Insurers as Partners in Inclusive Green Growth Evan Mills, PhD © 2013 International Finance Corporation The material in this publication is copyrighted. IFC encourages the dissemination of the content for educational purposes. Content from this publication may be used freely without prior permission, provided that clear attribution is given to IFC and that content is not used for commercial purposes. The findings, interpretations, views, and conclusions expressed herein are those of the authors and do not necessarily reflect the views of the Executive Directors of the International Finance Corporation or of the International Bank for Reconstruction and Development (the World Bank) or the governments they represent. IFC and the World Bank do not guarantee the accuracy of the data in this publication and accept no responsibility for any consequences of their use. Cover photo courtesy of the World Bank Photo Library. Insurers as Partners in Inclusive Green Growth Evan Mills, Ph.D.* * The author has worked for over three decades on energy-environment topics spanning developing and industrialized countries. He is currently a Staff Scientist at the U.S. Department of Energy’s Lawrence Berkeley National Laboratory at the University of California, Berkeley. He served as an author on climate change impacts, mitigation, and adaptation for several Intergovernmental Panel on Climate Change as- sessments, as well as on the Second U.S. National Climate Assessment. He has worked extensively with the insurance industry on matters pertaining to climate change, and maintains a global database of green insurance activities. ii INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Contents Preface. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v 1. Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2. Context. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Inclusive Green Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Insurance and (Inclusive Green) Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 The Importance of Extreme Weather and Natural Disasters. . . . . . . . . . . . . 9 Insurance, Development, and a Changing Climate. . . . . . . . . . . . . . . . . . . . . . . 12 3. The Greening of Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Modalities of Insurer Engagement in Inclusive Green Growth . . . . . . . . . . . 16 4. Insurance Capital for Green Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Finance and Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Facilitating Investment by Other Parties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Insurer In-House Greening Projects. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 5. Pinpointing Opportunities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Making Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Intra-Industry Transfer of Best Practices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Enhanced Availability and Affordability of Insurance. . . . . . . . . . . . . . . . . . . . 28 Improved Hazard Detection, Characterization, and Models. . . . . . . . . . . . . . 28 Responsive Policy and Regulatory Environments. . . . . . . . . . . . . . . . . . . . . . . . 30 Maximizing the Value of Public Insurance Systems. . . . . . . . . . . . . . . . . . . . . . 31 Public-Private Partnerships. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Appendices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 I: Statistical Overview of Insurance in Emerging Markets: 2012. . . . . . . . . 37 II. Alternative Risk Transfer (ART) Strategies and Definitions. . . . . . . . . . . 41 ii Contents iii III: Trends in Global Natural Catastrophe Events, by Income Group. . . . . 43 IV: Framework: Insurer Engagement in Climate Change Responses. . . . . . 44 V: Insurer Climate Change Adaptation Projects See Https://docs.google.com/spreadsheet Ccc?key=0Als8219SGDIjdGRQcU5XR3BheExLTUt4ajhrVnI3WUE#gid=1 VI: Insurer Investments in Climate Change Mitigation See Https://docs.google.com/spreadsheet/ ccc?key=0Als8219SGDIjdGRQcU5XR3BheExLTUt4ajhrVnI3WUE#gid=6 List of Tables Table 1: Implications of Climate Change for Insurability. . . . . . . . . . . . . . . . . . . 13 Table 2: Demonstrated Insurance Strategies for Managing Risks Associated with Inclusive Green Growth Projects.. . . . . . . . . . . . . . . . 29 List of Figures Figure 1: Insurance markets have grown steadily in the developing world. . . 7 Figure 2: Apple Computer’s supply chain in East Asia . . . . . . . . . . . . . . . . . . . . . 9 Figure 3. Flooding “hot spots” in the developing world. . . . . . . . . . . . . . . . . . . . . 10 Figure 4: Allocation of natural disaster impacts by region . . . . . . . . . . . . . . . . . . 10 Figure 5: Allocation of natural disaster impacts by type and region. . . . . . . . . 11 Figure 6: Trends in numbers of natural disaster events. . . . . . . . . . . . . . . . . . . . . 12 Figure 8: Investment Requirements to Limit Global Warming to 2°C, Compared to Business as usual, and Sources of Finance to Close the Gap. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Figure 9: Global fund management industry, assets under management, . . . 22 Figure 10: Green Finance and Investment by Global Insurers. . . . . . . . . . . . . . . . 23 Figure 11: Vegetated roof on Allstate Corporate headquarters. . . . . . . . . . . . . . 24 Figure 12: Tokio Marine Nichido’s mangrove reforestation project.. . . . . . . . . . . 24 List of Boxes Box 1: Alternative Risk Transfer Mechanisms. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Box 2: The 2011 Thailand Floods: A Teachable Moment in the Vulnerability of Insurers to Growth that is not Green. . . . . . . . . . . . . 10 Box 3: Examples of Green Insurance in Developing Countries . . . . . . . . . . . 17 Box 4: AIG’s Carbon Offset Strategy for Carbon Neutrality. . . . . . . . . . . . . 25 Box 5: Insurance Best Practices for Inclusive Green Growth. . . . . . . . . . . . . 27 iv INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH v Preface T he Group of 20 (G20) nations increas- These publications can all be found at www.ifc. ingly recognize the importance of green org/Report-MobilizingGreenInvestment. growth, and many countries are demon- Intrinsic to the concept of inclusive green strating strong leadership through effective growth is limiting damages due to natural disas- and progressive policies. However, govern- ters, including those stemming from global cli- ments do not act alone—the private sector mate change. Insurance is at an earlier stage of is an important partner, providing new tech- evolution in the developing world and takes a nologies, business models and investment different form there. As the incidence of weath- opportunities across a variety of sectors to er-related catastrophes has tripled in the past help scale up transformation. In 2012 the three decades, the underdevelopment of insur- G20 Development Working Group commis- ance markets renders a high proportion of losses sioned the International Finance Corporation, uninsured, and thus a rising stake in new loss-re- as the largest development finance institu- silient infrastructure. In many developing coun- tion dedicated to private sector develop- tries, insurance has been historically dominated ment with a strong emphasis on sustainability, by public entities. to take stock of mechanisms to mobilize pri- Insurers can materially engage in green vate capital, including from institutional inves- growth in several ways: by helping spread the costs tors, for inclusive green growth investments of everyday as well as catastrophic losses (their in developing countries. This work is intend- core business) that so often represent a setback ed to inform the creation of a public-private to development efforts; accurately evaluating and G20 Dialogue Platform on Inclusive Green communicating risks to inform public and private Investment. decision making; offering innovative risk manage- As part of this effort IFC commissioned a ment products and services; providing influential series of supporting documents and materials, input to the public policy processes; and directly including this publication, specifically created investing some of their substantial assets (more as underpinning material to inform the final syn- than $20 trillion under management) in inclusive thesis report produced by IFC for consideration green growth projects and providing risk manage- at the G20 meeting in St. Petersburg in 2013. ment tools for other investors. v 1 2 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Executive Summary A ttaining durable economic growth in In 2012, insurance represented 7 percent the developing world while stemming of the global economy—the world’s largest in- rising environmental impacts that oth- dustry—manifesting as $4.6 trillion in premium erwise perversely impede that very growth revenues, $22 trillion in assets under man- requires widespread deployment of green agement, and a large workforce. Insurance technologies and practices. Green growth be- premium volume in the developing world rep- comes socially equitable and inclusive when resents about 15 percent of the global total, and access to the accompanying efficiencies and growth rates are far higher than in mature mar- benefits to environment, health, and food se- kets given that demand is far from saturated. curity extend to those at the bottom of the This underscores a further role for insurance in economic pyramid. Intrinsic to the concept of economic development. inclusive green growth is the mitigation of and Insurers can materially engage in green adaptation to otherwise unavoidable natural growth in several ways: by helping spread the disasters, including those stemming from the costs of everyday as well as catastrophic losses systemic risks of climate change. (their core business) that otherwise represent a Navigating an increasingly challenging risk setback to development efforts; offering inno- landscape is a key to successful inclusive green vative risk management products and services; growth, and the insurance sector stands as a providing influential input to the public policy natural partner in that process. Conversely, processes; and directly investing some of their if increasing environmental degradation and substantial assets in inclusive green growth other risks go unmanaged, a crisis of insur- projects and providing risk management tools ability (availability and affordability of insur- for other investors. ance provided by the private market) could As an industry involved in every economic ensue, further hampering growth and shifting sector (i.e., real estate, industry, water, agri- a greater share of risk to an already over-taxed culture, transportation, energy, and health), public sector. insurers can support cross-linkages among a Climate change adaptation and mitiga- wide diversity of green growth project areas. tion are thus central to the insurance-and-In- There are many precedents, largely from the in- clusive-Green-Growth narrative. By spreading dustrialized world. In particular, as of late 2012, risk, the availability of insurance substantially nearly 400 insurers from 51 countries had em- diffuses the near- and long-term economic dis- ployed a versatile set of techniques to promote ruption from natural disasters, while reducing green technologies and practices and proactive the burden on individuals as well as in-country responses to climate change risks. and foreign governmental aid. Today, a quarter Of particular relevance, insurers provide of the direct costs of global catastrophes are fi- about one-third of the total $71 trillion insti- nanced through insurance. tutional investment currently in place globally. 2 Executive Summary 3 In the past decade, 25 insurers have collec- tively made over $40 billion in finance and direct investments relevant to climate and en- vironmental concerns, spanning venture cap- ital, private equity, public equity, and credit. Of the total, $23 billion was invested in cli- mate change mitigation projects. In addition, between 2004 and 2011, insurance companies provided asset financing in the form of cor- porate finance and loans in at least 29 trans- actions, valued at approximately $11 billion. This is accompanied by $7 billion in broader social-screened investments that include but are not limited to environmental criteria. Additional investment by at least 155 insurers in greening their own infrastructure is not in- cluded in these numbers, but is substantial,  Extending the availability of insurance to with 28 of these companies reporting attain- manage risks in the developing world. ment of carbon neutrality.  Facilitating resilience and adaptation to Existing green initiatives involve a diversity changing weather and climate extremes. of insurance industry actors, including direct  Introducing innovative products and ser- insurers, reinsurers, brokers, agents, actuaries, vices that support green growth. modelers, and industry associations, often in  Engaging in public policy and land-use partnership with regulators, academic institu- planning processes. tions, consumer groups, governments, and non-  Investing in and financing green growth, governmental organizations. resilience, and adaptation projects. The breadth of potential insurer engage- Success depends in no small part on fac- ment is consistent with an imperative to ap- tors out of insurers’ direct control. These proach inclusive green growth in an integrated include a host of political risks, regulatory fac- manner rather than a piecemeal project-by- tors such as pricing and public sector involve- project basis. Key opportunities for accom- ment in disaster management, and conditions plishing this by extending best practices from determining whether buyers will exercise the industrialized world to a developing country demand for green insurance products and context include: services. 