Navigating Climate Risk and Low-Carbon Economy Transition

By actively pursuing financial risk literacy, the insurance industry can prepare the foundation to help society reduce residual risks and narrow the protection gap.

Increased natural catastrophe exposure can lead to greater risk capital requirements or reduced reinsurance capacity for non-life insurers, or even higher premiums. This could be in the form of loadings for anti-selection, and also additional margins for the absorption of catastrophe-related losses that are becoming more frequent and severe.

There may also be a risk of financial exclusion of certain natural catastrophe-prone vulnerable policyholders, as premiums become unaffordable or the cover is not within an insurer’s risk appetite. Balancing premium affordability and risk-reduction incentives is important.

For life insurers, climate change may change demographics or mortality and morbidity and in turn increase investment uncertainty. It may leave insurers unable to meet guaranteed returns and see greater accumulation of risk, resulting in mass loss of life inherent to increased natural catastrophe activity.

How do we build resilience and reduce the protection gap? An enabling environment for disaster risk financing and using a risk-layered approach for developing national disaster risk financing plans for the deployment of a wide array of financing instruments is needed.

Promoting public–private partnerships and pooling mechanisms can help provide affordable coverage by helping real economy actors to absorb shocks and protect their debt-service exposure against climate change-induced events. This will in turn reduce the default rates and maintain creditworthiness.

A much greater volume, velocity, and granularity of data sets using modeling techniques and approaches are needed to allow consumers and insurers to understand and price risks. Any successful response must involve a mix of compulsory and voluntary measures backed by a robust framework for assessment, implementation, and monitoring that leverages the latest technologies—big data, data analytics, automation, artificial intelligence, and machine learning.

Policy reforms are needed to help drive climate-sensitive public policies, investments in infrastructure projects resilient to climate change impacts, and risk management solutions that shift market incentives in line with low-carbon growth strategies. Environmental, social, and governance issues are gaining traction, with institutional investors exerting influence and channeling investments into projects that deliver measurable non-financial benefits while improving long-term financial returns.

Insurers need to shift business models away from transactional risk transfers and indemnity payments, and toward mitigating physical climate risks. These include rebates for using resilient construction materials, working with governments to improve land use planning and building standards and policies, and supporting a just transition from coal to clean energy.

We cannot solve our problems with the same thinking used when we created them. Climate action can improve lives, create jobs, build green cities, and protect ecosystems. By actively pursuing financial risk literacy the insurance industry can help society reduce residual risks and narrow the protection gap.

The views expressed in this blog are those of the authors and do not necessarily reflect the views of the Asian Development Bank, its management, its Board of Directors, or its members.

Arup Chatterjee is Principal Financial Sector Specialist at the Asian Development Bank.