Insurance Business and Sustainable Development

*Dietmar Pfeifer and Vivien Langen*

### **Abstract**

In this study, we will discuss recent developments in risk management of the global financial and insurance business with respect to sustainable development. So far climate change aspects have been the dominant aspect in managing sustainability risks and opportunities, accompanied by the development of several legislative initiatives triggered by supervisory authorities. However, a sole concentration on these aspects misses out other important economic and social facets of sustainable development goals formulated by the UN. Such aspects have very recently come into the focus of the European Committee concerning the Solvency II project for the European insurance industry. Clearly the new legislative expectations can be better handled by larger insurance companies and holdings than by small- and medium-sized mutual insurance companies which are numerous in central Europe, due to their historic development starting in the late medieval ages and early modern times. We therefore also concentrate on strategies within the risk management of such small- and medium-sized enterprises that can be achieved without much effort, in particular those that are not directly related to climate change. We start this study with a general overview of the UN sustainable development goals and their implementation in the financial sector world-wide, with a major focus on climate change aspects of investments in a lower carbon economy and economic support of underdeveloped countries that were prevailing until very recently. Although the insurance sector can be considered as a particular branch of the finance industry there are several particularities which need a separate consideration. In the first place, insurance provides a protection of individuals and companies against severe material and non-material losses. Therefore the insurance premiums must be invested safely, in particular under actual insurance regulations like Solvency II. But the insurance industry is also faced with new emerging risks due to climate change, in both the life and non-life sector. Moreover, the European development of insurance regulation has very recently focused also on other sustainability aspects than those related to climate change. We discuss this aspect of risk management in a separate section of this study. Finally, we discuss in detail appropriate strategies how small- and medium sized insurance companies in Europe can handle the new challenges of insurance supervision without too much effort. Our suggestions are mainly driven by own experiences from practice.

**Keywords:** SDG, CSR, ESG, green finance, green insurance, sustainable development

#### **1. Introduction**

In 2015, the United Nations (UN) member states adopted a far-reaching resolution with the intention to transform the world [1, p. 7]. Under the impression that

the targets that were originally formulated in the Millennium Development Goals (MDGs), which were the dominating political framework from 2000 to 2015, were seemingly not completely reached, the MDGs were replaced by the 2030 Agenda for Sustainable Development [2]. The eight MDGs were replaced by seventeen Sustainable Development Goals (SDGs) that should be achieved world-wide by 2030:


A parallel initiative to these goals for long-range sustainable economic and business activities was the development of the concept of Corporate Social Responsibilities (CSR) [3]. "More specifically, CSR for example involves fair business practices, staff-oriented human resource management, economical use of natural resources, protection of the climate and environment, sincere commitment to the local community, and also responsibility along the global supply chain" [4], p. 3. PRI Association, an investor initiative in partnership with UNEP Finance Initiative and UN Global Compact, has introduced Environmental, Social, and Governance (ESG) issues in their principles for sustainable investments to varying degrees across companies, sectors, regions, asset classes and through time [5], p. 2. Some examples of ESG issues are [6], p. 3.


In the course of time, CSR has moved from a type of international private business self-regulation, along the lines of the UN SDGs expressed through the ESGs, to a more generally accepted source of principles and mandatory schemes at regional, national and international levels, including bilateral investment treaties and free trade agreements [7].

## **2. The role of the financial sector in sustainable development**

Climate change and ESG issues have strongly influenced the finance sector – both banking and insurance – world-wide in the last decades [8]. The manner in which institutional investors approach ESG issues is gaining increased attention in particular across OECD countries. Pension funds, insurers and asset managers have to understand and respond to potential risks and opportunities arising from ESG-related factors in order to safeguard the assets that they invest on behalf of their beneficiaries and clients. At the same time, regulators must be confident that institutional investors meet the required standards of prudence and care when they include ESG considerations in their portfolio decisions [9]. This is also stressed in the reports of the Global Sustainable Investment Alliance who define sustainable investing as an investment approach that considers ESG factors in portfolio selection and management [10].

