Climate-related risks expose insurer assets: California analysis

Insurance company assets are exposed to climate-related transition and physical risks, according to a new analysis released Friday by outgoing California Insurance Commissioner Dave Jones.  

California’s insurance department engaged Paris-based think tank 2° Investing Initiative to conduct an analysis of the 679 insurers in the state’s market with more than $100 million in annual premiums, which account for nearly $4.3 trillion in investments. The 2° scenario refers to the energy system deployment pathway and emissions trajectory consistent with at least a 50% chance of limiting the average global temperature increase to 2°C. The 2015 Paris climate agreement outlined a 2°C upper limit on global warming above preindustrial levels, with a preferred target limit of 1.5°C set out by the United Nations International Panel on Climate Change.

“Insurers, like all investors, need to analyze and consider the climate change-related risks facing their considerable investment portfolios,” Mr. Jones said in a statement on Friday. “I urge insurance companies to run multiple scenarios in assessing their investment and underwriting exposure to climate-related risk, especially in light of the recent UN Intergovernmental Panel on Climate Change and U.S. National Climate Assessment reports and the adoption of an international Paris agreement ‘rulebook’ at COP 24 (in Katowice, Poland) – all of which point to a transition away from burning fossil fuels. Climate-related physical risks such as wildfires are also becoming more pronounced, with implications for insurers as underwriters and investors.”

California insurers are headed for a “painful adjustment” because the analysis of the trajectory and aggregate of current industry investments suggests they are not aligned with that 2° scenario and are continuing to build up transition risks, said Jakob Thoma, a London-based managing director of the think tank who conducted the analysis with analyst Clare Murray.

“They’re not delivering on those outcomes,” Mr. Thoma said. “The production plans have not yet adjusted to the climate commitments made in Paris in 2015.”

Failure to address transition risks – broadly defined as economic and financial risks associated with the transition to a low-carbon economy – could result in these insurers having stranded assets on their books, he said. Stranded assets are those that have lost value amid regulatory, economic, physical or other changes.

“Part of the issue is there seems to be this idea that until policy is going to be very ambitious, there’s no need to be proactive,” he said of the reasons the insurers may not have taken steps to address such transition risks. In addition, risk management can be conducted on a short-term basis, meaning “long-term signals are generally not well integrated,” Mr. Thoma said.

Divestment from fossil fuels is one step that a few insurers have taken that will help address transition risks, but it is not the only step, Mr. Thoma said. For example, insurers can invest in fossil fuel companies investing significantly in renewable energy or car companies investing significantly in electric vehicles, he said.

“It’s clear you can be invested in those sectors, but still be invested in companies leading the transition,” Mr. Thoma said.

The automobile sector in particular has started to make positive strides in adjusting to the transition to a low-carbon economy and although the adjustment is not where it would be ideally, “the direction of travel has been relatively impressive,” he said, adding, though, that the fossil fuel sector’s transition pace has been more concerning. “The reality is the renewable power investment remains a major laggard so that’s a major concern.”

Physical climate risks have been identified by financial regulators and insurance companies as a major financial risk to portfolios and cut across a range of traditional natural disaster categories, according to the analysis, which found that 34.1% of the coal assets within the fixed income portfolios and 31.8% of the coal mining assets within the equity portfolios will be exposed to wildfire risks in 2020. Meanwhile, 16.7% of power assets within the fixed income portfolios and 13.8% of the power assets within the equity portfolios will be exposed to flood risks in 2020, according to the analysis.

There is a perception that fossil fuel assets are only exposed to transition risks, but the analysis indicates that many coal-fired facilities will be exposed to these wildfire and flood risks, Mr. Thoma said.

Such physical risks should be taken into account when making industrial planning and capital expenditure decisions, Mr. Thoma said. It does not necessarily mean that an automobile company, for example, should not build more factories in an exposed area such as Florida, but that such facilities should be built with adaptive capabilities, he said.

The results of the scenario analysis are consistent with Mr. Jones’ Climate Risk Carbon Initiative determination that thermal coal presents long-term financial risks for investors and will help insurers apply the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, according to the department.