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How one large insurer is tackling climate transition risk

Listen: How one large insurer is tackling climate transition risk

In this episode of ESG Insider we're talking with one of the largest U.S. property and casualty insurers, Liberty Mutual Insurance, about how the company is integrating climate change risk into its investment decisions and underwriting practices.

We interview Rakhi Kumar, Senior Vice President for Sustainability Solutions and Business Integration at Liberty Mutual Insurance, about a recent climate transition scenario analysis by the insurer.

"As much as we may want to go faster, we have to recognize that there are realities that need to happen," says Rakhi.

The analysis found that the lack of a coordinated global policy approach among countries presents the most immediate and greatest source of climate transition risk to companies.

Listen to the ESG Insider episode from the S&P Global Sustainable1 Summit in New York here.

Listen to the episode where we talk with MunichRe about the insurer's approach to natural disasters here.

Listen to our episode featuring Manulife's Global Chief Sustainability Officer here.

We'd love to hear from you. To give us feedback on this episode or share ideas for future episodes, please contact hosts Lindsey Hall (lindsey.hall@spglobal.com) and Esther Whieldon (esther.whieldon@spglobal.com).

Photo credit: Getty Images

DISCLAIMER

By accessing this Podcast, I acknowledge that S&P GLOBAL makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in this Podcast. The information, opinions, and recommendations presented in this Podcast are for general information only and any reliance on the information provided in this Podcast is done at your own risk. This Podcast should not be considered professional advice. Unless specifically stated otherwise, S&P GLOBAL does not endorse, approve, recommend, or certify any information, product, process, service, or organization presented or mentioned in this Podcast, and information from this Podcast should not be referenced in any way to imply such approval or endorsement. The third party materials or content of any third party site referenced in this Podcast do not necessarily reflect the opinions, standards or policies of S&P GLOBAL. S&P GLOBAL assumes no responsibility or liability for the accuracy or completeness of the content contained in third party materials or on third party sites referenced in this Podcast or the compliance with applicable laws of such materials and/or links referenced herein. Moreover, S&P GLOBAL makes no warranty that this Podcast, or the server that makes it available, is free of viruses, worms, or other elements or codes that manifest contaminating or destructive properties.

S&P GLOBAL EXPRESSLY DISCLAIMS ANY AND ALL LIABILITY OR RESPONSIBILITY FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, CONSEQUENTIAL OR OTHER DAMAGES ARISING OUT OF ANY INDIVIDUAL'S USE OF, REFERENCE TO, RELIANCE ON, OR INABILITY TO USE, THIS PODCAST OR THE INFORMATION PRESENTED IN THIS PODCAST.

Transcript provided by Kensho.



Lindsey Hall: Hi. I'm Lindsey Hall, Head of Thought Leadership at S&P Global Sustainable1.

Esther Whieldon: And I'm Esther Whieldon, a senior writer on the Sustainable1 Thought Leadership team.

Lindsey Hall: Welcome to ESG Insider, a podcast hosted by S&P Global, where we explore environmental, social and governance issues that are shaping investor activity and company strategy.

Esther Whieldon: In this podcast in the past, we've covered how scientists have projected that low carbon transition will require some significant action on the part of both government and the private sector. At the same time, big questions remain as to how that transition will play out in the real world versus how they look in climate models.

Lindsey Hall: We heard this theme come up at the S&P Global Sustainable1 Summit in New York City in May 2022, and we'll include a link in our show notes to the episode about that event in case you want to hear more.

Many large companies are working to figure out just what their role is in that transition, and they started studying what they need to do and what risk they might need to navigate in the future. For example, about 3,400 companies, governments and other organizations support the recommendations of the UN's Task Force on Climate-related Financial Disclosures, or TCFD. And that framework, among other things, encourages companies to perform a climate scenario analysis to understand future risks and opportunities.

Esther Whieldon: We talk about insurance at ESG pretty regularly on this podcast. A few weeks ago, we talked with Manulife about how climate change is impacting life and health insurance globally. Before that, we had a guest from big German insurer, Munich Re, talk about natural disasters, and we'll include a link to both episodes in our show notes.

