How Insurers are Integrating Climate Change into their Investment Decisions

Mitigating Climate-Related Risks

There is a direct benefit to insurers if the net zero transition is orderly and driven by broader responsible investment by institutional investors. The industry helps protect businesses and individuals from a range of physical climate-related perils, including wildfires, storms, and floods. Other types of insurance are also affected by climate-related transition risks including D&O insurance, health and life insurance, and motor insurance. 

However, as climate risks intensify, some might become uninsurable or require proactive measures to maintain insurability — for instance, homeowners may have to flood-proof their property to access flood insurance.

Supporting Renewable Energy and Sustainable Initiatives

Insurance also serves as a facilitator. It enables investment in renewable energy, insures electric vehicles and endorses sustainable building materials, to mention a few. These actions encourage the growth of environmental sustainability and contribute to mitigating greenhouse gas emissions. 

Insurers can also collaborate with the businesses they invest in to encourage better climate-related practices. This engagement drives innovation, while also inspiring responsible business behavior and catalyzing positive change across industries.

The Regulatory and Business Drivers Behind Responsible Investment 

Insurers pursuing responsible investment strategies can reap several business benefits and align themselves with regulatory requirements. For example, many insurers have increasing appetite for private debt and infrastructure debt investments, which, in addition to a good risk/return profile and fit for insurance liabilities, can align well with climate transition goals. In addition, embracing responsible investment enhances risk frameworks for insurers, mitigating climate-related risks and their associated financial and reputational consequences.

Growing regulatory measures further drive insurers to adopt responsible investment practices. The European Insurance and Occupational Pensions Authority, for example, recently published a consultation on the merits of increased capital charges for fossil fuel assets. While reporting frameworks like the Task Force on Climate-Related Financial Disclosures may sometimes be viewed as a mandatory box-ticking exercise, they do ultimately help improve existing risk management programs and support better decision making.

Overcoming Challenges

While there is widespread acknowledgement in the industry that limiting climate change is imperative, views vary on how investors should play a part. Limited priority given by boards and investment committees to responsible investment, along with a lack of stakeholder engagement, can impede progress. Additional hurdles include limited transparency and standardization of data and reporting, as well as resource constraints for assessing and implementing responsible investment.

These challenges may differ between regions, with insurers in some jurisdictions less keen or less able to adopt responsible investment practices given more general political and societal views, which can then also impact their subsidiaries in other countries. 

The latest report from the PRI³ highlights the continued progress of North American signatories in key areas, albeit with comparatively fewer public disclosures on responsible investment than their counterparts in Europe, Oceania, and Asia. Notably, Q1 2024 witnessed a surge in outflows from sustainable funds in the United States⁴, while European sustainable funds, commanding a significant share of global sustainable fund assets, have been on the rise.

Our institutional investor clients are proactively addressing these challenges through a comprehensive approach that includes:

1. Tailored training sessions emphasizing the financial relevance of climate change risks and opportunities, emerging market trends, and best practices. This initiative is geared towards raising awareness at the board level and fostering stakeholder engagement.
2. Reviewing governance structures, core beliefs, strategic objectives, and operational models to allocate dedicated resources towards prioritizing responsible practices throughout the organization.
3. Collaboration with industry peers and participation in sector-wide initiatives to drive enhanced data quality, transparency, and standardization in reporting practices.

Actively implementing these measures helps to further embed responsible investment principles across the organization and drive positive impact within the investment community at large.

Nurturing a Sustainable Workforce

It’s no surprise that skills such as data analysis, financial modeling with ESG integration and risk assessment are becoming increasingly valuable in the industry. By nurturing these skills within their workforce, insurers can ensure they are not only well-equipped to identify and capitalize on relevant opportunities, but also manage potential risks and generate long-term value. 

In theory, embracing responsible practices and integrating them into investment decisions might also enable insurers to attract and retain top talent who are increasingly drawn to environmentally and socially responsible organizations. Motivated professionals who are passionate about making a positive impact on the environment and society bring fresh perspectives, innovation and expertise to the company, fostering a culture of sustainability.

Finding the Right Strategy

While approaches to responsible investment may vary among insurance companies, the goal remains consistent: 

1. Incorporating climate-related factors into investment decisions across all asset classes.
2. Actively engaging with the companies they invest in to encourage better climate-related practices, rather than simply divesting from more carbon-intensive companies.
3. Considering broader measures that align with core business objectives and sustainability goals like water conservation, affordable housing and biodiversity.

As climate-related factors continue to influence investment decisions, it is important that insurers understand the evolving dynamics of the responsible investment landscape and its impact on their business, both now and in the future. No one-size-fits-all approach exists, but a crucial first step is to clearly articulate within the organization how key concepts, such as sustainability and responsible investment, are defined.