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Insuring the future

The transition to net zero will trigger a major shift in capital expenditure – and insurers have a critical role to play.

According to Aon’s annual Weather, Climate and Catastrophe Insight report, weather and natural hazards led to $343bn in losses to the global economy in 2021. In the US, Hurricane Ida cost $36bn in insured losses, while in Europe, $13bn of damage was inflicted by flooding in the month of July alone – the costliest amount recorded on the continent. More than half of the global $343bn loss, 62 per cent, was uninsured, and for the countries, local communities and families affected, the impact was devastating, with homes, livelihoods and lives lost. Climate change means that the number and scale of such events is rising, on average, every year. Insurance can play a vital role in preventing these disasters and mitigating their impact.

“The transition to net zero will impact every industry, every nation, every individual, every firm in the world,” says Richard Dudley, Aon’s head of climate strategy. “The whole economic system is going to be shifted and that will bring a host of new and evolving risks.”

Given the gravity of the challenges being contemplated, Dudley emphasises the insurance industry has perhaps the highest concentration of risk expertise of any sector, and so can play a pivotal role in the transition, particularly in the three key areas of enabling new technology financing (particularly those associated with the energy transition), encouraging physical risk mitigation initiatives (i.e. improving resilience to the actual effects of climate change), and providing cover for emerging liabilities.

“Governments and other financial institutions can lead on pledges to decarbonise the economy, but the flow of capital needs to accelerate,” says Dudley. “Building a net-zero future requires huge amounts of capital to invest in building new infrastructure such as wind, solar and hydropower.

Insurance plays a really important role in risk financing for projects such as new wind farms and solar schemes. These assets do not get built without the protection that insurance provides.”

Dudley points out that insurance is also crucial for reducing the risks and costs of developing new technologies, such as waste to energy (WTE) and carbon capture and storage (CCS) – including direct carbon capture where you’re sucking CO2 out of the air. Even carbon offsetting comes with its own risks: an institution that invests in planting a new forest or protecting an area of rainforest or mangrove swamps needs to understand the risks and the vulnerability to wildfires or other events. As a sector, insurance companies are also significant investors, and should be setting ambitious targets for investment in the transition to net zero.

Insurance is key to building physical resilience to weather and natural hazards. This is most pressing in the Global South where the vulnerability is much greater,” says Dominic Christian, global chairman of Aon’s Reinsurance Solutions and chair of ClimateWise, a global insurance industry collaboration focused on action on climate risks.

“While some communities are at greater risk of flooding, others are vulnerable to extreme heat, and both will have an impact on communities, with climate change likely to exacerbate the trends towards more frequent natural catastrophe events.

“We already have an Insurance Development Fund [comprising representatives from a group of insurance industry firms including Aon] that is part of work to mitigate the impact of climate change, where the impacted communities are also the most likely to be uninsured against risks and losses.”

Dudley explains insurers can encourage risk mitigation, for individuals, companies or governments, and encourage adaptation. This could be providing products to encourage investment in new tech or standards to make buildings more resilient.

Meanwhile, insurance products can be tailored to address areas likely to be specifically affected by climate change.

“There are areas of insurance that are becoming increasingly innovative. For instance, parametric insurance responds to certain weather data,” explains Dudley. That can include levels of rainfall, number of days of high temperatures, or low temperatures. So, if you are a company distributing energy, and climate change means the supply becomes regularly interrupted, you might face a massive financial loss.

“However, a parametric insurance policy would pay out based on just weather data – you don’t have to prove a loss in the way that is necessary in a traditional insurance policy.”

The third element insurers bring to the net-zero transition is the insurance of liabilities – everything from the liabilities associated with being a director of a company to working in a regulated market such as construction.

“There are many liabilities to be considered, which are all going to be affected by the transition to net zero,” says Christian. “Companies that are making commitments to net zero – or will be forced to make changes by lawmakers or regulators – are going to assume new or different liabilities, with a lot more associated risk. That is often regulatory and reputation-driven, and again, you can buy insurance to help to smooth the impact of taking on those new liabilities and keep investing in making the transition to net zero, which otherwise might be too risky.

“Meanwhile, many banks are asking hard questions of companies about net zero and their environmental, social and governance (ESG) policies. The problem is that each bank and financial institution has its own approach, making it hard to benchmark across companies and to coordinate action to ensure the best possible impact.”

The insurance sector will play an important part in managing climate change: it will help to facilitate the movement of money into areas that require investment – through reducing the level of risk associated with those investments – and it will also help to provide the necessary resilience for the most vulnerable communities, which are more likely to be uninsured.

This will help build equity in a world where individuals, businesses and governments will all face new risks. This can only help to ensure that the transition to net zero happens at a fast pace.

Download Aon’s full annual Weather, Climate and Catastrophe Insight report.

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