Insurance plays an essential role in helping manage global challenges, such as climate risk. Enterprise Risk Management is a necessary ingredient to make it successful.
The insurance industry is preparing to cope with emerging challenges under difficult market conditions, and risk management plays a major role in this transformation.
A solid Enterprise Risk Management (ERM) framework makes insurance undertakings more resilient and more profitable. ERM helps establish a risk culture within a firm and achieve regulatory compliance, as in the case ofinternal models for Solvency II. Moreover, ERM delivers business benefits by improving Asset Liability Management (ALM) and liquidity risk monitoring with the goal to align the asset allocation with the company’s risk appetite framework.
The starting point is a consistent representation of the market balance sheet, which allows firms to run large Monte Carlo simulations and quantify the tail risk. One can thus identify the drivers of rare, disruptive events, and rebalance the assets portfolio to reduce risks and increase returns. Therefore, ERM drives a competitive advantage from an individual firm's perspective.
As it enables risk-aware business management, ERM ensures further protection for the policyholders. When applied systemically, it contributes to stability across the entire sector, which is essential to stable economic growth, particularly in the face of challenges such as global warming and extreme weather events.
The insurance sector can contribute in many ways to reducing climate risks. Since insurers are large institutional investors, they can help facilitate the transition to a net-zero emissions economy by increasing the allocation to green assets and critical infrastructure. Their models of transition and physical risks can also be leveraged by businesses and governments to make informed decisions. Finally, the flow of capital to mitigation and adaptation projects can be prioritized by insurance underwriters.
These objectives can be achieved using ERM to integrate ESG (Environmental, Social, Governance) and climate into a consistent risk framework that empowers positive action. These transformations align the interest of individual competitive firms, who want to take more healthy risks, with those of government climate change policy and society.