Impact underwriting: Sustainable insurance as an opportunity for society and business

‘Impact underwriting’ can accelerate the global economy’s sustainable transformation. Due to its role as risk manager, risk carrier and major investor, the insurance industry is in a unique position to promote economic, social and environmental sustainability. But the way forward involves looking beyond focusing on already ‘sustainable’ activities. Changing for the better requires the implementation of more ‘impact’ activities that shift non-sustainable behavior and processes in a more sustainable direction. An impact-oriented alignment of just a fraction of the insurance industry’s capital flows would be a substantial catalyst for achieving the global sustainability goals.
Impact underwriting can offer a ‘double dividend’, generating revenues in a growing market besides realizing positive externalities for society. In this context, we identify 9 fields of sustainable action for the insurance sector:

1. Climate change & weather extremes: Global tropical cyclone storm intensity, for instance, is expected to increase by 5% and rain intensity by 15%. The risk associated with such disasters are increasingly covered via alternative risk transfers and impact underwriting needs to close existing insurance gaps.
2. Renewable energy investments: Global renewable energy capacities will more than triple by 2050. Accordingly, the demand for insuring renewable energy installations against physical, development or operational risks will rise. Risk consulting and risk service solutions support establishing new technologies or developing new territories and provide further opportunities for sustainable insurance solutions.
3. Alternative mobility: In 2024 a tipping point will be reached when battery electric vehicles (EV) become cheaper than internal combustion engines (ICE) for passenger vehicles. EVs will dominate new car sales before 2040. Impact underwriting can support this transition by offering insurance solutions to the areas of mobility sharing as well as autonomous driving, and can seize new opportunities in the sector coupling of vehicle batteries with the energy infrastructure.
4. Real estate: Non-financial barriers are a major obstacle against the demand of energy efficiency measures. Insurance can play an important role as mediator, service provider, and risk bearer and thus accelerate the implementation of efficiency gains.
5. Sustainable lifestyle: Improvements in the energy efficiency of appliances have come short of expectations due to rebound effects resulting from an increase in the usage of the appliances and a larger number of appliances per person. Impact insurance can counteract this trend by offering lower premiums for eco-friendly appliances, cars and buildings. Sustainable insurance claim regulation can allow for upgrades to eco-labelled appliances and machinery and, due to a life-cycle analysis of the emissions associated to a product, appliances might rather be repaired instead of replaced.
6. The future of work: Home office usage could double in the foreseeable future and impact underwriting can support the transition towards ‘new work’ and the sharing economy by reducing implementation barriers resulting from risk averseness, especially coupled with the underlying digitization.
7. Digitization & sector coupling: The realization of the energy transition or the sharing economy depends on the progress in digitization. Blockchain is a central enabling technology and its market size is expected to more than double within the next five years. Sector coupling leads to networked electric car batteries functioning as energy system storage, smart appliances’ energy demand being regulated according to energy supply and ‘prosumers’ sharing their self-generated electricity in communities. Impact underwriting can lower the associated risks and thus promote progress towards sustainability.
8. Emerging customers and regions: Half of global population is still not connected to the internet. With increasing access to mobile phones, the insurance industry will be able to provide impact insurance solutions to new population groups that are particularly challenged. For instance, in the area of agricultural insurance, insurers could provide microinsurance and further communicate weather alerts for livestock or crops, to support the decision-making of farmers.
9. Ecosystem: Intensifying rainfall and heat waves result in crop yields becoming more erratic, emphasizing the need for insurance and the role of impact underwriting.
   

‘Impact underwriting’ can accelerate the global economy’s sustainable transformation

In its role as risk manager, risk carrier and investor, the global insurance industry is in a unique position to promote economic, social and environmental sustainability. The vast capital flows and long-term horizon associated with its investment and underwriting businesses can help drive our society’s transition from narrowly focusing on short-run profits and job prospects to building a green, fair and inclusive economy. But the way forward involves looking beyond ‘sustainable’ actions and processes, which aim to preserve a preferred state, and focusing more on ‘impact’, namely actions and processes that shift non-sustainable behavior and processes in a more sustainable direction. An impact-oriented alignment of just a fraction of the insurance industry’s capital flows would be a substantial catalyst for achieving the global sustainability goals .
As Environmental, Social and Governance (ESG) methodologies and frameworks develop and start to be incorporated in risk evaluation, an increasing number of high exposures and extensive vulnerabilities have been identified in the insurance sector itself, which has the challenging position of being concerned with ESG from three different positions:

1. ESG in own operations
•    Sustainable and inclusive operations beyond traditional Corporate Social Responsibility (CSR) approaches.
•    Philanthropic support of environment, low-income and high-risk customers and regions.
2. ESG in asset management
•    ESG factors in investments and asset management (responsible investment).
•    Engagement, active ownership, good corporate citizenship (sustainable investment).
3. ESG in insurance underwriting
•    ESG factors in underwriting (responsible underwriting).

