Averting tragedy

Averting tragedy | Insurance Business

Averting tragedy

In September, Bank of England governor Mark Carney delivered a speech at Lloyd’s of London entitled, ‘Breaking the Tragedy of the Horizon’, addressing the potential impacts of climate change on financial stability. 

“Shifts in our climate bring potentially profound implications for insurers, financial stability and the economy,” Carney told the room,
warning that the challenges currently posed by climate change pale in significance compared to those that may yet be to come. “While there is still time to act, the window of opportunity is finite and shrinking,” he said. 

Carney identified three channels through which climate change has the potential to affect financial stability. They are:

  • Physical risks (impacts of increased natural disasters driven by climate change)
  • Liability risks (impacts that could arise if those who suffer loss or damage from the effects of climate change seek compensation from entities they hold responsible)
  • Transition risks (financial risks potentially presenting as a result of transitioning to a lower carbon economy)

Carney’s speech was a call to action to avoid potential disastrous ramifications brought about by climate change – the tragedy on the horizon.

So how should the Australian insurance industry prepare to address the potential impacts of climate change?

“The [range of] insurance products offered in Australia that could be impacted by climate change is very broad, and includes homeowner’s insurance, flood insurance, property and business interruption insurances, agricultural insurances and liability insurances,” says Samantha Kelly, a Sydney-based partner at law firm DLA Piper.

“The insurance industry needs to ensure that it has access to suitable and up-to-date modelling information when developing products and assessing risk. Failure to do so may result in a situation where premiums are unaffordable, reserve funding is depleted, or certain assets become ‘uninsurable’,” she says.

“The insurance industry could, for example, consider introducing their own ‘codes’ when insuring businesses, to ensure that buildings
and other physical assets are constructed in a manner that is most adaptive to the risks presented by climate change.”

Asked about the Australian regulatory landscape with respect to climate change, Kelly says: “In our opinion, comparative to the
international market, the issue of climate change in Australia remains relatively underregulated. The inconsistency in regulation and
policies developed during the most recent political terms actually represents more of a challenge to businesses. Without consistent
regulation, businesses are unable to effectively plan for the future.”

As in many other situations, preventative measures trump a cure, and when it comes to weather events, preparation is far less costly than efforts to resolve problems that arise later on. 

“Whether they’re caused or exacerbated by climate change or not, you want to have a level of resilience against extreme events that are feasibly going to occur in the lifetime of the asset, because it’s generally going to be much cheaper to incorporate resilience at the beginning than to try and fix things later when they’re damaged,” says Kate Mackenzie, manager of investment and governance at The Climate Institute.

She points to the Productivity Commission reports into climate adaptation and natural disaster resilience. “There’s a tendency to uninvest in resilience to the effects of weather, and that’s something that we could anticipate will become more and more of a problem as time goes on.” 

Work in progress
Sharanjit Paddam, an actuary at Taylor Fry, says while there’s still much to be done, there’s significant activity already being undertaken by insurers to address climate change.

“There’s a substantial amount of action being taken by insurers in terms of thinking about this transition to a [low carbon] economy,” he says, raising IAG’s role as founding member of the Australian Business Roundtable for Disaster Resilience and Safer Communities, and Suncorp’s work with local councils to encourage resilience efforts.

“We’re also seeing insurers taking leadership in this through working with the United Nations Environment Programme and their finance initiative,” he adds.

Paddam says the transition to a low carbon economy offers considerable opportunities for insurers. “For example, renewable energy
projects, design and construction risk [and] performance risk. There’s also potential to provide cover, for example, to solar farms or to wind farms because of changing weather patterns through things like weather derivatives.

“There’s also public policy risk. If the government suddenly decides to remove renewable energy subsidies, some insurers are
offering cover for that type of political decision.

“There’s also substantial opportunity to invest in green bonds. We’ve seen huge amounts of action on this. Even Goldman Sachs is
committing millions and large resources to this area because, as we transition to a low carbon economy, these green bonds finance the investment in renewable energy and low carbon consistent infrastructure.”

Making a contribution As to how insurance businesses of all sizes can prepare for climate change’s potential impacts, Martina Linnenluecke, a senior lecturer in sustainability at the University of Queensland, says there are a number of avenues available. “First is knowledge generation,” she explains. “This includes understanding climate impacts, regulatory impacts, as well as adaptation and
mitigation options.”

Linnenluecke cites work being done by Munich Re. “The company has started to support risk transfer solutions, including the commercialisation of renewable energies.”

She adds, “Climate change will have adverse impacts on both the affordability [and] availability of insurance for high-risk assets and/or high-risk locations. Insurers could join in lobby groups or public-private arrangements to argue a case for collective action on mitigation and adaptation.”

Discussing how insurance brokers could be taking climate change into account in providing advice to SME clients, Samantha Kelly highlights that the expected impacts of climate change in Australia are likely to affect almost all industries in some way. “Insurance brokers should be ensuring that SME clients are aware of the risks that their business is uniquely exposed to, as well as the overall risks that are facing Australia.

“Certain businesses may be located in areas that are known to have been historically exposed to flooding or bushfire. Those businesses should be made aware of the risks associated with property damage, business interruption, and stock loss.”

Linnenluecke thinks it’s important that brokers, in advising clients on their insurance needs, place considerable focus on advice about potential risks resulting from climate change. She belongs to a research team that recently published a paper entitled, ‘Planetary Boundaries: Implications for asset impairment’.

“Science tells us that there are nine planetary boundaries that define a safe operating space for humanity and should not be exceeded, one of them being climate change,” Linnenluecke says. “The paper talks about how each of the boundaries can cause impairments for firms.

“This is a must-read for insurance brokers giving advice to clients about how their business can be affected by not only climate change but the other eight planetary boundaries.”

Kelly concludes: “The insurance industry is uniquely placed to incentivise good environmental practices, while also accounting for the cost of extreme weather events, before such risks occur. 

“In order to ensure that the insurance industry is able to best respond to climate change and prevent a situation where risks become ‘uninsurable’, efforts should be made to increase the availability and awareness of suitable information, in order to ensure product innovation, adaptive policies and consistent regulation.”