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Tackling insurance's contribution to climate change will mean resolving a host of thorny challenges.

The United Nations' climate conference in Glasgow (COP26) has just started and the buzzword net zero is on everyone's lips, from government leaders to global CEOs and from impassioned youth activists to your local drugstore's latest advertisement. Several global insurance companies have committed to net zero strategies and defined specific goals for climate neutrality individually or as part of voluntary initiatives such as the Net-Zero Insurance Alliance (NZIA) and the Net-Zero Asset Owner Alliance (NZAOA). Such moves are understandable, considering that a significant part of insurers' business is to cover damages resulting from natural disasters which undoubtedly will become more severe and frequent as the climate heats up. However, insurers and reinsurers are not yet crowding to join the global race to net zero. In this article we assess the reasons for such restraint and the difficulties that implementing a net zero strategy for insurers could entail.

Identifying relevant business areas

To become net zero (often equated with "climate neutral" or "greenhouse gas (GHG) neutral") insurers need to take into account not only their own business operations, but also GHG exposures on the assets and liability sides of their insurance businesses. The latter two are key since they represent considerable emissions; as investors, insurers finance the GHG emissions of investee companies. As their insurers, they also enable their customers to conduct their business and consequently contribute to the customers' GHG emissions. These so-called Scope 3 emissions are difficult to capture, but of particular importance to credible climate action.

Defining GHG neutrality

Net zero is a technical term based on the climate agreement reached at COP21 in Paris (Paris Agreement). In its latest report, the Intergovernmental Panel on Climate Change (IPCC) calls for all global GHG emissions to be reduced to net zero by 2050 – across all sectors, economic activities and areas of life. Under the 1997 Kyoto Protocol, GHGs include carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulphur hexafluoride and nitrogen trifluoride. Carbon dioxide currently is the most significant GHG.

Net zero or GHG neutrality does not mean a company no longer emits any GHG. The net zero calculation also considers the removal of emitted GHG from the atmosphere via so-called carbon capture, utilisation and storage (CCUS) processes. CCUS range from nature-based solutions (mainly reforestation and preservation of natural areas) to the use of new technologies to filter carbon dioxide from the atmosphere and store it underground (eg, ClimeWorks, which cooperates with Swiss Re).

This is a sensitive issue since there are no uniform standards to assess the efficiency of such measures and avoid double counting when using them to offset GHG emissions despite recent industry efforts such as the Taskforce for Scaling Voluntary Carbon Markets. While some purists petition to disregard carbon offsetting based on CCUS entirely, the International Energy Agency (IEA) promotes CCUS as an essential interim solution until "real zero" can be achieved across all industry sectors and technologies.

Measuring GHG emissions

Clearly no net zero strategy is possible without proper identification and calculation of GHG emissions. However, this is the weak spot of many climate neutrality pledges, not only in the insurance industry. A company's GHG emissions are usually divided into three categories according to global standards of the Greenhouse Gas Protocol. Scope 1 covers direct GHG emissions from the company, such as from factories or company cars. Scope 2 includes GHG emissions for the generation of energy used by the company (electricity, heating, cooling and steam). Scope 3 covers all other indirect GHG emissions, including emissions from the business operations of insured or financed companies.

Such "financed GHG emissions" and "insured GHG emissions" are particularly difficult to capture since they must be accurately allocated to the respective financing or insurance. The Partnership for Carbon Accounting Financials (PCAF) developed standards for the calculation and disclosure of financed emissions for certain asset classes at the end of 2020. Currently, PCAF is working on a new standard for "insured emissions" from insurers and reinsurers in cooperation with NZIA. Regardless of emerging standards, GHG emissions can only be allocated correctly if they are known. This leads to another weak spot of the financial industry's climate ambitions: in the absence of comprehensive and standardised disclosure obligations, insurers are forced to work with a very limited patchwork of information.

Leading the way on net zero in the insurance industry

One of the first net zero initiatives deals with insurers' investments and was co-founded by Allianz and Swiss Re in 2019. The Net-Zero Asset Owner Alliance (NZAOA) now has 58 members including many insurers, reinsurers and pension funds. In total, they hold US$9.3 trillion (€8 trillion) in investments. NZAOA members have committed to achieving net zero in their investment portfolios by 2050 and regularly reporting on their progress. While NZAOA publishes guidance and provides support on target setting and achievement members are free to choose the measures that will lead to their net zero goal. Akin to the Paris Agreement, members set their own interim targets every five years.

In October 2020, NZAOA issued guidance on how members can set and publish the first interim target for 2025. Instead of a purely linear reduction of GHG emissions across all asset classes and sectors, NZAOA proposes sector-specific targets based on the IPCC calculations which consider reduction potential and technological progress. For example, Allianz committed in January 2021 to reduce GHG emissions from equities and corporate bonds by 25% and to implement a strategy for its real estate investments by 2025 that ensures their GHG neutrality by 2050.

Although NZAOA is driven by the insurance industry, it is also open to other big investors and, more importantly, does not consider the liability side of the insurance business. In July this year, a new net zero initiative dedicated to the industry launched under the leadership of AXA and the United Nations Environmental Programme Finance Initiative (UNEP FI): The Net-Zero Insurance Alliance (NZIA) now has 15 members, including global giants like Aviva, Munich Re, Allianz, Swiss Re and Zurich. NZIA is also committed to the Paris Agreement goals and aims to achieve net zero by 2050. NZIA focuses on insurance underwriting and the members' potential to reduce overall GHG emissions by a respective underwriting and engagement policy. Since NZIA only covers the liability side of the insurance business, members are advised to also make their investments GHG neutral by 2050 and join NZAOA.

Similar to NZAOA, it is up to NZIA members to define specific measures to achieve the targeted GHG neutrality. Each member commits to implement the net zero concept in all relevant areas. This includes developing underwriting guidelines, engaging clients in dialogue on decarbonisation, developing innovative products and solutions, making claims handling more sustainable and integrating climate factors and net zero targets into risk management. NZIA is currently working on respective guidance for its members.

Both bodies are also members of the Glasgow Financial Alliance for Net Zero (GFANZ) founded by United Nations' Special Envoy on Climate Action and Finance, Mark Carney. GFANZ aims to bring together banks, insurers, asset managers and other financial industry companies by mobilising more than US$100 trillion for the decarbonisation of the world economy. In its recent Call to Action, GFANZ urged G20 leaders to set interim GHG reduction targets and phase-out goals for fossil fuels, align regulatory frameworks with net zero, price carbon emissions and standardise CCUS markets and mobilise capital flows to help developing countries meet climate goals. With the G20 leadership summit in Rome being disappointingly reluctant to agree even on long-term GHG reduction targets, it remains unclear which of these thoughtful proposals will ultimately make its way into public policy.

Pursuing net zero after COP26

The implementation of net zero in the insurance industry is an ambitious undertaking that will prove hugely challenging for members of NZAOA and NZIA. However, the possibility remains that such voluntary measures will one day become mandatory, at least in certain jurisdictions like the EU and the UK, and that today's pioneers will benefit from their early action.

The insurance industry will continue to play an important role in combating climate change as a provider of capital and facilitator of the real economy. As the IEA pointed out in its report Net Zero by 2050, significant transformation is needed for energy supply, transport, construction and consumer goods. The required investments could exceed US$100 trillion, a sum that will require substantial private sector participation. In addition, climate data and insurers' know-how will help the wider business community transform their operations. One thing is certain: the insurance industry's challenging journey to net zero has just begun and COP26 is only one step on the long and winding road ahead.

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