Are You Covered?
In Part II, I argue that AXA is ahead of the three of the top ten American insurers who put out a detailed climate report (Chubb, Liberty and Travelers) in internalizing climate risk as a strategic priority while underwriting risks and assuming liabilities on its balance sheet.
Has the insurer articulated a climate strategy?
AXA states that its business strategy is intimately tied to climate goals. AXA’s change strategy rests on three pillars reflecting its role as an insurer, an investor, and an exemplary company. As an insurer, AXA wants to increase premiums on green insurance products to $1.3 billion in 2023 and to increase the number of customers covered by inclusive protection to 12 million by 2023, where inclusive protection refers to identifying and catering to especially underserved target groups. As an investor, they want to cut carbon footprint on general accounts by 20% by the year 2025 and to reach $26 billion in green investments in 2023. For the uninitiated, “general accounts” refers to funds the insurer deposits premiums from policies it underwrites and finances day-to-day operations of the business without dedicating collateral to the potential liability that might stem from a specific insurance policy.
AXA claims it wants to be an exemplary company in that they want to achieve carbon neutrality in their operations and to reduce their direct environmental footprint by 2025 and to make employees leaders in climate issues. AXA’s green insurance products cover one of four objectives: (i) climate change mitigation; (ii) climate change adaptation; (iii) transition to a circular economy; and (iv) limitation of biodiversity loss and pollution. Note the disclosure of quantified KPIs linked to climate goals. The U.S. counterparts are regrettably not that forthcoming.
In its first TCFD report (24 pages), Chubb’s climate strategy hinges on five promises: (i) achieve carbon neutrality in its own global operations (Scope 1 and Scope 2 emissions) by year-end 2022; (ii) develop and offer new insurance solutions for low–and zero-emission technologies; (iii) seek to encourage the transition through its decisions on specific underwriting and investment risks; (iv) assess coverage of carbon–intensive industries and their related strategies and plans for transitioning to a lower–carbon economy; and (v) adopted the TCFD framework. Chubb covers many of the standard points, but I do not see many numerical estimates to back up or quantify their statements, except perhaps for GHG emissions and for catastrophe losses discussed later.
Liberty’s strategy is predicated on (i) investing in education, expertise and capacity building; (ii) integrating climate-related risk management services and product offerings into their core business; (iii) advancing the energy transition; (iv) helping customers build resilience for climate-related risks through innovation and (v) advocating for climate resilience and adaptation. Liberty’s 2021 TCFD report, at 31 pages, is not as granular as AXA’s. Steps to map strategy into concrete measurable goals of the kind articulated by AXA are qualitatively discussed in Liberty’s report but specifics, especially numbers, are usually missing. Their report is relatively heavier on general macro policy discussions on climate risk.
Traveler’s 30-page 2021 TCFD report states that its strategy rests on four pillars: (i) supporting transition to a lower carbon economy; (ii) mitigating exposure to climate risk; (iii) building resilient communities and public policy advocacy and (iv) education and awareness. Under the first two categories, notable advances appear to be detailed modeling of incremental climate impacts on the range of potential average annual loss (AAL) and 100-year return period for the two emission scenarios (RCP 4.5 and RCP 6.0) at three snapshots in time (2030, 2050 and 2100). RCPs or “representative concentration pathways” represent standardized climate risk scenarios.
These scenarios are based on set of assumptions related to how much warming might happen, via higher greenhouse gases and what that warming might mean for various industries such as agriculture, the energy industry, and the downstream impacts of such changes on social and economic factors such as migration, population and GDP growth. RCP 4.5 assumes that “radiative forcing” stabilizes at 4.5 Watts per meter squared in the year 2100 without ever exceeding that value. Radiative forcing is what happens when the amount of energy that enters the Earth's atmosphere is different from the amount of energy that leaves it. Obviously, RCP 4.5 is a better or a more optimistic scenario than RCP 6.0. Travelers states that the hits appear relatively modest as the 50th percentile impact in annual average loss is an increase of 5% by 2030 under RCP 6.0 and 30% by 2100.
Travelers also highlights its global renewable expertise by tailoring insurance solutions that cover the entire life span of renewable energy businesses that invest in, develop, operate and maintain commercial and utility-scale operations – from research and development and manufacturing to permanent operations, as well as onshore and offshore wind, solar and biopower operations. They say that over the past three years, their Global Renewable Energy Practice grew at a compound annual growth rate of 30%, with revenue up over 120% since 2018. I could not find the exact revenue number to check whether this reflects a large growth percentage on a small base. Travelers has committed to carbon neutrality in their own operations by 2030.
How is climate risk factored into managing risk exposure of insured assets?
The detailed thinking underlying risk management at AXA is worth appreciating. In particular, AXA undergoes climate stress tests, which is an analytical process initiated by the Banque de France and ACPR to cover physical and transition risks. These tests stress the insurer’s balance sheet and P&L using forward looking calibration over several long-term horizons until 2050. This exercise helps AXA better appreciate its P&C physical risks and cover the drivers of natural catastrophe (NatCat) risks such as changes in hazard (the severity and frequency of events), exposure (the monetary value of exposed assets) and vulnerability (the susceptibility of the asset to a given hazard). AXA concludes that the biggest driver of losses in the last 10 years is due to exposure.
Liberty states that it has conducted climate stress tests on major hurricane frequency in their U.S. hurricane portfolio but stops short of sharing numerical ranges or estimates of such losses. Liberty discusses the importance of wildfire risks, water hazard and sea level rise in generic terms without numerical data. Travelers and Chubb, to their credit, disclose the exact dollar numbers of losses due to catastrophic events.
