Carolyn Kousky, Environmental Defense Fund, and Joseph W. Lockwood, Princeton University, explore the different levers currently being used by global insurers to help reduce greenhouse gas emissions, and how underwriting and the claims process could play a significant role in the transition to a low-carbon economy.
Even with substantial near-term reductions in greenhouse gas emissions, we are on a path to overshoot the global target of limiting warming to below 1.5 degrees Celsius during the 21st century (1). Each fraction of a degree of warming intensifies damages and increases risks of crossing tipping points in the earth’s system with profound negative impacts for human society (2). To minimise the growing risks, fundamental shifts in our economy are needed – and that will require participation from all sectors.
The global insurance sector is increasingly being called upon to help manage the physical risks of climate extremes, a task which is becoming more difficult as those risks rise globally. Insurance, though, is an enabler of much economic activity, and through its business decisions it can direct capital toward less carbon intensive activities and encourage faster adoption of low-emissions practices. There are five levers the sector can use to reduce emissions in the real economy, with varying degrees of impact: (i.) improving the environmental practices of their own operations; (ii.) applying a climate lens to their investments; (iii.) integrating climate considerations into underwriting and client engagement practices; (iv.) adopting claims processes that support the energy transition; and (v.) using their political voice to support climate policy.
To date, insurers have largely focused climate efforts on the emissions of their own operations, despite other levers likely being able to drive greater emissions reductions. Our analysis of the climate commitments of 52 of the largest property and casualty insurance and reinsurance firms, for example, shows that more than half lack any formal climate policy for either their underwriting or investmentsa. This is starting to change, although insurers do face unique challenges, such as regulatory constraints, the strong role of intermediaries in insurance purchases, and the need to maintain high risk management standards. There have been only minimal efforts to date to address decarbonization in rebuilding and the claims process, and the sector can also do more to vocally support climate policy.
Reducing direct emissions
Like all firms, insurers can begin by reducing emissions from their own operations, including emissions associated with the energy use in their offices and those associated with employee travel, for example. To reduce their own emissions, insurance firms can invest in energy efficiency improvements, procure or install renewable energy, adopt green procurement practices, use electric vehicles, and reduce employee transit on planes and personal automobiles. These efforts can be accelerated by adopting a price on carbon inside the firm. Swiss Re, for example, has set an internal price of US$112 per tonne of CO2e as part of its CO2NetZero Programme (3).
That said, while many insurers have limited their focus here, the overwhelming majority of an insurer’s carbon emissions are those in their supply chain: the emissions of their clients and emissions of the firms in which they have invested (4). Measuring these emissions can be fraught: a firm is tasked with the complicated process of delineating its entire value chain, much of which will have data voids, interoperability challenges, privacy concerns, the inevitable use of estimates, and difficulties demarcating clear boundaries (5). All of these concerns, as well as challenges with potential double counting and nuances in handling insurance policy terms and the implications for attribution, have so far prevented the development of a consensus on how to measure and attribute client emissions to insurers. Even in the absence of robust measurement, however, there are actions insurers can take to drive emissions reductions in their value chain, which we discuss in subsequent sections.
Insurer as investor
Insurers are large holders of capital. At the end of 2022, the National Association of Insurance Commissioners estimated that US insurance companies held cash and invested assets totalling US$8.2 trillion. Their primary asset class is bonds (at over 60%), with lesser amounts in common stocks or other assets. As with other large asset owners, insurers are being pressured to take a climate lens to their portfolios. This could mean targeting green investments, excluding high-carbon investments, and also being an active asset owner to push for a faster energy transition. Coalitions have formed to champion the shift towards net-zero investment portfolios and the enhancement of green investments, such as the Net Zero Asset Owner Alliance or the Principles for Responsible Investment group.
