Insurance’s unspoken role in the transition to net-zero

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Insurance should do much more than pick up the pieces

There are two key ways insurance can contribute to the climate challenge. One you will have heard of, the other you might not have.

This is partly because the insurance element of the deal is often actioned under the shroud of a confidentiality clause. But the following examples go to show you what is possible when you start to think of financial innovation and how insurance can grease the economic wheels to get capital moving to serve the greater good.

Much of the conversation around insurance’s role in the fight against climate change focused on the need to adapt in order to manage the increasing number of extreme weather events. People are rightly asking, how can traditional insurance be reliable and responsive enough to stay relevant in the face of such huge challenges?

There is a good deal of innovation in this area. COP27 saw lively discussions around the future role of “parametric” insurance products. This means designing insurance to pay pre-ordained sums at pre-agreed data-driven triggers, completely bypassing the traditional route of protracted claims assessment and a requirement to prove the loss.

Examples of these triggers include excessive rainfall or wind, drought or the height of a volcanic ash cloud.

In this way, “parametric triggers” make it possible to immediately get much-needed capital into disaster zones. This can make a real difference in how humanitarian organisations and small-holder farmers on island nations are able to manage the impact of natural disasters.

DE-RISKING INVESTMENTS

But to focus the conversation entirely around picking up the pieces after disasters misses a key point: the other half of insurance’s role in the climate response.

The investment needed for a global transition to net-zero emissions represents the biggest reallocation of capital in human history. There will be huge advances in energy technology. Innovative products will need to be developed and scaled up very quickly, which can amplify the financial risks.

This means investors are being asked to back things that are beyond the scope of their usual risk appetite. Banks usually have credit appetite models that large, technology-centric clean energy projects often do not fit in to.

But with intelligent use of credit insurance, it is possible to design policies to cover the repayments on a multi-year, uncancellable basis. This guarantees that they will be met throughout the project finance period.

In this way, banks are comfortable lending more, for longer, so key environmental projects can get off the ground.

A NEW INDUSTRIAL REVOLUTION

We are entering a period of unprecedented investment in essential technology and infrastructure projects. McKinsey, the US market analysis firm, estimates the figure to be around $125 trillion between 2021 and 2050.

This essentially means we are standing on the precipice of another industrial revolution—and in such times, insurance plays a vital role in the liquidity of capital markets.

It is difficult to overstate the role of insurance in the first industrial revolution in the 1800s. With the new factories, fires were a huge risk. The property insurance market evolved in step with the growing need, giving capitalists the confidence to invest.

There is a similar situation today, with more variety. Speaking to clients, every organisation has a different take on things like ten-year transport strategies, future commodity exposures or their shift to renewable energy and more sustainable materials.

Often they do not realise the role insurance can play in de-risking their efforts towards net zero. For most people, insurance is just an annual compulsory purchase problem, often governed by regulation. It rarely comes to mind as a tool to deal with the volatility and risks of tomorrow, but the opportunity is there.

CONSTANTLY EVOLVING

Insurance will have to evolve alongside every new technology or commodity. Sometimes the insurance products are not quite there yet, but conceptually insurance is incredibly flexible.

A good example is the voluntary carbon market, where a recent insurance innovation is making offsets more trustworthy and tradable by wrapping them with insurance.

Insurance greased the cogs of the industrial revolution—now it is time to be the wind in the sails of the clean energy revolution.