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16.1 Introduction

Climate change, one of the world’s most significant challenges in the twenty-first century, causes environmental and social issues and results in economic losses (Tol, 2009). Over the past ten years, extreme weather events caused 82% of the world’s total damage from natural disasters. In 2022, the cost of these events reached USD 211 billion, which is 183% higher than the average cost of the last 30 years, adjusting for inflation (EM-DAT, 2023). According to Swiss Re, by 2050, the size of economic losses due to climate change could reach approximately 18% of the world’s GDP (Guo et al., 2021). It presents a significant obstacle, particularly for developing economies that depend primarily on agriculture, have limited social safety nets, and have a high coverage gap (Collier et al., 2009; Tol, 2009).

The Intergovernmental Panel on Climate Change reported that in 2019 64% of global greenhouse gas (GHG) emissions were caused by energy production and industrial activities (IPCC, 2022). To address this issue, it is necessary to increase the use of renewable resources for energy production (Yüksel et al., 2021). However, renewable energy projects usually require a high initial cost, and, as an emerging sector, they are characterized by relatively high uncertainty (Steckel & Jakob, 2018; Dinçer et al., 2022). It leads to an increase in the perceived level of risk and a decrease in the interest of traditional financing sources in such projects. At this point, the insurance industry can play an essential role in promoting the transition to clean energy, thanks to its assets totaling USD 44 trillion (IAIS, 2023).

The insurance industry recognized that climate change amplifies social and environmental risks. According to Swiss Re (2023), insurers suffered substantial financial losses due to environmental risks in 2022. Therefore, promoting the clean energy transition is crucial for the insurance industry, considering it is no longer just a matter of choice but a requirement. The insurance industry can support the transformation of energy resources by investing in clean energy projects and green bonds. Furthermore, they can eliminate uncertainties associated with clean energy investments by leveraging their expertise in risk management and providing financial coverage (Mills, 2007).

Despite the significant relationship between insurance and the clean energy economy, there has been limited academic research on their interaction. This chapter aims to fill this gap in the literature by investigating how the insurance industry can contribute to the shift toward renewable energy. Specifically, the chapter examines how insurance companies can support clean energy projects and minimize the risks. The chapter will begin by examining how climate change affects the insurance industry and how insurers address it. Following that, the chapter will explore different tools and policies the insurance industry can utilize to promote the adoption of clean energy.

16.2 Insurance Industry and Climate Change

Insurers have faced unexpected costs due to the environmental shifts resulting from climate change. In 2022 alone, economic losses from natural disasters, predominantly extreme weather events, amounted to USD 275 billion. Of these losses, insurance companies incurred USD 125 billion. In inflation-adjusted terms, this cost borne by insurers is 54% higher than the last decade’s average. Additionally, the 2022 payouts represent the fourth-highest loss recorded over the past half-century. Despite the considerable costs incurred by the insurance industry over the last decade, 61% of total losses were uncovered, indicating that there is still a significant coverage gap in this area (Swiss Re, 2023).

The insurance industry is affected by climate change in numerous ways, both directly and indirectly. Table 16.1 details climate change’s impacts and potential consequences on the insurance industry.

Table 16.1 Impacts of climate change on the insurance industry and its possible consequences
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Although the exact effects of climate change on natural disasters cannot be measured presently, evaluating the shift in the historical patterns of disasters can give a general idea of its influence. Over the last 30 years, there has been a significant increase in the frequency and severity of weather-related natural disasters. Compared to the previous period, there has been a 216% increase in frequency and a 343% increase in severity. This growth in weather-related disasters is 50% faster than all other natural disasters (EM-DAT, 2023). The costs incurred by these disasters have directly affected insurers’ losses, resulting in decreased reserves and profitability. In addition, the shifting trend makes it more difficult to create precise risk models that work effectively for catastrophic events.

The calculation of losses expected to arise from extreme events is based on simulations which are carried out using the results of relevant historical events. However, using past data in such estimations undermines their predictive power regarding climate change. Misunderstanding the impact of climate change on natural disaster risks can lead to a significant difference between the measured risk and the actual loss incurred (Wolfrom & Yokoi-Arai, 2016). According to S&P Global’s analysis (2014), catastrophic losses in the previous decade were 50% greater than reinsurers had initially modelled.