2 4 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Context D evelopment paradigms have often sac- Inclusive Green Growth rificed environmental considerations for near-term economic gains, with The vast investment needed to overcome the added consequence of amplifying inequi- these challenges must, by definition, be ties in social welfare. Indeed, the inefficiencies framed by the notion of inclusive green embedded in traditional development and as- growth, which is the pathway to sustainable sociated investment decisions can ultimately development (World Bank 2012b). For the serve to constrain human wellbeing and eco- poor, traditional development has offered un- nomic prosperity. These tensions, however, are affordable, and thus often unobtainable, op- not pre-ordained. tions. Green growth, in contrast, emphasizes The real-world limits to traditional devel- affordable solutions, such as energy-efficient opment approaches are startlingly evident. and renewable energy systems with lower Today, nearly two centuries after the indus- lifecycle costs than traditional solutions (Mills trial revolution and untold investments in in- 2005a). Green growth can simultaneously re- frastructure for the developing world, poverty duce environmental degradation that adverse- remains pervasive: 1.3 billion people lack access ly impacts health and wellbeing, particularly to electricity, 2.6 billion have no access to sani- for lower income populations. tation, and 900 million lack safe drinking water. As articulated by the Af Development There are more people on earth today without Bank (AfDB 2012): electricity than the entire human population in Edison’s day. In addition to humanitarian con- By choosing certain activities, eco- siderations, these underserved markets repre- nomic growth can be decoupled from sent large uncaptured business opportunities. environmental harms. In some cases, en- Moreover, thanks to the inefficiencies of his- vironmentally superior choices may also torical development efforts, all populations—irre- enhance economic productivity (e.g., spective of their economic wealth—have emitted through efficiency gains) or human wel- sufficient greenhouse gas (GHG) pollution to fare (e.g., through goods and services trigger dangerous changes to the climate and ex- provided by natural environments). Green treme weather events, and are heading toward growth is the selection of economic activ- far more destructive, yet still avoidable levels ities that, at best, promote environmental of impact (World Bank 2012a). With countries and social development and, at a min- at all levels of wealth vulnerable to the impacts imum, do not harm the environment or climate change, environmental degradation is human welfare. This is achieved through eroding the resilience of human systems, magni- rigorous analysis of economic alterna- fying inequities, and impeding prosperity. tives and their related environmental 4 Context 5 and social impacts. … [G]reen growth will sector, and to a lesser but still important de- mean pursuing inclusive economic growth gree in the public sector. through policies, programs and projects that invest in sustainable infrastructure, better manage natural resources, build Insurance and (Inclusive Green) resilience to natural disasters, and en- Growth hance food security. Analyses by the World Bank (Arenal 2006) As a case in point, a major global chem- and others (Lloyds of London 2012) have es- ical company (Dow), oil company (Shell), tablished that the presence of insurance (both consumer products company (Unilever), rein- life and non-life) stimulates economic growth. surance company (Swiss Re), and NGO (The The same is said for the presence of institu- Nature Conservancy) looked in some detail tional investors, of which insurers are among at emerging examples of green infrastructure the top three globally (Grant 2013). This such as water treatment, coastal and floodplain makes intuitive sense, in that an environment protection, and fortifying the built environ- where physical and health-related risks are ment (Dow et al. 2013). The group found that by professionally spread and managed, coupled harnessing ecosystem services, such systems with higher levels of investment throughout increase resilience of industrial business oper- an economy and reduced burden of loss costs ations, often demonstrate financial advantages on governments, fosters economic activity. (both due to reduced capital and operating ex- Further synergisms with banking can be imag- penses), reduce energy and other resource use, ined, e.g., reducing risks for lenders where the and manage socio-economic risks. underlying (climate-sensitive) asset is insured. Developing nations possess a particular Insurance is an element of the financial ser- opportunity to “leapfrog” industrialized econ- vices sector not traditionally associated with omies whose historically suboptimal long- “green” initiatives. However, the industry has term infrastructure investment decisions have undertaken extensive activity regarding green locked them into less efficient and more pol- technologies and practices (Mills 2012a). This luting practices. stands as a strong exemplar of the often-as- While the notion of risk management has serted false choice between economic growth become embedded in the worlds of public and environmental or sustainability consider- policy and business, it has come late to the ations. Insurers’ rationale for engagement in environmental sphere where relatively sim- inclusive green growth should follow from the plistic cost-benefit analysis retains a dominant fact that emerging markets are the industry’s role in decision making. In reality, the environ- future as an underwriter, and they represent mental risks associated with development proj- the largest arena for associated investment. ects—even those associated with well-intended This is borne out in a recent survey where 70 improved practices—are not well known, and percent of insurance CEOs identified Asia and are in a dynamic state. This is particularly evi- nearly 50 percent Latin America as “very im- dent in the face of global climate change, which portant” to their company’s overall near-term is arguably the ultimate systemic risk facing so- growth prospects (Geneva Association 2012). ciety today. From a policymaker’s vantage point, insurance The insurance sector is key to under- represents a key private-sector modality of standing and managing risk within the private risk spreading, while green growth (by virtue of 6 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH reducing risks) can ultimately improve the af- risk management products and services; pro- fordability of insurance. viding constructive and influential input in The global insurance sector is well posi- public policy processes; and directly financing tioned to enhance inclusive green growth in or investing some of their substantial assets developing countries. Insurance markets have in inclusive green growth projects. As an in- grown steadily in the developing world, with dustry almost uniquely involved in every eco- 16 percent of the $4.6 trillion insurance reve- nomic sector (i.e., real estate, industry, water, nues in what insurers deem “emerging markets” agriculture, transportation, energy, and health), as of 2012, with the share projected to roughly insurers and their products can support double by 2023. Over $720 billion in annual pre- cross-linkages among disparate risks and green miums already come from emerging markets1 growth project areas. Through appropriate en- (Figure 1; Appendix I). Moreover, insurance can gagements, the insurance industry can also help offset the high proportion of GDP other- help enhance project quality and significantly wise lost due to natural disasters in the devel- leverage development funding. oping world. Most long-run economic costs of Insurance is a truly global industry, with natural disasters occur where insurance is not most major firms operating on multiple con- in use (von Peter et al., 2012). tinents. Yet, insurance is at an earlier stage of Insurance is a strongly crosscutting in- evolution in the developing world and takes a dif- dustry, reaching into virtually every segment ferent form there. While insurance markets are of the economy. As a result, insurers stand to largely saturated in industrialized countries, the offer a systemic perspective on green growth growth rate of insurance in developing countries topics. For example, we have seen the Chief routinely outstrips GDP (Appendix I). Premium Underwriter for the Asia Catastrophe Pool/ growth in emerging Asian markets is projected Asia Agriculture Pool express concern about at 11 percent per annum (Munich Re 2013a), while the challenges that climate change poses for developed markets are relatively saturated. food security on the one hand and competi- Despite relative market growth in the de- tion between water resources for hydroelec- veloping world, as the incidence of weather-re- tric power and agricultural irrigation on the lated catastrophes has tripled in the past three other (Corona 2013). They further couple this decades, the underdevelopment of insurance technical point with recognition of socioeco- markets renders a high proportion of losses un- nomic and demographic structural consider- insured, and thus a rising importance of new ations such as the potential value of increased loss-resilient infrastructure in conditioning the insurance (risk-spreading) in reducing the need market for growth. for rural populations to move to urban areas, In many developing countries, insurance has and the need for responses to take the form been historically dominated by public entities. of public-private partnerships. It is notable that the U.S. President Obama’s 2013 climate 1 Defined in the Swiss Re statistics (Swiss Re change platform calls for public-private collab- 2012a): Advanced economies include the US, orations with insurers (Executive Office of the Canada, Western Europe (excluding Turkey), President 2013). Israel, Oceania, Japan and the newly industri- alized Asian economies (Hong Kong, Singapore, Insurers can materially support green South Korea and Taiwan). All other countries growth in a variety of ways: by helping spread are classified as “emerging” and generally corre- the costs of everyday as well as catastrophic spond to the IMF’s “emerging and developing” losses (their core business); offering innovative economies. Context 7 FIGURE 1:  Insurance markets have grown steadily in the developing world Source: Swiss Re Economic Research & Consulting. Note: 16 percent of the $4.6 trillion insurance revenues are in what insurers deem “emerging markets”, as of 2012, with the share projected to roughly double by 2023 (Swiss Re 2013). 8 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Liberalization that has allowed commercial en- traditional insurance portfolios (assets) are in trants has taken place in many cases, beginning effect bundled and resold to investors on sec- in China in 1992 and in India in 1999. Conversely, ondary markets. There are many mechanisms Chinese insurers have begun writing policies in for ART (Appendix II), the most well known of the United States (Kenealy 2013). which are the catastrophe bonds (which thus Concerns about having sufficient ca- far been limited almost exclusively to industri- pacity to pay claims in the face of rising cat- alized countries) (Cummins 2012). astrophic losses have stimulated efforts to From the perspective of the inclusive develop alternative ways to transfer financial green growth policymaker, differences in tax risks. In response, insurance companies have treatment of ART and traditional insurance begun to venture outside of their traditional transactions could have implications for na- business model, using a variety of alterna- tional treasuries (GAO 2002). Consumer pro- tive risk transfer (ART) financial instruments tections should also be considered in light of which do not always involve the core busi- potential lack of oversight by insurance reg- ness of funding losses with premium reve- ulators. a concern voiced by the Lloyd’s of nues (Box 1). London Chairman recently in which he lik- Among the forms of alternative risk transfer ened the risk to that of the damaging “systemic are instruments such as weather derivatives risks” recently experienced in the banking in- and Insurance Linked Securities (ILS), wherein dustry (Business Insurance 2013a). Moreover, BOX 1:  ALTERNATIVE RISK TRANSFER MECHANISMS The common aim of alternative risk transfer (ART) mechanisms is to attract new sources of risk capital and thereby diversify and expand the capacity of individual companies (and the industry as a whole) to remain solvent in the wake of catastrophic losses, while mitigating reinsurance price volatility (RMS 2012). Proponents tend to position ILS as a substitute for reinsurance; others, as a compliment (if needed) (GAO 2002). In every case, their value is linked to the incidence and outcomes of insurance-loss events. These instruments are new to markets, first appearing in mid-1990s, in the wake of unprecedented losses from