Quantifying liabilities from climate catastrophes
Travelers estimates that there is a one percent chance that the Company’s loss from a single U.S. and Canadian hurricane in a one-year timeframe would equal or exceed $2.0 billion, or 8% of the Company’s common equity as of December 31, 2021. Travelers clearly discloses the losses from catastrophes. It states that such losses (post tax) have increased from $699 million in 2019 to $1.45 billion. The pre-tax numbers are $886 million and $1.847 billion, respectively. As an aside, the taxpayer has already subsidized some of these catastrophic losses via lower corporate income tax collections. Earned ceded premiums for reinsurance given up to reinsurers have increased from $1.79 billion in 2019 to $2.15 billion in 2021.
In 2020 Chubb disclosed net pre–tax catastrophe losses of $1.7 billion but those losses in 2020 “were within our risk tolerance.” I could not find such clear disclosure on catastrophe losses in AXA and Liberty’s climate reports.
Reliance on reinsurance, catastrophe bonds and diversification
Travelers flags increased reliance on reinsurance and Cat bonds. For instance, it states, “Travelers also utilizes catastrophe bonds to protect against certain weather-related losses in the Northeastern United States.” For the uninitiated, Cat bonds securitize risks of specific disasters to investors. In return, they pay higher interest rates and diversify an investor's portfolio if the natural disaster covered is not correlated with other economic risk. Depending on how a cat bond is structured, if losses reach the threshold specified in the bond offering, the investor may lose all or part of the principal or interest.
I found at least one paper that argues that cat bonds themselves underprice climate risks. Travelers goes on to argue that reliance on insurance related to worker compensation and liability, fidelity surety, cyber, management liability, and professional liability diversify potential losses from climate risk. The other insurance companies do not seem make similar arguments to manage climate risk. The other insurance companies do not seem to emphasize reinsurance, cat bonds and diversification as much as Travelers.
What are their self-imposed restrictions on their underwriting business?
The point to appreciate here is that an insurance business cannot blindly replicate the investment business (which I discuss in Part III) case for climate action. As AXA’s report says, “in a way, “stranded assets” does not apply well to underwriting.” AXA appears to have resolved this dilemma by working on the “longer-term, more indirect business case,” and by injecting “a healthy dose of vision, convictions and values.” For instance, coal plants are profitable to underwrite because they have a long claims history relative to offshore windfarms. Having said that, AXA and the three American insurers have quit the business of underwriting coal heavy exposures.
In particular, AXA does not underwrite insurance business in coal mines, a few partners of the coal industry (such as railways on a case-by-case basis), and oil and gas extraction business in the Artic. AXA also announced that it will no longer directly invest in companies deriving more than 30% of their production from fracking/shale oil and gas. AXA states it will cease underwriting new upstream oil greenfield exploration projects unless they are carried out by companies with the most far reaching and credible transition plans. AXA’s commercial lines insurance business restricts policy writing for businesses involved in illegal logging, companies involved in severe deforestation controversies, and traders of soy, beef, palm oil, and timber operating in high-risk countries.
Chubb goes on to claim that their “underwriting in this business restricts participation in certain industries, including mining and reclamation operations, oil refining, pipeline and related distribution operations, and chemical manufacturing and distribution.” No numbers are shared in the report. Chubb also states it “no longer underwrites the construction and operation of new coal–fired plants or new risks for companies that generate more than 30% of their revenues from coal mining or energy production from coal.”
Liberty’s underwriting policy states that they will no longer accept underwriting risk for companies where more than 25% of their exposure arises from the extraction and/or production of energy from thermal coal. Travelers states, “our direct exposure to thermal coal and tar sands is de minimis; simply put, these businesses are not attractive to us from a risk/return standpoint.”
How does the insurer deal with the relative lack of interest among retail clients for climate friendly insurance?
AXA’s report laments, “few retail clients knock on our doors asking for climate-friendly or sustainable insurance or savings products. For the time being, most do not make that connection. Low demand creates low incentives to create such offers, and more generally hampers sustainable finance in the longer run. Here too there is an element of conviction.” The other insurers do not appear to discuss retail attitudes towards climate risks.
How is the insurer responding to the need for adaptation?
Adaptation is the process of adjustment to actual or expected climate and its effects in order to moderate harm or take advantage of beneficial opportunities. Most of an insurer’s key activities relate to effective adaptation mechanisms: disaster risk management, climate services including early warning systems, social safety nets and risk spreading and sharing, for example. AXA has monetized its knowledge of adaptation responses into a risk consulting business. The other insurers are relatively silent about adaptation responses.
How does the insurer resolve tradeoffs between the E, S and G?
“Is a large dam flooding a valley and destroying biodiversity but producing decades of low-carbon energy a good thing?” AXA appears to defer that decision to a standard setting body such as the TNFD (Taskforce on Nature-Related Financial Disclosures). The other insurers do not discuss how they resolve such difficult tradeoffs.
Does the insurer consider biodiversity risks?
In 2021, AXA published for the first time an analysis of the impacts of its investments and operations on biodiversity, in line with French “Article 29,”and the Beta version of the Taskforce on Nature-related Financial Disclosures (TNFD). The other insurers do not refer to biodiversity in their reports.
Promotion of climate friendly insurance settlements
AXA states that it promotes the re-use “circular economy” through their claim settlements, for instance by helping customers rebuild more sustainably or repair their vehicles with recycled parts. Since 2015, AXA France customers have bought approximately 5 million citizen insurance contracts based on such an approach. I saw some references to the other insurers encouraging prevention or mitigation of risks in assets they insure but no reference to circular economy initiatives.
In sum, AXA is ahead of the American insurers in internalizing the management of climate risk as a strategic priority while underwriting risks and assuming liabilities on its balance sheet. In Part III, I look at how these four companies manage the climate risk embedded in the assets side or investments part of their balance sheets.
