Can insurers save the planet (and themselves)?
- Faced with global warming, it is now crucial for insurance companies to address environmental issues and climate disasters.
- Public policy plays a fundamental role in encouraging action on energy transition, particularly by making investments by other players more profitable.
- Despite the short-term costs associated with reducing emissions, these efforts are profitable in the long term because they prevent future climate damage.
- Insurance companies are facing changes in the claims experience of their policyholders, which raises the delicate question of possible price increases.
- The question is therefore how insurance companies could change their financing model to cover these future risks.
With the increase in extreme weather events, the insurance sector is on the front line when it comes to seeing the physical damage caused by climate change. However, according to several of its representatives1, this sector is also one of the main pillars – if not the main pillar – of investment in society. French insurers are said to account for €2.5 trillion of this investment. And, as Fanny Henriet, Director of Research at the CNRS at the Aix-Marseille School of Economics, argues in her book L’Économie peut-elle sauver le climat?2, the economy must play a leading role in the ecological transition, then isn’t it in the insurance sector’s best interests to take action on climate issues, which are among its most critical challenges for the future?
Christian Gollier, researcher, author and director of the Toulouse School of Economics, has been working on these issues for many years. In his new book, Économie de l’(in)action climatique3 (The Economics of Climate (In)action), he argues that climate change is the most radical failure of our liberal democracy and puts forward several ways to correct it, from ecological dictatorship to carbon pricing. The role of finance is also discussed. As the author of an article4 published in 2001 on the limits of insurability linked to climate risks, he is now able to take a step back from his past analyses and draw an alarming conclusion: “At the time of writing, there was widespread denial of global warming, but although it is now commonly accepted, there is still denial about the sacrifices that will have to be made to combat it. I am stunned by the contrast between awareness and the lack of convergence in political decision-making.”
“The insurance sector is both exposed to climate damage and a major player in investment. It is therefore at the heart of the issues,” explains Fanny Henriet. However, as she points out, investors will not invest “on principle, but for profitability.” The challenge, therefore, is to show that this fight can be economically profitable.
Are public policies an essential driver of transition?
In France, assurance vie is the most popular form of savings, accounting for nearly €2 trillion in assets. This alone represents a significant source of investment for the ecological transition. “In theory, the holders of these assets, mainly households able to save over the long term, could mobilise part of their savings to meet their responsibility towards future generations, particularly in terms of climate change. But their motivation remains primarily financial,” explains Christian Gollier. “In practice, it’s complicated, because traditionally it is the responsibility of the state, at least in the common view, to establish an economy that works for the common good.”
This idea of public responsibility tends to discourage massive investment by individuals, but also by the private sector, in the absence of public policy. This leads economists to consider the role of the state as the initiator of this fight, as in the case of café terraces that can no longer be heated, speed limits on motorways, or the introduction of a carbon tax. Fanny Henriet explains this well using the example of renewable energy: “As shown by the falling costs of wind and solar power, low-carbon technologies can become profitable over time through learning by doing. But this dynamic does not happen on its own: the government must play an initiating role by supporting investment at the outset, for example through subsidies, and by making polluting activities less profitable through a carbon tax.” This is how, through public action, investment in the transition could become profitable. Furthermore, Christian Gollier maintains that “if government doesn’t do it, who will? The individual sacrifices required to achieve this limit the level of commitment.”
This is especially true given that financing green activities is already, almost by definition, less profitable and more expensive than financing brown activities. For this reason, it is not enough to force investors to divest from carbon-intensive activities, as this will lead to “financial carbon leakage,” argues Christian Gollier. “Penalising the most carbon-intensive companies by increasing the cost of capital will also increase the profitability of investments in these companies. It is therefore a very ineffective solution, which will push investors motivated solely by profitability to favour companies with the most ‘brown’ activities.”
The State would therefore need to play a role in providing incentives, but this would not be easy to implement. The problem remains that, regardless of the public policy instruments used, the transition is costly, especially in the short term. “But we must bear in mind that, despite the short-term costs associated with reducing emissions, these efforts are profitable in the long term because they prevent much of the future climate damage,” insists Fanny Henriet. When it comes to covering the cost of climate damage, the insurance sector also has an important role to play.
A market weakened by climate change
“Insurance companies are faced with changing claims patterns among policyholders [Editor’s note: an average of €6 billion per year over the last four years in France5],” admits Christian Gollier. “This raises a delicate question about the insurance model, as it should lead to price increases.” Fanny Henriet agrees: “When the risk becomes too high or too systemic, insurance premiums skyrocket or insurers simply withdraw from the market. In the United States, several major insurance companies have stopped writing new home insurance policies in California due to the increased risk of wildfires. Similarly, in Florida, the increase in hurricanes has led to higher premiums and reduced coverage.”
The question is therefore how insurers could change their financing model to be able to cover these potential future risks. The increasing frequency of extreme weather events is making some exposed areas uninhabitable. “In the Cat-Nat system, the government’s desire to limit insurance premium increases in these areas creates a subsidy for settling there and imposes heavy losses on insurers,” adds Christian Gollier. “The desire for solidarity is commendable, but it leads to disaster.” Nevertheless, many risks remain difficult to quantify, which means that they are effectively uninsurable through the usual insurance mechanisms. The result is highly inefficient risk allocation and management in our society. “To address this issue, the government has developed compensation funds, often financed by taxpayers. However, this approach does not help to make individuals responsible for managing risk in the public interest, he insists. The market, for its part, has also developed solutions based on financial products, such as Cat Bonds6, which spread risks around the world and allow investors’ views to be aggregated through the emergence of a market price for risk.”
That said, concrete lines of action can be put in place. The insurance sector is both exposed to the consequences of climate change and has considerable financial leverage to respond to it. “These future challenges could also make European models precursors,’ she concludes. We often hear that taking the lead without global coordination would be futile. But in reality, being the first allows us to learn, test and demonstrate that the transition is feasible. This will inform the choices of other countries when they, in turn, are forced to act,” concludes Fanny Henriet
