Environmental systemic risks and the insurance industry
June 27, 2014
PwC were commissioned by the WWF-RSA partnership to help them understand environmental systemic risk and the insurance industry. A two-year joint initiative culminated in a white paper on Environmental Systemic Risk published by WWF and RSA , and a roundtable discussion on the findings, hosted by PwC in London. Jon Williams and Lit Ping Low, who led the study for PwC, report on the discussion.
Systemic risk refers to risks arising from interlinkages and interdependencies between places, activities and assets. The 2010 flooding in Thailand is a recent example of an environmental event which had systemic impacts; not only was there to death and destruction in Thailand, but economic losses for global companies whose supply chains were based in areas affected by the floods.
The study has come at a critical time since many industries are facing increasing regulation to manage systemic risk, while the recent IPCC reports show that the environment is undergoing unprecedented change.
Resource scarcity and climate change is rising up CEO’s agendas - PwC’s recent CEO survey found that 46% of CEO’s put this is in the top 3 risks that will transform their business over the next 5 years. But there is also a big disconnect between the insurance industry and their customers. Only half of insurance CEOs compared to the CEOs of primary businesses such as energy, forestry, power and utility ranked resource scarcity and climate change a transformative trend.
The first challenge for the study was to define the concept of environmental systemic risks (ESR), whether and why it is an issue, what the impacts might be on insurers, as well as the barriers the industry faces in incorporating ESR management.
The white paper was intended to fuel a discussion and provoke reactions on this issue, rather than to serve as the definitive answer.
To this end, the roundtable attendees, who include representatives from insurers and reinsurers, NGOs, academics, and government departments, have been insightful and challenging at the same time.
This was to a large extent credited to our masterful chair Nick Robins, Co-Director of the Inquiry into the Design of a Sustainable Financial System at UNEP, who teased out of the participants not just the obvious, well documented issues but also explored in some depth why managing ESR is easier said than done.
Challenges faced by the insurance industry
Despite the widespread recognition that the insurance industry plays a vital role in transferring and managing society’s risks, the link between environmental events to the insurance industry isn’t one that is widely recognised. One participant shared a story on the challenge of communicating the relevance of climate change to the life and pensions sector. It isn’t until the realisation that the climate does influences areas as wide-ranging as food and health that the link becomes apparent. In many ways, large parts of the insurance community still have some way to go before ESR hits home.
Awareness is just the beginning. The next challenge discussed was around the quantification and research into the size and therefore price of environmental risk, not just in itself but its wider implications. Valuation can allow previously unvalued ecosystems to become ‘insurable’ and as one of our participants noted that ‘the better we can get a pricing risk, the better we can develop insurance products’. But this is not an easy process as all around the table recognised that the value of the environment and majority of ecosystems remains inadequately defined.
And even as risks can be quantified and priced, the highly competitive nature of the insurance industry means that future and emerging risks may not be factored in contracts to avoid losing clients, which is one of the challenges pointed out in the white paper. A positive indication around the table was that this needs to change: ‘just as insurers can be fiercely competitive over clients they now need to be fiercely collaborative in the face of this changing risk landscape’.
But the real dilemma that many in insurance industry face is the counteracting pressure to keep things as they are. For example, the systemic nature of certain types of risks require an industry-wide approach, but collaborative activities can be deemed suspicious by regulators, especially if it involves the possibility of higher insurance pricing to take into account new and emerging risks. Innovative solutions which are being considered needs to be weighed against the concern that this could be sensationalised by the media as trying to line their pockets with money from vulnerable customers.
The role of insurers on risk management can also be contentious. Participants agreed that insurers have a role to identify and analyse risks, create new insurance products to manage new or emerging risks, engage their customers to help mitigate their own environmental risks. Many insurers with intentions of moving into emerging markets, or operating in areas where there is still vast underinsurance, can therefore play a role in improving adaptation and resilience to climate change and other environmental risks. But to what extent does this translate into ‘insurance being a substitute for risk management’? What is the role of the government in this context?
Small but meaningful steps
These are all difficult questions. The event was a great first step in the journey of getting discussions about environmental systemic risk to happen at all levels in the insurance industry. Participants were keen as a group we take forward concrete actions. These included identifying key stakeholders that the insurance sectors need to engage with, including information providers, NGOs, customers, credit agencies and regulators. Another was engaging with these stakeholder in a structured way focusing on ESR, in a way that is collaborative but not anti-competitive.
Industry’s contribution to the debate was strong, and even more so in the commitment by many participants to take away action points to be implemented individually or jointly.
Understanding and managing ESR will require time, so sustaining this momentum will be crucial.
See the views of participants at the event here.