Net-zero underwriting in P&C and the growth at stake

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The January publication of the Net-Zero Insurance Alliance (NZIA)1 “target setting protocol” marked a turning point and a step forward for the insurance industry. NZIA members committed to setting and publicly disclosing their first set of underwriting portfolio decarbonization targets by mid-2023,2 giving concrete form to members’ commitments to decarbonize their property and casualty (P&C) underwriting portfolios. According to an initial estimate, staying on the 1.5° pathway will require a 43 percent reduction of underwriting portfolio–enabled emissions by 2030 (compared with a 2019 baseline).3

While progress related to portfolio emissions transparency and target setting varies by geographies and is a popular focus primarily of European insurers and NZIA members, the growth opportunity presented by the net-zero transition is a key strategic priority for insurers around the world. Irrespective of public commitments and geography, those that take early steps toward technologies and sectors that support the net-zero transition are likely to generate a first-mover advantage—just as insurers that built early capabilities in renewable energies are now leading the market.

P&C insurers aspiring to contribute to the net-zero transition need to take a comprehensive approach to sustainability. Underwriters should proactively seize the opportunities resulting from the transition and position themselves as strategic partners to sectors and technologies that support net-zero efforts. Insurers can directly support the net-zero transition through risk transfer, prevention, and mitigation solutions. On top of this, P&C insurers should understand their own underwriting portfolio emissions and evaluate levers to advance decarbonization across industry sectors. Integrating the emissions perspective into underwriting will require substantial upgrades in technical and nontechnical capabilities, additional data, and a cultural shift to establish an additional “emissions perspective” in portfolio management and frontline underwriting decisions.

Focus is shifting toward the decarbonization of P&C underwriting portfolios

To date, P&C insurers have largely focused their efforts on reducing emissions associated with their own business operations (Scopes 1 and 2) and decarbonizing their investment portfolios (Scope 3 financed emissions), which have been the purview of the Net-Zero Asset Owner Alliance (NZAOA).

The growing attention on emissions related to P&C insurers’ underwriting portfolios is a comparatively recent development and has accelerated since the January 2023 launch of the NZIA net-zero target-setting protocol at the World Economic Forum. Under this protocol, NZIA members committed to disclosing emissions in their underwriting portfolios (Scope 3 insurance-associated emissions) by mid-2023 and setting initial concrete decarbonization targets for 2030.4 Members must specify how they plan to achieve sustainable underwriting portfolios—for example, by engaging with their clients or providing more coverage for sustainable technologies, or “sectors.”

While it is unconventional to aggregate the emissions of an insurer across emitting business areas because underlying methodologies vary, doing so emphasizes the real materiality of the underwriting portfolio in achieving net-zero emissions (Exhibit 1). According to our analysis, for a typical P&C insurer, the insurance underwriting portfolio accounts for roughly 50 percent of total emissions (enabled emissions), with the majority coming from retail motor insurance and commercial-lines insurance (30 percent and 15 percent of total enabled emissions, respectively).5 The investment portfolio accounts for the other half of total emissions (financed emissions), while Scopes 1 to 3 emissions from business operations are unavoidable but marginal in comparison (own emissions).

When added up for a complete picture, the materiality of the underwriting portfolio in reaching net-zero emissions becomes transparent.

While the NZIA represents broad industry support for the net-zero transition, nuanced perspectives exist. Some insurers remain skeptical of reducing their exposure to emissions-intensive sectors and question the technical profitability of covering green sectors and technologies. As long as covering high-emissions sectors is profitable, some insurers will act opportunistically by providing coverage to these sectors. Moreover, some insurers perceive that they have less direct influence over their clients’ decarbonization efforts relative to their own financed emissions; shareholders can directly contribute to the company’s overarching strategy, while an asset’s insurance provider can be more easily replaced.

But insurers should not think in absolute terms. Leading P&C insurers are taking a measured approach by engaging with clients and distribution partners to support their decarbonization efforts and transitions; they are also integrating a portfolio emissions perspective to gradually shift their portfolios to low-emissions sectors and green technologies. Consequently, insurers are starting to think consistently about their approach to net zero on both the asset and liability sides. In the long run, establishing a net-zero underwriting strategy today will contribute to combating global warming and will therefore mitigate the severity of physical or natural-catastrophe (NatCat) impacts and strengthen the resilience of underwriting books.

Four steps to net-zero underwriting portfolios

To achieve a net-zero underwriting portfolio by 2050—and any intermediary target—P&C insurers must take four steps: Use the best available data to establish a pragmatic emissions baseline; set granular emissions targets based on a forward-looking perspective; embed the emissions perspective into business processes; and continuously monitor progress and course correct as necessary.