Well today, we're talking with one of the largest property and casualty insurers in the world, Liberty Mutual Insurance, about how they're integrating climate change into their investment decisions and product offerings. The global insurance and investment firm recently conducted its first climate transition risk scenario analysis. Liberty Mutual published those findings in April 2022. The analysis looked at both macroeconomic, policy related, and portfolio-specific risks over the next 5 to 30 years.

Lindsey Hall: To understand what new insights Liberty Mutual learned and how that is shaping the firm's investment and underwriting practices, I spoke with Rakhi Kumar. She is Senior Vice President for Sustainability Solutions and Business Integration at Liberty Mutual Insurance. One quick note, you'll hear Rakhi mention “cat models” that refers to catastrophe models that insurance companies use to understand potential risks of catastrophic events. Okay, here's Rakhi.

Rakhi Kumar: We started our efforts on doing the climate scenario analysis way back about a year ago now. And as we're thinking of what we should do, we recognized that there were many models out there, and the typical way of doing a climate scenario assessment was taking a portfolio and stress testing that portfolio. One of the things -- and over a long period of time, so 5, 10, 15, 20, 30, 50 years, that's what TCFD asks for.

One of the things we -- when we were -- we had a small group of individuals who are talking about it as our climate counsel, and that's not how we manage our business, right? As one of my colleagues put it, doing a stress test for a portfolio over a 30-, 50-year period is like asking someone in 1970 to use a model that is going to predict what's going to happen in 2020, and then make portfolio decisions. That's not how we think. That's not how businesses are managed.

So what we decided to do were 2 different exercises. The first one was really trying to understand the models itself, and we really honed in on the NGFS or the Network for Greening of the Financial System, that model, and then really unpacked the model to understand what are the macro insights that we can gain over the long-term horizon. And that's what we are looking for in the 30- to 50-year period. And then on the 5, 10, 15, we actually did do a portfolio stress test to look to see what happens with the portfolio in that shorter time horizon.

Esther Whieldon: Great. And if I understand correctly, it focused specifically on transition risk, right, not the physical risk side so much?

Rakhi Kumar: Right. And so insurance is a very interesting business, right, because what -- as a property and casualty insurer, we're actually taking on physical risk, and that means our job is to really manage -- not necessarily to minimize or mitigate, but to manage physical risk. And we have -- as an industry, we have tools for that. We have the cat models, et cetera.

And for the transition risk models that most people are using, does have some physical risk built into it. But when we really studied physical risk over a longer period of time, you recognize that it's not very good, these transition models and the physical risk models that are capturing -- or the transition risks really miss some of the acute or the severe weather impacts that can happen that really do drive losses. So what we do is use this transition -- the whole exercise we focused on and we -- those models do have -- I just want to make sure that you understand that there is a physical risk element, but we use the insights to understand transition risk to our business.

Esther Whieldon: I see that makes sense how the things that are being observed by governments and society as physical risk might also manifest in transition risk itself?

Rakhi Kumar: Right. Because it does -- yes, because the physical changes or the physical impacts also help drive some of that -- the models.

Esther Whieldon: So what are some insights that you gained from this analysis? What are some of the findings did help you learn something new?

Rakhi Kumar: Yes. To me, the real interesting part was that broader macro level assessment that we did. And it really stems from identifying some public policy realities that are going to challenge companies in building achievable transition pathways.

So there are 4 core takeaways. And the first one was that we should not expect common action globally. And it's really not common action that is needed, it's actually coordination amongst countries on their own policies that reduces macroeconomic impact. And the pace and shape of policy development is really informed by the energy and carbon intensity of an economy. So how U.S. is going to transition is going to be very different than how Europe is going to transition and how Asia is going to transition.

I mentioned that we should not expect common action, and that makes complete sense when you think about the time horizons that have been set by different countries. So in Europe, they have set a net zero ambition by 2050, China has set one by 2060, and India has set on by 2070 with all caveats, which means that each one of them is going to come up with a policy impact, a policy change that is really going to be different in different time horizons. And that's going to challenge companies as they're trying to build their transition pathways, especially global companies.

One of the other insights that the research threw up was that TCFD describes transition risk as that's stemming from policy, from technology, market change and reputational risk. And the models are showing that the most acute or most imminent risk or part of transition risk is policy change. For companies to be actually mitigating and managing transition risk, they really need to start understanding policy changes globally.

