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Underwriting the Transition: extracts from the Executive Summary

Underwriting the Transition: extracts from the Executive Summary

Extracts from the report’s Executive Summary, presented below, explain the objectives and scope, as well as highlighting the potential actions, opportunities and risks.

Objective
This report provides an understanding of what a transition to a low-carbon economy may mean in various key sectors for the market. By identifying key decarbonisation levers, we aim to identify some of the implications for underwriters in terms of coverage and changes in peril that may impact their business. 

Scope
Given the transition needs to happen and be integrated across the global economy, it is necessarily a very broad subject. For the purposes of this inaugural report, we have focused on first-party property damage from a coverage perspective and on the following sectors:

1. Transportation (Aviation, Marine, Road Freight);
2. Energy (Oil & Gas, Mining, Power Generation & Distribution); and
3. Construction and Commercial Real Estate.

We have not considered geographical considerations, apart from where explicitly mentioned such as the examples around policy and regulation. In addition, the ‘Just Transition’ defined as “a low-carbon transition that is fair, inclusive, creates decent work opportunities and leaves no one behind” is not explicitly considered. Lastly, although nature is inextricably linked to the climate transition, we have not considered nature as part of this report.

As part of the work, KPMG climate and sector experts’ opinions were obtained, as well as the opinions and views of the other industry experts and insureds, to develop a view on sectoral transition. The insurance implications of these transition pathways were discussed with underwriters from the various sectors, including separate underwriter workshops on Transportation, Energy, Construction and Commercial Real Estate.

This report is a step in the journey to understanding how insurance needs will evolve. We make no claims that the report is comprehensive or that it is an accurate prediction of what risks may emerge in the future.  

The challenges of transition
Insureds are already experimenting with new types of transportation, moving towards renewable energy sources and using low-carbon materials in construction. Insurers need to be aware of insureds’ current transition activity which may not naturally be part of the information provided at placement, given the difficulty in defining and gaining additional details on an insured’s transition journey. This ‘silent’ transition and the data/information challenges it poses brings a risk of misalignment in terms of product and pricing in the future, but also an opportunity to change the way underwriters engage with insureds to become more relevant than they have ever done before.

To baseline our work, we have calibrated our view of the transition to a 1.5°C scenario to align to the Paris Agreement, regulatory policy developments and to ensure consistency across all the reviewed sectors. However, the report highlights areas where these scenarios are becoming increasingly unrealistic due to factors such as technology developments not currently being commercially viable and at the scale required for assets such as maritime vessels that typically have a long production and operational life span. 

This points to a drift from the 1.5°C scenario toward a more disorderly transition and therefore the need for underwriters to not only consider their clients’ transition path, but also how insurers will need to adapt to changes in risk. Assisting insureds in climate adaptation and resilience alongside the transition will become increasingly important.

Despite the reality of the difficulties of transition, international organisations and regulators have set decarbonisation targets, particularly in transportation. A good example is in aviation where there are hard targets for airlines and airports relating to the blend of Sustainable Aviation Fuel with kerosene (e.g. Refuel EU requires 70% SAF blend by 2050).

This points to an emerging change in risk levels, where the price of low-carbon assets increases indemnity costs at the same time as potential 'insurance green premiums’ for transition technology. This is separate to the impact of the physical risk element of climate change, which is forcing insurers to focus more on adaptation and how to deal with an increasing number of areas where insurance is unavailable or unaffordable.

Responding to the challenges of transition
Understanding insureds’ transition journeys is key to staying relevant and continuing to insure their business. Insureds will face huge changes in their business model as the economy transitions to electrification and investment in new low-carbon assets. Insurers will need to work alongside insureds and their brokers to get a better understanding of the transition risks being faced by businesses and work closer with financial backers to be part of the implementation of future transition projects.

Insuring new transition technologies will be a challenge for underwriters. This requires a deep understanding of the new technologies and the mitigants that should be put in place to reduce the risk – ideally through participation in industry and regulatory/policy working groups.

