Governing Insurance for Financial Stability and Environmental Sustainability

We are in the middle of a global crisis of climate change and nature loss. The rapid warming of the planet due to man-made greenhouse gas emissions since the beginning of the Industrial Revolution has created major physical and transition risks. Sea-level elevation, heat waves, and the intensification of windstorms, floods and wildfires are threatening people, economies, as well as global trade and supply chains. The social, technological, political and regulatory uncertainties associated with the transition to a low-carbon economy are also adding to the risks for individuals, corporations and the financial system. This climate crisis is part of a broader trend of nature destruction and biodiversity loss, linked to increased resource extraction, deforestation and land conversion, as well as the pollution and depletion of soils, freshwater and oceans. Critical ecosystem services upon which our economy and survival ultimately rest are being endangered like never before in modern history.

Climate, nature and the financial sector are linked through indirect transmission channels which are critical for policy and regulation. The direct climate and nature footprint of banks, insurers, pension funds, asset managers and other financial actors through their own operations is modest compared to industrial corporations. However, their real impact is indirect and through their financial activities. The financial system constitutes the lifeblood of the real economy: without financing, lending and insurance, economic activities would face higher costs and, in many cases, grind to a halt. Conversely, climate- and nature-related physical and transition risks can quickly translate into losses for the financial sector as insurance claims increase, investments become stranded assets, and loans cannot be repaid.

This policy brief focuses on the role of the insurance sector. Despite its links to climate and nature risks (for instance, through insurance against natural catastrophes), the insurance sector has so far received insufficient attention from most policymakers, regulators and supervisors. Against this background, we will examine the dual systemic roles of insurers:

• First, as risk underwriters and claims managers who help individuals, corporations and the economy absorb fluctuations and diversify risks that could not be borne in full by individual economic actors.
• Second, as major long-term institutional investors.

The analysis highlights the climate- and nature-related risk transmission channels between these two aspects of insurers’ activities and between insurers and the rest of the financial system to identify key challenges and formulate concrete policy proposals.

The report examines how insurers and their regulators should address risks linked to climate and nature. While climate is a subset of broader nature-related issues and one of the planetary boundaries, it has acquired, in recent decades, a specific focus. Methodologies and data are more widely available for climate than for biodiversity loss, for example. Therefore, climate-related examples feature prominently, but not exclusively, in the analysis. We also distinguish between climate mitigation, i.e., the reduction of greenhouse gas emissions to prevent further climate change, and climate adaptation, i.e., society’s physical, economic and financial resilience to climate warming. While insurers have a role to play in climate mitigation (for instance through insuring and financing renewable energy), they also have a key part to play in climate adaptation. Of course, insurance also has an important social component (such as complementing social security systems), but the report only addresses social topics in the specific context of their relation to climate and nature issues.

The policymakers, regulators and supervisors who oversee the insurance sector must set requirements and incentives for insurers to mitigate and mutualize climate and nature risks better across economic actors and the financial system. Policymakers, regulators and supervisors should give due consideration to the potential negative impacts on climate, nature and financial stability from insurers’ underwriting and investment activities. To that end, traditional supervisory objectives, such as protecting insurance policyholders and ensuring that insurance markets function correctly, require a more holistic, long-term and forward-looking view of climate- and nature-related risks. With this in mind, our key policy recommendations focus on enhancing financial stability and environmental sustainability by increasing macroprudential oversight for insurance, integrating transition plans into prudential supervision, adapting insurers’ capital requirements to evolving climate and nature risks, supporting society’s resilience against natural disasters, reducing the climate insurance protection gap, and ensuring the availability of insurance for transition technologies.

The scope of the policy brief is global, and examples from various parts of the world are analyzed. Several jurisdictions feature recurringly, either because they have a more advanced regulatory approach (such as the European Union) or because they are at the forefront of climate-related insurance market disruptions (such as the US states of California and Florida). Beyond insurers and their direct regulators and supervisors, we also explain how other stakeholders (from policymakers to tax authorities, insurance associations or non-governmental organizations) have an important role to play in addressing climate- and nature-related risks.

The report is structured as follows:

• In the first section, we provide a general overview of the insurance sector, its role within the financial system, and its relation to the broader economy.
• In the second section, we highlight the links between insurance, climate and nature and the corresponding risk transmission channels.
• In the third section, we analyze the challenges for policymakers, regulators and supervisors to ensure that the insurance sector adequately addresses climate- and nature-related risks for itself, for the financial system and for the economy as whole.
• In the fourth section, we formulate the main policy recommendations derived from this analysis, and we mention the key stakeholders for their implementation.

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