The Climate Change Committee (CCC) is an independent, statutory body created to advise the government on emissions and carbon targets as a way of adapting to the impacts of climate change. On 16 June, the CCC published its latest Independent Assessment of UK Climate Risk, setting out the risks and opportunities facing the UK from climate change.
The main report leads with the sobering headline that since the last Independent Assessment in 2017, the gap between the level of risk we face and the level of adaptation underway has widened; ‘adaptation action has failed to keep pace with the worsening reality of climate risk.’
But it is in the accompanying Technical Report, a more detailed and comprehensive analysis of the ‘61 climate change risks and opportunities’ identified by the 2021 Assessment, that encouraging and worrying signs are found for the insurance industry in equal measure.
The encouraging news is that the Assessment recognises insurance, and the UK insurance industry in particular, as a key lever in transferring, mitigating, understanding, and disclosing climate risk:
‘The UK is one of the leading insurance markets globally… Insurance can assist countries to recover faster from disasters as well as provide expertise in risk evaluation and exposure. This expertise, especially within re-insurance companies and catastrophe risk modelling organisations, therefore offers growth potential for the UK.’
While the industry’s function as a financial shock absorber has been recognised in previous CCC reports, this new emphasis on insurers’ role as risk engineers is a welcome message that must begin to tangibly impact government policy. Indeed, the National Preparedness Commission is one of a number of recent public forums in which leading industry figures have noted that the government has yet to fully leverage insurance’s potential as a climate policy tool from a risk adaptation as well as transfer perspective.
The skills and expertise of the industry can, and should, provide the basis for underpinning the UK’s transition to net zero. Rigorous modelling, quantification and understanding of actual and potential catastrophic events are core competencies of insurance since they are necessary to generate an insurance product. These competencies allow insurers to incentivise and reward businesses and individuals with reduced premium policies if they comply with accredited risk-reduction behaviours and comprehensively disclose emissions.
Insurers’ expertise could also play a greater role in the government’s own evaluation and understanding of the inter-connected risks associated with climate change. The Technical Report lists a number of capabilities ‘needed to close key knowledge gaps’ which the industry is well-placed to provide, including:
- A more systematic and comparable assessment of hazard, exposure and vulnerability to ensure comparability across risks, sectors and regions.
- Better visualization of geographical variations and clusters.
- Joint assessment of physical, transition and litigation risks and their interdependencies across different climate scenarios.
The pathway for insurers to feed their capabilities into the UK’s disaster-preparedness architecture has become clearer since the publication of the government’s Integrated Review in March 2021, which committed the UK to develop ‘a comprehensive national resilience strategy in 2021 to prevent, prepare for, respond to and recover from risks.’ Notably, the review also called for an external review of the National Security Risk Assessment (NSRA) and its underlying methodology, which is important because the NSRA is responsible for producing the National Risk Register (NRR).
The latest NRR, from December 2020, lists 13 ‘Environmental Hazards’, the assessment, mitigation, and transfer of which could be enhanced by integrating insurers’ expertise into the NSRA’s ‘underlying methodology’. Figures and groups from across the industry hope to be included in the NSRA review when it begins early in 2022, supported by the National Preparedness Committee which has already heard evidence from insurers in recent months.
Insurers of first – and last – resort
The more worrying note sounded in the CCC’s Technical Report is a familiar one within the industry: that there is an accelerating divergence between businesses’ catastrophe risk transfer requirements, and practical ability of insurers to cater for them. The Technical Report notes:
‘One issue of increased climate risk is the resilience of the long-term business model of the insurance sector… Rising physical risk levels are already threatening insurability as well as affordability of existing cover: higher claims costs will require a higher premium, which may jeopardize affordability, largely due to the financial dynamics of disasters… intensifying the current trend of underinsurance or non insurance.’
It also notes that globally, ‘only 50% of losses are insured’; recent industry reports indicate an even lower figure, with global losses from natural disasters in 2020 rising to $210 billion from $166 billion in 2019, with insured losses of $82 billion and $57 billion respectively. This growing ‘protection gap’ is concerning, not least because, as the CCC note, ‘the size of insurance buffer is critical to ensure that the insurance risk is not being passed on to the financial sector’ – and equally problematically, governments and their taxpayers, which as Covid-19 has demonstrated are the de facto “insurer of last resort” for any state emergency. This too is recognised:
‘Given rising uncertainty, Mckinsey (2020) recommend risk-sharing agreements between private and public financial institutions, similar to that seen in flood insurance, in order to meet financing gaps.’
The Report stops short of recommending more public-private risk-sharing agreements itself, but their inclusion is a positive sign of a growing awareness of the latent potential of a deeper and more holistic partnership between the insurance industry and the UK government in the management of societal risks, with climate foremost amongst them.
As natural catastrophe and terrorism pools around the world have demonstrated, state guarantees can facilitate the creation of viable insurance markets that can offer broad, affordable coverage for risks that are rightly considered ‘uninsurable’ without governments’ involvement. Such partnerships enable the industry to play their traditional role as insurers of first resort, even in the instance of climate risk, which ‘threatens the long-term business model of the insurance sector’