Climate risk: the unique role of insurers

Climate change is one of the most pressing issues that society at large is currently facing. In recent decades, the increasing frequency and severity of natural disasters, such as hurricanes, floods, droughts, or wildfires, have inflicted enormous and constantly growing human and economic losses. While policymakers have put forward several initiatives to address climate change, insurers can still play a unique role in the global transition to net-zero greenhouse gas emissions. As major financial investors and unique providers of insurance coverage, insurers can tilt both invested assets and underwriting portfolio from carbon-intensive sectors to ecological ones. Consequently, carbon-intensive activities would become economically unviable, reducing climate risk.

Insurers could have economic incentives to address climate change. The worsening of natural disasters is causing an upsurge of expenses and policyholder claims. In 2020, natural disasters cost the insurance industry $82 billion in policyholder claims. The huge losses caused by Hurricane Laura (2020) and Hurricane Ida (2021) led 11 insurance companies in Louisiana (United States) to insolvency. Even more worrying, the worsening of natural disasters also means higher insurance premiums, i.e., less affordable insurance protection. Worldwide losses due to natural disasters in 2020 amounted to $210 billion, more than 2.5 times insured losses. The wedge between potential and insured losses, the so-called insurance protection gap, is predicted to widen given current climate projections. Should climate risk turn into near-certain weather-related damages, losses would be no longer insurable. In fact, no insurer could insure damages that occur almost surely.

The objective of this research proposal is to assess the economic incentives of insurers to undertake a net-zero transition. Two voluminous, fast-growing, and disconnected streams of the finance literature investigate (a) the impact of climate change on asset prices and (b) the relevance of insurers as asset managers. The unique role of insurers in addressing climate change, at the intersection of these two streams of literature, is a much under-researched topic, as underscored in a recent special issue of the Review of Financial Studies. The present project timely contributes to fill this gap in the literature. First, we significantly generalize a market consistent valuation framework that we developed during our previous SNF grants. The novel theoretical framework identifies insurer economic incentives to undertake a net-zero transition and accommodates recent developments in the finance literature. Second, using this framework, we empirically assess the opportunity costs and main determinants of insurers to undertake a net-zero transition. Besides ESG data, we collect and process novel data from insurers' sustainability reports which became recently available.

The project seeks to address the following research questions. Does the net-zero transition of insurers pay off, and if so, in the short- or long-run? What are the main drivers of insurers' net-zero transition? Are insurers acting more on the investment side, the underwriting portfolio, or both? Is any of these actions especially costly in terms of foregone profits or particularly effective in decarbonizing insurer balance sheets? Investigating these questions can inform the policy actions to sustain insurers' net-zero transition and more generally to contribute to the debate on the global transition to net-zero greenhouse gas emissions. As the project output relates to long-term trends of the insurance sector, our findings can help understand the evolution of the insurance protection gap, namely whether in the coming years, insurance coverage against extreme weather-related damages will be generally available, only affordable by affluent entities because of heightened insurance premiums, or unavailable to everyone because those damages have become uninsurable.