Late transition to low-carbon economy a risk to reinsurance

In light of a global effort to improve economic resilience against the threats of climate change, a new report from the European Systemic Risk Board (ESRB) highlights potential systemic risks for reinsurance following a late transition to a low-carbon economy.

In order to effectively tackle the global threat of climate change governing bodies and organisations across the world underlined the importance of keeping global warming levels below 2 degrees centigrade.

To achieve this goal, significant reductions in global greenhouse gas emissions are required over the next few decades as countries throughout the world begin a transition to a low-carbon economy.

With this in mind, the ESRB has stressed that further implications and greater transitional costs will likely be incurred for insurers, reinsurers, and governments, should there be a late transition to a low-carbon economy.

“Global warming, and its implications for the frequency and severity of natural catastrophes, is increasing with the stock of greenhouse gases in the atmosphere. As such, a late transition to a low-carbon economy will aggravate the costs of transitions for, among others, general insurers, reinsurers and governments,” says the ESRB.

Furthermore, adds the ESRB, a late transition could result in a “concomitant rise in the incidence of natural catastrophes related to climate change, raising general insurers’ and reinsurers’ liabilities.”

Ultimately, a failure to implement greenhouse gas reduction strategies early, and effectively, which supports the transition to a low-carbon global economy, will likely result in global warming levels exceeding the proposed 2 degrees centigrade level, says the ESRB.

As a result of this the global economy would be exposed to increased physical risks, including the potential for more frequent and severe natural disaster events, a threat to the reinsurance and insurance-linked securities (ILS) industry.

The ESRB notes that over the last three decades insured, but particularly uninsured losses from natural disaster events have spiked. This is in part due to rising asset values and a growing middle class in developing parts of the world, which contributes to migration to hazard prone areas, such as coastal regions or densely populated cities, a risk exacerbated by low insurance penetration levels.

“In the short term, insured losses pose challenges for the profitability and resilience of the insurance industry, while the costs of the large and increasing share of uninsured losses will be borne by the larger economy,” says the ESRB.

Climate change contributing to a rise in the severity and frequency of extreme weather, and natural disaster events is something often discussed in both risk transfer and climate change discussions, and can draw opposing views.

But from its recent report, titled ‘Too late, too sudden: Transition to a low-carbon economy and systemic risk,’ the ESRB underlines that a slow, or late transition to a low-carbon economy could relate to a rise in the occurrence of natural catastrophes related to climate change.

The ESRB report, then, underlines that a late transition to a low-carbon economy could see a rise in the frequency, severity, and ultimately costs to insurers, reinsurance capital providers, and governments (as they foot the bill following an event absent sufficient insurance protection), following a natural catastrophe event.

“Disruptions due to natural disasters may impact negatively the capital stock, productivity and output, as well as public finances,” says the report.

Insurers, reinsurers, and the wider risk transfer and reinsurance capital landscape, are vital players in the global fight against climate change, providing much-needed experience, skills, and ultimately the risk capital to build the resilience of those in emerging and developed parts of the world.

But a late transition to a low-carbon economy could hinder this, as transitional costs and timeframes could be disrupted should global warming levels exceed the proposed limit, resulting in the possibility of more frequent and severe natural catastrophe events.

Of course a late or delayed transition to a low-carbon world and the resulting increasingly frequent and severe weather-related catastrophe events would also result in greater need for global risk and insurance capital. Hence insurance, reinsurance and ILS players are essential sources of risk capital support that the world should be leveraging to help it to transition as quickly and effectively as possible.

In fact risk capital could help to offset some of the risks associated with financial investment in transitioning to a low-carbon economy, with ideas such as resilience bonds (catastrophe bond technology leveraged for resilient infrastructure development) perhaps portable across to projects that would help to reduce carbon outputs.

This could present another opportunity for the ILS, catastrophe bond and reinsurance market to innovate to support resilience, by enabling capital deployed towards becoming carbon neutral to be protected against the increasing weather disaster risk.