Climate change leads to changes in the global risk landscape. As a result of global warming, losses are now occurring in areas previously considered low risk (Dlugolecki, 2008). However, due to the nature of risks, as the geographic scale decreases, the uncertainty increases, posing a challenge to assessing the impact of climate change at the local level (Prudential Regulation Authority, 2015). Developing countries are particularly vulnerable to climate-related risks due to their limited resilience and low insurance coverage against natural disasters. Countries with large populations living in coastal areas that are close to sea level and depend heavily on agriculture are at the highest risk. Moreover, these countries have limited financial resources and fiscal flexibility to address the impacts of climate change (Wolfrom & Yokoi-Arai, 2016).

The impacts of climate change may interrupt insurance companies’ efforts to establish a balanced portfolio and implement effective risk management strategies through risk diversification. Insurers typically seek to mitigate losses from one risk by providing coverage for various risks across different geographies. However, the systemic risks of climate change have increased the likelihood of chain reactions resulting from a single event (Grimaldi et al., 2020). A major disaster can cause damage not only to infrastructure and superstructure but also to human life and other personal and commercial properties. Moreover, it may result in a domino effect, causing business interruptions, increased investment risks, etc.

While climate change presents several challenges for the insurance industry, it also offers opportunities for development in certain areas. First, the increase in global risks also raises the awareness of individuals and organizations about risks. This may be an important opportunity to reduce the global coverage gap. Furthermore, as risks continue to surge, insurance companies emerge as key actors in managing the financial consequences of these risks within the global economic framework. By leveraging big data and data analytics, insurers can effectively mitigate the financial impacts of climate change through innovative product offerings, such as parametric insurance.

Insurers started expressing their concerns about climate change as early as in the 1970s. In the first report prepared by Munich Re (1973), global warming and the increase in GHG emissions were discussed as factors that would increase natural disaster risks in the long term. Since then, the leading players in the global insurance market have been collaborating with international institutions to reduce the effects of climate change (Prudential Regulation Authority, 2015). Despite the difficulties associated with climate change, insurers are taking preventative measures to tackle the issue. Their efforts primarily center on two key aspects: minimizing their carbon footprint and endorsing the transition toward clean energy.

Several insurers, which account for a significant portion of global insurance premium production, have committed to supporting the fight against climate change by reducing their carbon footprint. This approach includes mitigating carbon emissions from insurance operations and investing in low-carbon technologies and renewable energy. For instance, some of the world’s largest insurance groups, such as Swiss Re, Munich Re, and Zurich, have committed to achieving net-zero GHG emissions from their operations by 2030. To accomplish this, these companies reduce their energy consumption, increase renewable energy sources’ utilization, and buy certified carbon credits (Swiss Re, 2022; Munich Re, 2022; Zurich, 2022).

The insurance industry has taken collective measures in partnership with international organizations to support the transition to clean energy. In 2012, the United Nations Development Programme published the Principles for Sustainable Insurance (PSI), highlighting the environmental, social, and governance (ESG) risks and opportunities the insurance industry encounters. The PSI’s efforts led to the Net-Zero Insurance Alliance (NZIA) creation in 2021. This association includes a group of (re)insurance companies that collectively account for a significant portion of global insurance premium production. Members of the NZIA have committed to transforming their underwriting portfolios to achieve net-zero GHG emissions by 2050 (UN, 2023).

In 2016, the insurance industry collaborated with the United Nations, the World Bank, and other international organizations to establish the Insurance Development Forum (IDF) as an initiative to mitigate the effects of climate change. The IDF’s goal is to increase global insurance and risk management capabilities to enhance the ability of individuals, communities, and institutions’ resilience against natural disasters and associated financial risks. The forum provides guidance and advice to the insurance industry in various areas, including risk modeling, regulatory and legislative frameworks, resilience policies, and customized insurance solutions (IDF, 2023). Although the insurance industry has made efforts to respond to climate change, there is still room for improvement. To help facilitate the transition to clean energy, insurers can utilize the tools and policy recommendations provided in the following section.

16.3 The Role of Insurance in Promoting Clean Energy

The insurance industry is crucial in reducing uncertainty and providing financial protection to individuals and institutions. It has the potential to contribute significantly to the transition to clean energy by supporting renewable energy initiatives. Also, with their expertise in risk management and financial resources, insurance companies can help reduce the impact of climate change.

Table 16.2 outlines the significant policy opportunities available to the insurance industry for promoting clean energy. The next section will comprehensively examine these policies through three principal categories: carbon footprint reduction, clean energy transformation, and clean energy adoption.

