In Asia, a region both economically dynamic and diverse in its geography, climate change is reshaping the landscape of risks and opportunities. From the coastal cities facing rising sea levels to the agriculture-dependent nations grappling with unpredictable rainfall, the challenges are undeniable and widespread.
For the insurance sector in Asia, climate change isn't merely an external factor to observe; it's a transformative element that directly influences the core of risk assessment and management. Past models, grounded in historical data, are now met with the challenge of predicting a future where the climate plays an unpredictable role. These factors indicate a need for a recalibration in the risk management practices of the insurance sector.
The same can be said for the rest of the financial sector, such as the banks and investment institutions. Whilst certain segments of the financial sector have advanced in terms of pricing in climate change risks into their products and services, progress has not been even.
Review the panel discussion where we explored the criticality for the financial sector to price in climate change risks, what has been causing the inertia in doing so, and what can be done about it.
Summary
I. Introduction
In Asia – a region both economically dynamic and diverse in its geography – climate change is reshaping the landscape of risks and opportunities. From the coastal cities facing rising sea levels to the agriculture-dependent nations grappling with unpredictable rainfall, the challenges are undeniable and widespread.
For the insurance sector in Asia, climate change isn't merely an external factor to observe; it's a transformative element that directly influences the core of risk assessment and management. Past models, grounded in historical data, are now met with the challenge of predicting a future where the climate plays an unpredictable role. These factors indicate a need for a recalibration in the risk management practices of the insurance sector.
The same can be said for the rest of the financial sector, such as banks and investment institutions. Whilst certain segments of the financial sector have advanced in terms of pricing in climate change risks into their products and services, progress has not been even.
The Global Asia Insurance Partnership held a panel discussion to explore the criticality for the insurance sector to price in climate change risks, what has been causing the inertia in doing so, and what can be done about it.
This summary highlights the key points from the panel discussion.
II. Criticality of pricing in climate change risks
Addressing climate change in Asia has several unique challenges and opportunities. The region is distinctive due to factors like its large population growth, significant economic opportunities, and a relatively young fossil fuel energy system. Increasingly, the region also faces social and environmental risks.
The unpredictable nature of climate change – increasing frequency and severity of climate-related events and the shifting risk profiles across the globe pose challenges of incorporating climate change risk into traditional actuarial pricing models. Traditional actuarial models rely on historical data, which is insufficient for addressing climate-related challenges. To tackle these issues, the non-life insurance industry employs models such as Natural Catastrophe (NatCat) modelling. These models are continuously evolving, with new ones emerging to cover various perils over different geographic areas.
In the realm of life insurance, insurers are concerned about how climate change affects mortality and morbidity, given the increasing instances of extreme weather conditions. The challenge lies in identifying and modelling these risks effectively for actuaries and underwriters.
However, the panellists agreed that insurers faced the dilemma of pricing climate-related risks, as both under-pricing and over-pricing could have significant consequences, affecting affordability, availability, and financial stability. Regardless, the failure to adequately price climate change risk could lead to significant financial losses, particularly impacting the reinsurance industry.
On this front, international regulators are working together to address these issues and exchange views on emerging good practices, with potential guidance from the actuarial profession on pricing for climate risk.
While there are challenges in pricing climate change risk, there are also opportunities for insurers. The insurance sector could enhance climate resilience through risk adaptation measures and promote risk mitigation by offering products that support net-zero goals. Some regulators are encouraging insurers to consider adaptation measures and even provide premium discounts for customers who adapts such measures, such as fortifying their homes against climate-related events.
Overall, Asia's unique geographical and economic dynamics necessitate a different approach. While the insurance sector is starting to focus on the role of emissions and withdrawing capacity from certain sectors of the energy system as part of the effort to achieve net-zero emissions, every action taken by the industry, including pricing decisions should be oriented towards real world decarbonisation.
III. Causes of Inertia in Pricing Climate Change Risks
Pricing risk involves multiple factors beyond just climate, including recent loss experiences and interest rates. The distinction between climate-related and non-climate-related risks can be challenging to discern. While not every flood or wildfire can be attributed to climate change, there is a clear trend of continued intensification of hazard risk and a need to transition to a low-carbon economy.
To overcome these challenges, insurers could consider working backward from a vision of a low-carbon, resilient economy to understand the pathways and transitions needed to achieve a net-zero economy. This approach could help in pricing transition risks effectively in financial products, including insurance and in the broader financial sector.
The other challenge is the implementation and execution of climate change risk pricing considering that various stakeholders are involved and their differing priorities. Most importantly the perspectives of two key stakeholders: policyholders and regulators.
Policyholders may acknowledge climate change risks but find it challenging to understand and accept significant premium increases as a result. Regulators, on the other hand, aim to ensure both insurance availability for vulnerable groups and affordability. These goals can sometimes conflict with insurers' attempts to price for climate change.
Jeffery Yong, Principal Advisor of the Financial Stability Institute listed five broad categories of challenges the insurance sector faces from fully embracing climate risk pricing. These include i) technical challenges, ii) product design challenges, iii) regulatory blind spots, iv) policy dilemma, and v) lack of technical expertise.
These challenges highlight the complex and multifaceted nature of incorporating climate change risks pricing and underwriting with technical, regulatory, and policy-related issues to consider.
IV. The Path Forward
To drive better pricing of climate change risks, the insurance sector needs to focus on actionable steps and potential solutions to ensure more in-depth understanding of climate change risks.
First, the insurance industry is urged to focus on its core strength, which is pricing risk and facilitating the allocation of capital to mitigate risks associated with climate change.
Second, the importance of capacity building and upskilling. This is an area where the various stakeholders – insurers, government bodies, supervisors, and academia – could collaborate to provide technical training.
The third point is that while there are significant advancements in technology and modelling techniques related to climate change risk assessment, the challenge lies in the pricing power of the insurance industry to help transition the world from a more environmentally damaging “brown” world to a more sustainable “green” world.
The fourth suggestion is for global and regional bodies to work with supervisors to deepen the understanding of the role of the supervisory and policymakers community in promoting the incorporation of climate change in pricing. Supervisors' interest in climate-related risks is viewed from three perspectives: safety and soundness of insurance, affordability and availability of insurance coverage, and net-zero transition goals. While many supervisors lack explicit mandates for climate-related risks, they all have an interest in these issues from a prudential perspective.
Most importantly, the significance of a multi-stakeholder partnership is vital to address complex issues and calls for a thoughtful approach to promote sustainable growth in the face of evolving risks and opportunities. The need to bring different stakeholders together to define resilient infrastructure and discuss its impact on insurance costs and the broader financial system was stressed. Ultimately, the goal is to accelerate decarbonisation and achieve a low-carbon and resilient future through collaborative efforts.
V. Conclusion
In conclusion, the panel agreed that current actions are insufficient and will lead to serious consequences for the financial sector, the economy and society as a whole. As such, the industry is urged to consider scientific studies and evidence to convince more rapid and tangible actions.
The role of internal and external expertise in driving change management within organisations, the importance of governance structure, and board involvement is also crucial in accounting for climate change in risk assessments and pricing models. There is also a need to improve transparency in quantifying change and product pricing to encourage a shift from "brown" to "green" practices.
Overall, the panel concluded that significant collaboration among insurers, reinsurers, policy makers, regulators and industry associations in managing climate-change risks and driving sustainable development was key to success. The ultimate question is how far and how fast these efforts will be implemented and whether they will be sufficient to address the climate crisis.
