Insurers must ensure sustainability

By: Kirsten Barber, Senior Knowledge Lawyer at Hogan Lovells

Sustainable or ”green” finance, the process of taking environmental, social and governance (ESG) considerations into account in investment decision-making, and a focus on the impact of climate change have risen up the international regulatory agenda over the last few years.

Kick-started in 2015 by the adoption of the Paris Agreement on Climate Change and the UN 2030 Agenda for Sustainable Development, national governments, regulators and market bodies have been looking at how the financial services sector can play its part in achieving a more sustainable economy.

The Network for Greening the Financial System (NGFS) is a group of central banks and financial sector supervisors established in December 2017 to help strengthen the global response to the Paris Agreement on climate change.

According to the NGFS climate change is one of many sources of structural change affecting the financial system and climate-related risks are a source of financial risk.

Financial risks from climate change can be divided into physical and transition. Physical risks arise from a number of factors and can be related to specific weather events such as heatwaves, floods, wildfires and storms and longer-term shifts in climate such as changes in precipitation and extreme weather variability, and rising sea level and temperatures.

These risks can obviously impact insurers and reinsurers through higher claims. Global insured losses from natural disaster events in 2017 were the highest ever recorded. The number of registered weather-related natural hazard loss events has tripled since the 1980s and inflation-adjusted insurance losses from these events have increased from an annual average of around US$10 billion in the 1980s to around US$55 billion over the last decade.

Transition risks can arise from the process of adjustment towards a low-carbon economy. This adjustment is influenced by a range of factors including climate-related developments in policy and regulation, the emergence of disruptive technology or business models, and shifting sentiment and social preferences.

Insurers can, of course, make choices over what they underwrite; some risks may come to be seen as too risky or require specific exclusions, such as housing in flood plains or business disruption arising from weather events.

Recognition of the systemic impacts of climate change and the transition to a low carbon economy on the financial services sector has prompted a global response.

Through their underwriting and investment activities, insurers are particularly exposed to the risks arising from climate change. Increasingly, some insurers and reinsurers are starting to incorporate sustainability principles into their businesses. We can expect the trend for more regulation in this area to continue.

The challenge for regulators, insurers and other stakeholders is to ensure that regulatory initiatives are consistent, proportionate and do not result in constraints stifling the innovation of new products.

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