Table 16.2 Policies insurers can adopt to promote clean energy
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The insurance industry is a key player in the global economy, with the power to influence commercial activities worldwide through its investment and risk management policies. Insurance companies can adopt a policy to support clean energy by achieving carbon neutrality in their operations. By reducing energy consumption and transitioning to renewable energy sources, insurance companies can limit their carbon footprint. While some insurers have set medium-term goals in this area, the entire sector has not yet reached an agreement. Another policy that insurers can use to reduce carbon emissions is divestment from companies that produce energy from fossil fuels. The Global Fossil Fuel Commitments Database (2023) reports that 1591 institutions worldwide, representing USD 40.5 trillion in assets, have committed to divest from fossil fuels. Among these organizations are the world’s leading insurance groups, such as Allianz, Aviva, Generali, Mapfre, Munich Re, Swiss Re, Talanx, and Zurich. For instance, Allianz has decreased its GHG emissions by 35% between 2019 and 2022 by investing in low-emission companies (Allianz Trade, 2020). As more insurance companies refrain from funding projects and companies that produce high carbon emissions, financing in this area may become scarce, and these types of investments may lose their appeal.

Insurance companies can also reduce their carbon footprint by incorporating ESG factors into their underwriting processes. As environmental risks increase, ESG factors have gained importance for the insurance industry in recent years. Insurers have realized that ESG-related issues, such as climate change, ecosystem degradation, and pollution, can have major financial consequences. As a result, they are now placing greater emphasis on long-term sustainability when making underwriting decisions (UNEP, 2020). The NZIA member companies, who provide a significant portion of the world’s insurance capacity, have pledged not to offer coverage for projects with high carbon emissions. This decision could potentially make it difficult for these projects to maintain their sustainability. A significant adaptation gap remains in the industry despite the potential to incorporate environmental factors into insurance risk assessment procedures. A Capgemini study (2022) reveals that only 45% of insurance firms have integrated ESG factors into their underwriting procedures. Enhancing this ratio in the future would increase insurers’ contributions to the clean energy transition.

Supporting clean energy transition through investing in clean energy projects represents another pathway for insurers. Without taking action, it is predicted that energy consumption-related carbon emissions will rise by 70% by 2050. This will result in a more than 50% increase in total greenhouse gas emissions, according to OECD (2012). In order to reach the goal of achieving net-zero GHG emissions by 2050, investments in clean energy must increase significantly. The current average of USD 2 trillion over the past five years needs to rise to USD 5 trillion by 2030 and USD 4.5 trillion by 2050 (IEA, 2021). However, given the long-term and relatively risky nature of these projects, traditional sources of financing for renewable energy face limitations (Kaminker & Stewart, 2012). Insurers, who possess USD 44 trillion in assets, can play a vital role in bridging this financing gap in the transition to clean energy by investing in renewable energy projects and green bonds.

In recent years, the insurance industry has become increasingly interested in investing in clean energy. According to the interviews conducted by Ceres (2019) with major insurance companies in the United States, 52% of the respondents reported having clearly defined strategies and objectives for investing in clean energy. Additionally, 85% stated they considered investing in renewable energy sources. Swiss Re, for instance, has committed to hold at least USD 4 billion in green, social, and sustainability bonds by 2024 and to allocate an extra USD 750 million to renewable energy projects (Swiss Re, 2022). By investing in clean energy, insurers can diversify their investment portfolios and generate long-term sustainable returns while mitigating climate change. Despite these remarkable developments, clean energy investments by insurance companies represent a limited portion of their portfolios. The primary barriers to insurers adopting clean energy investments include inadequate government support, lack of investment experience, and difficulties diversifying investment instruments (Ceres, 2019; Kaminker & Stewart, 2012).

Investing in clean energy projects involves more uncertainty and risk than traditional fossil fuel projects. Since these projects require significant construction investments, they are exposed to property damage, business interruption, and liability risks. In this context, insurance can serve as a valuable tool for reducing uncertainties associated with developing and operating clean energy projects by enabling the transfer of risks from project owners to insurance companies. Traditional insurance products such as construction all risks, industrial risks, liability, business interruption, and loss of profit offer a safeguard against potential financial losses that clean energy projects may incur. These insurance products cover various stages of clean energy projects, from development to financing, construction, and operation. For instance, Munich Re’s Photovoltaic Guarantee Insurance, which extends for 30 years, covers losses arising from manufacturer-induced damages in solar power plants (Munich Re, 2023). It facilitates their financing by guaranteeing the long-term profitability of solar energy investments. Another innovative example is Euler Hermes’ Green2Green credit insurance, which ensures climate change mitigation projects and invests premiums in green bonds (Allianz Trade, 2020). This credit insurance mechanism not only eases financing for such projects but also invests the premiums earned in green bonds, thereby financing the projects.

