Climate change has a multidimensional effect on insurance investment, with physical risks impacting the underwriting business and transitional risks affecting the insurers' investment portfolio, according to a study published by the United Nation's Sustainable Insurance Forum (SIF) on climate risk.
William Davies, SIF’s secretary and one of the authors of the study, tells Insurance Asset Risk that the financial services industry, and especially insurance, is seeing a vilification of certain types of assets.
“In 2011, carbon assets had the potential to emerge as a bubble that would be similar to the financial crisis,” he explains. “Putting together the concept of carbon asset holdings or fossil fuel holdings potential systemic financial risks was something that caught people's attention.”
The ongoing shift to a low-carbon economy has had a profound impact on asset allocation, especially in the context of ESG investing.
The study finds that there is a concentration of holdings in specific, “environmentally friendly” firms or sectors.
Michael Lewis, head of ESG thematic research at the asset management firm DWS, said during Insurance Asset Risk’s roundtable on climate risk, that there is a change of perception on how ESG investing should be done.
“Asset managers are moving away from 'do no harm' into 'doing good' in terms of their ESG investment process,” he said. “As a result, they are increasingly screening their assets to see whether they are aligned to the UN Sustainable Development Goals, for example.”
Asset value at stake
However, the most profound impact of climate change, according to SIF’s study, is the hit on asset value which can trigger a domino effect for insurers and might end up creating solvency problems.
For example, stranded assets in the high-carbon industries are increasing exponentially. The study argues that by 2040 the upstream fossil fuel industry will have lost $33trn of its asset value.
In 2017, Lloyd’s market examined the implications of the insurer’s exposure to such assets, calling for a collaborative effort to tackle potential consequences.
Long-term debt instruments, some of the insurers’ most preferred assets, could also be impacted by climate factors, according to the SIF study.
For example, sovereign debt’s credit ratings can be influenced by extreme weather conditions through direct losses to infrastructure. The downgrade could be particularly harmful to vulnerable countries, as the value of their debt will plumb.
The credit quality of municipal bonds is also at stake, while policy measures for environmental performance of building stock have already affected real estate portfolios.
In the Netherlands, for instance, the requirement for a level C energy label on commercial property is colliding with insurer investments to properties with lower-range energy labels. Dutch insurers fear a portfolio damage as they face the risk of not being able to liquidate these assets.