Managing transition and sustainability risks 

Insurers are therefore increasingly focusing on understanding, quantifying and managing climate-related risks on both sides of their balance. This trend has seen recent retrenchment by some large insurers, who have backed away from public-facing net-zero campaigns such as the Net Zero Insurance Alliance, over legal fears they break anti-competitiveness rules. However, the move to net zero among insurers is a trend we expect to continue. While much of the shift towards net zero is currently voluntary, it's critical for insurers to track the rapidly evolving regulatory landscape with regards to climate change.

For example, in December 2023, the European insurance regulator, EIOPA, published a consultation paper on the prudential treatment of sustainability risks, including potentially higher spread and equity risk profiles from fossil fuel-related stocks and bonds. In addition, in April 2024, EIOPA launched a consultation on changing the solvency formula for insurers to account for increasing risks from physical climate events. These changes could mean that European insurers are required to change their capital structure to better manage these risks across their balance sheet.

As the risk and tangible impacts of physical climate change increases, the insurance industry is incorporating climate change into their risk models to a greater extent. However, to ensure they adequately capture the risk climate change poses to their businesses, many adopt a “double materiality” approach to climate risk, encompassing assessment of the impact of climate change on their business alongside the impacts on their business on climate change.

According to data from Marsh’s ESG Survey in 2023, 97% of insurer respondents are incorporating or planning to incorporate sustainability factors into their underwriting. While more insurers are using sustainability data in their underwriting, our analysis showed that its use remains relatively nascent.

On the other side of the balance sheet, across the investment portfolio, we believe that insurers are further along in understanding the carbon intensity and climate risk within their portfolios.

Many have already begun work to decarbonize their investment portfolios. However, as insurers begin to examine how they will achieve their transition to net zero, it is becoming apparent that some asset classes are more impactful than others in supporting portfolio decarbonization.

For example, bonds can deliver a direct, measurable impact on decarbonizing a portfolio, and investors can opt to invest in bonds that fund projects with the highest potential emissions reductions, or finance projects and businesses that support the transition.

One challenge for insurance investors is that a material proportion of investment portfolios are typically held in government debt - an area in which it remains challenging to extract data and assess impact.

While sovereign green bonds can go some way to helping investors meet their climate goals, by providing a greater level of transparency on the underlying projects being financed, reporting on the impacts of underlying investments is not yet consistent. Insurers can extract this type of information more consistently from finance teams issuing corporate debt, providing insurers with a valuable set of inputs to support the measurement of decarbonization across insurance portfolios.