Climate change and insurance — an economist's lens on the transition to net zero

When considering the words, “climate change”, insurers naturally think about how to appropriately provide cover and set prices in response to and in preparation for adverse weather events.

However, climate change drives a range of risks beyond the physical. Specifically, insurers need to consider "transition risk" — the potential disruption to our economy as we transition to net-zero emissions by 2050. What are the implications of this transition to insurers? And what role can economists play in helping insurers navigate the evolving landscape?

Transitioning to net-zero

The recent Cop28 conference has served to emphasise that globally, there is an urgent and concerted effort towards emissions reduction.

To play its part, the Australian government is aiming for significant cuts by 2030 and net-zero emissions by 2050. As such, we are seeing the implementation of broad-ranging policy, for example, the Safeguard Mechanism [1], to facilitate meeting these targets.

The implications of such policy for the economy will depend on the specifically measured industry investments and commitments, the availability of technologies, changes in consumer preferences, and incentives and regulations implemented by governments.

While the conversation at Cop28 highlighted the urgency to transition, it also shone a light on the associated uncertainty. The complexity surrounding net-zero transition pathways poses economic and societal impacts that stand to affect insurers significantly at various levels.

Inflation to balance supply against demand

Today, inflation is top of mind for most insurers as they try to contain costs and their customers’ buying patterns are impacted by affordability and cost of living pressures — and this is set to be a concern for some time.

Fossil fuels account for over half of Australia’s total energy exports and a third of the value of exports overall. However, with many of Australia’s partners also committing to emission reductions, it is expected that fossil fuels will play a much smaller role in future energy generation internationally.

This will affect not only our mining and transportation sectors but also tax revenue for the government and the value of the Australian dollar. It will increase the prices of all imported goods as well as pressure on inflation and the cost of living.

The phasing out of carbon-intensive production processes may also temporarily reduce the availability of high carbon goods, such as steel and cement, which could put additional upward pressure on prices and inflation. As it stands, energy prices have a sizeable direct impact on inflation.

Meanwhile, the increasing uptake of renewable energy and new technologies may also contribute to inflation, driven by shocks to electricity prices as these technologies and energy sources replace existing ones.

Industry and employment

As fossil fuels phase out, sectors like mining, energy production, manufacturing and construction will undergo substantial transformation, and the composition of the workforce will change dramatically. This will exacerbate trends such as automation, that between 2012 and 2021 reduced coal mining employment by 17per cent.

As some jobs become obsolete, there will be a host of new skill sets required to support emerging processes, products and technologies. The transition from a fossil fuel, high carbon economy to a renewable, net zero economy therefore, presents a high degree of employment volatility.

Investing in transition

Despite the economic risks, investing in a greener economy offers significant opportunities. For example, the Government’s Capacity Investment Scheme [2] commits $10 billion in new investment and 6GW of renewable energy installed capacity and storage.

The government has also committed $25 billion to its Powering Australia [3] plan to deliver climate change and energy transformation priorities. Additionally, the Clean Energy Council has called for a $100b investment for the next ten years. These investments have the potential to act as a boon to the economy.

Furthermore, as mining for fossil fuels in Australia sunsets, demand for the minerals necessary for renewable energy production is set to increase. Australia’s geology is rich in these natural resources — for example, copper, lithium, cobalt, zinc and lead represent substantial opportunity for the Australian economy.

Changing the face of insurance

In addition to the broader economic impacts of the transition to net zero, the changing economy presents more direct implications for insurers. The businesses, products, assets and processes that comprise the modern economy will change to accommodate net-zero, necessitating innovation and evolution across insurance sectors.

For example, how and where people are employed will change in response to transition, and the emergence of new risks and claim types will affect workers' compensation and other insurance products.

Similarly, changing methodologies and materials associated with construction and manufacturing represent multifaceted considerations across motor and property insurance.

The economist's role

Insurers must proactively adapt to the challenges and opportunities presented by the transition to a low-carbon economy.

Economists emerge as key players in this transition, providing insights into the macroeconomic prospects, workforce impacts, and key risk exposures for insurers.

Their sophisticated modeling and hands-on interaction with policy formation can provide insurers with a deep understanding of the evolving economic landscape, helping drive evidence-based, informed decisions.