A new analysis reveals that insurance companies could face billions of dollars in losses if they stay on the current course of investments that contribute to climate change, at a scale exceeding some of the worst wildfires in California’s history. That is one of the findings of a first-ever “stress test” of insurance company investments by insurance regulators from California, Oregon, and Washington. The analysis, “The Hidden Cost of Delaying Climate Action for West Coast Insurance Markets,” and executive summary are posted at the California Department of Insurance website.
Stress testing has been used for decades by businesses and governments to simulate and prepare for potential disruptions. Insurance companies now conduct regular stress testing of their book of business against economic shocks. Climate change is the latest area requiring stress testing and scenario analysis by insurance regulators in order to preserve market solvency for consumers.
Companies that do not have effective long-term plans in place would face higher costs in the event of a “transition shock,” or a revaluing of fossil fuel-related assets as the world economy moves to cleaner technologies. According to the report, these losses could range from $7 billion to $40 billion on corporate bonds alone in coming decades.
The report uses the Paris Agreement Capital Transition Assessment (PACTA) tool and the 1-in-1000 TRISK climate stress testing framework to compare insurance companies’ investments to the emissions-reduction targets set in the 2015 Paris Agreement that must be met to avoid the worst consequences of climate change. These open-source tools are available for companies to use, including for their annual NAIC Climate Risk Disclosure TCFD-aligned Survey responses. This report analyzes transition risks from assets controlled by insurance companies licensed in the states of California, Oregon, and Washington earning over $100 million in national premium – in total representing more than $2.9 trillion in corporate bond and stock market investments. Transition risks refer to shifts in supply and demand for high-emission industries such as coal, oil, and gas because of climate effects or climate action.
Insurance companies invest premiums that they collect from people and businesses, generating returns that enable them to pay future claims, meaning the performance of investment income can have a direct impact on a company’s ability to take on additional policies down the line. In recent years, insurance companies have restricted underwriting in response to U.S. and global catastrophes and economic conditions. Because insurance solvency is regulated at the state level, insurance regulators are working together for sustainable markets. This report implements part of the first-ever Sustainable Insurance Roadmap, released by California Insurance Commissioner Ricardo Lara and the United Nations Principles for Sustainable Insurance in 2022.
“Insurance consumers need a sustainable marketplace with many options to meet their needs,” said Commissioner Lara. “Our report shows that even with the growing threats of climate change, insurance companies that evolve to meet the needs of a transition towards zero-carbon energy and low-carbon technology will position themselves for growth to better serve consumers, while those that do not face significant losses.”
Key findings include:
Expected losses for corporate bonds related to coal, oil and gas, power, and automotive sectors are large, and losses increase dramatically the longer the transition is delayed. Aggregate expected losses on bonds range from $7 billion to $28 billion, depending on the pathway, with a shock transition in the year 2026 but more than double to range between $14 billion and near $40 billion if the transition is delayed to 2034. This is on scale with the 2017 and 2018 California wildfires which costed an estimated $22.7 billion in aggregate losses.
Insurance companies’ corporate bond portfolios have greater exposure to climate risk than their equity portfolios. This is significant because bonds make up a larger share of investments than stocks industry-wide.
Insurance companies are significantly invested in transition technologies such as renewable power capacity production, which are likely to grow with state and federal investments. Investments supporting renewable power, hydropower, and nuclear power made up more than a third of the total from power capacity production.
Insurers’ investments include companies ramping up zero-carbon technologies, but not quickly enough to meet the Paris Agreement goals. Investments in carbon-intensive technologies like oil power, oil extraction, and coal mining, are found to be misaligned with the Paris Agreement, posing potential transition risks. The major exception is coal power, where insurance investments are in companies whose plans align with a sustainable development scenario. Assets that are planning to transition to sustainable technologies will likely be less vulnerable to policy or demand-driven shocks that require rapid phase down of high-emitting technologies, regardless of their current carbon emissions.
California has targets for 300,000 zero-emission heavy duty trucks by 2029, and numerous other initiatives working towards the goal of being carbon neutral by 2045.
“I want to thank California for taking the lead on this important and critical analysis to help better understand and address climate change risks facing the insurance sector,” said Andrew R. Stolfi, Oregon’s Insurance Commissioner and Director of the Department of Consumer and Business Services. “Oregon is eager to continue partnering with other states and insurance companies as we proactively work to address climate risks to our sector and the economy as a whole.”
“This analysis is a critical step forward as we build capacity to understand and address climate risks to the insurance sector. As insurance regulators, we need to keep pace with an evolving market,” said Washington State Insurance Commissioner Mike Kreidler. “Insurance companies should be using available tools to also keep pace with the future of our economy. I look forward to continuing to work and innovate with our state regulator colleagues and partners.”
“Continuous efforts to measure and understand climate-related risks and opportunities highlight the commitment of the financial supervisory authority to secure the financial stability of the insurance sector,” said Kaitlin Crouch-Hess, Executive Director, Climate Finance for RMI, which stewards the Paris Agreement Capital Transition Assessment (PACTA) tool that was used in the study. “We expect the results of this exercise to have a ripple effect and motivate not only insurance companies but broader financial regulatory bodies to embrace continuous commitment towards climate alignment assessments.”