Several insurers, largely outside the US, have made public commitments related to their investing. For example, AXIS Capital Group has implemented a policy that prohibits new investments in companies deriving 20% or more of their revenues from thermal coal mining, or relying on thermal coal for 20% or more of their power generation. As large holders of bonds, insurers could also choose to limit or eliminate investments in bonds from major carbon emitters or originating from oil-exporting countries, when not constrained by local capital requirements. Although the number of coal exclusions is on the rise, there is a notable lag in the exclusion of investments associated with gas and oil among many firms, and American insurers are lagging behind their European counterparts in any climate-screening of their investments (6).
In the US, both California and New York have investigated the climate impacts of the investment holdings of insurers in their states. Those analyses indicate substantial variation between insurers, with a small percentage holding a majority of their investments in carbon-intensive ventures, while most firms having only a small amount invested in assets with high GHG emissions; in the near-term, the investments of most insurers were not Paris-aligned (7, 8). Only a very small fraction of assets were invested in green bonds. Overall, at the end of 2019, the US insurance industry had US$582 billion invested in some combination of oil, gas, coal, utilities and other fossil fuel related activities (9).
Underwriting for climate
Underwriting is the insurance practice of deciding what to insure and on what terms. The ability to secure coverage on favourable terms is necessary for economic transactions ranging from an individual buying a home to a global firm constructing critical infrastructure. Despite being core to business, a greater share of insurers have focused on climate related to their investments, not their underwriting; CDP reports only 27% of insurers are aligning their underwriting to Paris goals (10). Similar to their investments, insurance companies have three approaches to drive decarbonization through underwriting: (i.) insure carbon-friendly activities, (ii.) exclude carbon-intensive activities, and (iii.) engage with firms in the adoption of a transition path to a lower-carbon business. Across all of these, insurers must operate within the bounds of regulation and prudent risk management for their business. Insurers, by law, typically must charge prices in line with the risk; as such, financial incentives for activities unrelated to the risk of the policy are typically not a tool insurers can use. In some cases, though, there may be strong correlation between climate performance and the risk, such as for certain liability policies, or pay-as-you-go automobile insurance.
First, new technologies related to renewable energy, zero-emissions processes, and carbon-removal need insurance for construction and operation. In addition, insurers can play a role in providing insurance for climate policy instruments, such as carbon offsets, and for the decommissioning and dismantling of fossil fuel infrastructure. While established renewables, such as solar and wind, typically have little trouble securing coverage, emerging and untested technologies or products, such as direct air capture or carbon-negative building materials, can face a lack of availability for insurance or steep prices, which can slow or halt piloting and scaling. This occurs when insurers feel unable to adequately assess the risk due to insufficient loss history or performance data. Insurers may also not have the necessary engineering expertise to evaluate new technologies.
Two approaches might solve these challenges. First, the public sector could subsidise the premiums for new clean technologies that have the potential to be transformative for the energy transition. This could potentially be done in partnership with emerging impact insurance models. Second, the public sector, insurers, and energy companies could create an information-sharing hub to pool and share detailed engineering assessments, data, and reporting on new, clean technologies to support underwriting.
Beyond insuring the transition, insurers have been under increasing pressure from activists to stop insuring fossil fuel extraction and power generation. Growing numbers of the largest European insurers and reinsurers, and smaller numbers of American firms, are adopting limited exclusions related to fossil fuels. Most global insurers and reinsurers have pulled coverage for new coal power projects and a smaller number have restricted coverage for companies that derive a major share of revenues or power output from coal; far fewer have put in place a complete phase-out of all aspects of coal (11). A handful of insurers have adopted further restrictions around oil and gas, such as excluding tar sands operations or coverage in certain ecologically sensitive locations. Transparency, however, on implementation is difficult, as insurers of projects are typically confidential (12). While fossil fuel exclusions remain fairly limited, the most carbon intensive projects are also facing steep legal and transition risks and may not be good business.
