Butch Bacani leads the UN Environment Programme’s Principles for Sustainable Insurance Initiative (PSI), the largest collaboration between the UN and the insurance industry. For readers of Bermuda:Re+ILS, he articulates the PSI’s ‘master narrative’.
I led the global research, consultation and drafting process that created the Principles for Sustainable Insurance (PSI), which were launched in 2012 and endorsed by then UN Secretary-General Ban Ki-moon and insurance industry chief executive officers.
The PSI serves as a global framework for the insurance industry to address environmental, social and governance (ESG) risks and opportunities across its risk management, insurance and investment activities.
The ESG agenda originated in the investment industry to help investors better understand the elements of sustainability that were not traditionally integrated into financial analysis and decision-making. It clarified E, S and G issues, but these should not simply be taken in isolation because they are often interrelated. The ESG agenda in investment led to the development of the Principles for Responsible Investment (PRI). These are six voluntary and aspirational principles developed by the UN and institutional investors, including insurance companies and pension funds, which were launched in 2006 and endorsed by then UN Secretary-General Kofi Annan.
In 2012, we launched the PSI at the UN Conference on Sustainable Development in Rio de Janeiro, also known as the “Rio+20” Conference. That event marked the 20th anniversary of the Rio Earth Summit—the 1992 UN Conference on Environment and Development in Rio de Janeiro—which delivered the multilateral frameworks for contemporary sustainable development, including the UN Framework Convention on Climate Change, the UN Convention on Biological Diversity, and the UN Convention to Combat Desertification. We felt that the 20th anniversary was a special moment for the insurance industry to demonstrate sustainability leadership.
It took us six years to produce the body of work needed to develop and launch these global best practice sustainability principles for the insurance industry. Firstly, we identified key global ESG issues that we believe were most relevant to insurers and produced a report in 2007 called “Insuring for Sustainability”. That was the very first time “sustainable insurance” entered the lexicon of sustainable finance. We followed that two years later with the first-of-a-kind global report on ESG factors and insurance.
The sustainable insurance report and the ESG survey formed the research foundation for the development of the PSI, which incorporates the PRI into Principle 1 of the PSI when it comes to the investment activities of insurers.
The four PSI, which are based on the spheres of influence of an insurance company and include a menu of possible actions, are as follows:
- Principle 1: We will embed in our decision-making ESG issues relevant to our insurance business.
- Principle 2: We will work together with our clients and business partners to raise awareness of ESG issues, manage risk and develop solutions.
- Principle 3: We will work together with governments, regulators and other key stakeholders to promote action across society on ESG issues.
- Principle 4: We will demonstrate accountability and transparency in regularly disclosing publicly our progress in implementing the Principles.
To date, more than 230 organisations from around the world have signed up to these Principles. Of these, over 130 are re/insurance companies or brokers. Together, these re/insurers represent about one-third of world premium volume and $15 trillion in assets under management. The other 100 signatories to the Principles are supporting institutions—such as insurance associations and initiatives, and insurance regulators—who are key in amplifying sustainable insurance thinking and practices.
“Insurers need to be sustainable across all of their three roles.”
Last June, the PSI marked its 10th anniversary. Ever since the PSI was born in 2012, our master narrative has been clear—we believe that the global insurance industry has three principal roles to play in addressing sustainability issues.
The first role is that of a risk manager. The insurance industry’s innate experience in assessing, quantifying and modelling risk is an important skillset that could be more widely deployed in society, be it through governments, cities or communities. The basic idea is: how can better understanding of risk prevent and reduce losses to begin with?
The second role is that of an insurer. Insurance is a financial shock absorber that pays out when disasters strike in order to help people and businesses get back on their feet. This long-standing support for adaptation and resilience is the largely forgotten component of climate action and it is essential that we continue to close the protection gap, particularly in the most vulnerable communities and economies. However, here’s the twist: the PSI has repositioned the role of insurance in a way that it isn’t limited just to the traditional and narrow perspective of a financial shock absorber, but instead treats insurance just like any other form of finance. In other words, insurance can be an enabler of sustainable economic activity just as lending and investment can. Whereas before the question was simply, “are you insured or not?”, now it is also, “what is being insured, and is that activity or asset sustainable?”.
The third role is that of an investor. Globally, the insurance industry has over $36 trillion in assets under management and the ways in which that capital is deployed would have a telling impact on sustainable development.
The point is that insurers need to be sustainable across all of their three roles.