This understanding will be even more important given the lack of historical data available on these new technologies, which is typically needed for actuarial pricing models. Core underwriting skills will become increasingly important in relation to understanding these technologies and the key risk mitigants, which can then be included within the assessment of the product and its wording. 

Opportunities
Lloyd’s has always had innovation at its heart. Insurers can seize the opportunities that are presenting themselves through the transition that is already upon them.

• There is a spectrum of transition opportunities from insuring new businesses and activities at one end, to assisting existing businesses with their transition as they adapt to new technology and processes. 
  
• Responding to existing clients’ changing business models to continue to stay relevant will strengthen existing relationships. 
  
• Insureds have highlighted the need for insurers to provide more complete coverages for new technology and assets. Hence, there will be opportunities for underwriters who are able to provide such integrated coverages.
  
• With transition will necessarily come a focus on safe decommissioning and recycling of stranded asset materials. 
  
• Potential opportunities to insure new direct air carbon capture and storage facilities, which sectors that are hard to abate (like aviation) may have a greater propensity to adopt.
  

Risks
The low-carbon transition presents a prime opportunity for insurers but there are also serious risks to consider (both known and unknown at present). Among known risks, the report identifies:

• Increasing risk of unexpected claims from new technology and assets thought to be 'production-ready' or due to accreditation schemes being too opaque. Insurers need to be involved in setting standards for new transition technologies and assets so they can be insured appropriately with reasonable exclusions and conditions.
  
• Claim costs may change as a consequence of insureds needing to purchase more expensive low-carbon assets and potentially incurring additional costs for decommissioning or subsidies for changing. 
  
• Some additional risks from new technologies include chemical fires from batteries, and changes to new fuels such as hydrogen and ammonia to which underwriters will be less familiar.
  

And what do insurers need to do to respond?
Actions the report suggests could be taken now by underwriters include the following:

• Understand client transition pathways to build awareness of the adoption of emerging transition technologies and processes. 
  
• Importantly, this should include using information from insureds and monitoring/updating the ‘in-house’ view, taking account of regulatory and policy developments, which will become increasingly important for strategy and business planning. 
  
• Think about how key technology changes could be insured competitively in future with the right underwriting conditions in place.
  
• Introduce transition training for underwriters focused on understanding clients’ transition pathways and how core underwriting skills can be used to address their changing needs. 
  
• Consider working with clients and their financial backers to be involved in transition projects at an early stage.
  
• Think about how pricing models can be adapted to a more scenario-based approach, similar to some cyber pricing models, due to the lack of historical information.
  

Sectoral analysis 
For each sector the report sets out KPMG’s view on the current state of transition, decarbonisation pathway, key levers and challenges, as well as what this could mean for insurers in terms of sector-specific opportunities, risks, immediate actions and areas to collaborate on with others. The high-level sector summary from the report is provided below.

Transportation 
For transportation the main pathway to decarbonising is in alternative fuels. For aviation and road freight this lies in SAF and electrification, but for marine it's uncertain given there are several options currently under consideration, with no agreement and almost no supporting infrastructure. The challenge for transition will be in the supply and infrastructure needed to transition to these new fuels and so ports and service stations will play a crucial role.

Energy 
For mining and the oil & gas sectors, transition will mean a fundamental change in their business strategies, with mining increasingly focused on transition minerals and materials. However, both oil and gas are still expected to play a large part in the transition, with gas as a transition fuel and oil derivatives (e.g. plastics) still needed for transition, but the focus is expected to switch to renewables and carbon capture, utilisation and storage (CCUS).

Construction & Commercial Real Estate 
For construction, the transition is expected to focus on the use of timber and new low-carbon alternatives to cement, steel and aluminium. Recycling of embodied carbon-like cement will also be important. 

For commercial real estate, the focus is expected to be on the retrofitting of existing buildings and the construction of new low-carbon buildings in the developed and developing world respectively.