Hurricane Andrew and the Northridge Earthquake. A second wave of new products followed the extreme hurricane season of 2005. The growing use of both insurance and alter- native financial vehicles to generate capital for paying losses is often referred to as “convergence.” The market is small in comparison to traditional in- surance. Approximately 280 Cat Bonds have been issued to-date (http://www.artemis.bm/deal_directory/). There has been a resurgence of activity in 2012–2013 (aggregate capital of $45 billion), enough so to create downward pressure on traditional reinsurance prices (Guy Carpenter 2013). Of importance to the broader finance community is that ILS payouts had historically been assumed to be un-correlated with global financial mar- kets, but this was not borne out in recent years (Boucher 2009). Moreover, a large natural catastrophe hitting a major financial center (earthquake or ty- phoon in Tokyo) can of course have widespread economic repercussions. Insurance-linked securities have brought new risks to insurers and investors, along with new concerns to regulators. Investors cannot monitor the underwriting and loss-prevention practices of the insurers, and so may assume more risk than they realize (Thomas 2013). While a niche market within the broader structured-finance market, ART techniques have been more affected by the global financial crisis than anticipated (Weistroffer 2010). The value of four ILS instruments fell precipitously in the global financial crisis, by 40–80 percent in the case of those owned by Lehman (Boucher 2009). Derivative instruments are now being regarded with more scrutiny. Regulatory oversight may be quite different than for traditional insurance, and likely varies widely by country. According to the Wall Street Journal (Thomas 2013): “[T]he sustainability of alternative capital in this kind of investment hasn’t been tested by widespread, major losses. … As the market has expanded, it has become more concentrated. More than 70 percent of outstanding cat-bond volumes are exposed to U.S. hurricane risk. They could yet be called catastrophe bonds for a reason.” Context 9 not all ART mechanisms are applicable to im- Among insurers focusing on this issue, Allianz portant green growth populations, e.g., smaller found that natural disasters are the number farmers would not be likely to have access or one trigger of supply chain disruptions (59 per- sophistication necessary to employ weather cent of the cases) (Business Insurance 2013b). derivatives, or to all types of insurance activity Interestingly, “oil reliance” is cited as the top (e.g., insurance of real estate against non-cata- “weak link” among supply-chain risks that strophic losses). It is not clear whether, if at all, can be directly managed. Almost half of 170 ART can be used synergistically to stimulate in- global executives surveyed by Zurich and the clusive green growth in the same ways as can Economist pointed expressly to the risks of nat- traditional insurance. Among the important dis- ural catastrophes on IT infrastructure (Veysey tinctions between ART and traditional insur- 2013a). As a case in point, the developing world ance is that the former manages risk by using is at the heart of Apple’s supply chain Although financial mechanisms. These issues should be headquartered in the U.S., disruptions in many further investigated in the context of inclusive other countries have a material effect on the green growth. company’s fortunes. The globalization of commerce and infor- The 2011 flooding in Thailand was a wake-up mation technology has created unprecedented call for insurers about the sensitivity of cus- supply chains that stretch around the planet, tomers in the developing world and the insur- which globalizes previously “local” risks. As a ance industry burgeoning exposure to those result, natural disasters routinely disrupt global risks (Box 2). supply chains, networks, workforces, and distri- bution systems (UNISDR and PwC 2013). It is not surprising that insurers are among those The Importance of Extreme Weather who focus most on supply chain risks spanning and Natural Disasters sectors as diverse as manufacturing, agricul- ture, and telecommunications. Data compiled over four decades by the The Supply Chain Risk Leadership Council Munich Reinsurance company offer a unique identifies climate change as the foremost profile of global impacts from natural catastro- among 14 major emerging risks (SCRLC 2013). phes in aggregate (Figure 4) and allow for a more in-depth look at impacts by types of event, including those related to climate and weather extremes (Figure 5). FIGURE 2:  Apple Computer’s supply chain in East Asia (ChinaFile 2013) It is clear that the insurance industry ma- terially participates in spreading the costs of natural disasters. Managing approximately a quarter of total catastrophe losses globally, their engagement varies widely by region. For the period 1980 to the present, the insured fraction of total losses is 44 percent in North America, 29 percent in Europe, 9 percent in South America, and 8 percent in Asia. Insurers’ exposure, however, is rising everywhere. In sum, the developing world experiences funda- mentally different patterns of impacts from cli- mate and weather extremes, as follows: 10 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH BOX 2:  THE 2011 THAILAND FLOODS: A Teachable Moment in the Vulnerability of Insurers to Growth that is not Green Following the highest rainfall rates in 50 years, the massive 2011 floods in Thailand made world news, affecting businesses in many other countries and catching the global insurance industry largely by surprise. Total costs approached 9 percent of GDP (Lloyds of London 2012). Dams built with an ex- cessively narrow focus on impounding water for irrigation were filled to capacity, subsequently requiring large water releases in short periods of time. Flooding across an area the size of Switzerland continued for five months. Households and small businesses in Thailand held almost no insurance (~1 percent penetration rates). Meanwhile, high-tech and automotive manufacturing entities had developed infrastructure fortified only to average flood conditions, leaving exceptional vulnerability to extremes. The com- bination of unprecedented floods and inadequate preparedness led to $30 billion overall economic losses, of $12 billion were insured (the world’s larg- est-ever insured fresh water flood loss, four times larger than the previous record). The World Bank (2012c) has estimated a sub- FIGURE 3.  Flooding “hot spots” in the developing world stantially higher cost ($46.5 billion), attributed to a fuller ac- counting of supply-chain impacts. As a metric of the financial impact on insurers, their entire relevant industrial premiums the prior year had been only $0.37 billion. Consequently, flood insurance availability in Thailand contracted, and the government was forced to step in and create a pool (Hall 2013). Investigations conducted by the insurance industry fol- lowing the event identified seven other developing countries have become even more vulnerable than Thailand (Figure 3), particularly China (Swiss Re 2012). FIGURE 4:  Allocation of natural disaster impacts by region: 1980–2012 (Munich Re 2013b) Context 11 FIGURE 5:  Allocation of natural disaster impacts by type and region: 1980–2012 (Munich Re)  Number of events—The incidence of nat-  Overall economic losses —Here the bal- ural disasters is spread somewhat even- ance of total developing world impacts ly throughout the world, with more than shifts considerably to Asia, with the re- half of the events in Asia and the balance mainder almost completely in Europe in industrialized regions. Events arising and North America. Weather- and cli- from weather and climate extremes (as mate-related events cause the majori- distinct from those attributable to earth- ty of economic losses, particularly due quakes, tsunamis, and volcanic eruptions) to extreme weather (primarily storms). represent the vast majority of natural di- The dominance of climatological losses sasters: 80–95 percent in each region. In in Africa no doubt arises from agricul- the developing world, hydrological events tural and livestock losses stemming from (primarily floods) are the largest catego- droughts. ry, followed by storms and other meteo-  Insured economic losses—North America rological events. shoulders the majority of global insured  Fatalities —When considering human economic2 losses from natural disasters, costs, measured in terms of fatalities, with Europe in a distant second position. the developing world bears the brunt The balance—20 percent of the world’s of impacts. In the Americas, the dom- total—is spread throughout Asia and the inant number of fatalities arises from rest of the developing world. Pronounced non-weather-related events (especially differences in the distribution of total ver- earthquakes and tsunamis), while in Africa sus insured economic losses exist in most and Europe, climatological events (partic- regions. Areas without private earthquake ularly heat waves and drought) claim the greatest number of lives. (Health insur- 2 The qualifying term “economic” is used here be- ance costs from extreme events are not cause the allocation of insured losses arising from comprehensively tracked.) natural disasters is not tabulated by Munich Re. 12 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH FIGURE 6:  Trends in numbers of natural disaster events (Munich Re) insurance (notably North America) have challenges are vastly greater in a develop- a very low proportion of non-weather/ ing country context than in the industrialized climate-related insured losses. Weather world (Mills 2004). extremes and associated impacts such Insurability requires sufficient under- as floods and landslides are dominant in standing of the actuarial likelihoods and lo- most developing regions. cations of losses, market factors such as the willingness of customers to pay the associ- The numbers of natural catastrophes ated premiums, and the broader societal con- events are rising around the world (Figure 6) text with respect to policy and law. Among and Appendix III), seemingly fastest in the the myriad challenges in this regard are those poorest countries. arising from the expected increase in fre- quency and intensity of extreme events, along Insurance, Development, and a with shifting geographies (Table 1). Changing Climate Insurers are not new to the problem of climate change. Their earliest expressions of Every sector of the economy telegraphs concern date to the 1970s. By virtue of their unique climate risks to its insurers. In turn, cli- cross-sector risk-taking, insurers experience mate change—and the systemic risks that re- the full range of climate change impacts. sult—stands as the ultimate stress test for the Drought provides a clear illustration, as it si- industry as it threatens to reduce insurability, multaneously affects insured activities in ag- hinder growth (as prices rise), or even trigger riculture and livestock production, energy contraction (Mills 2005b; Lloyds of London production, wildfire, and supply chains (in- 2006; Dailey et al., 2009). Reaching back to cluding fuel) dependent on river-based ship- the Code of Hammurabi, insurers’ social and ping. The U.S. drought of 2012 exacted $15–$17 regulatory agreements must balance maintain- billion in public and private insurance claims, ing solvency following losses with availabili- out of a total economic impact of somewhat ty and affordability of their products. These over $20 billion (Munich Re 2013c). Context 13 TABLE 1:  Implications of climate change for insurability* Category Criterion Must be Complications presented by climate change Actuarial Risk/uncertainty Measurable Increasingly complex, volatile, decreasingly predicted by past loss expe- rience, and increasingly challenging to model Loss occurrences Independent (uncorrelated) Risk of increased correlation as events become more complex, frequent, and extreme Maximum loss Manageable Reserves must grow in proportion to magnitude and frequency of events Average loss Moderate Will increase Loss frequency High Will increase Moral hazard (fraud) Not excessive Unlikely linkage Adverse selection (dispropor- Not excessive Requires that changing risks are understood, premiums are sufficiently tionate purchasing of insurance risk-based, and risk pool remains large and diversified by high-risk customers) Market—and Insurance premium Adequate, affordable Insurance regulators must allow prices to reflect risks regulator-determined Insurance cover limits Acceptable to customers Gap between limits and need will likely increase, as will deductibles and exclusions Insurance capacity Sufficient to weather ex- Increasingly difficult treme events Societal Public policy Consistent with cover Increasing tension between public versus private risk-sharing Legal and regulatory Permits the cover Insurance regulators will be on critical path to allow “green” innovation * Adapted from Herweijer et al (2009) Adding to a highly problematic baseline Where there are risks, there are also op- situation, insurers are experiencing increas- portunities. Insurers have deeply rooted tra- ingly complex weather-related events, beget- ditions of assessing, communicating, and ting multiple cascading losses from property managing risks. The thought leaders have damage across every customer class, global evolved a nuanced view of climate change, con- supply-chain and business disruptions, life sidering abrupt as well as slow-onset events and health impacts, and even liability claims within a framework of enterprise-wide risk against emitters of greenhouse gases (Ross et spanning underwriting, investments, daily op- al., 2009; Carroll et al., 2012). Forward-looking erations, shareholder relations, and regulation. insurers are far more compelled by the pres- Recognizing that the marketplace has moved ence of these risks than they are dissuaded beyond most policymakers in embracing new by the exact degree of certainty about cli- technologies and business models designed mate science. In parallel, insurers must adapt to address climate change, a vanguard of in- to emerging risks stemming from society’s re- surers and affiliated institutions are proactively sponses to climate change. This includes how responding. customers construct buildings, transport people and goods, design products, and pro- duce energy. Reflecting these considerations, 3 More recent surveys showed global economic a 2008 survey of 70 insurance analysts ranked concerns ranking first. These concerns, however, climate change as the industry’s primary stra- are presumably more temporary than those of cli- tegic risk (Ernst and Young 2008).3 mate change. 