If the balance sheet of an insurance company shows that it is providing X million in catastrophe coverage to X million people in developing countries, that’s indeed helpful. But if it is also insuring or investing in projects, companies, assets and activities that are damaging the environment and violating human rights, then these negative impacts have to be accounted for.
“Climate change science continues to evolve and now shows that the past is no longer a reliable indicator of the future.”
The right qualifications
Does expertise in weather risk make re/insurers qualified to manage climate risk? Yes and no. It is a good foundation because everything that the insurance industry has learned since Hurricane Andrew devastated Miami in 1992, which led to the creation of a catastrophe risk market in Bermuda, has helped them find the intersection of science, engineering and insurance to better understand natural hazards. That’s been helpful for insurers to better understand physical risk.
The “no” answer to that question is that the traditional understanding of physical risk isn’t enough, and for two main reasons. One is that climate change science continues to evolve and now shows that the past is no longer a reliable indicator of the future. This means re/insurers need to have a forward-looking approach towards climate risk because it is no longer sufficient to say you’ve modelled the past 1,000 years. Climate change is disruptive: there are tail risks and black swan events that will not necessarily be an extrapolation of the past.
Furthermore, the traditional focus of risk modelling, insurance-linked securities, catastrophe bonds, parametric insurance and other forms of coverage has been on resilience and adaptation. However, climate change mitigation, which is about reducing greenhouse gas (GHG) emissions, is—in the insurance underwriting context—virtually a new risk space. That’s because the correlation between loss and emissions was not clear in the past because GHG emissions have not really been a key factor in insurance underwriting. If emissions continue on the current trajectory, we all know what the science is telling us: it will lead to catastrophic climate change, which will ultimately lead to even more frequent and more severe events, and then to more economic losses and more insured and uninsured losses. That will manifest itself more starkly over a future time horizon of decades.
One potential result of intensifying climate change impacts, and which is increasingly becoming evident, is litigation risk. What will happen when there’s more climate change-related litigation in the real economy? And what will happen to companies that have D&O insurance coverage and professional indemnity coverage? There’s a new suite of risks that were not traditionally within the classic weather-related events space but are increasingly going into the climate change risk space.
“Climate change is not the only planetary crisis we are facing.”
The UN Decade of Action
That’s a good segue to our priorities at the PSI, whose overall goal is in line with the UN’s Sustainable Development Goals (SDGs), the blueprint to achieve a better and more sustainable future for all. The SDGs address the global challenges we face, including poverty, inequality, climate change, environmental degradation, peace and justice. The 17 SDGs can be simplified into just seven words: “prosperity for all on a healthy planet” and are meant to be achieved by 2030.
In this decisive decade, there are three overarching priorities.
One is well-known: to halve emissions by 2030 if we are to have a chance of limiting global warming to 1.5°C.
Two is to be “nature-positive” because climate change is not the only planetary crisis we are facing. There will hopefully be a “Paris moment” for nature in December, when the Post-2020 Global Biodiversity Framework is expected to be adopted. Science is showing us that we’ve degraded nature and lost biodiversity to the extent that we’re approaching tipping points. We’re on the cusp of sending into extinction a million plant and animal species, largely through humankind’s destruction of natural ecosystems via harmful and unsustainable industrial development. How can we reverse nature loss and become nature-positive within this decade? And then how can we regenerate nature for it to make a full recovery by 2050? The concepts of net-zero insurance and nature-positive insurance are subsets of sustainable insurance that the PSI has created to drive this 2030 agenda forward.
The third priority this decade is achieving the SDGs themselves, which has a core tenet: to leave no one behind. In other words, prosperity should not be for an exclusive few, but for everyone. This is why it is vital to have a socially just and inclusive transition to a net-zero and nature-positive economy.
“If you are an insurance company without an ESG strategy, there is now a global guide for you.”
PSI priorities to amplify sustainable insurance
That frames what the PSI’s priorities are in this UN Decade of Action, in line with our master narrative on the three roles of the insurance industry in addressing sustainability challenges and opportunities: risk manager, insurer and investor.
The first concerns the insurance industry’s role in supporting the implementation of the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Last year, the PSI produced a report called “Insuring the climate transition”. This was the result of a multiyear collaborative effort by 22 leading insurers and reinsurers from around the world in using forward-looking climate change scenarios to better assess climate-related physical, transition and litigation risks in the context of insurance portfolios. We learned that insurers are most comfortable with, and most knowledgeable about, climate-related physical risk. Nevertheless, the latest climate change science that stretches decades down the road is challenging insurers to enhance their risk modelling capabilities. There is also still much room for improvement in how insurers assess climate-related transition and litigation risks in a forward-looking way using climate change scenarios. The TCFD aims to help insurers overcome these challenges and sharpen their axe to be able to better manage climate risk. We’ll be producing more reports in the coming months, and stretch that work out to include life & health insurance and assessments at the national level.
