How is the insurance industry responding to climate change?

The insurance expert at the ADB speaks about the insurance industry coping with the growing number of extreme weather events

24 August 2021

An interview with

Arup Chatterjee Principal Financial Sector Specialist, Sustainable Development and Climate Change Department at Asian Development Bank

In this second part of the interview, Arup Chatterjee, Principal Financial Sector Specialist, Sustainable Development and Climate Change Department at Asian Development Bank, speaks about how the insurance industry is coping and innovating to respond to the growing number of extreme weather events. He also speaks of strategies being used by insurance companies to better manage extreme weather events.

Unravel: In the first part of this interview, you talked about responses financial market stakeholders and governments are considering to mitigate climate risks. Is it practically possible to implement these measures in emerging and developing economies transitioning to a low carbon economy?

Arup Chatterjee: Overall, financial authorities in emerging markets note significant teething problems in capabilities, data and tools. Today’s reality is that the taxonomy, necessary rules, regulations, standards and best practices remain nascent, weakly defined and not harmonised. As a result, immense challenges confront financial institutions, particularly around quantification and scenario analysis.

Due to weak policies and conventions in the financial industry and a lack of climate risk disclosure besides adequate support and incentives to act, very few financial institutions actively incorporate climate risks into their financial decision-making. Moreover, because of the immaturity of business models and the risk management practices still evolving, there is a perceived lack of private benefits to scale up climate finance.

A few financial institutions have incorporated their exposure to climate risks in their investment, lending, and underwriting decisions and integrated them into their broader risk management processes. As a result, environmental, social and governance (ESG) issues are gaining in with institutional investors exerting their influence and channelling investments into projects that deliver measurable non-financial benefits while improving long-term financial returns.

Even major credit rating agencies now factor ESG elements, including climate risks, in their ratings, to varying degrees.

Any successful response will need to involve a mix of compulsory and voluntary measures backed by a robust framework for assessment, implementation and monitoring. Such a framework should leverage the innovations happening in big data, data analytics, automation, artificial intelligence and machine learning to help meet the sustainability ambitions.

Unravel: With the number and frequency of these events multiplying at such speed, can the insurance industry cope even if awareness increases and buy-in for insurance increases?

Mr Chatterjee: One cannot precisely comment on the level of preparedness of the Asian insurance industry to deal with rising climate change-related losses and the extent it will threaten their underwriting and investment portfolios.

In the absence of adequate disclosure and climate-specific stress-testing, beyond traditional catastrophe models, it may not be easy to assess the effectiveness of insurers’ actions to withstand extreme weather events and defend their underwriting and pricing decisions.

Insurance of some risks can either become unaffordable for customers or unfeasible for insurers. And, this could lead to underinsurance, higher rates of self-insurance and increased demand for disaster relief from the public sector.

However, compared to other financial market participants, insurance companies still fare much better in understanding the impact of climate risk on their balance sheets.

Insurers need to shift business models away from transactional risk transfers and indemnity payments towards mitigating physical climate risks such as rebates for using resilient construction materials