14 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH While elements of the industry have Stephen Weinstein historically been ambivalent about publicly Senior vice president and general counsel, expressing concern about climate change, pri- Renaissance Re marily in the United States, recent interviews of 30+ insurance executives indicate a real- The climate is changing, and it is in- istic shift in perspective toward recognizing creasingly more reliable to associate that climate is changing, the impacts are in- certain kinds of events—such as wildfires creasing, and delayed action is imprudent and drought—with climate change. (Rousseau 2013): Lindene Patton Chief climate product officer, Zurich Financial Push politics aside. To us it is very clear: The risk of climate change is very real, Statistically, it’s clear something is hap- and it has a real potential to be disrup- pening. An increase in the frequency and tive to our business. severity of natural catastrophes can be Chris Lewis plotted—and they’re getting worse. … We Senior vice president of insurance risk have to rethink damage amounts, rethink management, The Hartford risk management, rethink the planning and design of buildings. The assumptions We are seeing and feeling the effect of we have made based on the past are what we know is climate change. We no longer valid. We have to plan for a know more intense storms and weather much different future with more frequent will continue…. droughts and forest fires in areas where Mario Vitale they never had them before. CEO, Aspen Insurance Rod Taylor Managing director, Aon’s Environmental We’re not sticking our heads in the Services group sand. Clearly there is a change in tem- perature. We need to mitigate and Given all the attention around climate adapt. change, clients, naturally, are asking David Zona us when it’s going to happen…. Given Chief underwriting officer, Fireman’s Fund, a the loss experiences of the last two to unit of Allianz three years, our answer is: ‘It’s starting to happen now.’ Climate change is real, and you don’t Cliff Warman risk the solvency of your company by Head, Marsh’s Environmental practice inEurope saying, ‘I don’t believe it.’ The Middle East and Africa Maurice “Hank” Greenberg CEO, Starr Companies The insurance industry finds itself as the conduit through which a significant proportion In our SEC filings, we have stated that of climate change impacts reach the broader we believe climate change is occur- economy. In this role, insurers are witnessing, ring and is contributing to an increased first-hand, the intensification of natural haz- probability of more severe weather ards, more rapid return periods between major events. events, a changing geography of impacts, and Context 15 mounting claims. As climate changes, and pop- In any case, a reactive response by this in- ulations move increasingly into harm’s way, his- dustry (such as reduced coverages, exclusions, torically based models of vulnerability and loss withdrawal, or price increases without accom- costs are losing predictive power. The uncertain- panying support for loss reduction) would have ties surrounding all of these factors constitute adverse effects for inclusive green growth, in- a material challenge to the insurance business. sofar as the erosion of insurance availability In tandem with changes in the physical and affordability would put a chill on economic environment, insurers are embedded in an activity and development (Mills 2005b). This equally rapidly changing business and regu- could occur both directly, via a reduced con- latory environment. Rising losses translate to tribution to economic activity by the insur- rising premiums that jeopardize affordability, ance sector, and indirectly, through reduced and providing insurance at any price becomes infrastructure investment where insurance untenable when the uncertainties are too high. cannot be procured and thus debt not secured. Meanwhile, responses to climate change bring Ultimately, a reactive approach is not in the new risks. Foremost among these are climate business interest of insurers, as it equates with engineering, but virtually every new technology market contraction. (or revival of those, such as nuclear power, that Disaster risk financing using traditional had languished in the past because of exces- alternative risk transfer (ART) techniques sive risk) has a unique risk profile (Mills 2012b). compensates for losses but does nothing to Some insurers, nonchalant about climate physically shield populations and assets from risk, point to annual renegotiation of prices natural hazards. A number of recent innova- (through policy renewals) as a sufficient “escape tive disaster risk financing tools have forged hatch,” coupled with the optionality of serving more explicit links between disaster risk fi- a given market. This approach of course carries nancing and disaster risk management. These reputational and regulatory risks, among them instruments make access to financing con- that regulators often reject proposed price in- tingent upon engagement in disaster risk creases, and, as seen in the wake of Hurricane management activities. The World Bank, for Andrew, have impeded insurers’ ability to exit example, established a contingent credit fa- markets. Moreover, demand for insurance is cility in 2008 with an eligibility requirement certainly price-elastic, particularly in a devel- of implementation of national disaster risk oping country context where premiums repre- management strategy; the Inter-American sent a far higher proportion of income than is Development Bank (IADB) has since followed the case in developed markets. suit with a similar facility. 3 16 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH The Greening of Insurance D riven by the potential for commer- Extending the Availability of Insurance To cial and reputational rewards, insurer Manage Risks in the Developing World engagement in green growth themes Although collecting $72 billion per year in extends well beyond increasingly definitive premiums in emerging markets, insurance statements. Tracking with the perspectives of penetration in these markets is far low- the broader climate research and policy com- er than in the industrialized world. The ab- munities, insurers have applied a variety of sence of insurance can deter investment and tools toward climate change mitigation and growth, particularly the riskier investments adaptation. Nearly 400 insurance companies typical of many green growth markets. With from more than 50 countries have engaged in a potential of $40 billion per year in premi- climate change adaptation and mitigation ac- ums, micro-insurance (which some now refer tivities (Figure 4 and Appendices IV and V) to as “inclusive insurance”) has emerged as (Mills 2012a). Box 3 notes early examples of one category of risk-transfer products appro- activities in emerging markets. priate for the lower-income segments of de- Climate-focused insurance innovations veloping countries. (aside from direct investment) have been lim- In some cases, insurers are working di- ited almost exclusively to property insurers. rectly with governments to bolster public insur- However, the case for engagement on the ance programs. The World Food Programme part of life/health insurers is relatively strong (WFP), in cooperation with AXA Re, developed in emerging markets, e.g., as suggested by and pilot-tested drought insurance for the recent research showing that air pollution Ethiopian government. The product was de- (largely related to coal burning) shortens life signed such that in the event a drought index expectancy by 5.5 years in Northern China was exceeded, AXA would pay a pre-agreed (Chen et al., 2013). amount to the Ethiopian government (via WFP), which would then be distributed to the im- pacted households (Herweijer et al., 2009). Modalities of Insurer Engagement in Insurers are recognizing coverage gaps Inclusive Green Growth that amplify vulnerabilities to climate change. Insufficient purchasing power within small Building on a solid base of experience, there countries led the World Bank to collaborate is a potential for significantly increasing the with the Secretariat of the Pacific Community insurance industry’s engagement with inclu- to finance an insurance pool to aggregate cov- sive green growth. Several major avenues ex- erage for a set of pacific states ((Samoa, Tonga, ist, which can be illustrated with real-world Vanuatu, Solomon Islands and Marshall Islands) precedents. (Maclellan 2013). The mechanism will also ensure 16 The Greening of Insurance 17 BOX 3:  EXAMPLES OF GREEN INSURANCE IN DEVELOPING COUNTRIES Promoting green buildings and vehicles—203 examples in the marketplace. Mileage-based insurance, with premiums paid by the mile, drivers are rewarded for reduced driving. While most products have been offered in industrialized countries, Nedbank and MiWay have done so in South Africa. Other companies (e.g., HBN Assurance in Sri Lanka) offer significant premium credits for hybrid vehicles. Green buildings products and services; Fireman’s Fund penetration 150 million square feet. Other players: ACE, Aon, Allianz, AXA, Chartis, Chubb, FM Global, The Hartford, Nationwide, Sompo Japan, The Travelers, and Zurich Financial. Forestry projects—Obtaining carbon offsets and enhanced resilience, Tokio Marine Nichido has refor- ested 8,200 hectares of mangroves in Fiji, India, Indonesia, Myanmar, the Philippines, Thailand and Vietnam. Carbon markets: CDM credits for carbon neutrality and risk services—At least 155 insurers have engaged in substantive in-house energy management projects and 28 have become carbon neutral, primarily through the use of credits obtained via developing country projects financed under the CDM. In some cases, the projects are performed directly by insurers, as done by AIG in China. Some firms offering services for carbon project risk, e.g., (upstream) project development advisory and (downstream) non-delivery insurance. Industry-driven climate change policy and corporate governance initiatives—129 insurers; 29 countries participating in initiatives launched by UNEP, Geneva Association and ClimateWise. Emerging market members include insurers from Brazil, China, Colombia, Nigeria, South Africa and Thailand. Participating in climate science, including next-generation climate modeling—Dozens of studies conducted. One example is analysis of outlook for torrential rainfall, wildfire, and coastal risks under climate change in collaboration with Santam (South Africa). Partners: WWF, the University of Cape Town, Council for Scientific and Industrial Research (SA), UNEP-FI. Cost-benefit analysis of climate change adaptation projects—in one large effott, focus countries included India, Guyana, Tanzania, Mali, China and Samoa. Led by Swiss Re, partners include McKinsey, Global Environment Facility (GEF), European Commission, the Rockefeller Foundation, Climate Works, and Standard Chartered Bank. Public-private partnerships to improve post-event liquidity and access to post-disaster finance for recovery efforts—Many examples, e.g., the Caribbean Catastrophe Risk Insurance Facility is a public-pri- vate partnership across 16 CARICOM governments provides short-term liquidity following hurricane and earth- quake events while the slow process of insurance loss-estimation and claims handling is completed. Munich Re and insurers in the Philippines have teamed up to insure low-income microinsurance borrowers and associated loan portfolios against liquidity problems after major catastrophes. World Bank is helping Island states pool insurance purchasing power +120M donor funds for enhanced resilience. Lastly, an initiative with AXA and World Food Program used drought index to trigger food relief payment to Ethiopian government. that recover funds flow more quickly than is the governments with immediate funds following case with traditional disaster relief, and will be hurricane or earthquake catastrophes. augmented with $120 million in donor contribu- Bes practices proactively employ tech- tions for improved resilience and adaptation, niques to physically “de-risk” a customer or an allowing practical projects such as raising road insured asset. If climate change progresses un- elevations. Another example of this pooling checked, a widespread insurability crisis can be approach is the Caribbean Catastrophe Risk expected in the developing world, thereby un- Insurance Facility (CCRIF), which provides dercutting growth (green and otherwise). 