A very important point was raised by the Chairman of the Insurance Regulatory and Development Authority of India (IRDAI) recently, that insurance and reinsurance firms hold significant exposure to climate related risks in their investment portfolios, as well as the exposures they assume through underwriting.
It seems a simple thing and something that everyone should appreciate, but the industry spends so much time concerning itself with the underwriting losses it faces from severe weather, natural disasters and climate related factors, that it perhaps forgets the other side of the balance-sheet.
Climate related risks are embedded in the asset side of the insurance and reinsurance business as well, with equities often highly exposed, but so too certain fixed income and sovereign bond instruments, as well as some alternative asset classes including infrastructure.
We often hear from major insurance and reinsurance firms about their desire to make their investment portfolios work harder in addressing climate change risks, given the industry has huge investment piles of cash to deploy that could be put to work in new asset classes such as resilient infrastructure.
But it is also important to remain cognisant of the risks embedded in the investment portfolio as well, especially as perception of climate related risks becomes increasingly heightened and expectations that climate change will hurt investors over the longer-term become more accepted.
IRDAI’s Chairman, Dr. Subhash C. Khuntia, was speaking specifically about climate change and the risk it can pose to insurers and reinsurers in the Indian local market at an event this week, but noted that addressing the risks associated with climate needs both the asset and liability sides of the balance-sheet to be looked at.
“Climate change is real,” he explained, stressing the need for insurance and reinsurance firms to consider the asset side risks at the same time as their underwriting portfolio risks that are linked to climate.
The industry needs to find mechanisms for “innovative risk transfers,” he continued.
At the industry meeting, the IRDAI Chairman urged re/insurers to ensure their investments are sufficiently diversified to avoid concentration risks.
He commented, “There are many methods, such as risk pooling or securitisation of climate risk liabilities through instruments like catastrophe bonds,” adding that the industry needs to consider the real potential for impact from climate related risks and ensure it is dealt with on both sides of the balance-sheet.
His points raise interesting issues.
While the insurance, reinsurance and insurance-linked securities (ILS) industry is always asked about how it deals with climate change related risks within its underwriting and whether it is priced into the risks, the same is rarely broached as a subject relating to the asset side.
On the underwriting side, the industry relies on its risk models being updated regularly as well as the fact the majority of the contracts are only one-year in duration, meaning they get re-priced using the latest views of risk at renewal.
But on the investment side of the insurance and reinsurance business the subject does not arise too often, unless related to investments in carbon emitting asset classes such as coal.
But of course, an investment portfolio of the scale of a major re/insurer’s will contain significant exposure to climate change from multiple industries and asset classes.
Should these climate related risks be measured and considered as risks, almost akin to the liabilities on the other side of the balance-sheet? Or can a hybrid approach to buying protection (hedging) be developed, whereby re/insurers can hedge out their liabilities exposure to climate at the same time as their asset-related exposures to climate risk as well?
Is there a need for a hybrid climate risk transfer and hedging tool that covers the needs of the re/insurance industry, taking into account both liability and asset-side climate exposure?
It would be an interesting hedging tool, with broader applicability than just re/insurance, and perhaps one that the expertise in the ILS market and depth of institutional capital could help to drive and provide the capacity for.
When we say broader applicability, we mean that large corporations around the globe have climate change linked risk within their physical assets as well as their investment portfolios, in some cases much of which may not be properly or fully hedged. In addition institutional investors clearly take on huge amounts of climate exposure, much of which isn’t hedged either.
It strikes us that there is a need for some deep thinking about how to solve for the full-range of climate related exposures, not just in the insurance and reinsurance industry, but more deeply throughout the global economy as well.
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