Lloyds Bank: Insurers and Banks Are Key Allies in Enabling the Net Zero Transition

A changing climate is impactful for insurers on both sides of the balance sheet. Global estimated losses from natural disasters have risen from roughly $160bn in 2019 to US$210bn in 2020 according to Munich Re. It is driving a rise in insurance premiums, yet insurance companies also face significant opportunities to invest in the net zero transition to mitigate the worst impacts of climate change.

To discuss these issues we met with Lloyds Bank’s Tara Schmidt, Director and Vai Patel, Associate Director in the Sustainability and ESG Finance Team and Richard Askey, Managing Director and Head of Insurance on how they can support insurers in the transition to net zero.

Askey: Lloyds Bank's sixth annual Financial Institutions Sentiment Survey revealed in 2021 insurers placed climate change and sustainability as their third most important priority (6^th in 2020). This was ahead of developing new products, responding to Covid-19 and expanding into new markets. Furthermore it revealed that 64% of UK insurers plan to make their sustainability goals more ambitious over the next 12 months with increased board and management team focus seen as the key driver to their business becoming more sustainable.

It is very relevant to continue to focus on the 'protection gap' as the physical loss from natural catastrophes, for example, may well be uninsured or have low coverage levels. To mitigate this, the coordination between the industry and governments needs to improve. In the UK we see this with Flood Re, but in developing economies the evolution is often much slower.

The industry has deep experience in risk analysis including that from natural catastrophes, however these models are often backward looking. As we stare into changing climate characteristics, the models need to evolve so the pricing is more representative of the true forward-looking risks.

Schmidt: A key regulation that we see evolving and being mandated in a number of countries is the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD published its status report recently and insurance leads all sectors in integrating climate into their governance, strategy and risk management processes. But like many sectors, insurance companies have opportunities to improve, particularly in regards to establishing climate-related targets.

There is a lot of focus on science-based targets, but for insurance companies there are challenges around that in terms of data access, for instance climate-integration into credit and insurance ratings. While the TCFD will help insurance companies start to think about these targets themselves, it will also help in better understanding the climate risks and opportunities of the companies they underwrite.

There are a number of guidelines around new business, whether it is in coal or oil activities. We also need to consider the composition of the boards where there is a real drive towards female, black and minority representation. This leads to a willingness to explore new ways of thinking and doing.

Patel: Regulatory pressures such as the TCFD reporting requirements, are unsurprisingly resulting in an increased focus from insurers on monitoring and mitigating climate exposure and risks. But beyond the immediate regulatory pressures, some leading insurers are also utilising other frameworks to help themselves manage ESG factors to protect and create long-term value for key stakeholders. Examples include the UN Sustainable Development Goals framework, investor-led coalitions such as the UN Principles for Responsible Investment and accounting standards like those set by the Sustainability Accounting Standards Board. The latter lists product design, risk management and selling practices as key topics that are likely to affect the financial condition or operating performance of companies within the insurance sector.

There is growing awareness that to manage climate risk in particular, insurers' business models will need to be reassessed, starting with underwritten product innovation that appropriately captures risks through new policies and premiums. This will need to be matched by the investments insurers are making (which would benefit from having an ESG or a climate risk lens attached to it). While there is also growing awareness that if the products are not fit-for-purpose for these particular institutions or businesses, this could result in a substantial mismatch between assets and liabilities. This is a likely area of focus for regulators going forward given the impact on regulatory capital and broader systemic risk concerns.

Askey: Our clients are adopting ESG underwriting guidelines to reflect these changing dynamics and support the transition to a low-carbon economy. In December 2020, Lloyd’s of London published its first ESG report, in which it announced that for the first time they would be setting targets for responsible underwriting and investment, in particular by asking managing agents, from 1 January 2022, to stop accepting new business on certain coal and oil activities and to phase out existing coverage by 1 January 2030.

Within investment portfolios many fund managers are now providing green options around investment opportunities for insurers. This in itself can provide the consumer with the ability to steer their insurance premiums towards insurers who offer these green investment funds alternatives.

Patel: Industry leaders are actively engaging with their end customers to create products which are relevant for climate risk or sustainability issues, and guiding them through consulting services. This is creating more resilient businesses that helps reduce transition risks going forward both for the insured and the insurer.

Schmidt: A growing opportunity for insurance companies is supporting ESG focused companies with the right level of risk and reward. While climate has been front and centre, it is becoming increasingly clear how important the social contributions of companies are in the call for a fair and just transition. Some insurance companies are developing innovative business models (through both the environmental and the social lens), to support companies and local communities in advancing climate adaptation and resilience.

Equally, a growing number of insurance companies are investing in low-carbon infrastructure minimising physical risks by investing in the net zero transition. It is exciting to watch how the industry’s thinking begins to broaden beyond the insurance underwriting process in seeking out holistic ESG-focused solutions to minimise future climate risk.

Askey: If we want a green, sustainable and resilient recovery, this will call for a transformation across our entire economy. A cross-industry solution is going to be required that leverages the transformational opportunities that sustainable finance could offer and banks have a key role in that to support insurers.

Patel: Some insurers are assessing how impactful potential ESG actions are, versus their ambitions, stakeholder expectations, importance to business and risk management, and how easy they are to implement, including how ‘doable’ ESG innovations are. However, there is a growing awareness across the industry, including the broader financial services sector that when linking financing to these ESG commitments, there has got to be a balance between the reputational risk of executing a sustainability-linked financing, as well as whether it is unambitious or considered greenwashing.

It is worth noting the market has evolved very quickly across the broader financial services sector – all lenders now have much more stringent requirements to make sure KPIs and targets are material and stretching. This is where we are helping clients beyond the core banking products and advising them on ESG financing that reflects this new market reality.

Beyond sustainability-linked general corporate financing, Lloyds Bank is also working with insurers on the regulatory capital front including looking to make Funds At Lloyd's (FAL) Tier 1 & Tier 2 Letter of Credits sustainability-linked, as well as in debt capital markets (DCM) to structure green bonds for Solvency II capital requirements.

Lloyds Bank is also expanding its ESG advisory function, with ESG ratings being a core element. Insurers need to keep an eye on how the various ESG rating agencies see key emerging sustainability risk factors for the industry, which in turn are reflected in the risk weights assigned in their ratings models.

While methodologies across agencies differ, common themes include growing materiality of the industry's ESG risk across the full value-chain and a greater emphasis on both governance and social elements. While that may seem counterintuitive, this reflects insurers' role as risk carriers, whereby they assume their counterparties' exposures to risk through their underwritten products and investment portfolios. This can be mitigated through factors like appropriate corporate governance and transparency, product development and fair availability, and hiring and retaining a diverse workforce.

Askey: The concept of linking corporate ESG goals to bank / public markets financing is a topic that we discuss with all clients. We have supported clients with this style of financing on DCM transactions, sustainability-linked loans and in the Lloyd’s of London market through Letters of Credit and T1 style arrangements. There has been a significant up-scaling in this activity through the last 12 months.

This article is produced for general information only and should not be relied on as offering advice for any specific set of circumstances.