18 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Facilitating Resilience and Adaptation To customers proactively improve their phys- Changing Weather and Climate Extremes ical and economic resilience to a changing cli- Insurance is a centuries-old technique for mate (Appendix V). One evaluation compiled managing risks, although in modern times it insurer efforts to enhance adaptive capacity has focused more on financial risk spreading (Surminski 2011) to flood, windstorm, hail, wild- than on loss prevention. Risk-based, insurance fire, rain, and mold, spanning 15 countries at pricing also sends signals to the market that scales from individual buildings to entire re- can foster less risk-taking and underscore the gions. The strategies include a mix of financial cost-benefit tradeoffs for risk-reduction. and physical risk management, and most in- The process of adapting to hazards is clude engagement from non-insurance entities. familiar to insurers, and is echoed in their Canada’s largest insurer (Intact) sponsored historical involvement in the founding of fire de- a major assessment of climate change adap- partments, and development of building codes tation needs, calling for active collaboration and auto-safety test procedures. This, coupled among the insurance, science, construction, with use of insurance to transfer risk, makes and regulatory communities on efforts such it a relatively minor conceptual step—and one as improving the construction of new homes, with a strong business case (Herweijer et al., fortifying existing homes, and enhancing risk 2009)—for insurers to engage in global environ- communication (Feltmate and Thistlewaite mental issues. Insurers with banking operations 2012). Recognizing the deficiencies in building can also engage in financing client-side adapta- code enforcement, the U.S.-based Insurance tion improvements Services Office promulgates a voluntary Insurers are in a unique position to apply Building Code Effectiveness Grading Scale, highly developed loss-estimation models to intended to spur reward for the development estimate the costs of climate impacts on ex- and enforcement of codes via insurance dis- isting infrastructure, as well as the cost-benefit counts or surcharges. That said, even relatively tradeoffs of making adaptation investments. As straightforward efforts to reward customers a case in point, insurers used their models and for reducing risks remain the exception rather actuarial data to map climate risks and evaluate than the rule in this industry. potential adaptation investments, finding that a $120 billion investment in adaptation on the U.S. Introducing Innovative Products and Gulf Coast would avoid $200 billion in losses Services That Support Green Growth over the next two decades (America’s Wetland Many insurers, primarily in the industrialized Foundation and Entergy 2011). Similarly, anal- world, offer “green” insurance products that ysis undertaken by Lloyd’s of London and ca- incentivize energy-efficient and renewable en- tastrophe modeler RMS found that insurance ergy use among their customers (e.g., lower losses from unmitigated coastal risks could premiums for energy-efficient housing or ve- nearly double in high-risk areas under 2030s hicles), or fill coverage gaps that otherwise sea-level rise, or be reduced by far below cur- stand as barriers to development and infra- rent levels with concerted efforts at adaptation structure investment (e.g., coverage for off- (Lloyd’s of London 2008). shore wind energy infrastructure). With one While insurers have begun to reactively of the more long-standing offerings, the prod- adapt to rising weather-related losses by ad- ucts from Fireman’s Fund have been applied justing insurance prices, contract terms, to 150 million square feet of commercial floor and availability (Mills et al., 2006), at least area. ACE, Aon, Allianz, AXA, Chartis, Chubb, 22 have sought to directly or indirectly help FM Global, The Hartford, Nationwide, Sompo The Greening of Insurance 19 Japan, The Travelers, and Zurich Financial are Engaging in Public Policy and Land-Use also among the active companies in the green Planning Processes buildings area. An emerging category of green For centuries, insurers have influenced pub- insurance helps de-risk clean energy invest- lic policy on issues ranging from land-use ments, e.g., via performance (aka “efficacy”) planning in flood zones to automobile safe- insurance or warranties for energy-efficiency ty, frequently striking agreements on the pric- and renewable energy projects. Where insur- ing of risk and the establishment of public ers assume these risks and apply engineering risk management activities. As an example skill to preventing losses, their interests be- of the latter, insurance industry associations come productively aligned with the broader have supported reduced speed limits (citing policy-level importance of verifiable and per- co-benefits of improved fuel economy and re- sistent emissions reductions. This form of risk duced accident rates) and public transit (citing transfer also makes it easier for innovative benefits of reduced vehicle use and roadway projects to secure financing. congestion and public health). Insurers have In tandem with their underwriting activity, been engaged in climate policy forums since insurers have brought forward technical ser- the mid-1990s, participating in every interna- vices in support of climate change mitigation tional climate negotiations meeting, in addition efforts on the part of their customers. These to national venues such as the U.S. Climate include inspections, energy auditing, carbon Action Partnership, in which Marsh and AIG accounting and risk management, technology were members. Lloyds of London is one of assessments, and financing. the more prominent voices on the interna- Some “green” technologies are advanta- tional stage, identifying climate change as the geous in that they intrinsically align with low- industry’s number one issue and admonish- er-risk behavior. Progressive Insurance, for ing its market to take the risks more serious- example, pioneered pay-as-you-drive prod- ly (Lloyds of London 2006). Insurer advocacy ucts that achieve more accurate roadway acci- has promoted proactive loss-prevention ef- dent insurance premiums by using telematics to forts and helped overcome excessive risk-tak- verify actual distances driven. Driver responses ing induced by subsidized insurance and to this price signal (equivalent to a $1/gallon publicly financed disaster recovery. gas tax) could reduce U.S. driving by 8 percent Through engagement in discussions (4 percent of national oil consumption), yielding of flood planning and policy in the United consumer savings of $50-$60 billion per year Kingdom, the Association of British Insurers while reducing the probability of accidents and employed climate and catastrophe models to premium cross-subsidies from those who drive create a policy-relevant synthesis of the oppor- little to those who drive a lot (Bordoff and Noel tunity costs of not mitigating emissions and a 2008). Ford and State Farm are collaborating window into how climate change could increase on a similar offering. About 2.5 million such pol- macroeconomic insurance expenditures. Given icies have been issued across Europe and the questions of insurability, the specter of com- United States, and 7 million premium credits plete exit from the U.K. flood insurance market have been awarded to low-emission vehicles was raised and then averted as government (the purchase of which is seen as a proxy for produced better flood maps and tightened safer driving habits) by Sompo Japan and Tokio land-use planning criteria. Similarly, Allstate ex- Marine and Nichido, based on the assessment ited the Mississippi homeowners market until that those selecting such vehicles exhibit less building codes were improved so as to reduce risky driving behaviors. hurricane risk. Insurance Australia Group has 20 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH performed precipitation modeling for local gov- a recent political risk insurance policy provid- ernments, enabling them to revise their long- ed $150 million in coverage for an equity in- term flood planning. vestment in a 147MW hydroelectric project in Pakistan (Insurance Journal 2013). Investing in and Financing Green Growth, Insurers are recognizing that truly sustain- Resilience, and Adaptation Projects able infrastructure is both disaster resilient and Insurers could bring large amounts of new energy/water efficient. Beyond their core role funds to bear on inclusive green growth proj- in sending market signals that loss-prone ac- ects, and have already made a strong start in tivities are not sustainable, some insurers rec- devoting resources to green projects in the ognize instances of emissions reduction and industrialized world. Insurers may also seek adaptation co-benefits. Zurich Financial com- to assume some of the risks of donor invest- bines incentives for post-loss reconstruction ments and public finance mechanisms seeking of buildings to green standards with improved to leverage private investment, or otherwise fortification to extreme weather (Patton 2008). help address risks perceived by third-par- Projects with adaptation mitigation co-benefits ty investors (e.g., via political risk insurance). would thus be particularly attractive to insurers, Insurer investment is discussed at length in as they generate unique revenue streams that the next section. In an example of the latter, help offset adaptation costs. 4 21 Insurance Capital for Green Growth T he need for green growth finance is Finance and Investment enormous, pegged at $1 trillion per year beyond current levels (Kaminker Insurers provide nearly one-third of the and Stewart 2012). Public funds can set good $71 trillion currently managed by institution- examples and provide leverage, but will pro- al investors globally (Figure 9). As evidence vide perhaps only one-quarter to one-fifth of that the G20’s vision for inclusive green the investments needed (Figure 8). growth may be met, the Green Insurance The 2012 G20 Leader’s Declaration man- Data Service has identified 25 insurers that dated its Development Working Group to ex- have collectively made over $40 billion in fi- plore ways how to mobilize more private funds nance and direct investments relevant to cli- for green investments in developing countries, mate and environmental concerns (Figure 10; especially lower income countries: Appendix VI). 4 Of this, $23 billion has been di- rected to climate change mitigation activities. “We encourage further exploration of In addition, insurance companies provided as- effective mechanisms to mobilize pub- set financing in balance sheet funding and lic and private funds for inclusive green convertible/term loans in at least 29 transac- growth investment in developing coun- tions (valued at approximately $10.8 billion be- tries, including through the public-pri- tween 2004 and 2011). This is coupled with an vate Dialogue Platform on Inclusive additional $7 billion in broader social-screened Green Investments.” investments that include but are not limited to environmental criteria. At least 31 major in- The acute remaining need for infrastruc- surers routinely prepare environmental, social, ture investment in low-carbon energy systems, and governance (ESG) reports.5 combined with the current environment of low interest rates, slow growth in industrialized countries, and new constraints on the ability 4 Other investments are known, but the amounts of banks and bond issuers to scale up their not documented. activity, suggests that clean energy is an ideal 5 For a list of insurer ESG reports, see http://in- “play” for institutional investors. surance.lbl.gov/cr-reports.html 21 22 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH FIGURE 8:  Investment Requirements to Limit Global Warming to 2°C, Compared to Business as Usual, and Sources of Finance to Close the Gap (World Economic Forum 2013) Companies such as Allianz, Manulife, plus 7 solar-electric generating facilities with a Metlife, Munich Re, and Prudential have each total capacity of 74 megawatts (Kaminker and made billion dollar equity investments in ac- Stewart 2012). In some cases, these invest- quisition of renewable energy production fa- ments are made through funds, e.g., by Aviva cilities. Allianz now owns 34 wind farms with via the European Renewable Energy fund a total generating capacity of 658 megawatts valued at approximately €250 million, which FIGURE 9:  Global fund management industry, assets under management, $ trillion: 2009 (Della Croce, et al., 2011) Insurance Capital forGreen Growth 23 has been allocated to a full range of renewable FIGURE 10:  Green finance and investment by global energy projects, with funds provided by the in- insurers: as of Q3 2012 surer as well as from life insurance annuities, and from external investor clients (e.g., pen- sion funds). Others such as AXA and Tryg have taken equity positions in startups developing new clean energy technologies. Many insurers, e.g., AXA and Prudential, participate in clean infrastructure projects through municipal and corporate bonds. Insurers are