Compared to other energy projects, clean energy projects are more sensitive to the impact of environmental factors. For instance, wind power plants depend on the availability and stability of wind levels for energy production. These vulnerabilities contribute to the unpredictability of clean energy projects’ financial income and production levels. Parametric insurance, a type of new-generation insurance, offers protection against income loss caused by environmental factors. Unlike traditional insurance, which measures financial loss after the occurrence of a risk, parametric insurance automatically pays out when a predefined event is triggered, measured by a specific parameter or index. For example, Swiss Re (2015) provides parametric insurance for an Australian renewable energy producer’s wind farms with more than 500 megawatts of capacity. The insurance product pays the producer a fixed amount per megawatt hour for energy that cannot be produced due to low winds. As of 2021, the global parametric insurance market had a premium production size of USD 11.7 billion and is projected to reach USD 29.3 billion by 2031, with an average annual growth rate of 9.9% (Kanhaiya et al., 2022). Although these forecasts indicate significant growth potential, the penetration of parametric insurance in the global insurance market remains low, given its overall size. There is still much potential to improve the adoption and implementation of parametric insurance.

Insurance companies can act as consultants for clean energy projects by managing their associated risks. They offer extensive risk management services for every project phase, utilizing their expertise and statistical data on various risks in different geographic regions. These services include risk management, avoidance, and mitigation associated with clean energy projects (Kaminker & Stewart, 2012). By accurately measuring and assessing risks associated with clean energy projects, essential strategies can be developed to mitigate these risks and prevent potential losses.

With a global premium production size of USD 7.2 trillion, the insurance industry has a unique opportunity to provide financial incentives to support the adoption of clean energy by individuals and institutions (IAIS, 2023). One direct approach to achieving this objective is offering discounted policies to customers using clean energy sources. For instance, travelers and farmers offer varying discounts on home insurance for green-certified homes. However, these practices are not industry-wide (Roberte, 2021). Similarly, some insurance providers offer reduced premiums for car insurance policies covering electric and hybrid vehicles. Conversely, the increased costs of spare parts and repairs for electric vehicles relative to traditional gas-powered cars result in higher car insurance premiums, ultimately limiting the efficacy of this approach to incentivize the transition to clean energy (Forbes, 2023). As a result, there is limited evidence that insurance companies accelerate the clean energy transition through premium discounts.

A more indirect policy that insurers can implement to support the clean energy transition is incentivizing energy consumption reductions. For instance, Metromile (2023) promotes reduced driving via usage-based car insurance pricing. Under this scheme, policyholders who drive less are charged lower premiums. This initiative reduces carbon emissions, benefiting the environment and lowering the risk of accidents for insurers. Insurance companies may also customize their insurance products to encourage energy efficiency. For instance, following a covered loss, an insurer may offer to rebuild an environmentally friendly and energy-efficient structure by providing additional compensation. Additionally, some insurers offer hybrid vehicle upgrades in commercial vehicle fleets as a replacement option (Capgemini, 2021). Insurance companies increasingly adopt sustainable insurance practices to reduce energy and resource consumption. With growing awareness of the impacts of climate change, these practices are likely to become more widespread and impactful.

16.4 Conclusion

This chapter examined the impacts of climate change on the insurance industry and outlined alternative tools and policies that insurance companies can use to promote the clean energy transition. Insurers should set industry-wide targets to minimize their carbon footprint and to reach net-zero GHG emission UW portfolio. Moreover, they should invest more in clean energy projects and offer financial protection to mitigate uncertainties during their development and operation. Also, companies should encourage the adoption of clean energy by incentivizing environmentally friendly practices among their customers. However, the lack of common strategies for incorporating sustainable insurance policies may create a competitive disadvantage for some companies and slow down the adaptation of the practice. To avoid this, standards and guidelines should be established to assist insurance companies in implementing clean energy strategies effectively.

In order to improve the involvement of the insurance industry in promoting the shift toward clean energy, it is essential for industry stakeholders, policymakers, and researchers to work together and take specific actions:

  • Companies should enhance collaboration to increase the transparency of their commitments toward the clean energy transition and make it an industry-wide standard.

  • Policymakers should introduce regulatory measures and incentives that encourage the adoption of clean energy initiatives.

  • Researchers should propose alternative strategies that insurance can use to mitigate the impacts of climate change and support the clean energy transition.