Now -- and policy change is also driving market change, and we know that, that doesn't happen. I think there's a lag between when policies and actually put into action and then it actually manifests itself in the marketplace. And then technology change also, the models don't show any immediate disruption to the way we are working or actually living, but they are really signs for opportunity, and they can really be the markers. They can set markers. So there's no imminent change that's going to happen. By imminent, I mean, like in the 3- to 5-year time horizon or 3-year time horizon.

So when you -- for a company who's trying to mitigate or manage transition risk, they really need to focus on policy. And I mentioned that different regions are going to transition at different points. So if I'm a company that has a presence in Asia, Europe and, say, the U.S., Europe, I have policies and the government action that is allowing all businesses in that region to transition. Consequently, I know my clients are going to transition, and I can meet a net zero transition.

When I'm in Asia, and I have my clients who are -- and policies that are being set to a 2060 or 2070 time horizon, I know those clients that I'm servicing are not going to be transitioning for another 10 to 20 years after I made my commitment. So what do I do then? Do I step back or do I stop doing business? And that's a question that needs to happen. And that's where companies actually start creating transition risk, right? So they start creating the transition risk with certain actions that they may be taking in the market because you really can be creating disruptions by pulling away from businesses, et cetera.

Esther Whieldon: Can you go into a little more detail about the difference between sort of a common policy action versus coordination? What does coordination among governments look like under the different scenarios?

Rakhi Kumar: You have to look at your own economy and how the economy is going to transition. So you see Europe has a certain degree of energy dependency. And it's actually, at this point, far more reliant on coal than the U.S. is from an energy percentage mix perspective. And it needs to transition away from coal, and how it's going to do that, probably solar, wind, et cetera, or any other way.

U.S. is actually far more reliant on the -- it has oil and gas as an energy mix. And we have to acknowledge that gas is not going away. Like you're not going to minimize gas. So that's one of the reasons you're having this conversation in Europe where they have this green deal and this taxonomy where they're trying to figure out whether they should classify gas as good or bad. In the U.S., it is going to be good because you're going to continue to have gas powering the economy.

So by actually labeling things and creating -- and I'm not saying that taxonomy is a bad thing. It's designed to support the green deal. I'm just saying we need to be very careful when we're just going to take taxonomies that are developed for a particular purpose and then try to make that a universal taxonomy and this calling things good or bad, and then actually that could further create more transition concerns or risks for companies and economies because suddenly, it's not realistic to think we can't be reliant on gas for at least the next 20 to 30 years.

Esther Whieldon: So is coordination more of a passive thing then of just acknowledgment of the differences between regions? Or is that something that governments and companies within different regions will need to work with each other on?

Rakhi Kumar: Well, interestingly enough, if you think of -- if you actually go back to the Paris accord and how it was thought of and conceptualized, every country made a commitment to go back and figure out how they, for their economy, were going to reduce emissions based on their sectors. It was not that you're all going to go only after energy or you're all going to go only after forestry, et cetera, right? Because every economy was different. And so there was this flexibility given to countries to identify what part of their framework or what part of their economies they were going to, I guess, energize to reach that -- to make that commitment.

Now we have made net zero a goal for companies. And when it comes to companies, we're expecting companies to do the exact same thing. And the companies -- and now somehow we've frozen our thinking into we have to -- everybody has to address, at least in the financial sector. Where's most of your emissions? It's coming from your high-emitting sectors, right?

So we've moved to -- when we flipped over the Paris accord and how it was designed with the flexibility to actually understand and evaluate to this more well, here is where most of the world's emissions are coming from, and these are the sectors that need to be tackled. You've gone to a bit more of a rigid system that was not the original intent.

Esther Whieldon: Can you talk about how Liberty Mutual is evolving your underwriting practices with ESG in mind?

Rakhi Kumar: Yes. I think integrating ESG or a framework into our underwriting is an ongoing process. And one of the things that this kind of research does is allows us to have a conversation with our underwriters about what models are. It gives them real life information. It gives them information that is actionable. And it makes them see risk in very interesting and in a more realistic way.

So I'll give you an example, right? So you can actually go and tell a portfolio -- and this is just -- this is not a real examine and just a conversation that you can have, right, with an underwriter. You could say, "Oh, by the way, you're going to have climate risk in your portfolio over the next 20 years. This model is going to be showing -- we did a stress test." And they're like, "Okay, fine. talk to me in 20 years, right?"

