This blog describes the discussion from an interactive session exploring climate scenarios for insurers. It outlines some lessons this exercise might have for life insurers when developing climate scenarios as part of their risk management processes.
The IFoA Sustainability Board is researching the impact of climate change on actuarial work. As part of this, the Climate Scenarios Working Party ran an interactive session at the IFoA Life Conference 2024 exploring climate scenarios for insurers.
We looked at the short to medium term impacts of a scenario where progress on addressing climate change is initially delayed and derailed. We then considered a follow-on scenario where a rapid transition is triggered by a global realisation of the increasing dangers of rising temperatures.
Our key conclusions are that:
Here we are focused on how climate change will affect insurance companies, but it is important not to lose track of the bigger picture. This risks from climate change are manifold. The overriding imperative is for society to work to limit warming and its implications as quickly as possible.
The IFoA continues to produce work in this area. In particular, the recent work on ‘Planetary Solvency’ uses a risk management approach to highlight the extreme dangers of un-checked climate change. Our working party agrees with the conclusion that global, co-ordinated action is required now to reduce emissions as quickly as possible if the worst impacts are to be avoided. In addition to the specific risks discussed here it is important for insurance companies to be ready to support the transition and prepare for the emergence of physical risks over time.
The session initially considered a short-term scenario running over 2025 to 2039, before moving to look at a medium to long term horizon. In the first section we asked the group to explore the legal and reputational risks that an insurance company might face over the next five years.
We looked at a scenario where, following a Trump win in 2024, it becomes increasing obvious that global progress on reducing emissions is nowhere near on target for a Paris aligned, ‘well below 2C’ outcome. In response more and more companies are backing away from the 2030 targets to reduce emissions by 50% and ‘net zero’ promises are becoming less realistic. The relevance of this scenario has been reinforced by Trump’s election in November and his initial steps to pull out of the Paris Agreement.
The group came up with a range of responses considering different stakeholders:
The changing environment may affect customers buying habits. It could lead them to boycott companies moving away from net zero commitments. Or they may even look for insurers that provide exposure to companies aiming to persist in exploiting fossil fuels. More bleakly, reduced confidence in a liveable future may reduce customers propensity to save, with serious impacts on insurers ongoing viability.
The group considered that shareholders might feel conflicted between the legal risks of stepping away from publicly made climate commitments, while trying to operate in an environment where lack of progress on net zero makes it more difficult to source assets to meet net zero targets, while still meeting fiduciary duties to customers.
With a reduction in global focus on climate change we may see government reallocate resources away from climate action. This could mean reduced regulation concerning climate reporting and sustainability. And it could make meeting existing climate pledges harder if government is not driving progress. For global insurers there may be additional challenges of meeting conflicting expectations across jurisdictions, making it difficult to develop coherent strategy.
If companies’ actions diverge from previous commitments they could face increased action from activist groups. Both in terms of publicity from groups such as Make Money Matter and in direct action from more radical activist groups.
These conclusions highlight the wider tension between the promises insurers have made and current levels of progress in wider society. In a world that is not making progress towards net zero it will be difficult for companies to meet the commitments they have made. This prompted some wider discussion about how companies should communicate climate action to maintain trust with their customers.
Following this initial exercise, we asked the group to look further into the future and consider the strategic risks facing an insurer in the 2030s, following low levels of action in the 2020s.
Specifically, we looked at this scenario:
“Reaching 2030 after a decade of inaction, the likely physical impacts of climate change and their impact on the world become increasingly clear. Improved modelling highlights the increasing risks faced by the world. This realisation catalyses an opportunity for global action.”
We asked the group to split into four and separately consider the impact on either investments or products of orderly and disorderly transitions. To support this, we provided a range of context highlighting the nature of the changes that might be required as part of the energy transition. For example, the widespread electrification that will be required across transportation and heating of buildings.
One of the most interesting areas that the groups addressed concerned how industry might interact with the public sector. Another was the role of experts in providing input required to make the development of scenarios meaningful.
To understand the capabilities required to support investment throughout the transition, insurers will need to develop an understanding of the key themes underlying these transitions. This might well require additional expertise beyond that typically found in insurers.
The transition will require major changes across the economy, with a large role for the public sector acting as a key enabler. Discussions in a session looked at the capabilities insurers would require to work closely with government to access appropriate investment opportunities. We discussed greater roles for lobbying and industry bodies to ensure that the industry can contribute effectively to the build out of key transition technologies. This might require changes to regulation of insurers, not something that happens quickly.
The transition will lead to a decline in the value of some assets over time. For example, legacy fossil fuel companies not looking to participate in the transition to renewals and electrification. Managing these exposures will require careful monitoring and planning, ensuring that such exposures are consistent with an insurers wider investment strategy.
As providers of pensions the ongoing level of pension savings is key for the viability of the industry. The groups discussed how the financing of a transition might affect this. They considered a scenario where, to enable a rapid transition, financing is provided by the public sector and the private sector is crowded out of the development of key technologies. Therefore, the group thought that it would be key for insurers to engage with the development of the key transition technologies from an early stage.
Throughout the discussion many participants felt that while quantitative models are essential to understand measurable risks, qualitative scenarios can provide a broader context that captures the multifaceted nature of climate transitions.
In a rapidly shifting environment where there are so many uncertainties, qualitative analysis can help insurers better capture these second order impacts. Things like regulatory changes, or tariffs shifting trade dynamics interplayed with the transition risks.
The impact of President Trump’s slew of tariffs on so many countries is a great example of how fast politics can impact trade dynamics. Climate politics will similarly ramp up and get more volatile as we get closer to 2030, further increasing the importance of modelling these ‘what-if’ narrative scenarios.
The discussion did not focus heavily on the physical risks associated with climate change, instead focusing on how companies would manage the complexity of the transition. In discussions following the session it was suggested that insurance companies routinely discount the worst outcomes. Not because they are considered unrealistic, but because if society breaks down following 3C or 4C of warming, most risk professionals would no longer be concerned whether a company’s solvency ratio is still within risk appetite. In these scenarios a company’s strategy is unlikely to be very relevant. This reinforces the conclusion that the best outcomes result when there is a clear, well-planned transition, that rapidly de-carbonises the economy. Insurers can prepare for this by continuing to lobby government and by making sure that they have the capabilities to invest in the transition.
Following the session the working party came together to reflect on the session.
Firstly, we observed that given the complexity of these scenarios and the multifaceted nature of the risks, it is very difficult to develop quantitative scenarios that will really help a company to develop its strategy.
Secondly, that understanding and managing these risks requires deep knowledge and expertise of how the transition might unwind. Our exploration of this was, inevitably, shallow, but on recurring output of the discussions was the need to know more to make better decisions.
Hopefully this exercise might help insurers to understand what they need to do to develop, richer, more decision-useful scenarios that will form an important step in improved management of climate risks.
