Insurance Sector and Climate-Related Financial Risks: Unholy Nexus Between Private Equity & Insurance Industry Exacerbates Climate Risk Impacts

The $5 trillion insurance industry finances (insurance premiums are being used to fund climate damaging investments) and in turn is exposed to, risks from climate change. Insurance firms are exposed to climate risks in their underwriting and investments in physical properties, in fossil fuel projects, in emissions intensive industries and projects as well as in multiple other areas. Given low yields on junk bonds, to meet liability obligations it is increasingly teaming up with private equity which finance dirty high emission projects.  The insurance industry and banks are big investors in companies that contribute to climate change. They are now a significant portion of Blackstone’s assets for which it even has a dedicated Blackstone Insurance Solutions group. To earn the float, many firms have been acquiring insurance companies e.g., KKR – Global Atlantic,  Carlyle Group – Fortitude Re, Apollo Global Management – Athene Holding, Blackstone managing parts of AIG portfolios etc. Private equity investments are opaque and long term, and little is known about their private fossil fuel assets financed by insurance money.  

Also, since rating agencies have woefully categorized climate impacts on portfolios many insurance firms are grossly under capitalized against potential future climate related losses. There is very little data from insurers on property claims payouts, claim rates, premium rate increases, rates of non-renewals, claims denial, and systematic regional exits of property insurance markets in climate-impacted areas.

I recommend that insurance companies now beef up their capital structures, optimize their capital and most importantly adjust for potential liabilities. 

How Can Insurance Firms Optimize Required Capital – Asset Risk

ActiveAllocator Research Insights: How Can Insurance Firms Optimize Required Capital – Asset Risk

Using economic capital measures determined for each business and investment category firms can optimize (minimize) their required capital given the firm’s return targets

-Business units (lines of business) that have higher capital requirements with lower return expectations can be reduced or managed for higher returns, e.g., through higher premium rates

-Business units that have higher returns on capital (based upon either lower capital requirements or higher returns) can be targeted for growth using capital released by lower returning businesses

-Investments can similarly be optimized to maximize returns given required capital

Optimizing Insurance Company Capital Needs to Be Ongoing Process

Insurance companies need capital to absorb losses from expected events, unexpected but foreseeable events and unexpected unforeseen events in order to meet their obligations to policyholders and other stakeholders

Insurers protect their policyholders from financial losses associated with risk, including:

Insurance risk – property damage, bodily injury, legal liability, early death, disability, illness and longevity
Volatility risk – the volatility of financial markets and/or the incidence of insurance risk – i.e.,, the unexpected occurrence of foreseeable loss events


Capital Management Involves Four Basic Steps:

Determining Required Capital – how much capital does the company need to survive the risks it has assumed at a selected probability
Optimizing Required Capital – minimize the capital needed to absorb those risks
Funding Required Capital at Optimal Cost – obtain capital at the lowest effective cost to owners
Maintaining Financial Flexibility for Foreseen and Unforeseen Events – have a margin for error that provides the company:
Incremental capital for error in its risk models
Capacity to raise additional capital at reasonable terms when needed

Contingent Hybrid Surplus Note Structure

Insurers are exposed to event risk from a variety of causes:

—Natural Catastrophes – Tornado, hurricane, flood, earthquake, conflagration

—Investment Market Disruptions – credit losses, “flights to quality”, equity market declines, real estate values decline

—Pandemic – death claims, morbidity losses, investment losses, operations risk

 Historically, many insurance companies have responded to such events by raising equity capital after the event – at depressed prices

—None anticipated the specific triggering event, but all recognized the potential for tail events

—All were required to raise capital at highly depressed values in order to survive.

—Many insurers have had to raise equity at depressed values to maintain ratings or even solvency

  —Contingent Capital can provide guaranteed access to capital at a pre-determined price when most needed

Can Catastrophe Bonds be Purposively Included in Strategic Asset Allocation?

2020 had around $16 billion of catastrophe bond and insurance linked-securities issuance. Around $47 billion capital remains outstanding. And No, there were no Covid-19 Cat bonds issued prior to the pandemic! I have concluded that these instruments indeterminate payouts have huge optionality which cannot be correctly modelled and therefore this security is not amenable to purposive inclusion – despite their non correlated characteristics – with the strategic asset allocation process. Certain other insurance linked securities may be, but even those are a stretch and should reside within the realm of tactical and opportunistic play.