Where Is The U.S. Insurance Industry On Climate Change?

The analytical rigor and discipline that we see in modeling and managing mortality risk in life insurance policies is almost completely missing from managing climate risk in U.S. property and casualty (P&C) industry. Are one year P&C policies to blame? In this first of three posts, I will compare the largest European insurance company, AXA, with the largest P&C U.S. firms that publish a climate report: Chubb, Liberty Mutual, and Travelers. Part I is an overview of the topic. Part II examines insurance practices or the liability side of a P&C’s balance sheet. Part III examines investment practices or the asset side of their balance sheets.

One would expect the property and casualty (P&C) insurance industry to be at the front lines of the fight against climate change. Hurricanes, floods, and forest fires hit the pocketbooks of the insurance industry before anyone else’s. On top of that, it is well known that population growth since 1990 has been above average in the U.S. in regions that are at a high risk for hurricanes and wildfires. These climate catastrophes are also becoming more common. For instance, Travelers states in its 2021 TCFD report, “California wildfires…we now view events such as those of the past few years as being less remote than we thought previously.”

Climate risk affects both the asset (investments) and the liability side (obligations to make good on losses) of an insurer’s balance sheet). These companies should have expertise in climate as they process a vast number of claims relate to climate induced threats. Hence, if there was ever an industry where doing good coincides with doing well, it must be insurance. Moreover, the analytical rigor that actuaries bring to prediction and management of mortality risk in U.S. life insurance companies is worth celebrating. Why is that formidable intellectual and managerial talent absent in the management of climate risk of U.S. P&Cs? SwissRe, a prominent reinsurer’s 2021 climate report states, “from 2010 to 2020, realized loses have exceeded expectations in almost every year. Very likely, part of this gap can be attributed to trend effects due to climate change.”

The usual assumption in the U.S. P&C business has been that the possibility of a wildfire in say California is not correlated with a possible hurricane in Florida. What if these events begun to become correlated on account of climate change? Would a simultaneous wildfire in California and a large hurricane in Florida potentially jeopardize the capital position of an U.S. P&C insurer? More worrisome, a massive climate related disaster or a series of big losses will make the hit to the insurer’s capital exponential, as opposed to linear, over time.

My assessment is that the P&C industry in the U.S. has not been as visible or active as it could have been in leading the climate risk conversation. This is partly because the social, political and economic pressures in Europe are different, and partly because incentives for U.S. policy holders are somewhat more myopic.

Annual policy writing incentives

Is the annual policy writing cycle to blame? An insurance company that writes a life insurance policy for the next 15-30 years has incentives to devote actuarial resources to forecast your mortality. However, P&C insurance contracts, covering losses from climate events, are usually written for one year only and the incentives for the industry to look far into the future are necessarily limited.

The top ten U.S. P&C insurers

To understand the landscape a bit better, I started digging deeper into the sustainability disclosures of a top French insurer AXA XL (latest available 85 page 2022 climate report). AXA’s revenues were 99 billion euros, half of comes from the P&C business and around 20% from health-related insurance. I consider AXA to be the gold standard of thinking about how climate risk affects both their coverage and investment decisions.

To benchmark AXA with an insurer from the other side of the Atlantic, I found the top ten P&C insurers, ranked by revenues in the U.S. Those are State Farm, Berkshire Hathaway, Progressive, Allstate, Liberty Mutual, Travelers, USAA, Chubb, Farmers Insurance, and Nationwide. The returns were somewhat disappointing.

State Farm’s 2021 sustainability report is basic and covers none of the issues AXA raises. My initial thought was such silence may be excused away if most of State Farm’s business relies on covering automobiles and life. But it turns out that $25 billion was collected by State Farm in 2021 as premiums for their home insurance business. That is not pocket change and climate issues would be relevant for the home portfolio.

Berkshire Hathaway is well-known skeptic of ESG, and their sustainability discussion of their conglomerate covers a grand total of one page. Progressive puts out a 51-page sustainability report but the CEO statement in that report focuses heavily on Progressive’s DE&I efforts, not on climate. Progressive devotes one page to a generic discussion of risks (page 13 and 14) and publishes half a page of generic text on climate (page 15). On the investment side, Progressive states that 80% of their bonds have an MSCI ESG rating. They also state they have started tracking the LEED status of buildings in their CMBS (collateralized mortgage-backed securities) portfolio. Roughly $35 billion of Progressive’s 2021 $47 billion revenue comes from auto insurance for which climate is not such a big concern. However, around $2 billion of annual premiums comes from insuring physical risks where climate should be a risk factor. Moreover, the assets side of all these insurers’ balance sheets is exposed to climate risks.

