societal pressures than large emitters and they are not wholly reliant upon carbon-intensive industries for their profits.
We see three key areas in which the insurance industry may play a role in reducing climate change:
• Reducing or withdrawing insurance cover for greenhouse gas emitting industries, forcing them to pay higher premiums as competition decreases, or forcing them to self-insure, increasing their risk and thereby reducing their ability to raise equity and debt funding
• Increasing reluctance to invest their reserves in those industries, further denying them essential equity and debt funding
• Policy clauses targeting greenhouse gas emissions reductions
Reduced or withdrawn cover for large emitters
Large greenhouse gas-emitting industries are increasingly reporting difficulty in persuading insurers to cover their risks. This is not because of a concern that those industries will suffer insured losses as a result of the effects of climate change, such as storms and flooding, but because insurers are beginning to respond to activists’ demands that they recognise a wider responsibility not to support businesses that contribute to climate change.
In 2021, the UN convened a Net-Zero Insurance Alliance of insurers and reinsurers representing more than 11% of premium values globally. Its members are a ‘who’s who’ of global names such as AXA, Allianz, Aviva, Zurich, IAG, Munich Re and Swiss Re. They have committed to transition their insurance and reinsurance underwriting portfolios to net-zero greenhouse gas emissions by 2050. While this remains only a small proportion of the global industry and the target date is decades in the future, it is an indication that the insurance industry is committing to move away from insuring carbon intensive businesses.
The language used is strident: the chief executive of AXA, Thomas Buberl, is reported to have said that the goal is to have “all the insurers applying a methodology to only underwrite companies directed toward climate transition and not to the dark ages of burning coal.”
Some climate change activists have criticised the Net-Zero Insurance Alliance for a lack of ambition. The Association of British Insurers, in contrast, has issued a climate change “road map” with an earlier target of 2030 to halve emissions linked to its members’ operations, supply chain, investment and underwriting portfolios. That is only 8 years from now.
European insurance companies appear to be leading the way, with a number having announced restrictions on their willingness to cover the coal and mining industries. AXA was an early adopter, announcing in 2015 that it would not make new investments in the coal industry, initially excluding companies that earned 60% and then 50% of their revenue from carbon-emitting operations. Other insurers followed. Chubb, for instance, avoids making new debt or equity investments in companies that generate more than 30% of their revenue from thermal coal mining or energy production from coal, and it no longer offers underwriting for the construction and operation of new coal-fired plants for companies that generate more than 30 percent of their revenue from coal production. It has said that it will phase out its insurance cover for existing coal plants that exceed this threshold this year. The large US insurers appear at present to be moving more slowly in this direction, although that could change quickly.
The effect of all this is likely to be that large emitters will increasingly become uninsurable at commercial rates, which will force some to self-insure. This will result in those industries becoming operationally riskier, making them less attractive to lenders and investors. This will drive down their market values, resulting in investor losses (or lower profits) and reduce their ability to grow and maintain their businesses.
Not only coal miners and coal consumers will feel the pinch. Other large emitting industries such as aviation, shipping, cement, steel, oil and gas are likely to experience rejection from insurers in time. Methane-intensive agriculture such as dairy farming may also experience the same problems; a significant issue for New Zealand.
Increasing premiums are also likely to drive business behaviour. As the liability risk associated with emitters increases, so too will premiums, which could in turn lead insured businesses to move away from operations which put them at risk of claims. As financial markets and regulators react to the threat of climate change by requiring disclosure of insured businesses’ climate information, the risk of liability for disclosure breaches and other liabilities such as regulatory action for “green-washing” is also on the increase. Underwriting focus, particularly in D&O, statutory liability and environmental liability lines, will likely sharpen given the increased risk of climate change-related regulatory actions.
These changes could have a very significant effect upon the global economy as insurers’ actions starve essential industries of critical investment. While this may assist in the move to a net zero economy, it risks doing so in an ad-hoc manner that may not produce the best outcomes for the least economic pain.
Reduced investment
Importantly, large insurers, because of their need for substantial financial reserves to enable them to pay claims, are significant investors in the bond and equity markets as well as providers of insurance services. This means that greenhouse gas emitting businesses face a double-whammy – at the same time insurers are increasingly reluctant to insure them, their sources of finance, which provide a buffer against losses and permit them to self-insure to some extent, are also becoming constrained.
As major participants in the equity markets, the spotlight will be on insurers to ensure that they are investing appropriately and consistently with their advertised environmental, social and governance targets.
New policy obligations
The insurance industry is also beginning to experience a push for mandatory disclosure of climate-related information. Insurers are beginning to request disclosure of climate-related risk information
from insureds.
New policy clauses may play a role in this. Some insurers, particularly those based in the US, recognise that many large greenhouse gas emitters are essential industries that will require a transition period if economic collapse is to be avoided. They may seek out a pragmatic middle ground where they continue to support essential large emitters provided they demonstrate an intention to reduce their impact.
The recently established Chancery Lane Project provides “climate clauses” for use in many kinds of contracts, with insurance policies being no exception. Model clauses specifically for insurance purposes include:
• a General Condition requiring companies to carry out a climate change risk assessment (Kitty’s clause);
• a coverage extension to cover any pending climate change litigation on the condition that the insured
discloses its net zero targets and climate risk exposure (Cassie’s clause);
• explicitly excluding cover for climate liability, costs and losses where the insured fails to meet its greenhouse gas emissions reduction targets (Conor’s clause); or
• incentivising insureds to mitigate their climate risk and for insured’s directors and officers to comply with their duties by reducing insurance premiums for insureds that meet agreed disclosure standards regarding climate related financial risks (Archie’s Clause).
Whether these market changes will ultimately drive better business behaviour remains to be seen. One possible development could be a growth in captive insurance for large-scale emitters, although the reinsurance market may in time come to respond to the same pressures as the primary market.
Insurers bear a heavy responsibility. While they have an opportunity to lead meaningful change, they will need to tread carefully and consider the risks that their actions will have unintended consequences.