Concerning climate change aspects, the Financial Stability Board Bank for International Settlements has established a Task Force on Climate-related Financial Disclosures (TCFD), which establishes recommendations for disclosing clear, comparable and consistent information about the risks and opportunities presented by climate change. Their widespread adoption will guarantee that possible effects of climate change become regularly considered in business and investment decisions. A routine use of these recommendations will also support companies in a better demonstration of their responsibility and foresight in climate issues [11]. Nearly 200 countries agreed in December 2015 to reduce greenhouse gas emissions and accelerate the transition to a lower-carbon economy. A particular issue here are investments in alternative clean, energy efficient energy sources, for example, windmills, solar energy or water power. The expected transition to a lower-carbon economy is estimated to require around \$1 trillion of investments a year for the proximate future, thereby also generating new investment opportunities. The United Nations Environment Programme (UNEP) has been supporting the idea of creating a sustainable financial system since 2014 with a purpose of mobilizing capital for sustainable development and achieving a green and inclusive economy.

A particular strategy that has been singled here out is green finance. Globally speaking, developing economies face serious challenges concerning mobilizing

capital related to green investments. For these countries, one source for external capital flow is represented by foreign direct investments (FDI), which generally target projects related to energy, waste, water, or agricultural development. In addition to FDI, other sources of external capital flow are concessional loans from international financial institutions, long-term commercial debts, aid and remittances. The major aim of issuing green bonds is raising financial resources for climate change initiatives. These fixed-income instruments are generally oriented to climate-friendly activities. The performance of green bonds issued in US dollars and Euros has been superior as compared to non-green bonds [12]. A recent study by the National Bank of Belgium has investigated this topic in more detail [13]. It is interesting to notice that the authors have applied sophisticated statistical methods to obtain their conclusions. In particular, their findings were:


Sophisticated econometric statistical methods were also the basis of the recent paper [12]. For their analysis, the authors used the variables domestic credit from banks and domestic credit from the financial sector in USA, Canada and Brazil. Gross domestic product (GDP) was used as a proxy for sustainability of economic growth, along with CO2 and N2O emissions, which are caused by manufacturing, agriculture, the use of forests and fisheries. According to their findings, bank credit is insufficient to achieve green financing. For the purpose of increasing economic growth and reducing global warming, the financial sector should assume a bigger role in increasing green investments. Their results show that the level of domestic credit within financial sectors contributes to green financing, while CO2 emissions remain a challenge for reaching the 1.5 ° C target.

The use of science-based methods in the judgment of climate related risks is also stressed in the Technical Supplement by the TCFD [14]. In general, the most significant effects of climate change are probably emerging over a medium- to long-term time horizon, but their precise timing and magnitude are uncertain. This uncertainty induces challenges in understanding the potential effects of climate change on business, strategies, and financial performance. It is, therefore, important to investigate how climate-related risks and opportunities may potentially evolve and how they affect business under different conditions. One way to assess such implications is through the use of scenario analysis.

Scenario analysis is a well-established method for developing input to strategic plans in order to enhance plan flexibility or resiliency to a range of future states. The use of scenario analysis for assessing climate-related risks and opportunities and their potential business implications, however, is relatively recent. Given the importance of forward-looking assessments of climate-related risk, the Task Force believes that scenario analysis is an important and useful tool for an organization to use, both for understanding strategic implications of climate-related risks and opportunities and for informing stakeholders about how the organization is positioning itself in light of these risks and opportunities. It also can provide useful forward-looking information to investors, lenders, and insurance underwriters.

#### *Insurance Business and Sustainable Development DOI: http://dx.doi.org/10.5772/intechopen.96389*

This topic has also been addressed in a Working Group of 16 banks piloting the TCFD Recommendations under a UNEP Finance Initiative, with a special emphasis on credit risk [15]. The physical aspects from a changing climate were accompanied by a follow-up study [16].

In the insurance and reinsurance industry, these aspects have already been the basis of judgments on the effects of natural catastrophes like windstorm, hailstorm or flooding on insured portfolios for a long time [17].

Another central aspect in this discussion is the public disclosure of sustainable business activities. In order to implement and internalize the sustainability by businesses, it should, first of all, be traceable and measurable. This is possible through sustainability reporting. Sustainability reports show that there are differences among countries and even among sectors. In developed countries such as the USA, the UK, and Australia, such reports contain – besides climatic and environmental aspects – qualitative information in social and governance areas such as number of employees, salary and bonuses, and employee training [18].
