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Bridging the climate-nature nexus in income strategies

Focus on insurance

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Insurers and reinsurers are finding themselves at the intersection of climate change and biodiversity. Just as they have weaved climate considerations into their enterprise risk management processes, the importance of mitigating biodiversity loss emerges as a natural extension of these efforts. The relationship between climate change and biodiversity is becoming increasingly evident. It is a two-way street in which addressing one could help manage the other. This demands a more nuanced approach from (re)insurers seeking to decarbonise their portfolios. Beyond carbon emissions, they should also consider their biodiversity footprint.

From an asset allocation perspective, (re)insurers traditionally hold substantially more debt than equity instruments in their investment portfolios (see below chart). Therefore, it is vital to understand the changing dynamics where biodiversity risks and opportunities are evolving in the bond market. Furthermore, these factors are becoming increasingly material to both sides of the balance sheets for (re)insurers.

Average asset allocation for (re)insurers in the European Economic Area

Average asset allocation for (re)insurers in the European Economic Area

Source: EIOPA, data as of March 31, 2023. Note: Investment funds include pooled funds that focus on debt, equity, asset allocation, cash, private equity, real estate, infrastructure, and other asset classes.

Measuring biodiversity-related impact

To effectively address nature loss, (re)insurers must understand the synergies and potential trade-offs associated with the climate-nature nexus. Crucially, nature and net zero strategies should complement and reinforce one another. Misalignment of investment decisions with nature-related regulatory, technological, legal and consumer trends can negatively affect the return expectations from their portfolios due to mispriced risks. 

Compared to climate change, assessing exposure to biodiversity impacts and dependencies is far more challenging. When decarbonising a fixed-income portfolio, carbon emissions can serve as a relevant, comparable, and reliable global metric. There is no equivalent metric when gauging a portfolio’s biodiversity footprint. Additionally, the effects on issuers are not equal. Some sectors are more influenced by biodiversity than others (see below chart).

Potential biodiversity impact, by sector

Potential biodiversity impact, by sector

Source: Finance for Biodiversity Foundation, April 2023. Note: The data are calculated based on 250 listed companies of the MSCI World Index.

Why biodiversity matters

Around the world, about half of the global gross domestic product (GDP) - or about $44 trillion in economic value generation - is moderately or highly dependent on nature. Therefore, failure to mitigate and reverse ecological degradation affects economic growth. As demonstrated in the chart below, environmental factors can result in transition and physical risks that flow through the economy.

In addition to its vital role in economic stability, nature also acts as a defence against climate change. An imbalance in climate dynamics can disrupt ecosystems. For example, climate change is increasingly exacerbating nature loss. Other drivers of nature loss include an increase in invasive species, pollution, over-exploitation of natural resources, and change in land use. The negative feedback loop accelerates nature’s continued decline. It undermines society’s ability to achieve the goals of the Paris Agreement, which is to keep global average temperature increases at 1.5°C and well below 2.0°C relative to pre-industrial levels.

How drivers of nature loss can lead to financial instability

How drivers of nature loss can lead to financial instability

Source: Association of British Insurers (ABI), based on information from the Cambridge Institute for Sustainability Leadership Handbook for Nature-related Financial Risks, July 2023.

(Re)insurers already face direct nature-related risks in their underwriting activities. The next step is to manage the indirect nature-related physical and transition risks in their investment portfolios. The task will vary, depending on the products on offer and the risk encountered in the balance sheet. In general, the longer investment time horizon reflects a higher exposure to nature-related risks, so more rigorous management of material nature-related risks may be required. Certain approaches, including thematic strategies, can help mitigate those risks within an investment portfolio. 

By using existing tools and data, (re)insurers can better understand the effects of their investment decisions on contributing to - or mitigating - nature loss. The choice will have long-term consequences on both their investment portfolios and the environment.

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