also investing in energy effi- ciency projects in the developing world. For example, in one of its 20 such projects under development, Allianz invested in an energy-ef- ficient lighting project in India under the Clean Development Mechanism (CDM) (Allianz 2012). The project will deploy 8.5 million compact fluorescent lamps, reducing emis- sions equivalent to one million German cars. Allianz will, in turn, purchase some of the re- United Nations Principles for Responsible sulting tradable CDM credits to offset a por- Investing [UNPRI], and the Investor Network tion of its own corporate emissions. Allianz on Climate Risk (INCR) is encouraging. Unlike has also made an equity investment in project other institutional investors, insurers both own developers of forest conservation that plan and manage investments. to generate emissions reductions under the Reducing Emissions from Deforestation and forest Degradation (REDD) scheme. While significant, the current level of ac- Facilitating Investment by Other tivity may foreshadow an even greater level of Parties investment. Munich Re is among the founders of an ambitious initiative to supply 15 percent Insurers have long-standing experience in fa- of Europe’s electricity through a $500 billion cilitating investment by third parties (e.g., via investment in renewables across North Africa annuities). Insurers have developed or par- and the Middle East.6 ticipated as founding investors in a number Despite these strong indications of ability of green funds, the first of which was the to invest in green infrastructure, insurers and Environmental Value Fund established by other institutional investors traditionally allo- Storebrand and Scudder in the mid-1990s. cate a small share of their resources to infra- In other cases, insurers have developed structure projects (although more comes from risk management products to help other inves- bond investments). That said, with increasing tors manage risk. For example, several compa- emphasis on the fiduciary duty of firms to ad- nies (Swiss Re, Munich Re, Tokio Marine/Kiln) dress issues such as climate change, the emer- have offered products that respond to non-de- gence of large gatherings of institutional livery of carbon credits to the European Trading investors intent on increasing such investment (e.g., the Carbon Disclosure Project (CDP), 6 See http://www.dii-eumena.com/home.html. 24 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH FIGURE 11:  Vegetated roof on Allstate Corporate “Efficacy insurance” is a particular prom- headquarters ising product category. A significant number of insurers have launched products that respond to underperformance of energy efficiency or renewable energy projects. Geothermal en- ergy exploration risk insurance has also been developed. Those financing renewable power or green buildings projects (e.g., under the GEF, CDM, or via development banks) can procure these insurance products to reduce financial risk throughout the project cycle (UNFCCC 2007). Insurer In-House Greening Projects Insurers have also invested in “green” projects Note: The company installed a 1,254m2 (13,500ft2) vegetated roof in 2008, accessed from its cafeteria. in more direct ways, i.e., as part of in-house The technology sequesters carbon, reduces water runoff, and lowers air conditioning energy requirements. http://www.greenroofs.com/projects/pview.php?id=801 energy management efforts and programs to reduce carbon footprint or even achieve carbon neutrality. According to the Green System. These products address potential loss Insurance Data Service, at least 155 insurers mechanisms ranging from the efficacy of under- have engaged in substantive in-house ener- lying projects to political risks. gy management projects (Figure 11) and 28 have attained carbon neutrality (GIDS 2013). Given the sheer size of this industry, and its real estate holdings, these projects can be significant. FIGURE 12:  Tokio Marine Nichido’s mangrove Insurers have also engaged in major green reforestation project (Mills 2012a) projects outside their own sphere of opera- tions. A notable set of examples is embodied by AIG’s carbon-neutrality plan, under which proj- ects involving agriculture, energy, water, and land-use management were placed in China (Box 4). In another example, Tokio Marine Nichido (Japan’s largest insurer) eliminated its corporate carbon footprint. To achieve this, it embarked on a mangrove reforestation project in 1999 (Figure 12). The project is approaching its target of just over 8,200 ha (20,265 acres) across seven countries. The company cites carbon sequestration (contributing to its own carbon neutrality since 2008) and enhanced resilience to storm damages as joint mitiga- tion-adaptation benefits of the project. Insurance Capital forGreen Growth 25 BOX 4:  AIG’S CARBON OFFSET STRATEGY FOR CARBON NEUTRALITY (MILLS 2009) To attain carbon neutrality as part of an overarching plan to reduce emissions from its business operations, in 2008 AIG announced a portfolio of agricultural projects in China and the United States to offset 630,000 metric tons of carbon dioxide emissions, at a cost of $4 million, or about $6.50 per ton. The China projects, located in the Xinjiang and Sichuan provinces, were developed by U.S.-based Environmental Defense Fund and supported and assessed by Boston-based nonprofit EcoLogic. The offsets are being registered and retired in the China Beijing Equity Exchange. Among the most notable benefits, the China projects:  Allow crops to be grown with lower consumption of water and fossil fuels through drip irrigation[a].  Promote use of more efficient nitrogen fertilizers through “precision fertilizer” production.Produce bio- gas from human and agricultural wastes that will be used for cooking and lighting [b, c].  Improve water management in rice farming and production.  Help retain water, control dust, and reduce soil erosion through trees planted in desert lands. In the United States, a portfolio of three projects focuses on reforestation and ecosystem enhancement.  A project funded through Equator Environmental, LLC, in the prairie pothole region of North Dakota, South Dakota, and Montana to protect native grasslands that have been converted from margin- al farmlands. This effort is registered and offsets retired in the Environmental Resources Trust, Inc. (ERT)/Winrock GHG Registry®. [d]  A project funded through Trust for Public Land to reforest marginal cropland in the Mississippi River delta region of Louisiana. This effort also is registered and offsets retired in the GHG Registry.  A project funded through The Conservation Fund to improve management of California harvested tim- berlands and to produce increased standing volume biomass. This effort is registered in the California Climate Action Registry. [e] 5 26 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Pinpointing Opportunities T he insurance industry routinely marshals to virtually every major green growth activity a versatile set of techniques that could area, helping manage key risks of infrastructure be used to enhance efforts at inclu- projects; disaster preparedness, recovery, and sive green growth in the industrialized world. resilience; and in commerce and financial ser- A high-level summary of demonstrated best vices associated with inclusive green growth. practices in this regard is outlined in Box 5. Most efforts to date, however, have taken place The insurance business is a combination of in the industrialized world, and without much underwriting and asset management. Insurers’ focus on social inclusiveness. Box 3 provides potential to finance and make direct investment examples of activities in the developing world. in green technologies and projects is vast. Even Following are some broad themes and when not acting directly, insurers are a signif- strategies to be kept in mind. icant resource for understanding and man- aging financial risks, be it through engineering methods to reduce project development and Making Markets subsequent operating and performance risks, hedges against uncertain prices or weather, Insurers must first be present in a given mar- property insurance, or removing political risk ket and committed to expanding their op- with specialized insurance policies (UNFCCC erations in order to participate in broader 2007; UNEP 2009). inclusive green growth efforts. Analyses find Importantly, the industry is not a mono- that low insurance penetration rates (insur- lith, and must be engaged in an appropriate ance per GDP) correlate with low foreign di- fashion. The many thousands of direct insur- rect investment, together with the absence ance companies operate largely independently, of a strong “rule of law” (Swiss Re 2012a). while a vastly smaller number of reinsurers pool Cultural factors often apply, e.g., in the case layers of risk from large numbers of direct in- of Muslim markets where Sharia law does not surers. An array of related firms and organiza- accept conventional western insurance busi- tions are also essential players. These include ness models. Takaful insurance has been de- brokers, agents, actuaries, and loss modelers. veloped for these situations, and with Islamic Insurance industry associations, regulators, and world assets at $1.6 trillion, demand is on the consumer groups also play a role. Many existing rise (Veysey 2013b). green insurance initiatives are conducted in Risks must be sufficiently well character- partnership non-insurance entities such as gov- ized for insurers to be able to set prices and ernments, academic institutions, and nongov- terms, and the resulting insurance products and ernmental organizations. services must then be affordable. Related bar- Table 2 more specifically illustrates how riers to wider availability and uptake of insur- insurance considerations could be applied ance include excessive risk-taking inadvertently 26 Pinpointing Opportunities 27 BOX 5:  INSURANCE BEST PRACTICES FOR INCLUSIVE GREEN GROWTH An insurer that integrates best practices into its business will implement the following 10-point strategy (Mills 2007): 1. Make concerted efforts to restore and maintain the insurability of extreme weather events. This may require partnerships with governments (e.g., in cases of improved land-use planning and enforced building codes); 2. Improve modeling and other methods of analyzing climate change risks; 3. Utilize terms and conditions to foster the right decisions by customers. This could range from rewarding risk-minimizing behavior to exclud- ing climate change liabilities for those who make imprudent decisions either as emitters of GHGs or as managers of risks associated with cli- mate change; 4. Develop new products and services to facilitate maximum customer utilization of climate-friendly technologies and practices, especially in cas- es where they yield loss prevention co-benefits; 5. Invest in strategic R&D and rebalance investment portfolios to recognize climate-related risks to investments and capitalize on climate change solutions; 6. Actively participate in carbon markets, both as an investor and risk manager; 7. Lead by example in minimizing the insurer’s own “carbon footprint.” This includes minimizing the climate impacts of real estate owned by the insurer, as well as the “carbon footprint” of business operations. Analyze and disclose exposures to climate change; 8. Take an active role in the education of customers about climate-related risks and opportunities for minimizing them; 9. Actively engage in public policy discussions about appropriate responses to climate change; and 10. Tighten terms and conditions, withdraw from markets, or increase insurance prices only when the aforementioned best practices have first been exercised to their full cost-effective potential. caused by other actors, legal systems that inad- nascent and uncertain stage of development equately enforce contracts, and regulation of (e.g., off-grid lighting products being promoted pricing that doesn’t reflect both true risk levels by the World Bank’s Lighting Africa program and affordability. Only through public-private and UNEP’s en.lighten program). collaborations can this process be optimized. Insurers can clearly offer a spectrum of green innovations relevant to inclusive green Intra-Industry Transfer of Best growth. However, there is no market without Practices buyers. Major users of insurance in associa- tion with green growth infrastructure projects There is considerable scope for insurers can use “market-pull” techniques to foster in- from more advanced markets to engage in troduction and speed the scale-up of green in- relevant technology  transfer and capacity surance products in developing countries. They building. can also mandate or otherwise incentivize best Insurers have organized within several practices in terms of resilience in the projects global initiatives to develop and share in- they fund. Similarly, public-sector deployment formation within their industry and with the programs may find use for insurance products broader market and policy community (under such as agricultural micro-insurance coupled ClimateWise, the Geneva Association, and with enhanced resilience or product warran- UNEP) (Mills 2012a). Participation in these ini- ties (backed by insurers) for emerging technol- tiatives by insurers domiciled in developing ogies where private market offerings are in a countries could be improved. 