Or you could turn around and have a conversation that if this -- if an event happened today, here's how much risk your current portfolio can tolerate. Here's the loss you may have. That's a very different kind of conversation that we're having with our -- you're showing them or you're talking about risk in a very different way.

And so I think that's the kind of conversations. We're changing the way we are talking about risk, the way we're thinking about risk, the way we're measuring risk. We're doing thresholds for risks and setting thresholds is all -- it's all underway in terms of the way we are -- it's a journey, and we're on that journey.

Esther Whieldon: And it sounds like a lot of that is involving engagement with your findings with those your underwriting?

Rakhi Kumar: Absolutely, absolutely. Because when you show them actual data and research from a third party, which an open source tool and it actually gels with what's happening in the real world, they're like, okay, I get it, I understand, right, because you're seeing all this happen. We did this research in November, December last year, but the war right now has actually shown that all these observations are true. And we cannot be building transition pathways without looking at reality and realistic path data. Otherwise, we are going to be deeply disappointed, and everyone who's trying to really make -- take action and do the right thing.

Esther Whieldon: So let's say, I am a company or somebody listening in on this podcast, what should they take away? What should they do with the findings that you had from this scenario analysis?

Rakhi Kumar: Right. I think the key takeaway for us, I can tell and I think that is equally applicable to other companies is when we are talking about transitioning to a low-carbon economy, we really need to understand what we mean by it, what is realistic and within our control at this point. What are the wildcards with regards to technology? What are the time horizons that we need to transition? We don't have a transition today. We have some -- we have time of what does that transition look like. And all through a realistic lens, right.

I think there's a desire to reach net zero 2050, it has to be public-private partnerships. It cannot be done alone by companies. Otherwise, companies are going to start creating transition risk in the marketplace. And we're going to have huge problems around just transition, and climate justice issue is going to keep coming up and there's going to be green washing litigation, et cetera. So I think the reality is that realistic understanding of what transition means, what's in your control, what can you control, and really understanding the long-term time horizons, markers, technology markets, policy markers that will start creating transition risk or that you have to start preparing for transitioning parts of your portfolios based on those markers.

And I think what we are doing at Liberty is really looking at it with a realistic lens, looking at the data lens and actually trying to figure out where can we move, what is the time horizons we need to move in and what actions do we need to take now in order to mitigate the risk when it does rear itself in order to prevent it from actually creeping into our business.

Esther Whieldon: How do you balance this need between what's realistic and also the need to dramatically accelerate progress.

Rakhi Kumar: Right. So obviously, there's a lot of effort going into investing in technology, et cetera. But breakthroughs in technology also need to be scalable. And we have to recognize that it is going to take time. I think one of the focus -- one of the lessons learned is policy that we've been focusing has only been on energy policy. We need to look at geopolitical energy policies or policies around energy independence also in order to understand realistic time horizons.

I think the other thing we haven't really done is focus on resiliency and building resilience -- and investing in resilient infrastructure, right? And I know this is -- the answer is I don't have an answer -- I don't have a pill, but as much as we may want to go faster, for example, CCUS technology is -- without CCUS technology, none of us are meeting the net zero transition. It's not possible. So that's why a lot of companies are investing and looking at and supporting CCUS, right? But CCUS is one aspect. Technology around storage is another aspect, right?

I think funding -- the small little low-hanging fruit such as improving efficiencies in the existing frameworks of like transferring of electricity and energy -- like along the value chain. There's so much lost. We can do things which can minimize and mitigate -- they're not -- they will help. Even a small bit in the ocean helps. But we're looking for like these big wins and these big ahas where we're not educating our populations on their responsibilities and the behavior changes they need to undertake. We need to rethink from a realistic lens as to while we are waiting and supporting the technology, are there other things like improving efficiencies in your current system to reduce leaks, to reduce et cetera.

A lot of people have talked about carbon pricing and how that helps with bringing efficiencies in and then actually investing in resiliency to make sure our populations and communities are safe and can withstand the impacts of -- the physical impacts of climate that we know are going to come even if we currently meet all our reduction goals because it's going to take time before the current emissions help future -- like reduce temperatures in the future. So we know it's going to get worse before it gets better.

Esther Whieldon: Okay. So you have both the insurer and investor component of your business. So how does Liberty Mutual integrate ESG considerations in your investments?

