COP23: warming warning to banks, insurers

It’s a question increasingly on the minds of investors and one recently addressed by a report “Climate Risk Disclosure – financial institutions feel the heat” for the Actuaries Institute.

" The rapid growth in renewables and battery technology are significant climate-related opportunities for banks, insurers and investors" - Sharanjit Paddam

The world’s largest sovereign wealth fund in Norway has already announced divestment from companies with coal-related activities. It recently added it’s considering divesting from oil and gas.

BlackRock, the world’s largest fund manager, is threatening to vote out directors who fail to address threats posed by climate change. Aviva Investors has said it will vote against reports and accounts of companies that do not disclose their climate risk.

Risks are clear

The economic risks are clear. Banks and insurers which continue to do business with significant fossil-fuel activities face similar risks of increasing defaults and reduced business.

Conversely, the rapid growth in renewables and battery technology are significant climate-related opportunities for banks, insurers and investors. The question is are they taking advantage of that?.

Without immediate and drastic emissions reduction, the future will bring increased weather related disasters, including cyclones, coastal erosion, storms and floods, bushfires and drought. At a 2˚C global mean temperature rise we are likely to see the end of the Great Barrier Reef and the significant amount of tourism it generates.

A recent Deloitte Access Economics report commissioned by the Australian Business Roundtable for Disaster Resilience & Safer Communities estimates the total average annual economic cost of natural disasters will rise from $A19 billion today to $A39 billion by 2050, without any allowance for increases due to climate change.

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Insurance companies generally only look at risks over a 12-month period and climate change is unlikely to have an impact over such a short timescale.

Insurers have the flexibility to increase their premiums each year. But premiums will soon become unaffordable for the large parts of Australia exposed to natural disasters. 

Ultimately, without rapid and immediate mitigation of carbon emissions, as well as adaptation and resilience building, exposed areas will become uninsurable.

That then is a significant reputational risk for insurers. In addition they may also face government intervention within their markets, such as the ACCC review of premiums in Northern Australia currently under way.

Insurers will face a contraction in their market over the same timescales as driverless cars, which is predicted to significantly reduce demand for motor insurance.

Equally tough

Banks may think they are protected from such physical losses by the building insurance they require their home loan customers to purchase. However, most do not routinely check if customers continue to purchase insurance, or indeed check whether the insurers cover flood or ‘actions of the sea’ as in Collaroy, NSW in 2016.

Exposed customers forced to pay rising insurance premiums may end up in financial distress and become unable to pay off their home loan. That’s a credit risk for the bank and not a risk for the insurer.

Actions of the sea – including coastal inundation not caused by cyclones or storms – are excluded by insurers in Australia and flood insurance is generally not required by the bank.

We only need to look at Collaroy to see the damage actions of the sea can inflict on our homes. Banks are already exposed to climate risk through their 30 year home loans.

Customers also have yet to realise the gap in their cover. This poses another reputational headache for both insurers and banks.

For a country with banks having some of the highest concentrations of residential lending assets in the developed world, and an economy deeply dependent on fossil fuels, exposure to climate risk could be the biggest threat to economic security.

Australian boards have also been warned by leading barrister Noel Hutley SC, who said “company directors who fail to consider climate change risks now, could be found liable for breaching their duty of care and diligence in the future”.

In 2017, the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures recommended an international cross-industry standard for disclosing climate risk in the financial reporting of companies.

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Climate disclosure is no longer just about carbon emissions – it’s now about the financial impact of climate risks and enabling investors to make wise choices about how they allocate capital.

Financial institutions that fail to adequately disclose their risks and how they will manage them will be likely to face adverse responses from investors.

Conversely, those that seize the opportunity to deliver innovative products for their customers and deploy effective strategies to anticipate and manage their risks, stand to gain a competitive advantage.

Sharanjit Paddam is Principal, Deloitte Actuaries & Consultants and Convener of the Climate Change Working Group of the Actuaries Institute