28 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Enhanced Availability and risks uninsurable. This has wide precedent in Affordability of Insurance the industrialized world, e.g., for nuclear power, terrorism, flood, and crop risks. While these in- Economic growth cannot fully manifest without terventions are often couched in the terms of insurance or analogous risk transfer and risk insurance, they are in practice not always based management mechanisms. Third parties provid- on strict insurance/actuarial principals. ing upstream corporate finance to newer and smaller insurance market entrants could use- fully focus on those companies.7 Conversely, Improved Hazard Detection, investor assessments of candidates should Characterization, and Models benchmark the subject firm’s positioning to contribute to green growth as well as its vul- Baseline data on catastrophe loss costs nerabilities to climate change and other conse- are lacking even in developed countries quences of environmental degradation. (Pendleton et al., 2013). Insurers play a crit- For inclusive green growth, consumers and ical role in collecting and analyzing such in- microenterprises at the lower end of the eco- formation, and improvements are particularly nomic spectrum must be served. An already needed in the developing world. widespread market of micro-insurance, predi- Insurers are already bringing “risk-de- cated on inclusive principals, has the potential for tection” technology (e.g., via remote sensing) $40 billion per year in premiums (Swiss Re 2010). into developing countries for the purposes of On the one hand, risk-based pricing is identifying triggers for paying micro-insurance essential in order to compel rational deci- claims to farmers. sion-making, minimize mal-adaptation and In one example of areas where best prac- risk-taking, and maximize the adoption of loss tices could be more widely disseminated, in- prevention techniques. Premiums that are sub- surers have worked for decades to develop sidized, or cross-subsidized (e.g., diverse risks data and loss models to help pinpoint and pooled into an “average price” situation, distort manage risks. While these models are relatively market signals. On the other hand, a rush to- well established in industrialized countries, ward risk-based pricing, particularly under cli- they are often non-existent or very primitive in mate change and with insufficient attention to developing countries (Hall 2013). Data incom- enhanced resilience, could create a palpable pleteness and bias are also of particular con- crisis of insurance affordability. Interested in- cern in developing country settings (Corona termediaries, such as development agencies, 2013). Closing this gap can mitigate informa- may look for ways to buy down insured costs tional market failures, making uninsurable risks such as premiums or deductibles. This sort of insurable, while helping manage pricing, which financial support could even be directed at the will inevitably be higher where risks are not incremental costs of green insurance. well characterized. Recently, these have been To accelerate the introduction of green in- adapted to understanding emerging risks asso- surance in emerging markets, public entities ciated with climate change. and offshore investors could lead by example. Engagement of the allied industry of ca- This would take the form of voluntary purchase tastrophe (“Cat”) modelers is essential. These of green insurance for the projects they finance or otherwise oversee. 7 An example is LeapFrog Investments, which pro- Public entities may also opt to provide in- vides venture capital for microinsurance compa- surance where the private market deems the nies. http://www.leapfroginvest.com. Pinpointing Opportunities 29 Demonstrated insurance strategies for managing risks associated with inclusive green growth projects TABLE 2:   Sectors & activities Risks potentially mitigated Demonstrated strategies for insurer engagement Infrastructure Residential and non-residential built Physical damages and losses  Conventional insurance infrastructure  Micro-insurance for poorer segments Commercial and industrial infrastructure Physical damages and losses  Conventional insurance  Micro-insurance for poorer segments Losses arising from supply chain issues and other triggers of business interruptions Transportation Urban air pollution, conjestion  Conventional vehicle insurance Water Availability; quality  Risk-management re: role of water in business continuity and health Food security Drought, pestilence, loss of soil carbon  Conventional crop insurance (public or private)  Microinsurance for poorer farmers  Risk-management assessments and risk-mapping services Forestry Wildfire  Standing timber insurance products Public health Infectious diseases, consequences of eroded water  Health insurance quality, air pollution  Health micro-insurance for lowest-income groups Energy Renewable Generation Shortfall in performance and associated revenues  Output efficacy insurance  Technology warranty enhancement products  Engineered risk-management services for proper design, con- struction, and operation Residential, commercial,  Betterment clauses (upgrade-to-green following loss) industrial energy end-use efficiency  Energy savings efficacy insurance  Technology warranty enhancement products  Engineered risk-management services for proper design, con- struction, and operation Transportation  Differentiated insurance premiums for low-emission vehicles  Mileage-based premiums for all vehicle types  Public policy interventions for speed limits, public transporta- tion, etc Disaster preparedness, recovery, resilience Coastal protection Storm surge, gradual erosion, salt water intrusion  Ecosystem-enhancement projects (e.g. mangrove reforestation)  Conventional property insurance  Microinsurance for lowest-income consumers and businesses  Risk-differentiated premiums to discourage maladaptation or other tendencies to develop in harm’s way Buildings Natural disaster damages  • Differential insurance premiums, services, guidelines for resilience  Advocacy for improved building codes  Business continuity and supply chain risk assessment and risk services  Betterment endorsements to ensure post-event reconstruction to higher level of “green” and loss-resilience Food and food security Crop damages  Risk-mitigation services Modeling Inadequacy of present models to inform essential  Best-in-class loss models. Improved models allow for insurance planning decisions underwriting, enhancing insurance availability and optimal pricing (continued on next page) 30 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH (continued) Demonstrated insurance strategies for managing risks associated with inclusive green growth projects TABLE 2:   Sectors & activities Risks potentially mitigated Demonstrated strategies for insurer engagement Commerce and financial services Employment Underemployment  Insurers are a major employer  Growth of insurance and allied industries creates a variety of job types (agents, brokers, inspectors, underwriters, financial special- ists, regulators) Investment Inadequate capital  Insurer investment in green-growth-related projects Finance Inadequate financing  Insurer financing in green-growth-related projects Emissions reductions Loss of persistence (eroded energy savings, forest  Performance-based insurance products destruction, etc.)  Insurer-provided risk management services for inventorying and maintaining carbon-reduction projects Political risk Expropriation of green technology assets or prop-  Political-risk insurance products erty constituting the basis of carbon credits owned/ financed by foreign entities models also enable insurers to make pricing (witness the current protracted global econom- more risk-based, thereby encouraging and re- ic crisis), insurers have also counted climate warding resiliency in planning. Models should change among the systemic risks. also capture instances in which resilience and The ability for insurance markets to func- green growth work synergistically. Disparate ef- tion is contingent on the presence and enforce- forts have been made to incorporate sustain- ment of contract law, control of corruption, and ability considerations, such as those associated other factors. with climate change, into insurance models Direct regulation of insurance plays a key (Mills 2007; Mills 2009). role, both in underwriting practices and in asset Access to detailed, reliable data on ex- management. Ideally, regulators and rating posures underpins the entry of insurers in a agencies will not stifle innovations that will con- market, and their ability to maintain availability tribute to inclusive green growth, but, rather, and affordability. Insurers and non-insurer will support it (Mills 2007). Innovative prod- stakeholders can each play a role in collecting ucts and services must be given careful consid- and mobilizing this information. eration by regulators and not dismissed out of hand. The “Solvency II” regulations (anticipated to go into force 1 January 2014) will likely call Responsive Policy and Regulatory for greater capital reserves than at present for Environments riskier and/or unlisted investments. Since the perception of systemic risks drives such regu- The policy and regulatory environments clear- lations and concern by parties such as the G20, ly shape insurers’ ability to engage in busi- it is critical that assessments of insurers’ vul- ness generally, and green growth in particular. nerability—as individual companies, and as an Regulators are often in the position of ap- industry—incorporate considerations of their proving new insurance products and services. exposure to climate risks, together with steps Insurance think tanks recognize “systemic risks” taken to reduce those risks. as being of particular concern, and advocate Regulated insurance premiums are also a policy interventions (Geneva Association 2013). concern. As previously noted, if insurers per- While normally viewed as financial in nature ceive that prices inadequately reflect risks, they Pinpointing Opportunities 31 will shy away from markets. This is of course a Insurance Program (as had Hurricane Katrina material concern under climate change, given just a few years before), public insurers took that insurance rate-setting is often based on the politically unpopular step of making historic losses as opposed to projections of terms more risk-based. This included require- future losses. The broader energy and devel- ments that homes in at-risk areas be raised, opment policy environments can enhance or or face steeply increasing insurance rates detract from insurer engagement; the latter (ClimateWire 2013). case can apply, for example, where there is no Public insurance entities (particularly price on carbon or other forms of uncertainty common in the case of crop and flood risks) can or risk of policy reversals. Thus, agents of inclu- fruitfully engage with leading green insurers sive green growth may find it prudent to engage in an effort to transfer best practices from with insurance regulators. the private to public spheres. The Caribbean Catastrophe Risk Insurance Facility is an ex- ample of government-operated mechanism cre- Maximizing the Value of Public ated in close cooperation with private insurers. Insurance Systems In the developing and industrialized worlds Public-Private Partnerships alike, the public sector often finds itself in the role of insurer, sometimes on its own in Many risks are beyond the control of insur- the case of risks deemed commercially unin- ers. Subsidized disaster insurance, coupled surable, or as a backstop insurer of last resort with disaster relief for those opting out of where the private market is not willing to as- the commercial insurance system (or commer- sume the full extent of a risk. In either case, cial insurers exiting markets), is a widely not- the aforementioned green insurance concepts ed example. Properly conceived, this type of fully apply. Private insurance thought lead- risk sharing is of benefit to all parties. ers could be engaged to help transfer their Insurers are particularly wary, however, methodologies to public insurers in develop- when governments support policies that lead ing countries. This is needed, even in the in- to maladaptation and moral hazard. Distortions dustrialized world, as pointed out recently by created by insurance taxes have been noted to a U.S. Congressman , Rep. Matt Cartwright create barriers to climate change adaptation (Lehmann 2013): in Australia (Productivity Commission 2012). Similarly, policy uncertainty (e.g., lack of re- “…[L]ook, our country is acting as an in- solve on electricity feed-in tariffs) creates ma- surance company,” … “We have flood terial financial risk for insurers or other private insurance. We have FEMA bailing out investors contemplating engagement in renew- natural disasters constantly. And ... ev- able energy projects. Policymakers must make ery insurance company in business en- a place at the table where matters potentially gages in actuarial science [and] makes adversely affecting insurers are discussed. an assessment of what its potential li- It will increasingly be prudent for private abilities are. We don’t do that. That’s entities, e.g., real-estate developers to proac- crazy.” tively engage with insurers in order to under- stand trends that may erode the value and/or After Hurricane Sandy threatened the un- insurability of their projects (Herweijer et al., derlying solvency of the U.S. National Flood 2008). 