Report: US insurers could lose billions of dollars from transition shock

February 22, 2024|Written by

Insurance companies on the west coast of the US could lose billions of dollars if their investment portfolios continue to contribute to climate change, the first-ever stress test of insurance company investments has found.

The analysis from the California Department of Insurance found that insurance companies in California, Oregon and Washington that do not have long-term plans in place could face higher costs in the event of a transition shock, with losses ranging from US$7bn to US$40bn on corporate bonds alone.

The longer a transition is delayed, the more those losses skyrocket, the report found. Corporate bond portfolios are more exposed to climate risk than equity portfolios, which is alarming given that bonds make up a larger share of investments in the insurance industry, the report says.

Exposure to fossil fuels varied widely among insurers. While the average was 4.5%, some have up to 95% of their corporate bond portfolio invested in fossil fuels. Life insurers are the biggest investors in oil and gas, with an estimated US$150bn invested. And while insurers invest in green technology such as renewable energy and hydropower, it is not enough to meet the Paris Agreement goals.

The report confirms what advocates have been saying for years, said Carly Fabian, insurance policy advocate at Public Citizen: insurers are not doing enough to align their portfolios with emission targets, and voluntary initiatives are not enough to combat the issue.

“Regulators and policymakers should see a clear sign that they need to take bolder action to require insurers to meet their own stated climate commitments,” she said.

While a lot of attention has been called to the physical risks from climate change on the industry after insurers in California paused policies over wildfire concerns, there should be more attention on the “equally significant transition risks, as a delayed transition could lead to financial losses exceeding some of the worst wildfires in California’s history”, Fabian said.

The lack of transition plans in the industry is not just an environmental issue but also concerning from a consumer protection and prudential perspective, she added.

“A lack of progress on climate commitments should trigger concerns about whether management is capable of understanding their commitments or operationalising their plans,” she said.

Insurance companies can play a key role in the transition to a green economy, as they have the expertise to assess risk, said Elizabeth Jacobs, a senior specialist at climate change thinktank E3G.

Misalignments in insurers’ investment portfolios will contribute to increased physical and transition risks, which will ultimately make certain areas uninsurable. In turn, this could put insurance companies’ business models at risk.

“We’ve been here before — financial stability risks could arise from their focus on short-term profit and socialisation of risks,” Jacobs said.

Last year, US Treasury Secretary Janet Yellen voiced concern about the protection gap of American homeowners who live in areas affected by climate change and called on the Financial Stability Oversight Council (FSOC) to examine how a lack of insurance coverage could affect the financial system.

Still, heeding those concerns about the financial risks is a low threshold, said Jacobs.

“There’s concern that FSOC and its members’ actions to date are not nearly commensurate enough to address crystallising risks, especially in the insurance sector,” she said.

Climate financial policy consultant Jordan Haedtler said current disruptions, such as increasing costs of premiums and coverage cancellations, are evidence of a disorderly transition in the coverage and underwriting side of the insurance sector and now it seems “we are headed toward a disorderly transition on the investment side too”.

Regulators should require insurers to conduct climate-related stress tests both for their balance sheet but their investments as well.

“The western states putting out this data really can’t afford to wait to have wildfire risk embedded into the National Association of Insurance Commissioners’ formula for capital requirements,” he said.

This page was last updated February 22, 2024

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