How ESG risks are increasingly affecting insurers’ credit profiles
Evolving regulations, climate change and shifting demographics are becoming increasingly important to insurers and their credit ratings.
Insurers may insure the world’s risks, but that doesn’t mean they are risk-free themselves. Environmental, social and governance risks, collectively known as ESG, are becoming increasingly important to insurers, insurance regulators, investors and consumers.
A recent report from Moody’s, “Insurance – Global: The Impact of Environmental, Social and Governance Risks on Insurance Ratings,” explores how these related risks are affecting insurance ratings.
ESG risks are becoming more significant
“ESG risks have become more significant for insurers in recent years due to evolving regulations and policy measures, climate change and shifting demographics,” Brandan Holmes, vice president and senior credit officer at Moody’s, said in a news release. “Climate change in particular gives rise to greater uncertainty for insurers, both with respect to expectations for frequency and severity of natural catastrophes, and exposure to carbon transition risk through their investment portfolios and the possibility of stranded assets.”
From climate change-driven weather events to governance issues that can lead to fines or reputational damage, ESG risks can seriously affect insurers’ ability to meet their financial obligations, thus impacting credit strength, with each risk affecting different insurers in different ways.
- Environmental risks: According to Moody’s, air pollution; soil/water pollution and land-use restrictions; carbon regulations; water shortages; and natural and man-made hazards are the most material to credit quality across all sectors. “Natural and man-made hazards are the dominant environmental risk for P&C (re)insurers. This reflects their insurance of property and corporate supply chains, which can both be severely affected by natural catastrophes,” said Holmes.
- Social risks: Aging populations, increasing urbanization and rising wealth levels are key demographic trends that create both challenges and opportunities for insurers, noted Holmes. “Insurers are also exposed to changes in regulation prompted by evolving social demands, which could have a negative impact on their profitability,” he said.
- Governance risks: Key person risk; strategy and management; dividend policy and financial policy; and compensation policy are all governance factors that can impact an insurer’s rating. Holmes explained,“Governance weaknesses or failures have contributed to a significant weakening of insurers’ credit profiles, resulting in a number of negative rating actions.”
How ESG risks shape insurer behavior
Insurers are facing increasing pressure from government and regulatory bodies to play a larger role in the development of a sustainable economy. “Failure to meet these expectations could result in reputational damage,” remarked Holmes.
These considerations have driven some insurers to limit coverage or investments in certain sectors, such as Chubb, which recently announced that it will stop underwriting the construction or operation of new coal-fired plants to fight climate change.
ESG exposures vary by region
To reflect ESG risks in its ratings, Moody’s considers qualitative and quantitative factors in its overall analysis of credit drivers. For example, life insurers are more vulnerable to social risks such as the U.S. opioid crisis. Differences in natural, regulatory and social features across regions also affect insurers’ ESG exposures.
“Risks arising from the transition to a low-carbon economy tend to be higher in Europe, where decarbonization has been on the agenda of investors and policymakers for some time,” explained Holmes. “Physical risks related to climate change tend to be higher in coastal or drought-prone regions. Insurers with extensive geographic footprints may be exposed to a greater range of ESG risks, while relying on diversification to limit individual risks.”
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