Insurance Plays a Key Role in Transitioning to a Low Carbon Future

Insurance Plays a Key Role in Transitioning to a Low Carbon Future
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This insight is part 05 of 12 in this Collection.

December 7, 2023 19 mins

Insurance Plays a Key Role in Transitioning to a Low Carbon Future

Insurance Plays a Key Role in Transitioning to a Low Carbon Future

The insurance industry can help the economy transition to alternative energy sources and mitigate the impacts of climate change — from facilitating capital for clean technologies to protecting people and businesses.

Key Takeaways
  1. With climate change-related weather events growing in frequency and severity, insurance is critical for protecting businesses, governments and communities.
  2. Insurance promotes the flow of capital for innovative new technologies that help the transition to a lower carbon economy.
  3. Analytics will be essential to better understand and mitigate the financial implications of climate change.

Climate change is tied to concrete risks with immediate impacts, including secondary perils like business interruption, material scarcity and supply chain issues. In 2023 alone, global disasters have cost $295 billion in economic losses,1 and climate-related events are only expected to rise.

Insurance plays a pivotal role in accelerating the climate transition. The industry was therefore featured on many recent climate event agendas that Aon colleagues both attended and hosted, including the African Climate Summit and Climate Week NYC. And as global climate stakeholders converge for COP28 to close out 2023, this topic will remain front and center. 

The emerging impacts of climate change threaten to destabilize the global economy and affect people’s health and safety. Insurers play an important role in transforming this volatility into opportunity by closing the protection gap and helping individuals and communities. There are three areas where insurance plays an active role: 

1. Pricing out financial implications: Stakeholders can understand the financial implications of climate change through advanced analytics.
2. Mitigating physical risk: Develop strategies to de-risk these financial implications through alternative transfer solutions, such as parametric insurance.
3. Enabling capital: Provide capital to innovative clean technologies through de-risking, longer insurance policy terms and government policies. 

“At its core, our business is about creating resilience to both protect the assets of today and foster the growth of tomorrow,” Eric Andersen, president of Aon, recently told the U.S. Senate Committee on the Budget. “We do this by spreading the impact of risk across a wide community of financial participants across time to help people and businesses withstand volatility, to have the resources and confidence to invest, and to protect and rebuild when necessary.”

Better Informed

Pricing Risk Using Multiple Climate Models and Analytics

Drawing on a wide range of data sources will help insurers and businesses develop an informed and customized view of risk. Unlike traditional catastrophe models, which often leverage historical data to identify near-term risk, climate risk models are designed to be forward-looking and quantify the probability of costly, but rare events in a physically consistent way.

“With the cost challenges and the need to make decisions that will impact people’s lives over the coming decades, it’s critical to get the right information to decision-makers,” said Liz Henderson, global head of Aon’s new Climate Risk Advisory team, at an Aon-hosted event during Climate Week NYC. “Decisions about risk that come from models based on climate data are never perfect, but the insurance industry has become comfortable operating within this uncertainty. We try to offer guiderails.”

Multiple data sets and models are important for a variety of reasons, including:

  • Climate risk is unpredictable; the past can no longer predict the future.
  • Climate models vary widely in their assumptions and in the data they use. Therefore, multiple models should be reviewed.
  • The level of risk will differ depending on a specific location and many other factors. 

Climate analytics can provide forward-looking diagnostics for a range of climate scenarios. For example, hazard data can be applied to specific locations where companies have assets, allowing them to better understand their risks today and into the future. Analytics can address the physical risks of climate, provide more clarity for the voluntary carbon market and help finance the energy transition through innovation.

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The insurance industry has a large body of climate risk and disaster cost data and insight because it monitors climate-related risks across the economy.

Liz Henderson
Global Head of Climate Risk Advisory & Head of U.S. Catastrophe Analytics, Reinsurance Solutions

Global economic losses from natural disasters in 2022 were $313 billion, with only $132 billion of that amount insured. That makes 2022 the fifth-costliest year for insurers on record. Insurance plays arguably the most important role when it comes to protecting assets and closing the global protection gap. This can be done through parametric solutions complementing traditional cover, facilitating capital supply for disaster relief, longer-term insurance products, policies to encourage climate adaptation and improved analytics. 

Case Study: Renewable Energy Provider Uses Parametric Coverage to Mitigate Risk

A leading renewable energy provider in the Philippines used parametric coverage to mitigate risk. The client had a vast network of physical infrastructure and distribution networks across the country and was concerned about the potential impact of a catastrophic weather event on its facilities. The Philippines averages 20 storms and typhoons annually, causing millions in losses and disrupting vital public utilities like electricity services. The local insurance market provides limited coverage from traditional property damage products for the energy transition and distribution industry. 