Beyond simple exclusions, insurers can assess the carbon intensity of their book of business and consider how its composition should shift over time to align with the goals of the Paris Agreement. While measuring insured emissions is extremely challenging, as noted above, some tools are in development to help insurers with identifying client emissions and impacts on their underwriting portfolios, such as methods to convert underwriting portfolios to temperature metrics, standardised assessment of clients’ transition plans and alignment with the Paris Agreement (Climate Transition Pathways), as well as tailored assessment of insurer portfolios (Milliman and OneRisk Consulting) (13).
Over time, insurer portfolios should shift away from carbon intensive clients and sectors. In the near-term, however, a key concern is leakage: if one or even a handful of insurance firms refuses to provide coverage for a carbon-intensive activity or firm, coverage can still often be found elsewhere or the client could self-insure (either directly or through captives). There is very little research on this, but recent analysis suggests that as banks divested from coal, targeted firms were more likely to retire coal-fired power plants and thus lower their emissions, suggesting much less substitutability for financing that previously believed (16). News reporting on the evolution of financing and insurance for coal suggests that even while some large firms made public commitments to end backing for coal, others were waiting with capacity, such as Asian banks, export credit agencies, and private-equity firms, but as the number of firms leaving coal grows, prices are increasing and capital is growing more scarce (14). Such exclusions, beyond direct impacts, may also send important political and economic signals about the speed of the energy transition.
As the final strategy, insurers can engage directly with clients. Insurers could condition coverage on certain emissions reducing activities and also provide needed technical support and guidance. Chubb, for example, announced new underwriting criteria for oil and gas operations, and also provided clients with a Methane Resource Hub to help them implement measures in the very-near term to reduce methane emissions, a very potent GHG. Related to investments, this has been referred to as “tilting” (15) — here, it would be offering insurance only if the polluting firm is making improvements. An engagement strategy is preferable when there are actions that can be taken to reduce the harm the firm is causing. In these cases, by implementing a tilting strategy that evolves over time, insurers can incentivize companies to improve their climate performance. For activities that are not compatible in any way with a 1.5 degree target, however, such as expanded coal use, exclusion is a necessary complement. Engagement, though, requires attention to actual performance to avoid rewarding firms for target-setting or pledges not backed by emissions reductions in the real economy. This is again where emerging tools at evaluating the credibility and progress on transition strategies could be helpful.
Claims processing to support the transition
Property and casualty (P&C) insurers can use the claims process to support policyholders in rebuilding from a loss in a manner that leads to lower GHG emissions. This could be done through extra funding for approaches and products that lower emissions at the time of rebuilding, but also will necessitate provision of expert guidance post-disaster to help policyholders incorporate such changes.
On the former, a few insurance companies have been exploring “green endorsements,” which are optional riders on insurance policies that provide the policyholder with additional funding at the time of a claim to choose higher-cost but environmentally-friendly rebuilding materials. So far, however, these are not in widespread use. Unfortunately, very few policyholders voluntarily opt-in to such coverages; consideration should be given to making them a default option in P&C commercial policies. The public sector could be a partner in paying the additional premium for such endorsements for homeowners policies. To be most impactful, such endorsements should be written broadly to include (depending on the insurance product) use of low-carbon rebuilding materials and electrification following substantial building damage, installation of rooftop solar in the event of roof replacement, and/or upgrading to electric vehicles following complete loss of a vehicle. Such endorsements would face some amount of supply chain risk if the needed green options were not immediately available. In this case, some policyholders might not want to wait; insurers would need to determine ahead of time if a policyholder would be reimbursed for any paid premium if they did not activate their endorsement due to supply chain disruptions. To explore the best structure for such policies and not slow down their deployment, they could be part of a regulatory sandbox. Indeed, creating such a sandbox for wider insurer innovation around climate could be an efficient way to quickly test various models.