32 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH In many cases, collaboration of private micro-insurance offerings that merely spread insurers, other private concerns, and public risk to include an explicit physical adaptation entities will thus be essential to success of in- component. Incentives could include better clusive green growth projects. In the words of terms and conditions where there is a simulta- the Geneva Association, an insurance industry neous effort at adaptation, affecting improved think tank: practices as a condition of claims payment, or limiting product availability to circumstances “With regard to climate risk and pro- where there is associated adaptation effort. viding greater resilience against natu- Insurers have demonstrated their concern ral disasters, improved private-public about global climate change, and their desire cooperation could truly harness the in- to mobilize market-based strategies to under- surance industry’s usefulness as a risk stand and mitigate those risks. Virtually all management tool in better preparing for green growth projects could benefit from the and responding to mega-events, there- risk assessment and risk management perspec- by mitigating the resulting human, social tive that insurers bring. The World Bank, for ex- and economic loss.” (Grant 2012) ample, has long recognized that climate change can present new risks to infrastructure invest- A key precedent is insurer engagement in ments (Burton and van Aalst 1999). Where the establishment or improvement of building there are losses due to climate and weather ex- codes and land-use planning decisions. tremes, insurers paying those claims can pro- mote betterment at the time of reconstruction *** so as to enhance both ‘greenness’ and disaster resilience—true sustainability. Engagement may The potentially holistic breadth of insurer also take the form of lobbying for improved engagement is consistent with urgings by the building codes or land-use planning. African Development Bank and others to ap- While insurers’ outward-facing role is to proach inclusive green growth in a cross-sector, manage risks for their customers, they must integrated manner rather than a piecemeal also do so internally. Developing markets are project-by-project fashion (AfDB 2012). Best- the most risky markets in which they operate: practice insurer involvement could reinforce physically and politically. Public sector entities the proper valuation of otherwise unrecognized and organizations seeking insurer engagement constructive linkages among diverse develop- can take steps to mitigate these risks. ment projects. For example, the value added If barriers to constructive engagement by forestry projects that improve soil manage- by insurers can be alleviated and opportuni- ment and erosion control could be reflected in ties grasped, green growth will yield more and reduced premiums at risk of flooding and mud- better infrastructure, translating to more pre- slides. Similarly, value added to public health mium volume for insurers. 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May 20. and Accenture, 40pp. 37 Appendices Appendix  I:   Statistical  Overview  of  Insurance  in  Emerging  Markets  (top:  Life;  bottom:   Appendix   Property/Casualty).   I:   (Swiss   Re  2013)   APPENDIX I:  Statistical Overview   of Statistical   Insurance Overview     in Emerging Markets (top: Life; bottom: Property/Casualty). of  Insurance   in  Emerging  Markets  (top:  Life;  bottom:   Property/Casualty).  (Swiss  Re  2013)   (Swiss Re 2013)     Source: Swiss Re Economic Research & Consulting. Draft  –  v5   46   Source: Swiss Re Economic Research & Consulting. Draft  –  v5   46   (continued on next page) 37 38 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH   APPENDIX I:    Statistical Overview of Insurance in Emerging Markets (top: Life; bottom: Property/Casualty). (Swiss Re 2013) (continued) Source: Swiss Re Economic Research & Consulting. Source: Swiss Re Economic Research & Consulting. (continued on next page) Draft   Draft   –   –  v v5   5   47   47   Appendices 39 APPENDIX I:  Statistical Overview of Insurance in Emerging Markets (top: Life; bottom: Property/Casualty). (Swiss Re 2013) (continued)     (continued on next page) Draft  –  v5   48   40 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH APPENDIX I:  Statistical Overview of Insurance in Emerging Markets (top: Life; bottom: Property/Casualty). (Swiss Re 2013) (continued)     Source: Swiss Re Economic Research & Consulting. Draft  –  v5   49   Appendices 41 Appendix II: Alternative Risk Transfer risk. Issuing the preferred stock can dilute the (ART) Strategies and Definitions value of the firm’s existing shares. Captive Insurance — Captive insurance com- Catastrophe Risk Swaps — Catastrophe panies are formed by firms to receive premi- swaps can be executed between two firms ums internally and thereby prefund potential with exposure to different types of cata- losses. The practice is often referred to a strophic risk. Swaps are facilitated by the self-insurance. Catastrophic Risk Exchange (CATEX), a Web-based exchange where insurers and re- Catastrophe Bonds — Typically sold by insur- insurers can arrange reinsurance contracts ers to investors, “Cat bonds” are a class of and swap transactions, and is used by the insurance-inked security. If the underwritten Caribbean Catastrophe Reinsurance Facility. catastrophe event (life or property) occurs, If the paired events have equal risk, funds the investor loses its principal, which shifts to only change hands in the event of a trigger- the issuing insurer or reinsurer and used to ing event. pay claims. If no event occurs, an attractive rate of return is earned. Contracts and trig- Contingent Surplus Notes — Insurers typically ger definitions can be complex, and can apply have difficulty borrowing money to cover ex- to single events or any events occurring over cess claims in the event of a disaster. With a a period of time (e.g., one year). CSN, an insurer establishes a trust which is- sues notes paying a premium yield (y) to a lim- Catastrophe Equity Put Options — Insurers ited group of investors. To pay the interest, sell these options on the financial markets, the CSN trust invests the proceeds in stable, which enable them to sell their stock at an fixed income securities earning a lower yield agreed upon price in the event of a catastro- (x) while the insurer makes up the difference phe. Proceeds reduce the need to liquidate (y-x). If an agreed upon disaster strikes, the assets at “fire-sale” prices to pay claims. insurer can claim the trust assets and is then responsible for paying the entire interest (y) Catastrophe Options — Options exchanges and principal, over an agreed upon period of sell options which compensate insurers if ag- time. The premium interest rate (y) is nota- gregate industry losses for a given region fall bly lower than what an insurer could get from within an agreed upon range. borrowers following a disaster. Catastrophe Risk Equity Puts — Cat-E-Puts Extreme Mortality Securitization — Transfers are not asset-backed securities, but options. “peak mortality risks” to capital markets, anal- In return for a premium paid to the writer of ogous to CAT bonds for property losses in the option, the insurer obtains the option to the event of extreme mortality events. issue preferred stock at a pre-agreed price on the occurrence of a contingent event. This en- Industry Loss Warranties — A form of rein- ables the insurer to raise equity capital at a surance or derivative contract through which favorable price after a catastrophe, when its an entity (often an insurer) receives a capped stock price is likely to be depressed. Because payout based on the aggregate insured loss they are not collateralized, these securities ex- experienced by the industry rather than its pose the insurer to counterparty performance own losses from a specified event. 42 INSURERS AS PARTNERS IN INCLUSIVE GREEN GROWTH Sidecars — Sidecars are special-purpose vehi- Weather Derivatives — A put- or call-hedge cles (off-balance-sheet, with extra premiums) for adverse weather, in the context of risks formed by insurance and reinsurance compa- such as those associated with event cancel- nies, usually for property catastrophes and lation, energy production or costs, or crop marine risks. Most sidecars are capitalized by yields. They are activated when a pre-negoti- private investors such as hedge funds. In ad- ated trigger is reached, such as a level of de- dition to providing capacity, sidecars also en- gree days, temperature, and rainfall. Enron able the sponsoring reinsurer to move some was among the early popularizers of weath- of its risks off-balance-sheet, thus improving er derivatives. leverage. Note: This list is indicative of an even broader ar- ray of related products. Value-in-Force Securitization — Monetizing Sources: Boucher (2009), Cumins (2012), Mills, et the estimated future profits of a portfolio of al., (2001), RMS (2012), and http://www.artemis.bm/ insurance policies. deal_directory/ Appendices 43 APPENDIX III:  Trends in Global Natural Catastrophe Events, by Income Group "*<=:*4,*<*;<:781.;26-2//.:.6<4A     -.>.478.-.,76752.; 4*;;2/2,*<2767/<1.?7:4-.,76752.;-./26.-+A?7:4-+*63 "7-*<* %7=:,.)7:4-*637=6<:A4*;;2/2,*<276 20126,75.,7=6<:2.; '88.:52--4.26,75.,7=6<:2.; 7?.:52--4.26,75.,7=6<:2.; 7?26,75.,7=6<:2.; "'%  8.:,*82<* "'%   8.:,*82<* "'% 8.:,*82<* "'%8.:,*82<* '8<7  .>.6<;+.260:.02;<.:.-047+*44A.>.:AA.*:<1.:.*:.67.@,.8<276;<7<12;:=4. =<2<2;<1. 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The premiums for hybrid vehicles or green build- terms of the associated agreements are char- ings). Includes new products that fill coverage acterized by a commitment to addressing gaps, e.g., microinsurance for weather-related climate change that stretches across the in- hazards in developing countries. surance enterprise, from products to invest- ment to corporate governance. Participating Providing technical services: Defined by companies are listed in table S1. Participation engineering or financial services offered to signals a systematic (rather than piecemeal) customers to identify and manage risks associ- approach, coupled with a willingness to ated with climate change responses or other- make that commitment public. In the case of wise assist in the implementation of improved ClimateWise, participants also agree to annu- practices. Examples include energy audits, al reporting and independent audits of com- carbon footprint accounting, and adaptation pliance. cost benefit assessments. Engaging in climate science and commu- Offering carbon risk management or off- nications: Defined by the funding or con- sets: Defined by products that assist cus- duct of research on climate change, and the tomers in managing risks associated with presentation of climate science to stake- carbon-reducing projects, including risks of as- holders. Includes analyses of historical data, sociated financial transactions such as carbon forward-looking modeling, field-based re- trading. In some cases, insurers couple emis- search, and integrated assessments. sion offsets with their core products, e.g., ve- hicle emissions offsets with auto insurance. Promoting loss prevention and adaptation: Defined by customer-focused activities or in- Financing customer projects: Defined by in- ducements to advance the state of the art surers offering debt financing to customers or in weather—and climate-related disaster resil- other entities for climate change mitigation or ience generally, and climate change adapta- adaptation projects. tion in particular. Investing in climate change mitigation: Aligning terms and conditions with risk-re- Defined by direct investment in climate change ducing behavior: Defined by activities that si- mitigation projects, e.g., an equity stake in a multaneously reduce the risk of insured losses wind power development or a company man- while contributing to climate change mitiga- ufacturing an energy-efficient technology. Also tion. A prominent example is mileage-based includes investments in funds by using selec- insurance, which provides discounted premi- tive environmental screening processes that ums for reduced driving to lower the probabil- incorporate climate change factors. In some ity of roadway accidents as well as emissions cases, insurers are disinvesting in companies of greenhouse gases from vehicles. with risky environmental practices. Appendices 45 Building awareness and participating in pub- reduce the carbon footprint of insurers’ in- lic policy: Defined by specific activities to im- ternal operations (buildings, business travel, prove understanding of climate change among computing, and supply chains). For inclusion, a policy-makers. Examples include participation threshold level of activity is required, beyond in climate change negotiations, engagement in highly routine activities such as “using ener- efforts to reform land-use planning to proac- gy-efficient light bulbs.” tively anticipate sea level rise, or promotion of building codes that improve disaster resilience Disclosing climate risks: Defined by re- or energy efficiency. sponding to climate risk disclosure requests from the CDP, F& Investments, or the U.S. Leading by example: In-house carbon man- Securities and Exchange Commission (SEC). agement: Defined by specific activities to Contact Information Climate Business Department International Finance Corporation 2121 Pennsylvania Ave., NW Washington, DC 20433 www.ifc.org/climatebusiness