In March 2021, Hymans Robertson hosted ‘Building a sustainable future for generations to come’ as part of its 100th birthday activities. As part of his keynote speech, Steve Waygood (Chief Sustainable Investments Officer, Aviva Investors) highlighted that climate change, unabated, could become an existential threat “if not for humanity, then for the insurance industry as well as civilisation more broadly”.

In this article, we look at the progress and commitments made by insurers and consider what further action we should expect in the near future. Whilst there is still a lot of work to do, we have reason to believe hope is on the horizon as the insurance industry takes some bold steps towards addressing this challenge.

What pledges and steps have insurers made?

Since the Paris Agreement 2015, many insurers have set themselves long-term targets for net-zero carbon emissions across their operations, supply chain and financing activities by 2050 or sooner; many insurers now need to map out how this commitment will be achieved and the underlying short-term milestones to keep themselves on track. For most, investment strategies form a key part of this.

Zurich recently announced they will require companies they invest in to set targets aligned with the Paris accord. Large swathes of the insurance industry (including Scottish Widows, L&G, Scor, Zurich, Phoenix and M&G) have committed to net-zero investment portfolios by 2050 having signed up to the UN Net-Zero Asset Owners Alliance, (or equivalent such as (Net Zero Asset Managers Initiative)). Aviva have gone one step further and committed to net-zero by 2040.

Beyond the net-zero investment portfolio pledges, many insurers have signed up to international pledges such as Science Based Targets and Climate Action 100+. These industry groups are leading the way towards a zero-carbon economy targeting lower green-house gas emissions for corporations. Whilst some firms have not made public pledges, we understand they are working behind the scenes to create a detailed map of their intended route.

Many firms are expanding their internal expertise and capabilities for the management of climate change-related risk, with a number of insurers creating new roles and teams and bringing fresh insight and expertise from climate change experience outside of the insurance industry. Collectively, these actions reinforce insurers’ commitment to their focus on sustainability and achieving climate-related targets.

How can promises and investment by the insurance market make a difference?

In the UK, the insurance industry is a vital part of the economy, managing investments of £1.8 trillion which is equivalent to around 25% of the UK’s total net worth. Collectively, this level of influence is highly significant when it comes to driving change in behaviour across markets. Key managers of institutional investments (including Aberdeen Standard Investments, Legal & General and Aviva Investors) shunned the Deliveroo IPO due to a corporate governance issue related to workers’ rights. This is a prime example of how investor influence can put pressure on company actions. Whilst this isn't a climate change issue, it highlights the extent to which such market participants can make a difference when it comes to environmental, social and governance factors.

We expect that insurers will continue to use this power to push for the firms that they invest in to take appropriate action to address climate-relate issues.

Some insurance companies have made their own specific investment pledges. Legal & General, for example, plan to commit 5% of the capital behind UK clean energy by 2021. According to their latest disclosure, Pension Insurance Corporation (‘PIC’) have informed their investment managers that they should divest their remaining holdings in companies that rely on either the extraction or burning of coal (for more than 10% of their turnover) by 2025. These pledges, once met, will collectively act to move the UK forward towards The Paris Agreement.

What is coming next?

Progress in the space has been made due to a combination of regulatory interest, firms’ internal drive and push from policyholders. Insurers, and the wider financial services sector are only just starting to fully understand the implications of climate change, though, and much of the thinking behind it is still in its infancy – there is still a lot of work to do in the coming years. We see four key areas of focus that are likely to dominate the next phase of activity:

Climate disclosures: the push from regulators for action on climate change means that the UK will become the first G20 country to make TCFD-aligned disclosures mandatory across the UK economy by 2025. Many insurers have already made significant progress in their latest Year-End Financial Statements. Some firms, including Phoenix and PIC, published separate ESG reports. For others, climate change pledges and disclosures could be found at the forefront of their Annual Reports. This change is fundamental: with proper, transparent reporting investors will be able to make more informed decisions, leading to capital being allocated more efficiently to ‘greener’ initiatives, driving companies to seek to improve performance against climate-metrics and ultimately contributing to a reduction in greenhouse gas emissions. As these disclosures become more common and accepted in the industry, firms with enhanced disclosures may find themselves with a competitive advantage.

Climate Activism: From David Attenborough to Greta Thunberg, climate-consciousness has become far more commonplace. Young people see climate change as a big issue, with a recent YouGov poll showing that 40% of people aged 18-24 cited the environment as one of the most important issues facing the UK. However, climate consciousness is certainly not just limited to young people, and failing to act on climate change is not only a large source of reputational risk for firms, but also financial risk as policyholders vote with their feet.  

Scenario Analysis: Insurers are investing further to develop their capabilities for modelling climate change scenarios ahead of the 2021 Biennial Exploratory Scenario (‘BES’) on the financial risks from climate change expected to be published by the Bank of England in June 2021. Whilst this is only mandatory for large insurance firms, many smaller insurance firms are looking to use the detail in these published scenarios to develop their own version of BES ‘lite’ to inform their understanding of the climate risks in their business. The modelling of climate-related risks, and the mapping from climate scenarios to changes in financial variables in particular, alongside the life insurance industry’s extensive time horizons, are currently, and will continue to prove challenging and will require a significant investment of time and thought.

Developing investment capability: The volume of “green”, ESG or sustainable investment by insurers has increased significantly in recent years. Many have announced billions of further promises, and actions like this are essential in leading the way towards a low-carbon economy (as well as demonstrating that investment such as these e.g. in infrastructure or low-carbon housing, also look favourable under more typical profitability metrics). Firms are considering their ability to deploy capital in more, green infrastructure, helping Britain to “Build Back Better” and align with the government ten-point climate plan.

However, significant expertise and careful risk management is needed for those investing in these assets due to nuanced complexities (such as allowing for a construction phase, uncertain cash flow profiles, multiple stakeholder involvement and a range of different financing structures). Making the investment to build such expertise, though, will enable insurers to gain a competitive advantage, helping them to spot the best opportunities (some of which may come from smaller firms e.g. new technological advances) and avoid being “duped” into “greenwashed” investments.

Further regulatory change

Although insurers’ desire to do their bit to combat climate changes – through the pledges made and investment decisions taken – is clear, there are still elements outside of their control. This includes, for example, the need to tailor UK regulation to support a much wider range of sustainable investments. In particular, calls to replace the Matching Adjustment’s requirements for “fixed” cash flows with an allowance for investments whose cash flows are simply “highly predictable” cash flows will allow firms to invest in “greener” assets that, at present, may not necessarily have cash flows that are as fixed in nature as other debt instruments. It could also include removing eligibility restrictions for trivial pre-payment risks (common for certain types of investment in renewable energy), and removing the cliff-edge capital effects for sub-investment grade assets (such as certain infrastructure assets during the construction phase or other relevant, start-up technologies, such as firms looking to roll-out electric car charging networks).

Change is happening, and insurers are taking action. Government momentum and the potential for sensible, helpful regulatory changes should mean that the insurance industry’s ability to make a significant contribution towards meeting the Paris Accord is only likely to increase over coming years. For insurers, now is not the time to take the foot off the accelerator.

How Hymans Robertson can support you

Hymans Robertson has a wealth of experience in managing climate change considerations for insurers, we are happy to discuss any aspect of this with you. If you would like to discuss with one of our specialists, please get in touch.