Climate risk transfer an opportunity for product design innovation: Greg Lowe, Aon

The growing pressure on corporations to take greater responsibility for the climate related risks and exposures they carry could present an opportunity for insurance and reinsurance market participants to demonstrate innovation in product design, according to Aon’s Greg Lowe.

Greg Lowe, the Head of Resilience & Sustainability at insurance and reinsurance brokerage and advisor Aon, spoke with Artemis on a range of topics related to climate risk exposure and disclosure, as well as the role of the risk transfer markets in helping in the response to climate threats and climate change adaptation.

With regulators working on establishing climate risk exposure standards and stress tests being conducted, it’s possible that insurance and reinsurance markets could find their capacity coming under pressure, as demand and supply adjust to a new paradigm where climate risk responsibility and management are the norm.

We asked Lowe whether these shifts could drive more purchasing, to which he said, “It’s hard to say. Ultimately with extremes becoming more extreme, there is a case for shifting more of that to reinsurance.

“The challenge is the whole distribution curve of risk is being shifted, so presumably some of what is retained may have previously been reinsured. There are many ways this could play out.

“Does this shift things in favour of facultative solutions? More to alternative capital? Insurers need to think of the different ways it could impact reinsurance purchasing and take a view.”

The UK’s Prudential Regulation Authority (PRA) of the Bank of England is currently conducting stress tests for the insurance and reinsurance sector, within which they are being asked to consider climate change risk and how it impacts their “liability exposure management.”

At the same time the Bank of England is seeking to mainstream climate risk management and encouraging disclosure more widely in the economy.

Whether the findings from such exercises could influence solvency capital rules, to penalise those bearing more climate risk and which would ultimately encourage more risk transfer and hedging remains uncertain. But Lowe feels these are important steps and worth watching closely.

“I think it’s too early to tell, but I would pay very close attention to the PRA’s response to the submitted stress tests. We’ll probably need to go through at least another iteration of these stress tests before the regulator would make more specific changes to capital and solvency rules. Climate change is a systemic risk so there will need to be careful consideration of both the asset and liability sides of the balance sheet,” he explained.

We asked Lowe whether this dual-focus on the climate risk on both-sides of the balance-sheet means that the asset side climate exposure should be combined with the risk side, to give a single metric for re/insurers climate risk exposure.

He responded, “Climate risk on the asset side is absolutely a focus and the PRA makes this clear. More of this emphasis is on energy transition risk, but a more careful consideration of how physical and transition risks impact both sides of the balance sheet is needed. We are some ways off from a single risk metric for re/insurers climate risk exposure, but that is certainly the Holy Grail. There needs to be a rethink on correlation of risks.”

On the risk transfer side, the shift towards climate disclosure standards, reporting and the resulting need for risk management and adaptation plans, all suggests a growing importance will be placed on catastrophe and severe weather insurance, reinsurance and of course insurance-linked securities (ILS).

Lowe commented, “The design of risk transfer products is less likely to be driven by the developments at the PRA or other regulators. This will come from clients who may be subject to their own climate risk disclosures and scenario exercises.”

Data is going to play a key role in helping the understanding of climate risk exposure and what can be done to manage it, or hedge the exposure from balance-sheets, which is where Lowe sees innovation as key.

“Looking at how climate scenarios unfold, particularly with emerging climate analytics, raises really interesting questions that lead to potential innovations in product design. I see this as a collaborative opportunity between brokers, risk consultants, insurers, and reinsurers,” he explained.

Continuing, “Insurers have a range of products that are underutilised by commercial clients that could help them manage climate risk more effectively. Take parametric weather products, for instance.”

Capacity is clearly abundant to help those needing to shift climate related exposures from their balance-sheets, with both traditional insurance / reinsurance and the capital markets adept at measuring and underwriting climate related weather exposures already.

“We have a challenge of demand, not supply,” Lowe said. “Alternative capital solutions and innovations in risk consulting are readily available, but clients aren’t typically thinking about how risks may be evolving. There is still an overwhelming view of the current state of risk being static, at least in terms of buying habits.

“We have a long way to go from corporate statements on climate change and strategic visions lining up to risk management and insurance procurement.”

A long way to go, but this is a journey that promises to drive further innovation in risk transfer, as markets seek to provide responsive tools that can deliver risk transfer and balance-sheet hedging against the potential negative effects of climate related exposures.

As the world embraces more climate disclosure standards and encourages greater responsibility to be taken for climate risks, there is a clear need for a new breed of risk transfer products, as well as a greater use of instruments based on index and parametric triggers, in order to equip companies, communities and people for the climate reality they will be facing.

You may also find our recent article on the need for cost, efficiency and unbundling of the risk transfer transaction itself to help in providing greater climate related protection gap coverage of interest.