To address this, Aon modeled past catastrophic weather events over a two-year period. A bespoke windstorm model was developed to quantify the infrastructure and property loss at different pre-agreed levels of maximum sustained wind values on a one to five category scale based on historical pricing. This allowed the development of an appropriate cost for potential damages to the network. The captive obtained terms for a parametric solution covering windstorm risk, with claim payments designed to match storm proximity and severity. The solution enabled a quicker and more transparent claim settlement. In December 2021, the program was triggered following Typhoon Rai, with a payment made within 30 days (and within 10 days of the program being finalized).

Adapting and building resilience to climate change impacts and maintaining a strong focus on climate change-induced loss will be prominent discussion points in climate events, including the UN Climate Change Conference or COP28 and beyond.

Conversations on the global stage around climate are increasingly focused on de-risking clean technologies and sustainable practices — for example, new ways of building projects and regenerative agriculture.

Unlocking Capital for Clean Technologies

To fully seize the opportunity to help transition to a lower carbon future, the insurance industry must formulate a consistent forward-looking pricing model for new risks and support large-scale, complex risks. The good news is the appetite is there, says Carol Stark, managing director and North American Renewable Energy practice leader at Aon. She spoke at Climate Week NYC about new developments: “A lot of stakeholders are coming together to help owners and developers de-risk their projects. When the industry comes together like it has, and other stakeholders realize the impact, they’re going to get more involved and behind renewable energy.”

The industry should consider longer policy terms than the usual annual renewal cycle. New clean technologies, for example, are often not investable at scale. This impedes financing for green projects as the long-term insurability of assets comes into question. In turn, it also places more risk on investors who may not finance certain projects. Stable and predictable insurance coverage over longer periods could free up capital flows.

New legislation has encouraged investment in renewable energy and sustainable building. The U.S. Inflation Reduction Act (IRA), for example, provides substantial tax credit incentives for clean energy projects (e.g., solar, wind, battery storage, hydrogen), electric cars and more. Since the law was passed in August 2022, $110 billion has been poured into clean energy projects in the U.S. — 60 percent of which come from foreign companies. Fifteen of the 20 largest investments — nearly all battery factories — involve businesses overseas.2

The IRA also permits the transfer of tax credits. This enables corporations to purchase tax credits from renewable energy sponsors and developers through simple purchase and sale agreements. This transferability requires less documentation than in the past, increasing efficiency and the potential for a faster overall timeline. 

Businesses purchasing tax credits should be aware that tax authorities may challenge the amount or qualification of tax credits. This, alongside the risk of clawbacks, points to the need for a solution to protect against these challenges. Wrapping tax credits with tax insurance will be important to provide strong assurance that allows the purchasers to sell the transaction internally up the chain for approvals, smoothing wrinkles to help see deals through to fruition. Tax insurance protects against tax credit challenges and clawbacks and provides a gateway for meeting ESG goals and driving meaningful change, both during transactions and organic growth.   

Other countries are now considering regulation to encourage similar levels of inbound investment. The European Union released its own Green Deal Industrial Plan in February 2023, while Canada said it would provide $80 billion in clean energy tax credits and sustainable infrastructure as part of its 2023 budget.

Better Decisions

The Changing Geopolitical, Legal and Climate Risk Landscape 

There continues to be rapid innovation and progress toward a low carbon future. Through engaging new stakeholders and implementing new solutions, the insurance industry is ready to play a truly transformational role in the climate transition. In this context, traditional insurance — such as property and casualty, environmental, trade credit and political risk — sets the foundation for de-risking projects. When coupled with tax liability, credit protection, performance guarantee, carbon credit and build back better greener solutions, insurance offers the financial protections that will attract the capital needed to accelerate the energy evolution.    

Learn more about Aon’s climate solutions and get in touch with us.

Aon’s Thought Leaders
  • Sophie Burnoud
    Global Energy Lead, Climate Solutions
  • Liz Henderson
    Global Head of Climate Risk Advisory & Head of U.S. Catastrophe Analytics, Reinsurance Solutions
  • Dominic Probyn
    Global Head of Climate Strategy, Climate Solutions
  • Carol Stark
    Managing Director and North America Renewable Energy Practice Leader, North America
  • Natalia Moudrak
    Head of North America, Aon Climate

1 Aon Global Catastrophe Recap, H1-H3 2023
2 The Biggest Winners in America’s Climate Law: Foreign Companies

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The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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