Rakhi Kumar: On the investment side, our focus really has been on energy transition, and I have to give credit to our investment team where they have managed to transition the portfolio more towards renewable energy. And I think we have numbers in our TCFD report would say that in 2019, for every dollar we had in renewable energy, we had about 10 in traditional energy. And now, over just a short period of 2 years, it's for every dollar we have in renewable energy, it's $3 only in traditional. So it's a huge shift and pivot in 2 years. I think that's an example of some of the proactive action that has been -- that Liberty has been taking.

Esther Whieldon: And going back to the physical side of things. I noticed one of your strategic pillars is increasing customer resilience. So how is Liberty Mutual pursuing that goal of helping customers have more resilience and understand what the risks are.

Rakhi Kumar: Esther, before I go into actually what we are doing, I just want to stress why resiliency is important for the economy and also for Liberty and the insurance sector.

When you really think about reducing, what does reduce climate risk? It's not necessarily mitigating. Like if individual companies were to mitigate physical risk, it doesn't -- or we take on less risk as insurers, the risk doesn't go away. The risk still exists, it really is who's left holding the bag. It's the government and the citizens who are really left holding the bag. And so resiliency is something that actually does reduce systemic climate risk. And one of the -- some of the products that we are starting to bring in or advisory that we're getting into is one is parametric insurance from a product perspective. Parametric insurance is event driven, so it's not loss driven. So it's really for governments, individuals, companies, which are in high impact or in regions with high -- which at risk, and it could be from cyclones, wildfires, hail, et cetera. And these are insurances that pay out as soon as an event happens and makes the individual whole when they really need the money in order to rebuild and come back up again.

We also have -- offer eco-friendly upgrades. So if a customer is trying to replace damaged product with products of equal value, we actually cover some of the additional costs with upgrades that are higher to -- and encourage them to go to a higher green or eco-friendly standard that would allow for them to move in more of a -- to support a transition.

And then we've had some strategic partners with -- on groups such as flash flood where we can provide real-time flood warnings as well as provide insights from a commercial flood insurance perspective on what parts of their that business are really prone to flooding, et cetera. And so it's better tools than insights. So you see a whole host of activities that we are taking on internally in order to help our customers build resilience.

Esther Whieldon: So as you can hear, Lindsey, Liberty Mutual Insurance is working to understand how real-world policy developments will play out on a regional basis. And it is considering what role the insurance company as both an underwriter and an investor can play in mitigating those risks while also advancing the transition.

Lindsey Hall: Please stay tuned as we continue tracking how the energy transition evolves for insurers and beyond.

Thanks so much for listening to this episode of ESG Insider, and a special thanks to our producer, Kyle Cangialosi. Please be sure to subscribe to our podcast and sign up for our weekly newsletter, ESG Insider. See you next time.

Copyright © 2022 by S&P Global.

 

DISCLAIMER

By accessing this Podcast, I acknowledge that S&P GLOBAL makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in this Podcast. The information, opinions, and recommendations presented in this Podcast are for general information only and any reliance on the information provided in this Podcast is done at your own risk. This Podcast should not be considered professional advice. Unless specifically stated otherwise, S&P GLOBAL does not endorse, approve, recommend, or certify any information, product, process, service, or organization presented or mentioned in this Podcast, and information from this Podcast should not be referenced in any way to imply such approval or endorsement. The third party materials or content of any third party site referenced in this Podcast do not necessarily reflect the opinions, standards or policies of S&P GLOBAL. S&P GLOBAL assumes no responsibility or liability for the accuracy or completeness of the content contained in third party materials or on third party sites referenced in this Podcast or the compliance with applicable laws of such materials and/or links referenced herein. Moreover, S&P GLOBAL makes no warranty that this Podcast, or the server that makes it available, is free of viruses, worms, or other elements or codes that manifest contaminating or destructive properties.

S&P GLOBAL EXPRESSLY DISCLAIMS ANY AND ALL LIABILITY OR RESPONSIBILITY FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, CONSEQUENTIAL OR OTHER DAMAGES ARISING OUT OF ANY INDIVIDUAL'S USE OF, REFERENCE TO, RELIANCE ON, OR INABILITY TO USE, THIS PODCAST OR THE INFORMATION PRESENTED IN THIS PODCAST.