Climate change has the potential to erode insurers’ profitability as they face increased payouts from claims associated with extreme weather. Yet many remain reluctant to adjust their underwriting activities. Environmental, social and governance (ESG) reporting requirements are slowly increasing but are they enough to ensure the industry reaches net zero by 2050? mallowstreet Insights believes the UK re/insurance industry would benefit from more stringent guidance, and here is why. 

 

 

The Bank of England’s (BoE) first Climate Biennial Exploratory Scenario 2021 (CBES) concluded that insurers would, on average, experience an annual drag on financial results of 10-15%, but its extent could vary considerably in different climate scenarios. As expected, under the ‘No Additional Action’ scenario, a build-up in physical risks could lead to a rise in average annualised losses of general insurers of around 50%, and higher for international insurers in the UK market. 

 

Claims from natural catastrophes are already rising, however most insurers have not yet set risk appetites for underwriting activities, and avoidance of cover for certain businesses in carbon-intensive sectors was still rare in 2022, when the BoE conducted its most recent CBES. 

 

To help the industry prepare, the UN-convened Net-Zero Insurance Alliance (NZIA) published a reporting standard in 2022 to help re/insurers attribute GHG emissions to insured assets, insurance underwriting, and companies associated with these activities, so they transition their underwriting portfolios to net zero by 2050. 

 

The NZIA also put in place a target setting protocol in January 2023. Initial targets were meant to be disclosed by July this year (initially just one target, then one in each of the three categories by 2024): 

 

However, members left the NZIA in droves, with just 11 members left from nearly 30. Many departed due to antitrust concerns in the US but reaffirmed commitments to set their own strategy and approach, albeit with a much greater focus on their investment activities. Eventually, the NZIA dropped demands from members to disclose emission targets. Instead, its target-setting protocol will serve as a voluntary best practice guide to aid standardisation. 

 

 

Despite being out of scope for NZIA recommendations, life insurers are leading the way towards net zero. Their ESG credentials are increasingly under scrutiny, as pension schemes prepare to transfer risk to insurers while following the Pensions Regulator’s (TPR) guidance on ESG reporting. While transaction pricing is much more important, sustainability requirements can be the deciding factor when quotations are tightly grouped and schemes are in surplus. 

 

As a result, all life insurers providing bulk annuities have net zero targets now, according to Hymans Robertson. But a separate analysis by Lane Clark & Peacock has found only half were reporting in line with the recommendations of the Task Force for Climate-related Financial Disclosures (TCFD) at end of 2021. 

 

 

In the UK, firms supervised by the Prudential Regulation Authority (PRA) are expected to integrate climate change considerations across all assets and liabilities. However, some say the PRA appears to have downgraded the importance of climate change risk – and only says it will continue to ‘assess firms on their ability to meet supervisory expectations’. TCFD requirements currently only apply to firms with assets under management over £50bn, with smaller firms over £5bn coming into scope from 2023. 

 

As a result, the mallowstreet Insurance Report 2023 revealed that risk management, rather than engagement and decarbonisation, is the preferred approach to ESG integration. Insurers lag their pension fund peers, a majority of which have policies on engagement and stewardship activities. Furthermore, TCFD reporting and target setting has been a requirement for schemes over £5bn since 2022, and two-thirds of them have committed to net zero, versus just 44% of insurers. Additionally, just 22% of insurers have emissions reduction targets, while 38% of large schemes have set 2030 decarbonisation targets. 

 

 

 

 

The reforms of Solvency II in the UK are expected to unlock tens of billions of productive capital, much of which would support the funding gap in green and renewable infrastructure, as well as other climate solutions. The UK insurance industry even recently launched an ‘investment delivery forum’ to get ahead of investment opportunities made possible by the reforms of Solvency II, and make sure the industry is ready to deploy capital into much needed solutions. However, only a small group of insurance firms have so far backed this initiative. 

 

Mandatory TCFD reporting and target setting in UK pensions has created a positive feedback loop, making trustees and CIOs more aware of both the risks and opportunities resulting from climate change, as well as keener to take advantage of them. Prior to mandatory reporting, most UK pension schemes took only a risk management approach to ESG factors. 

 

We equally expect mandatory TCFD reporting to make UK insurers more interested in the investment opportunities presented by the climate transition, but they have some catching up to do if the industry is to meet its net zero goals by 2050.