The ‘double dividend’: Business opportunities in impact underwriting

As sustainable insurance solution markets offer particularly high growth potentials, engagement in impact underwriting offers a ‘double dividend’,  generating revenues in a growing market as well as realizing positive externalities for society. Table 1 lays out criteria and definitions for sustainability in the context of impact underwriting in insurance.

Table 1: Criteria for sustainable insurance solutions

The scope of the definitions covers environmental and social criteria and spans from mitigation over adaptions to resilience. In this paper, the criteria for sustainable insurance products are applied to the three ESG risk components of:
•    physical risk: e.g. tangible losses from natural catastrophes, disruption of supply chains or rising morbidity and mortality
•    transition risk: e.g. disruptions of business models by changing demand preferences, technologies or regulation
•    liability risk: e.g. claims of third parties who have suffered loss and damage from an ESG hazard.
Based on this, we identify the business opportunities ahead in nine fields of sustainable action:

Table 2: ESG insurance solution opportunities

Climate change and weather extremes

As environmental indicators measuring anthropogenic impact continue their long-term post-industrial rise, physical risks such as the tangible disaster losses from natural catastrophes are mounting. Figure 2 shows that the frequency of natural disasters has been increasing in recent years, and researchers predict more severe meteorological and hydrological events to come (Knutson et al. 2010). Recent evidence from a meta-study by Knutson et al. (2020), shows that global tropical cyclone storm intensity, for instance, is expected to increase by 5% and rain intensity by 15%.

Figure 2: Global reported natural disasters by type  (1960 to 2019)

The physical impact of these natural disasters on value chains and trade relations presents a huge opportunity for insurance to generate positive impacts: Both economic and insured losses resulting from weather-related catastrophes show an upward trend. Moreover, areas with high industrial activity are often concentrated in coastal areas, and along rivers and river deltas, putting them particularly at risk of extreme weather events. And many regions that have not experienced incidents in the past are likely to be unprepared for extreme events to come in the future. Consequently, the demand for new insurance products for extreme weather events induced by climate change will continue to grow.
In financial markets, investors have already started seizing opportunities to invest in catastrophe risk via alternative risk transfers. Figure 3 shows the increased participation in the insurance-linked securities market, especially for catastrophe bonds , designed to hedge sponsors against losses caused by natural disasters. Going forward, it makes sense to hedge against market impacts due to natural catastrophes. Insurers could offer export or other guarantees to cushion the physical impact of extreme events or to mitigate business interruption risk.

Figure 3: Catastrophe bond and ILS risk capital issued and outstanding by year

Renewable energy investments

To limit the extent of global warming to 1.5°C, global capital flows need to finance the energy transition, moving towards carbon-neutral infrastructure projects and technologies (see e.g. Schmidt, 2014). Renewable energy generation and capacity have been rising over the past decade, with a record-high increase in installed capacity expected in 2020, outpacing net installations for fossil fuel and nuclear power combined (REN21, 2020). According to U.S. Energy Information Administration (2019), renewable production capacities have to more than triple by 2050. With the International Renewable Energy Agency (IRENA) projecting major shifts in energy carriers by 2050 (Figure 4), there’s significant scope for sustainable insurance solutions.
Demand is expected to rise for insuring renewable energy installations against physical or development risks. Furthermore, operational risks like earthquakes (e.g. caused by geothermal energy production) or groundwater pollution widen the field of sustainable action. Additionally, the risk of decommissioning or any long-term performance guarantees for energy infrastructure and especially the demand for risk consulting and risk service solutions in establishing new technologies or developing new territories, provide opportunities for the insurance sector.

Figure 4: Renewable electricity – the world’s largest energy carrier by 2017 and 2050

Alternative mobility

The future of mobility is electrified, autonomous, shared and connected, and this will create economic opportunities for impact insurance activities. Electric vehicles, for instance, are already seeing vital progress, with dramatic falls in the cost of renewable power and recent gains in the rate of energy productivity (Energy Transitions Commission, 2017).

With battery prices coming down, a tipping point will be reached soon when battery electric vehicles (EV) become cheaper than internal combustion engines (ICE) for passenger vehicles. Even though forecasts differ, the common trend points approximately towards 2024 (Energy Transitions Commission, 2020 & BloombergNEF 2019). The predominance of electric passenger cars on the street will still take decades after this price switch, but the share of EVs in new car sales is expected to surpass 50% shortly before 2040 (Figure 5).

