Climate change the biggest ESG opportunity in non-life: Jefferies

Climate change and providing risk transfer products to protect against its effects and to aid the world’s climate transition, is the biggest single environmental, social and governance (ESG) related attribute and opportunity for the worlds non-life insurance and reinsurance industry, according to analysts at investment bank Jefferies.

Naturally, climate change comes with both risks and opportunities for the non-life marketplace, given the uncertainty in loss trends it could create and the exposure insurance and reinsurance players have to it.

This exposure is embedded in the non-life re/insurers business, on both the underwritten risks and investment sides.

However, the ESG attribute for non-life re/insurers from writing climate change linked risks is strong, as insurers and reinsurance capital play a vital role in recovery after disasters, Jefferies notes.

We’d highlight here that this opportunity is still expanding, as the world requires new climate risk transfer products, to aid in hedging to support climate transition goals, as well as in carving out climate related risks from portfolios of physical and financial assets, to de-climatise or hedge them from the rising exposure linked to climate change.

Jefferies analysts see climate change as a major opportunity that investors in the sector are perhaps overlooking at this time.

“In our view, from our conversations with investors, the potential risks arising from non-life insurers exposure to climate change are a major focus. However, we believe that the potential rewards tend to be overlooked,” the analysts explained.

This is natural, as investors tend to be extremely focused on the risks climate change poses to their own portfolios, hence when looking at the insurance and reinsurance sector they may still be more focused on the risk side, than the opportunity.

This goes for insurance-linked securities (ILS) too, where many institutional investors we speak with struggle to connect climate risk with an opportunity for the sector, at the moment only really seeing recent loss activity and linking that to climate change.

We believe this opportunity only outweighs the risk as long as pricing keeps pace and the market remains disciplined when it comes to charging for its products and this is going to be even more important as new climate risk transfer offerings are launched over the coming years.

Jefferies sees a number of dynamics playing out over time for the non-life insurance and reinsurance market, related to climate change.

All of these apply to insurance-linked securities (ILS) as well, including the catastrophe bond market.

First, the opportunity for product development and entry into new markets.

“Increased frequency of weather events presents opportunities by raising awareness, where there is a structural demand for insurance – particularly in emerging/developing markets where insurance penetration is low,” Jefferies analysts explain.

Pricing power is another factor, as Jefferies analysts rightly believe that rising climate change risks will mean the industry has to raise prices and become more disciplined on that as well.

“As catastrophe models are adjusted to reflect higher probability and magnitude of losses, the industry will increase prices in order to reflect the new and elevated view of risk.

“Moreover, as some capital that had previously supported catastrophe risk has exited or is trapped, overall capacity to protect against property catastrophe risk is diminished, resulting in more pricing power for the remaining available capacity,” the analysts wrote.

That last statement is what we see today in market’s like retrocession, where capacity has been diminished after catastrophe events and as a result capacity is tighter, providing more pricing power to those able to raise new capital, divert capital to retro, or create new products for that segment.

Climate change is going to drive this pricing power opportunity both for those with the capital and appetite to absorb climate risks, as well as to those able to innovate and create new climate risk transfer products and solutions.

There are also positives for those that can write more of this emerging climate exposed business, as well as normal property catastrophe risks, according to the analysts.

“Insurers that write more catastrophe insurance have enhanced data capabilities, providing them with a pricing advantage which ultimately should improve market share,” they explained.

Less positive factors are those related to rising claims, which of course any company is likely to face at times if they write catastrophe and climate exposures, while the uncertainty associated with climate risk could drive more losses, but also drive underwriting and balance-sheet volatility, elevating costs of capital.

The opportunity is significant and Jefferies favours those able to grow into the property cat market, especially if they can evidence more stable underwriting returns.

Over time, the data advantage these companies can generate could also be significant, particularly on the reinsurance side of the market.

The ability to write this business is a true ESG attribute for the industry and those best able to innovate on products for climate change related risks may find they can generate greater investor interest too.

Which reads across to the ILS market, where those ILS fund managers best able to capture a share of the emerging market in climate related risk transfer products, while also writing catastrophe risks in a balanced and sustainable manner, may find themselves best positioned to attract capital from ESG allocators and major institutions that want to put their capital behind those helping to offset climate risk with their underwriting and investment capacity.

ESG investing and the opportunities it presents are a growing focus for the insurance-linked securities (ILS) market. Read more of our insights on this topic here.