Beyond funding, however, policyholders, particularly in a post-loss context, require guidance and advice on how to use the rebuilding and repair process as an opportunity to decarbonize. In the aftermath of a disaster, insurance companies can establish rapid response teams or dedicated departments who specialise in integrating emissions reduction strategies into the claims process. These teams can be deployed immediately to provide on-site guidance, assess the feasibility of implementing specific measures, and expedite decision-making for clients. This could involve partnerships with building standards, such as LEED (Leadership in Energy and Environmental Design) or BREEAM (Building Research Establishment Environmental Assessment Method). Relatedly, AIG collaborates with organisations such as the National Institute of Building Sciences (NIBS) and the US Green Building Council (USGBC) to provide guidance on sustainable rebuilding, participating in joint initiatives, and sharing resources.
Preferred vendor networks can also be established, ensuring that clients have access to trusted professionals who specialise in sustainable rebuilding practices. For instance, Travelers Insurance maintains a network of “Green Building Designated” contractors. This could also be done in partnership with local non-profits that may have more detailed knowledge of local builders, contractors, and vendors to support the needed upgrades. Simplifying the claims and rebuilding processes for such approaches can also be done to further promote more sustainable rebuilding. This involves expediting claims processing, simplifying documentation requirements, and fast-tracking approvals for emissions reduction measures or renewable energy installations.
Political voice
Finally, insurance companies can play an active role in advancing climate policies by voicing their support and not funding or supporting groups or candidates with hostile climate positions. Collectively, in 2021-2022, Open Secrets reports that US insurers, for example, donated US$25.66 million to PACs, with slightly more than 53% to Republicans and the rest to Democrats. We are not aware of analysis as to whether those dollars are supporting candidates with pro-climate or anti-climate policies, but withholding funds from those with anti-climate views could contribute to greater political support for needed climate policy. Insurers can also play a role in advocating for specific climate policies or legislation and in being a vocal educator about climate change.
Moving in the right direction
The global insurance sector possesses a range of strategic levers to significantly contribute to the reduction of greenhouse gas emissions and facilitate the transition to a low-carbon economy. These levers encompass reducing the emissions over which they have direct control, adopting a climate lens for their investing, integrating climate considerations into underwriting practices and client engagement, utilising the claims processes to support emissions reductions, and advocating for strong climate policy. The emissions of insurer clients are estimated to dwarf the emissions that insurers control directly, such as the electricity in their offices and employee travel. Policies to help facilitate emissions reductions by clients are still nascent, but represent an opportunity to drive substantial reductions in the real economy through both underwriting criteria and direct client engagement as well as in the rebuilding process after a loss. Such approaches may require new partnerships, new tools, and expanded data collection efforts, but could align insurers and their clients with goals of the Paris Agreement to speed the energy transition.
Footnotes
a. We looked online for public climate documents for the top 20 US insurers, the top 30 global insurers, the top 15 global reinsurers, and the top 10 US reinsurers as identified by market cap through Bloomberg Terminal.
References
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- S&P Global, “Climate Risk & Resilience Analysis” (S&P GLobal Market Intelligence, completed for the California Department of Insurance, 2022).
- H. Ross, “Climate risks for insurers: Why the industry needs to act now to address climate risk on both sides of the balance sheet” (S&P Global, 2021).
- J. Powers, J. McDonald, S. Lefebvre, T. Coleman, “The Time to Green Finance: CDP Financial Services Disclosure Report” (CDP Worldwide, London, UK, 2020).
- P. Bosshard, “Exposed: The Coal Insurers of Last Resort” (Solutions for Our Climate and Insure our Future, 2022).
- J. Thornhill, Insurers Distance Themselves from Disputed Australia Coal Project as Backlash Grows. Insurance Journal (2020).
- C. Bronwyn, L. Meng-Lian, “Insurers in Paris-aligned climate transition: Practical actions towards net zero underwriting” (ClimateWise, Institute for Sustainability Leadership, University of Cambridge, Cambridge, UK, 2021).
- E. Cadman, Here’s Who’s Backing Coal as Someof the World’s Biggest Banks Get Out. Bloomberg (2020).
- A. Edmans, D. Levit, J. Schneemeier, “Socially Responsible Divestment,” Finance Working Paper N° 823/2022 (European Corporate Governance Forum, 2023).
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