Figure 5: Projected development in electric vehicle sales

Real estate

Regulators are increasingly focusing their attention on the pressing issue of improving the energy-efficiency of buildings, setting greener building standards in order to achieve their efficiency ambitions. As a result, construction material demand and installations will change in response to performance requirements, which will be relevant for manufacturers, investment partners and other industry professionals. A surge in demand for the technologies required for high-performance buildings is looming ahead, in particular mechanical equipment such as heat pumps and heat recovery ventilators (Vancouver Economic Commission, 2018).
Besides health and social reasons for building green, the growth of the market is also being pulled by client demand and pushed by environmental regulations globally. For instance, European legislation makes nearly Zero-Energy Buildings (nZEBs) a standard by 2020. Buildings accounted for 40% of the EU's energy consumption, 36% of its CO2 emissions and 55% of its electricity consumption in 2016 (European Parliament, 2016). Given that at least two-thirds of today's buildings will still be standing in 2050, and considering their vast energy consumption, a longer term vision is necessary to align with the challenges ahead (ZEBRA, 2016).
Figure 6 shows the major equivalent renovation rates  for EU member states. The annual share of the building stock undergoing major renovations is very low: it is below 0.5% in Spain, Poland or Belgium; around 1% in the Netherlands or Lithuania and above 1.5% in others like Germany, France or Austria. Even though the current renovation rate of existing buildings is low, it is estimated that renovation accounts for 57% of all construction activity (European Parliament, 2016). The annual renovation rate of building stock will need to more than double to reach the 3.0% renovation rate necessary to reach the EU's energy efficiency and climate objectives (European Commission, 2019).
In order to make use of the potential environmental, social and economic benefits of a faster transition, insurance companies should extend their solutions to insure, for instance, delay risks or improper implementation risks . Non-financial barriers are a major obstacle for the demand of energy-efficiency measures and include misinformation, distrust and the inability to find qualified workers that are able to implement the measure. Insurance can play an important role as mediator, service provider and risk-bearer and thus distinctly accelerate the implementation of efficiency gains.

Figure 6: Major equivalent renovation rates of residential buildings across EU member states

Additionally, operating cost savings, short payback periods and asset value increases achieved from investments in new green buildings and green retrofit projects will give further rise to market demand. Consequently, for insurers, a stronger involvement in the business of renovation and refurbishment of real estate or retrofitting of whole industries provides manifold opportunities for impact underwriting activities.
Sustainable lifestyle
In EU households, 20% of energy consumption at home is caused by cooking, lighting and other appliances. Unfortunately, improvements in the energy efficiency of haven’t brought this down, as increased efficiency has led to reduced usage costs that resulted in (1) an increase in usage and (2) a larger number of appliances per person. Consequently, as shown in Figure 7, the absolute value of energy demand has grown even as the individual energy consumption of each electrical appliance has decreases.

Figure 7: Energy consumption of electrical appliances

In this context, impact underwriting could play an important role by tailoring P&C insurance conditions and claiming regulation towards attaining reduced energy demand. Insurance companies already offer lower premiums for certified and eco-friendly appliances or electric cars and eco-efficient buildings, respectively. Upgrades to eco-labelled appliances and machinery will foster green insurance products. In a life-cycle analysis of the emissions associated with a product, this could mean that appliances are repaired instead of replaced. In this respect it is not only important to advance the methods used to determine life-cycle emissions but also to stipulate resource preserving repair options in the product design, which can be further stimulated through promoting beneficial insurance conditions for such products.

Corporate citizenship and the future of work

The Covid-19 pandemic has been a trial run of remote work at a grand scale, giving an indication of what the future of work could be like in the context of greater digitization and automation. Mobility to places of work experienced an unprecedented decline and industry experts expect this pattern to persist: Business trips will be replaced by virtual meetings and office tables by the kitchen table at home. As employers realize that working permanently from home is a feasible option, they could be tempted to give up expensive office space. Figure 8 shows the home-office potential across sectors in Germany, according to an analysis by Alipour, Falck & Schüller (2020).

Figure 8: Home office potential by sector in Germany (in %)

Impact underwriting can play a role in adapting solutions to this new work environment by reducing implementation barriers resulting from risk averseness, along with supporting the transition to the sharing economy and underlining the importance of creating value in things that otherwise would be dumped.

Digitization and sector coupling

Progress in digitization underpins most of what we have discussed in the previous sections, from the energy transition to the evolution of remote work and is thus an essential requirement for achieving sustainability. However, this progress can be held back by risks related to cyber-induced business interruption. Figure 9 shows that distributed denial of service  (DDoS) attacks on non-physical ICT infrastructure have peaked recently, and the trend of significant growth continues year-over-year (Anstee et al., 2016 & Coburn et al., 2019). With businesses moving to take advantage of digital efficiencies, the number of connected devices used is growing at around 12% annually (Coburn et al., 2019), and this makes business activities even more vulnerable to cyber-attacks. Impact underwriting could cater to the demand for non-damage business interruption insurance, offering affirmative cyber insurance or entire cyber insurance portfolios, as well as risk consulting and risk services.