Step 1: Use the best available data to estimate an initial baseline

The biggest challenge to developing an accurate underwriting portfolio emissions baseline is the uncertainty that stems from a lack of historic data. However, data will not become perfect in the short term, and uncertainties will remain, requiring insurers to take a pragmatic approach and leverage the best available data. In November 2022, the Partnership for Carbon Accounting Financials (PCAF6) published standards for assessing emissions in both commercial-lines and retail motor segments.7 Meanwhile, leading P&C insurers also incorporated residential-home-and-property insurance into their baselines,8 applying an emissions-accounting methodology inspired by the one used in retail motor insurance.

In the absence of company-specific emissions data, especially for small and medium-size enterprises (SMEs) and midsize companies, P&C insurers can apply sector averages to estimate an initial emissions baseline for commercial-lines portfolios. One resource is McKinsey’s Planetrics database, which provides average emissions for more than 300 industry sectors, scalable by company size—including a forward-looking view of emissions and revenue trajectories for different transition scenarios (see sidebar, “About McKinsey Planetrics”).

For commercial-lines portfolios, an effort is required to collect data on companies’ emissions and transition plans, which can then gradually replace initial average-based assumptions in calculations. A granular understanding of client-specific emissions is critical to determine the effectiveness of an insurer’s individual decarbonization actions on their own clients’ emissions.

In retail motor insurance, individual-vehicle emissions present a similar challenge: the available data is fragmented, and information rarely exists at the level of kilometers driven per customer. To fill this gap, future underwriting processes should include the collection of customer-specific data on vehicle emissions and kilometers driven. This gradual move from estimated to actual emissions data will allow insurers to effectively measure the effects of their individual decarbonization actions.

Step 2: Set granular emissions targets based on a forward-looking perspective

After establishing an initial emissions baseline, insurers need to set evidence-based, achievable targets for underwriting portfolio emissions. The NZIA estimates that staying within the 1.5° limit specified by the Paris Agreement will require an approximate 43 percent reduction in underwriting portfolio emissions by 2030 (using a 2019 baseline).9

To define their targets, insurers should consider commercial and retail segments separately and break down the overall targets by sector or subsector (for the commercial-lines segment) and by line of business (on the retail side). “Inertia pathways”—projections of business-as-usual emissions in the absence of intervention—can also provide valuable insight into the relevant transition scenarios:

  • For commercial-lines portfolios, sector decarbonization pathways from the Science Based Targets Initiative (SBTi) can serve as references, though most are still in development. McKinsey’s Planetrics transition model is another data source that can support evidenced-based target setting.
  • For retail motor portfolios, reference scenarios can be drawn from external models, including those from the McKinsey Center for Future Mobility10McKinsey Center for Future Mobility,” McKinsey, accessed March 1, 2023. on the projected rise of electrification and the corresponding decarbonization of the vehicle fleet.

When choosing metrics, insurers, like their banking counterparts, tend to prefer emissions intensity metrics based on physical activity, such as emissions per vehicle or emissions per volume of steel produced, in line with the PCAF methodology. In commercial lines, calculating such physical metrics requires additional client data. Economic activity–based emissions intensities—or revenue-based metrics—can provide a temporary solution.

Step 3: Embed the emissions perspective into business processes

It is critical that emissions perspective and decarbonization targets are incorporated into the relevant business processes to shift the portfolio onto a credible net-zero pathway. The objective is threefold: develop a comprehensive understanding of emissions intensity and growth in individual sectors and subsectors and in green technologies; shift the portfolio to more climate-friendly clients; and develop the right insurance products for those clients (in other words, “insuring the transition”).

For example, sales and underwriting teams in commercial-lines units—in collaboration with distribution partners—will need to collect data on their clients’ emissions and physical output (such as production volumes) and discuss decarbonization plans and overarching sustainability and environmental, social, and governance (ESG) strategies with clients. Every step a client takes to reduce their emissions contributes to the insurer’s portfolio emissions targets. When plans involve net-zero-transition technologies such as electricity storage, underwriters must also develop the capabilities to produce individual estimates and risk scenario models for these emerging technologies, which are often prototype-like, given the lack of historical data. Finally, portfolio managers must incorporate the emissions perspective into the portfolio strategy next to profitability, loss history, and capital intensity, which will remain the ruling criteria. Understanding different sectors’ decarbonization pathways—including their growth opportunities and transition risks—will become an important part of portfolio management in the future. Insurers should engage with operational stakeholders such as frontline underwriters, members of the sales team, portfolio managers, agents, and brokers each step of the way.

P&C insurers that can effectively build the right capabilities and business processes will be best positioned to outpace the competition. They will be able to better identify net-zero supporting sectors and green technologies, understand the underlying risks, and win market share with a compelling value proposition and tailored solutions.

Step 4: Continuously monitor progress and course correct

Measuring insurance portfolio emissions on an annual basis is critical to effective decarbonization. This involves continuously tracking progress against targets and determining whether corrective action is required. Insurers can focus on three areas in which to adjust their portfolios if they are falling short of their decarbonization targets.

