Life Insurance Companies are Facing a “Climate Paradox” – How Do They Solve It?

This piece is by Paul Vozzella, who is a Director at GRESB & Asset Impact looking after North America with a focus on business development and advisory services. Before joining GRESB in 2022, Paul worked in previous sales and business development roles at RepRisk, Intercontinental Exchange and NASDAQ.

Primarily focused on ESG data integration and the implementation of ESG frameworks across both corporates and the institutional investment community. Paul is a graduate of the University of Massachusetts – Amherst and is an FSA Credential Holder.

There is a growing materiality of climate risk to life insurers. For the last few decades, life insurers have invested significantly in the corporate bond market to secure future payouts. Specifically, the oil and gas and power generation sectors where the potential for consistent long-term returns have aligned well with the insurers’ long-duration liabilities. Yet, these are the same companies that are most exposed to climate transition risk, as assets such as coal, oil, and natural gas are at risk of decreasing demand and increasing prices relative to other low-carbon solutions.

Hydrocarbons that are robust investments now may become stranded in the next twenty years as the world continues to move towards net-zero goals. This is the financial climate paradox that life insurance companies face today, as they think about diversifying their portfolios to better manage and mitigate climate risks. Concurrently, from an underwriting perspective, heat-related deaths and hospitalizations have increased over the last decade and will continue to increase as temperatures rise. While lower air quality due to pollutants, warming temperatures, and wildfires are having short and long-term implications on respiratory health. Showing a real link between climate change and higher mortality, increasing financial risk for life insurers.

When insurers look to understand their carbon risk exposure within their investment portfolio, understanding the specific carbon risk of each issuer within their portfolio is crucial. There is varying risk of exposure for investments in fossil fuel assets; not all fossil fuel companies have the same emissions profile. For example, when looking at two U.S. shale producers, EOG Resources Inc. and Coterra Energy Inc., most investors would expect Coterra and EOG to have similar company-level GHG intensities.

However, by examining the specific basins and underlying assets where they operate, Coterra has half the emissions intensity of EOG. This is due to Coterra having exposure to basins with significantly less emissions intensive operations than where EOG’s production is mostly concentrated. Several factors ultimately influence the GHG intensity of a basin, including age, recovery techniques, the degree to which operations can be electrified, and the amount of venting and flaring that occurs. Tracking and ensuring the accuracy of each underlying issuer’s emissions is important from a baseline perspective, helping effectively measure current exposure, while also enabling life insurers to pinpoint areas in their portfolios with the highest emissions and develop targeted strategies for decarbonization. Especially, as oil & gas companies are issuing bonds with increasingly longer maturities, increasing life insurers’ exposure to transition risks with the shift to a low-carbon economy.

Despite the United States’ recent step back from mandatory regulatory disclosures, worldwide, scrutiny is increasing as regulators mandate the assessment of climate-related risk within financial portfolios. Canada’s Federal Office of the Superintendent of Financial Institution’s (OSFI) Guideline B-15 on Climate Risk Management is just one example. The ruling expects insurers to report their climate risk and opportunities across their entire value chain, including their third-party asset management businesses.

Even if a business is not based in Canada, any business operating in the country must follow this regulatory disclosure. It is only expected that mandatory climate disclosures will become more common and standardized over time. Providing a signal to insurance companies that they should not wait for mandatory regulatory disclosure in their domiciled country; instead, they should take steps now to align with common disclosure practices to avoid potential penalties wherever they may operate, but also to not fall too far behind in assessing risk within their portfolios before it’s too late to take action.

While risk is top of mind for many life insurers when understanding the impacts of climate change, the transition also presents an opportunity for insurers to be at the center of financing the low-carbon economy. For example, oil and gas companies are diversifying assets and transitioning towards net-zero operations, providing opportunities for insurers to finance these efforts through green bonds or through joint ventures and partnerships.

One example is Cosmo Energy Holdings Co., Ltd., which established a Green Finance Framework to support its commitment to a decarbonized society by 2050, including the reduction of CO2 emissions and the development of renewable energy and next-generation technologies. The Framework, which aligns with the Green Bond Principles and Guidelines, is the basis for two recent green bond issuances by the company. Other examples include Mutual life insurance company MassMutual’s commitment of up to £400 million (USD$516 million) in renewable energy developer Low Carbon to fund investments in large-scale renewable energy projects across the UK, Europe and U.S.

These financing solutions provide insurers and their investment teams the opportunity to redirect capital towards projects and companies that not only align with sustainability goals but also improve long-term investment results.

While every life insurer may have different exposures to climate risk, understanding the multidimensional challenge that climate change presents, affecting both the liability side and the investment side, is critical. What underlies this exercise is granular and contextual data on those they insure and lend to. The latter is being severely overlooked by insurers as compared to other financial institutions in recent years, revealing a gap in the assessment of climate impacts on lending and investment practices.

When life insurers start to track critical metrics within their investment portfolios such as financed emissions, net-zero alignment, and green energy ratios, they can move beyond generalized insights and have the intelligence needed to adapt investment strategies, manage risks effectively, seize opportunities, and ensure long-term resilience in the face of a changing climate.