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A coherent climate change strategy is as vital as ever for insurers

  • Market Insight 8 July 2020 8 July 2020
  • UK & Europe

  • Climate Change Risk Practice

The lessons learned by the insurance industry from this pandemic will be useful in coping with the disruption to come from climate change over the next decade.

A coherent climate change strategy is as vital as ever for insurers

The scale of the economic impact of the Covid-19 pandemic is remarkable. On the debit side of the balance sheet, the price of oil went briefly negative as demand plummeted, ships have been put on a go-slow as ports close, supply chains are stuttering, the travel and leisure industries are moribund, high streets remain shuttered, unemployment is rising and inflation threats lurk. Global recession seems a given. Depression a possibility.

On the plus side, carbon emissions have plummeted. China’s carbon emissions were down by 25% between mid-January to mid-February and Paris’ nitrogen dioxide level dropped by 70% in April. In the UK, road travel decreased by 73% and globally, air traffic is down 95%.

Against this backdrop, a key question for governments and business leaders is how do they move forward and shape the new normal? How do they restore profitability and shareholder returns without risking the kind of climate change exposures which were already being litigated in the US? How do they demonstrate they understand risk, in all its forms and demonstrate they have realistic mitigation plans in place and, make changes that will help to tackle climate change in the long-term?

Stakeholders may weather a global shock once, they will not forgive directors (or politicians) for getting it wrong twice.

Since March, the oil industry has been in freefall, with global demand plummeting. The glut of surplus oil is causing oil fields to close and storage facilities to become overloaded. Lord Browne, ex-BP chief executive, recently commented: “The coronavirus-linked oil price crash will serve as a warning for the industry of what is to come.” He suggests the world will be so changed by coronavirus that the world might have passed “Peak Oil”, years ahead of most forecasts.

Demand for thermal coal was declining before the pandemic, and the global lockdown has exacerbated the situation, resulting in the International Energy Agency predicting an 8% decline in global coal demand this year, the largest drop in over 70 years. Financial think tank Carbon Tracker recently reported that 46% of coal power plants will run at a loss in 2020; that percentage looks set to rise as the price of electricity from new wind and solar projects continues to fall (the unsubsidised price of electricity from utility-scale solar projects has fallen by a factor of between five and eight in the past decade).

Revert or change?

In China, emissions are already back up as the economy restarts. As the rest of the world starts to open for business again and as demand recovers, businesses and governments face a choice – continue to support traditional fossil fuels or switch to greener options?

Investors will take notice of the choices companies make.

Pre-Covid 19, many were already turning their back on fossil fuel investments, and this trend is likely to continue as they look around the wreckage of the stock markets. The current situation presents a unique opportunity to invest in new green energy generation projects such as enhancing charging infrastructure for electric vehicles, fitting green home energy solutions, and investing in clean power projects, and in industries and businesses which take a greener approach.

Similar choices extend to other sectors beyond energy and power. Astute finance directors are already revaluating their office space requirement and the need to travel for meetings. This will have significant repercussions for transport infrastructure, digital industries, real estate and the workforce, more broadly.

Of course, the pandemic has also shone a harsh light on the vulnerabilities in extended supply chains. Firms will be reassessing their “just in time” supply chain strategies, as well as their dependence on suppliers in China and other emerging economies. Resilience and agility will assume greater importance, even at the cost of pure economic efficiency.

Some may consider building a web of more local suppliers. Others may also look at additive manufacturing (3D printing), AI and robotic manufacturing solutions. Robots don’t get sick or require social distancing rules; 3D printers can be located close to customers. These moves could reduce carbon footprints (not least by reducing the volume of shipments by sea and air), but at what cost to ageing or traditional workforces and to urban centres, let alone emerging economies?

The current situation is clearly a wake-up call for boards and risk managers in every sector who have had global risks such as pandemics and climate change in their “too difficult” tray.

The pandemic is also testing the insurance sector, with Lloyd’s forecasting that it could cost insurers more than $200bn ($107bn in claims and $96bn in investment losses). As with previous disasters (such as windstorms, floods and earthquakes), the “protection gap” between total economic losses and insurance payouts will be substantial. Can insurers develop commercial solutions to bridge this gap, so that the world is more resilient against future crises? Is there a role for governments as “reinsurers of last resort”?

Pandemic and climate change risks expose directors and other senior executives to scrutiny, and they will be judged on the effectiveness and implementation of their business continuity plans as compared to their peers. D&O insurers could play a role in assessing policyholders’ readiness in this regard.

The world’s economy faces enormous challenges as it emerges from this pandemic, which in some ways is a portend of the disruption to come from climate change over the next decade. Whether the world heeds this message on this postcard from the future is open to question. Whatever happens, both pandemic and climate risk are here to stay, and the insurance industry has a vital role to play in supporting business to navigate the new normal.

This article first appeared in Insurance Day.

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