  • Shift focus within sectors and subsectors. Insurers can rebalance their portfolios to clients that demonstrate a credible path to net-zero emissions.
  • Grow in low-emissions sectors. Insurers can take a forward-looking perspective by proactively focusing growth activities on sectors and subsectors with lower emissions and attractive revenue forecasts that reflect the transition to net-zero emissions (Exhibit 2).
  • Engage with individual clients. Insurers can deepen their understanding of clients’ decarbonization targets and plans and use this to inform coverage decisions. The annual renewal process should include an active discussion of current and future actions to reach decarbonization targets.
Emissions intensity and growth projections for sectors are significantly affected by the net-zero transition.

Growth opportunities from the net-zero transition

The path to net-zero emissions is paved with growth opportunities and value at stake for P&C insurers. On the retail side, this can take the form of tailored coverages for environmentally friendly behaviors, such as those related to e-mobility or green building technology. In the commercial-lines segment, attractive growth opportunities stem from green technologies and industry sectors and subsectors that contribute to the net-zero transition and have rapid decarbonization pathways. Globally, capital expenditure investments of approximately $28 billion will flow toward green sectors by 2030, with the largest share of nearly $16 billion to be invested in clean-energy systems, including carbon capture and storage and wind power technologies (Exhibit 3).11

Significant investments in green sectors offer growth potential at stake for insurers.

Insurers can capture these opportunities in three ways: developing innovative risk transfer products in growth sectors and green technologies, expanding decarbonization advisory services, and pioneering new business models and partnerships beyond the core business.

The path to net-zero emissions is paved with growth opportunities.

New products for risk transfer in growth sectors and green technologies

For commercial-lines P&C insurers, the first step is to identify attractive sectors and green technologies and develop an in-depth understanding of their risks and value chains. These insights can then inform growth priorities for the future.

A primary challenge for insurers is building the relevant technical expertise to underwrite new green technologies such as hydrogen—due, in large part, to the lack of historical data. A first-mover strategy, however, can yield significant returns. Take the wind power sector, for example: In the early 2000s, a few insurers began focusing intensely on wind power and have continued to refine their understanding of the underlying risks. Today, they command a combined market share of more than 30 percent.12

Insurers can strengthen their value propositions in target sectors and technologies with innovative products that provide coverage for the new risks—including supply chain risks in expanding renewable energies, the risk of solar-panel performance loss, or energy price volatility. Alternative risk transfer solutions and passing on risk to capital markets can also help to make these types of risks insurable.

In retail lines, opportunities arise from trends such as e-mobility and building retrofitting, including the installation of green building systems. To participate successfully in these areas, insurers need a comprehensive net-zero value proposition for customers, as well as products with specific commitments and services, such as a completely emissions-free claims process.

Advisory services to support decarbonization

Both private and commercial customers face challenges in reducing their carbon footprints. Insurers that have developed a clear perspective on the relevant decarbonization levers can position themselves as partners to help customers and distribution partners achieve their net-zero aspirations.

  • In retail lines, P&C insurers can provide guidance on residential-building retrofitting and energy efficiency. This type of support is especially relevant after a customer files a claim because insurers can leverage the opportunity to offer their expertise on energy-efficient retrofitting when customers are most likely to need it.
  • Small businesses typically have industry-specific emissions levers. Insurers could develop and scale digital platforms that allow clients to compare their energy costs and emissions against industry averages and could suggest ways to reduce them.
  • For commercial clients, insurers can build on risk engineers’ proximity to clients and their production processes to offer decarbonization risk advisory services. This would strengthen insurers’ value propositions for both clients and sales intermediaries, especially for larger family- or owner-managed companies and the upper-SME segment.

New business models and partnerships

The net-zero transition creates opportunities for insurers to develop new business models beyond the classical insurance model. For example, insurers’ access to customer data enables direct contact with building owners—and, as a result, access to a large number of roofs where solar-energy systems could be installed. P&C insurers can connect these owners to solar-energy companies while also offering insurance products related to the installation and operation of solar-power equipment. For retail motor insurance customers, insurers can provide ways to offset emissions with verified climate-protection solutions. They can also work with commercial clients to develop and test innovative green technologies and support them with both insurance and asset management solutions.

The transition to net-zero underwriting in P&C is accelerating, with lasting risks and opportunities for insurers—regardless of whether or not they are an NZIA member. To stay ahead, they must develop forward-looking decarbonization targets, proactively seize the transition’s growth opportunities, and take a pragmatic approach to calculating underwriting portfolio emissions. This shift will require new capabilities: a perspective on sector and subsector decarbonization pathways and revenues trajectories, as well as an understanding of the new, often prototype-like nature of emerging risks—enabled by a cultural shift in underwriting, sales, and portfolio management. P&C insurers that rise to the challenge will emerge as leaders in the net-zero transition and capture the value at stake.

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