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KBRA: Balancing Climate Change Priorities Never More Challenging for Insurers

Flats on the edge of famous eroded cliffs in Hunstanton, Norfolk, UK

Climate change presents significant risk for the insurance industry on both sides of the balance sheet, and KBRA offers a new metric to help investors dimension an otherwise amorphous aspect of climate risk to specifically move beyond assuming the level of credit risk is related to total emissions.

Insurers face climate risk on the asset side of the balance sheet when investing and underwriting risk on the liability side, especially in the property and casualty insurance lines.

Insurers have modified their asset management to incorporate climate change considerations more explicitly, while others have re-evaluated their investment strategies.

On the liability side, insurer balance sheets, product line and customer considerations will necessitate insurers take a more nuanced risk-based approach.

According to the Global Risks Report 2022, extreme weather and climate action failure are among the top five short-term risks to the world, and the insurance industry plays a key role in the mitigation of these risks.

And while insurers have taken several measures to address some of these risks, one of the biggest challenges they face is the impact climate change has on underwriting.

This report explores climate-related risks and how insurers are incorporating sustainability into their underwriting and investment strategies, including:

  • Asset management and the transition to a low-carbon future

  • The complexities of underwriting in addressing climate change

How Insurers Can Assess Climate-Related Financial Risks with Quantifiable Metrics

Environmental, social and governance (ESG) has become important in the investment decision-making process. However, objective and quantifiable metrics do not build a complete picture of the credit risk that climate transition poses to inform these investment decisions.

Most economists and policymakers believe a carbon tax is the most effective method of helping companies reduce their carbon footprint.

Insurers often rely on ESG scores or total emissions to assess the amount of credit risk that climate transition poses.

There are a number of ESG frameworks used, such as the Task Force on Climate-Related Financial Disclosures (TCFD) and the Sustainable Accounting Standards Board (SASB), however this means there is a lack of a standardised system.

While ESG factors can affect credit risk, a more comprehensive approach is to assess a company’s financial capacity to absorb any future costs associated with emissions.

In a new report: ESG: KBRA Launches Carbon Transition Risk Metrics— Carbon Quantum (KCQ) Ratios, KBRA explores its new metric that's been designed to help quantify and benchmark the hypothetical carbon transition risk to each individual company to provide insurers with a better understanding of the challenges companies face in addressing emissions targets.

It considers:

  • Carbon tax and climate transition risk

  • How KCQ ratios can be used as a risk mitigation tool for investors

  • KCQ peer comparison