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Political Risk

How Insurers Can Become Climate Champions

Daniel Wagner | January 26, 2024

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Red and orange clouds surround the planet Earth

Making real progress in climate action is not a multibillion-dollar proposition—it is a multitrillion-dollar endeavor. Although global climate finance almost doubled between 2011 and 2020 to a cumulative $4.8 trillion, current finance levels continue to fall short of the amount necessary to avoid the worst impacts of climate change by not bringing adaptation and resilience measures to a meaningful level.

To deliver on development and climate goals, emerging markets and developing countries (other than China) will need to spend approximately $1 trillion per year by 2025 (4.1 percent of gross domestic product (GDP) compared with 2.2 percent in 2019) and around $2.4 trillion per year by 2030 (6.5 percent of GDP) in the form of human capital, sustainable infrastructure, adaptation and resilience, and natural capital. Getting there will require not only enormous financial resources but creative thinking about resource mobilization, particularly given the historical hesitancy on the part of investors and lenders to dedicate resources to the most needy and climate vulnerable countries due to perceived higher levels of risk.

The Role of Insurers

Banks are often resistant to supporting transactions in these countries in the absence of credit enhancement from multilateral development banks (MDBs), insurers, or guarantors. These organizations act as the silent "lubricant" that can enable thousands of transactions to reach the finish line. The MDBs have committed themselves to reforming their financial architecture while also being even more supportive of environmentally friendly projects. This is especially helpful considering that some private sector insurers and guarantors may only agree to support transactions in developing countries when MDBs also participate.

Partnering with MDBs and combining resources is one way insurers and guarantors can become climate champions. Another way is to begin to set aside a small portion of their earned premiums toward climate action. In 2022, total global insurance premiums were estimated to be approximately $7 trillion. If insurance underwriters were to donate just 1 percent of their earned premiums each year, they could generate $70 billion worth of funds that could be devoted to climate action. That would be almost two times the annual adaptation and resilience fundraising target for the entire world ($40 billion by 2025) or 70 percent of the annual amount that developed countries' governments have committed to raising for climate action in developing countries ($100 billion, which has been difficult to raise).

Yet another way is for insurers to create new forms of risk transfer solutions, providing extra incentive for investors and lenders to commit funds for environmentally friendly transactions. For example, providing parametric coverages at scale by enhancing risk modeling techniques and developing more standardized approaches to coverage could go a long way toward moving the needle on climate finance.

It is worth noting that approximately 80 percent of the insurance market and 53 percent of the reinsurance market have imposed no restrictions on providing coverage for the oil and gas industries. It would be simple for insurance companies to take the same approach the MDBs have taken on this subject, which is to commit to broadly aligning their operations with the 2015 Paris Agreement. If insurers were to do so, it could have a real impact on the oil and gas marketplace, for if insurance were not available, many of them could not operate in the jurisdictions where they do.

Insurers have large pools of capital that can be deployed in new and socially responsible ways. These capital pools can be directed toward any number of pathways that are consistent with climate action, whether it be renewable energy, sustainable infrastructure, or financial instruments designed to support climate action. They can also direct more of their resources to encourage environmentally friendly projects and behaviors. They can develop models to identify and mitigate against the financial risks associated with climate change. And they can support global alliances focused on climate finance to enhance and standardize climate-related investments and financial decision-making.

To date, most of the world's insurers have only just dipped their toes in these waters. Few are actually leading, and there is too little being done to forge and strengthen insurance-oriented alliances to promote climate action. Some that have been formed have become politicized, prompting insurers to take a step back. As the silent lubricant that enables so much of the world to function, insurers have a tremendous opportunity and responsibility to become more engaged in the climate action battle. The question is whether the majority of them will do so now or continue to wait on the sidelines as climate change becomes more consequential with each passing year.

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