Another PSI priority is ESG risk management spanning a range of sustainability issues, from climate change, biodiversity loss and ecosystem degradation; to human rights and corruption. The PSI launched the first-ever ESG guide for non-life insurance in 2020, and launched the first-ever ESG guide for life & health insurance in 2022. We call both branches “insurance business”, but non-life/P&C is a very different kettle of fish to life & health, and, within non-life, marine and aviation are very different from property and auto. So, if you are an insurance company without an ESG strategy, there is now a global guide for you, whether you are a non-life insurer, a life & health insurer, or both.
Another PSI initiative is the Sustainable Insurance Facility of the Vulnerable Twenty Group of Finance Ministers (V20). The V20 currently comprises 58 of the most climate-vulnerable countries in the Asia-Pacific, Africa and the Middle East, and Latin America and the Caribbean, represented by their finance ministers. I have seen many initiatives seeking to close the protection gap over the years and realised that a core problem is how to make insurance solutions affordable, available and accessible for the long term. So what I posited was: can there be an insurance facility that’s going to be owned and directed by developing countries themselves? That led to my engagement with the V20 during their meeting in Asia in 2017 and the idea of creating a V20 Sustainable Insurance Facility.
The aim of this facility is to bridge the protection gap for micro, small and medium-sized enterprises (MSMEs), which account for more than 80 percent of businesses, and contribute anywhere between 20 and 70 percent of the GDP, of developing countries. They are largely underserved, and in many cases unserved, by insurance. The V20 Sustainable Insurance Facility materialised and became operational last year at COP26. We have received core funding from the German Federal Ministry for Economic Cooperation and Development (BMZ) to set up the project office within the PSI which will become its core team liaising with ministries of finance and the wider public sector, MSMEs, private insurers, and other key stakeholders. This is one of the PSI’s main contributions to climate change adaptation and building resilience: a pipeline of insurance solutions for MSMEs that we expect to start delivering from next year. Indeed, this is so timely and important. At COP27, the long-standing issue of “loss and damage” in developing countries finally got to the heart of the negotiations with a breakthrough agreement after nearly three decades of COPs. Equally, COP27 saw the launch of major climate resilience initiatives such as the V20 and G7-backed Global Shield against Climate Risks and the commitment to create an African Climate Risk Facility by insurers who are part of the PSI-supported Nairobi Declaration on Sustainable Insurance initiative.
The newest kid on the PSI block is the Net-Zero Insurance Alliance (NZIA), which was launched by the PSI at the G20 Climate Summit in July 2021 with eight founding members: AXA (chair), Allianz, Aviva, Generali, Munich Re, SCOR, Swiss Re and Zurich Insurance Group. Today, it is a group of 29 leading insurers and reinsurers representing nearly 15 percent of world premium volume. Alliance members have committed to transition their respective insurance and reinsurance underwriting portfolios to net-zero GHG emissions by 2050.
The NZIA’s sister initiative at the UN Environment Programme, the Net-Zero Asset Owner Alliance (NZAOA), started in 2019 and is made up of insurers and other institutional investors, such as pension funds and foundations, who are doing the same thing as the NZIA, but in the context of transitioning investment portfolios.
We believe that insurers have a role to play not only in adaptation and resilience, but also in decarbonisation. The basic premise here is: how can insurance help decarbonise the real economy in line with a net-zero transition pathway that would limit global warming to 1.5°C?
There are various net-zero insurance approaches that an insurer can independently take to decarbonise its underwriting portfolio. One way is to set underwriting criteria for certain high-carbon activities, particularly with respect to fossil fuels. A second way is to engage with your clients, both corporate and retail, supporting them in having a credible transition plan to net zero. A third way is to insure the net-zero transition, including renewable energy projects; zero-emission transport; energy efficiency; and nature-based solutions, such as forests and mangroves, which also sequester carbon aside from building coastal resilience. Going beyond those approaches is claims management, where you can encourage “repair instead of replace” and help your clients build back, not only stronger, but also greener, by using sustainable construction materials and energy-saving appliances.
If the real economy is net zero, then finance—be it insurance, investment or lending—is automatically net zero. However, the real economy is not net zero; it is currently high carbon, so we want to use insurance as a lever to decarbonise the real economy and help avert catastrophic climate change.