Allstate’s 2021 10-K states that out of their $40 billion of premiums revenue, $27 billion relates to auto but a sizeable $10 billion comes from insuring homes. Allstate puts out a 106-page sustainability report but the word “climate” appears only on page 65. The climate discussion spans three pages after page 65. Allstate says it has enough capital to withstand climate stress.

The efforts of USAA, Farmers and Nationwide in the climate area appear to be minimal. USAA has a webpage labeled “environmental responsibility” where they talk about recycling, reduction of paper usage, savings in water and energy usage. Farmers publishes a page called “corporate citizenship” where their focus is mostly on their employees, diversity and inclusion efforts, cutting usage of plastic, paper, planting of trees, charitable contributions, involvement with charitable NGOs (non-governmental organizations) and the “Farmers Insurance Open,” a golf tournament they organize with the PGA (Professional Golf Association).

Nationwide puts out a 15-page corporate responsibility report that covers communities, giving, food security, work with the American Red Cross, United Way, investments in affordable housing, health care, education, clean water, children’s wellbeing, diversity and inclusion efforts, diverse boards of directors, ethics and governance. They devote one page to the environment which touches on reducing their own carbon footprint, reducing waste, water usage, paper usage and landfill diversion.

Liberty Mutual has put out its second TCFD report in 2021. Travelers and Chubb have also published a TCFD report. So, it seems worthwhile to compare the efforts of AXA with these three U.S. firms Chubb, Liberty Mutual, and Travelers. Before embarking on a deep dive, it is worth reiterating that seven of the top 10 U.S. P&C insurers do not report a serious discussion of the implications of climate risk on their balance sheets. The default answer might be to argue that their climate risk exposures are not large enough to warrant a bigger discussion. I doubt that hypothesis. I have to assume that absence of reporting implies absence of either an internal consensus on the importance of climate inside their companies or a lack of investment in understanding that risk.

The discussion follows a series of questions and different strategies followed by AXA relative to the three American insurers: Chubb, Liberty and Travelers. The comparison is simply meant to be a benchmarking exercise. I understand that every firm would likely follow its own strategy given their opportunities and constraints. Moreover, every company has its own learning curve in building infrastructure required to support such thinking and institute organization wide buy in and processes.

Here are some high-level findings that cover both the liability and asset side of the companies’ balance sheets.

High level findings

Has the insurer articulated a climate strategy?

All the four companies have articulated their climate strategy. I will leave the discussion of the details to the next part. As a summary, AXA is the only company that linked strategic goals to specific KPIs (key performance indicators). The U.S. insurers produced high level statements without clear links to numerical targets.

What are the insurer’s views on double materiality?

AXA is a staunch supporter of double materiality while thinking about ESG. For the uninitiated, “double materiality” simply means thinking about the impact of climate on their investments but the externalities imposed by the operations of the firms underlying these investments on climate. The other insurers do not devote much or any space to double materiality.

Is a full dashboard of metrics presented?

Ideally, the firm should present a dashboard of its metrics benchmarked to some objective target or standard and time series data of its metrics over time so that the user can track progress, both over time and keeping time constant, to a benchmarked portfolio. AXA has an excellent dashboard along these lines. I could not find such a detailed dashboard for the other insurers.

Voluntary audits of climate data

PwC has issued a limited assurance report on AXA’s processes and underlying assumptions. The other insurers do not discuss assurance of climate risk metrics and processes.

Is executive and staff compensation tied to climate goals?

AXA, states that the following three key performance indicators (KPIs) will be included in the compensation packages of executives and 5,000 AXA employees: (i) Dow Jones Sustainability Index ranking; (ii) reduction of operational carbon emissions; and (iii) reduction of investment-related carbon footprint (for its general account assets). I did not find such a commitment in the disclosures of the other insurers.

I will show in Parts II and III that AXA is similarly quite distinctive compared to its three selected U.S. counterparts. I have not done an in-depth analysis of the differences in the regulatory environments of these four companies regarding corporate reporting and this may explain some of the differences.

In Part II, I will compare AXA to these three companies in terms of their insurance business or the liability side of their balance sheet.