Figure 9: Peak DDoS attack intensity from 2004 through 2018

Blockchain and distributed ledger technology (DLT) are beginning to rewire our digital infrastructure and challenge our thinking on how data, information, assets and even governance can be reorganized and reimagined. In 2018, PwC’s global blockchain survey identified that 84% of the respondents are actively involved  with blockchain technology. Moreover, Deep Analysis (2019) forecasts a tremendous market growth for the enterprise blockchain market in the years ahead (Figure 10).

Figure 10: Enterprise blockchain market growth (2019 – 2024)

Insurance companies are already starting to offer cryptocurrency theft coverage in cyber affirmative policies, which includes the cover of theft of cryptocurrencies in digital wallets caused by malicious outsiders (Barlyn, 2018).
Beyond the risk of cyber-attacks, society will also be exposed to cascading and ripple effects in case of any physical damages to critical ICT infrastructure. Changing catastrophe patterns and increasing terrorist threats result in the re-evaluation of locations that were previously thought to be secure. Future attacks that trigger fires, damage to machinery and physical loss to major assets may trigger unanticipated claims to insurers through traditional non-cyber insurance lines (Coburn et al., 2019). Changing patterns of risk make it more challenging to apply actuarial analysis of past years of claims experience to next year’s likely cost structure. Crucially, the potential for accumulation risk from a major cyber catastrophe is continually shifting. It will take a concerted effort by many different organizations and agencies, investment in law enforcement, legal reforms and changes in the economics of software production to reduce the loss rates to society from cyber-attacks.
Insurance companies will play a major role in this growing and competitive cyber risk market in the future as adoptions will accelerate thanks to advancements in big data analytics solutions. Integration of responsible data handling, data protection issues and cyber-ethics will be part of it.

Emerging Customers and regions

With increasing access to mobile phones and the internet in Emerging Markets, the insurance industry will be able to provide insurance solutions to population groups that have been particularly challenged by not being able to insure their risks. The current offline population (see Figure 11) represents future insurance clients who become approachable and addressable. Impact underwriting can provide new insurance products tailored for their specific needs, enhancing for instance the provision of inclusive and accessible insurance products to low-income customers, customers with disabilities, elderly customers and minorities. By offering solutions to customers via connected mobile devices, the insurance industry could actively shape their risk behavior. For instance, in the area of agricultural insurance, insurers could include weather alerts for livestock, crops, fishery and forestry to support the decision-making of farmers. For poor farmers, microinsurance or index based insurance  is an innovative and increasingly popular approach to insurance provision (International Association of Insurance Supervisors, 2018). Linking agricultural insurance to an index rather than to actual incurred losses is more cost-effective and, if communicated effectively, can foster trust between insurers and the insured.

Figure 11: Access to mobile phones and the internet (a) by population and (b) by country

Mobile banking, which is more and more accessible to the poor, can also make agricultural insurance more affordable and simultaneously increase its availability and quick payouts. Claims processing is likely to be the next area of focus for IoT  investment. Finally, this type of insurance allows farmers to invest more confidently and manage losses better, which helps smallholders to improve their productivity and grow their business in a more sustainable way. In this way, improved access to insurance can directly and indirectly enhance livelihoods, reduce poverty and create opportunities for sustainable economic advancement.

Ecosystem

Regarding agriculture in particular, the provision of effective insurance is also a way to facilitate a more productive agricultural sector. Intensifying rainfall and heatwaves are making crop yields more erratic, emphasizing the need for insurance and the role of impact underwriting.
Figure 12 illustrates the results from a multi-model simulation study for different underlying climate change scenarios (analyzing various scenarios in various different models). The red areas indicate a significant (more than 5%) decrease and the blue areas a significant increase in the respective crop yield, for the indicated share (>50% or >75%) of the underlying model runs, given a 2.5°C increase in global mean temperature. Still, with rising average temperature it is predicted that also the variance of temperature and precipitation will be impacted, including an increase in the frequency and duration of extreme events. When evaluating the effect of climate change on crop yields it is crucial to account not only for the mean effects of rising temperature but also for crop yield variance. Figure 13 illustrates expected significant (larger 5%) increases (blue) and decreases (red) in variance, for the indicated share (>50% or >75%) of the simulation runs, given a 2.5°C increase in global mean temperature. While the losses in average yields are particularly affecting developing and emerging countries, increases in yield variability are expected in much of the Northern Hemisphere, particularly in North America, Central Asia, and China.

Figure 12: Changes in crop yields at different levels of global warming

Figure 13: Changes in crop yields variability at different levels of global warming