Financial and insurance companies have driven substantial progress in solutions for understanding, mitigating, and adapting to global warming. Nevertheless, the extent to which sustainable-finance and sustainable-insurance practices will make a meaningful difference in the world's ability to address the climate crisis remains uncertain.
The European Commission defines sustainable finance as the process of considering environmental, social, and governance (ESG) matters while making decisions about financial-sector investing, which results in long-term investments in sustainable economic endeavors. Sustainable insurance refers to insurance practices that incorporate ESG considerations into insurers' risk-management and investing strategies. Sustainable finance and sustainable insurance thus encompass more than just environmental-sustainability issues such as global-warming mitigation, biodiversity preservation, and recycling; social considerations such as diversity, equity, and inclusion are important factors as well. Likewise important are changes to institutions' governance, such as management structures, executive-compensation schemes, ownership structures, and employment policies. Governance changes can help support institutions' environmental- and social-sustainability goals.
Despite ESG considerations' broad focus on areas beyond the environment, most sustainable-finance and -insurance efforts emphasize environmental considerations heavily, while emphasizing social and governance considerations much less strongly. Many reasons exist for this disparity in attention. For example, social and governance considerations are difficult for financial and insurance institutions to quantify; in comparison, environmental considerations are easy to quantify and measure. Overwhelmingly, however, sustainable-finance and -insurance efforts tend to focus on environmental issues because those issues can create enormous opportunities and threats for businesses, governments, and society itself.
Investors and insurers understand that global warming represents a severe and imminent threat to a wide range of financial assets. Effects such as changes in rainfall patterns, flooding, and wildfires could cause catastrophic losses for insurance companies and investors alike. Future limits on greenhouse-gas emissions—and the emergence of low-carbon alternatives for the energy-production, agriculture, and similar industries—could cause many existing financial assets to become stranded. Meanwhile, technology advances and the progress of global warming are making environmentally sustainable assets much more attractive—particularly as long-term investments. Similar logic applies to other types of environmentally sustainable investing, although much greater urgency exists around climate-change-related investments. In addition, growing evidence suggests that addressing social and governance issues produces financial benefits for companies and their stakeholders, but such benefits tend to be much smaller—and much harder to estimate—than are the benefits that can come from a successful focus on environmental issues.
Sustainable finance has become a rapidly growing industry that comprises a wide variety of funds, financial instruments, and financial assets that have a total value in the tens of trillions of dollars. Growth has been so extensive that analysts estimate that as much as a third of all global assets under management will have an ESG focus by 2025. Among other growth drivers, concerns about climate change and social inequality have motivated investors to gravitate toward ESG‑focused funds and to divest from companies and assets that have negative ESG‑related reputations. Companies have thus been instituting ESG practices to preserve their attractiveness to investors, and financial institutions have created many ESG‑focused investment vehicles to capture investors' demand.
In addition, government regulators and financial-exchange operators have been mandating that companies disclose climate-related risks, greenhouse-gas emissions, and other environment-related risk factors. Beginning mostly in Europe, such mandates have become increasingly specific, encompassed a broad array of ESG factors, and spread to jurisdictions such as the United States. Companies have invested in their ESG practices to comply with regulations, and financial institutions have needed to invest in solutions for measuring and verifying ESG performance to establish their investments' ESG qualifications.
Insurance companies are major investors and thus have motivations to adopt ESG‑investing strategies. Property and casualty insurers have increasing exposure to losses that could come from climate disasters, and these losses can be vastly larger than the kinds of losses that the insurance industry has had to deal with in the past. Insurers have thus been investing in advanced technologies for predicting climate impacts and changing the types of assets that they will insure. The growing difficulty of insuring certain assets is becoming a major driver of climate-resilience and climate-adaptation solutions.
ESG considerations will almost certainly continue to proliferate among organizations, and ESG investing will likewise continue to increase rapidly. However, various factors will likely prevent sustainable-finance and -insurance practices from achieving the type of scale, scope, and speed necessary to avoid harmful impacts from global warming. Nonetheless, potential developments could produce a better—or worse—outcome. Some examples of such developments follow:
- Emergence of a global consensus about ESG‑related financial-disclosure regulations, standards, and practices. Despite being increasingly commonplace, ESG‑related investments also tend to be frustratingly opaque. Investors frequently complain that institutions fail to provide enough specific and reliable information to substantiate ESG compliance and that disclosure frameworks are confusing and inconsistent. Improvements in ESG‑disclosure requirements could help investors obtain better information, but they could also slow growth rates of ESG investment by making institutions' qualifying for ESG status more difficult.
- Substantial advance of technology for climate-related measurement, modeling, reporting, and disclosures. Current technologies limit institutions' abilities to assess climate risks accurately—especially the climate risks that arise from institutions' downstream value-chain partners and from the uses of the products and services that institutions might offer the market. Technology improvements could allow for more-accurate and more-comprehensive measurement at a lower cost. Improved technologies could also convince institutional leaders that they should make more aggressive investments in solutions to global warming.
- Nationalization or privatization of climate risk. Insurers' ability to drive climate-change adaptation depends largely on policy makers' decisions about insurance regulations and publicly funded insurance programs. For example, a state-funded insurance system could continue to insure buildings in areas that are at enormous risk of experiencing climate-related disasters, even after private insurance companies cease offering coverage.