There are foundational challenges. One is that all the work on decarbonisation and finance over the past decades has focused on investment and lending. This means that the metrics in attributing emissions in the real economy to financial portfolios have largely been for investment and lending, not insurance. This November, however, the first-ever global standard to associate emissions with insurance portfolios was launched. This is a result of the NZIA’s collaboration over the past year with the Partnership for Carbon Accounting Financials (PCAF) to produce the first global standard to measure and disclose insurance-associated emissions. This is a major step for insurers on decarbonisation because unless you can quantify emissions and attribute them to insurance contracts, it will be difficult to set science-based decarbonisation targets for underwriting portfolios in a credible, accountable and transparent way.
Another credibility challenge is that anyone can say “net zero by 2050” but without showing how they will get there in an accountable and transparent way. In the NZIA, member insurers and reinsurers will independently set interim science-based decarbonisation targets for their respective underwriting portfolios and publicly report on their progress annually. On November 1, we released a public consultation version of the first-ever target-setting protocol for underwriting portfolios. It’s a different space from the equally important protection gap space which focuses on adaptation and resilience to the physical impacts of climate change. In the net-zero space, decarbonisation is the mantra and tackles the root cause of climate change.
To drive further systemic change, the PSI is supporting the development of sustainable insurance roadmaps in different jurisdictions.
A first-of-its-kind sustainable insurance roadmap has been produced by the California Department of Insurance and was launched at COP27. We’ve been supporting roadmaps and strategies across regions over the years. Whether it’s California, Canada or Costa Rica; or Africa, Australia or Brazil, we’re working with insurance market participants, associations and regulators so that they can take their own journey on sustainable insurance through a comprehensive strategy and action plan for their respective jurisdictions.
“We want to use insurance as a lever to decarbonise the real economy and help avert catastrophic climate change.”
Next stop, nature
The next port of call is nature-positive insurance and we expect and hope for “a Paris moment for nature” next month. One can expect that we will have a similar initiative to the NZIA, especially following the Nature-Positive Insurance Series the PSI organised with the UN Convention on Biological Diversity last year. Following the Paris Agreement and latest climate science, the overall goal is to limit global warming to 1.5°C this century. But what does a Paris moment for nature mean and look like? There is already a draft Post-2020 Global Biodiversity Framework that is being discussed. Just as there is a COP for climate change, there is a COP for biodiversity. The next UN Biodiversity Conference, COP15, will take place this December in Montreal, Canada.
Over the years, we’ve done and supported work with insurers to produce guidance to reverse nature loss and prevent pollution. These include guidance to combat illegal, unreported and unregulated (IUU) fishing; to tackle plastic pollution and environmental pollution; to address high-impact hydropower; and to protect World Heritage Sites.
A key difference with the nature agenda is that biodiversity and ecosystems are local. For example, the Amazon and Canada’s boreal forests are different ecosystems, whereas carbon is the same unit everywhere in the world. However, we should not silo climate and nature because they are two sides of the same coin. If you want to achieve a net-zero economy, then you need to address deforestation and the destruction of natural ecosystems. If you want to achieve a nature-positive economy, then you need to reduce GHG emissions because climate change impacts natural ecosystems.
The metrics are coming. The Taskforce on Nature-related Financial Disclosures aims to capture how nature-related risks impact companies in the real economy as well as financial institutions. The financial sector underpins the real economy and, as with climate change and the net-zero transition, there are also many opportunities related to the transition to a nature-positive economy. But we need a strong and ambitious policy signal to come from COP15 in Montreal. The policy signal from COP21 in Paris in 2015 reverberated around the real economy and now it is reverberating around the financial sector as well. That’s why we’re discussing climate change mitigation and adaptation with greater depth and breadth right now. We need to make the nature agenda as visible as the climate change agenda. This goes as well for the legally binding treaty on plastic pollution that will be forged by governments by 2024 under the auspices of the UN.
The triple planetary crisis and the SDGs
Science is showing us right now that we need to tackle the whole environmental agenda spanning the triple planetary crisis—climate change, nature and biodiversity loss, and pollution and waste. And since this is a planetary crisis, it is equally a social agenda as it impacts each one of the eight billion people that inhabit this planet. That means it is also a governance agenda since the world needs to come up with solutions to these global problems. In short, this is an ESG agenda.
This is why the PSI’s master narrative is encapsulated in the PSI’s priorities in this UN Decade of Action—to harness the global insurance industry’s risk management capabilities, insurance solutions and investments to help cut emissions in half, reverse nature loss, and achieve the SDGs without leaving anyone behind.
UN, Principles for Sustainable Insurance, Butch Bacani