At a glance
- This blog, focused on insurance brokers’ wholesale operations, builds on a series of reports issued by Deloitte’s EMEA Centre for Regulatory Strategy on the key climate-related regulatory considerations for different financial services sectors, including insurance, banking and asset management.
- Brokers’ wholesale operations are exposed to financial risks from climate change in a number of ways, with transition risk of particular concern given brokers’ important role as intermediaries in facilitating the transition to a zero-carbon economy.
- As a result, some brokers will have to consider changing their business models to take account of the risks and opportunities posed by climate change and the global transition to net zero carbon emissions, while at the same time disclosing their climate strategies through various disclosure initiatives to manage reputational and regulatory risks.
Who should read this blog? Executives and non-executives working across the strategy, risk, regulatory affairs, sustainability and compliance functions in the wholesale (re)insurance broker market, but also across the wider insurance industry, including (re)insurance companies, retail brokers and intermediaries.
Reading time: 10 minutes
The regulatory and customer expectations on insurers are changing – brokers need to change, too
As the insurance landscape changes due to growing regulatory pressures on climate change, insurance brokers need to change and adapt to this “new normal” too. Brokers find themselves in a unique position whereby they are both affected by climate-related regulatory expectations for insurers given their roles as intermediaries, and at the same time, facing increasing scrutiny of their own management and disclosure of climate risk exposures.
This blog focuses on the specialty wholesale insurance broking market in particular. This forms an integral part of the London Insurance Market, which accounted for approximately $110bn of Gross Written Premium in 2018. In our view, this segment of the broker market is particularly exposed to climate change given its reliance on traditional property and casualty (P&C) business, lines of business that are among those most affected by climate change.
Below, we highlight how brokers are exposed to climate change, both directly via their own business models and indirectly through their association with insurers, what we think are the key considerations for them in relation to this topic, and what actions they can take to anticipate and respond to questions by regulators.
How are brokers exposed to climate change?
Insurance brokers are exposed to financial risks from climate change in a number of ways. Understanding the extent of exposure, the level of potential future regulatory scrutiny and the scope of the exercise will be key, and will require significant cross-border coordination and engagement, in particular if operating across different jurisdictions with varying degrees of regulatory expectation and policy maturity with regard to climate change. We have identified the following broad categories of impact that we think are the most acute for wholesale brokers in the context of climate change.
- Transition and product risk
As the main conduit through which businesses buy insurance, wholesale brokers are potentially materially affected by transition risk in particular. The risks for which their clients will seek cover will change over time as their risk profiles and insurance needs change - some coverages may simply become obsolete, while some new risks will require new products. In this context, brokers face both risks and opportunities; while some current business models may be over-reliant on carbon-intensive industries as clients, they may also find new clients as the carbon transition continues.
Specialist wholesale brokers in carbon-intensive sectors such as energy and shipping could, in particular, be significantly affected by climate transition risk, with marine, aviation and transport, energy and motor representing 15% of total Gross Written Premium (GWP) at Lloyd’s of London These sectors are likely to change significantly as the world transitions to a low-carbon economy, and could lead to reduced premium income for those who rely extensively on clients in this industry.
Insurance products themselves could also be affected by physical, transition, or liability risks related to climate change. Climate change could affect the price of insurance – for example, in an extreme scenario, certain commercial properties may become “uninsurable” due to the increased underlying physical risks, and therefore impossible to rent or buy. If these scenarios become widespread and lead to a shrinking addressable market, brokers’ bottom lines could be affected. Brokers need to work with insurers to understand what they are doing to adapt insurance products to the changing climate, and how this will affect their clients.
What’s more, the interpretation of the scope of existing insurance coverages may change as a result of climate change. For example, liability-type policies that were not originally designed to include climate-related risks may be seen to cover climate risks in the absence of explicit exclusion clauses. Brokers need to work with clients to understand any changes in risk profile, assess the coverage of current insurance policies, and identify products to transfer new risks where necessary. Brokers should also work with insurers to identify new commercial opportunities to create products to cover these risks. The concept of “parametric insurance”, for example, is a new innovative solution where the insurance policy provides cover for the probability of a predefined event occurring, and pays out according to this predefined scheme.
- New commercial opportunities
Meanwhile, many insurers are announcing plans to stop providing insurance to certain non-sustainable sectors and activities. The Lloyd’s of London market, for example, has announced its aims to phase out insurance coverage provided by Lloyd’s managing agents for thermal coal-fired power plants, thermal coal mines, oil sands and new Arctic energy exploration activities by 2022 (new insurance covers) and 2030. This also applies to companies with business models which derive at least 30% of their revenues from these activities from January 2030. As the intermediary between insurance companies and their clients, brokers need to adapt and form new relationships to sustain revenue streams while also protecting their own reputations.
Here, we also see significant opportunities for brokers, who may increasingly be asked to perform due diligence on their clients to make sure they fulfil certain criteria set out by insurers. Brokers could, for example, have a role in verifying that clients do not invest in coal, or are taking steps to reduce its impact on the climate, in order to be allowed to purchase a specific insurance policy. On the flipside, brokers could also advise clients on how to diversify as an organisation in order to fulfil some of these criteria set by insurers that will become more and more prevalent. Brokers who want to get ahead of the curve should map out the key criteria set out by relevant insurers, and then approach clients to discuss how to best meet these within a given timeframe.
To enhance their understanding of clients’ risks and exposures, brokers could perform their own risk and catastrophe modelling (indeed, the most advanced reinsurance brokers already do this), and partner with weather analytics and other fintech firms to provide real-time risk monitoring. By doing this, brokers can play an important role in giving independent advice to commercial and retail clients on how to undertake the transition away from carbon and how to minimise the impact of climate change throughout the different stages of transition.
What are the key regulatory concerns?
Based on the two categories of impact as outlined above, we have identified three key regulatory concerns and risk areas that we think will be most pertinent to wholesale broking operations. These relate to greenwashing, financial adequacy, and disclosure/reputational risks.
- Greenwashing is high on the regulatory agenda
The risks associated with greenwashing remain high on the regulatory agenda, and are particularly pertinent in the retail insurance broker model. But greenwashing is also relevant for wholesale brokers – for example, if a wholesale broker markets an insurance cover as “green” and consistent with a commercial clients’ sustainability objectives, when in reality it is not, this also constitutes greenwashing. Additionally, brokers, or indeed the firms they work with, may market their overall operations and activities as “green” and sustainable when in reality they are not.
To demonstrate that reasonable steps have been taken to prevent greenwashing, brokers should invest time and resource in product and insurer due diligence to understand the intricacies of the “green” insurance products and any associated policyholder incentives, or risks. These should in turn be communicated clearly to the end-consumer, both in the relevant contract documentation and any face to face conversations.
- Climate risks to financial and operational resilience
Insurance brokers are not subject to the same prudential regime as banks and insurers. Climate change may, however, nonetheless be relevant to brokers’ assessments of the adequacy of their financial resources, particularly given the FCA’s recent finalised guidance on assessing adequate financial resources (FG 20/1). The FCA expects firms to assess the potential depletion of financial resources or inability to convert assets into “cash” in a timely manner, under adverse circumstances. This includes, for example, losses arising from failure of clients or counterparties to transactions in financial instruments, change in the value of positions in financial instruments, and being unable to convert different types of resources into available “cash”.
Similarly, brokers may have to take into account the regulatory risks that could emerge from the operational risks presented by climate change. Physical climatic events such as flooding, storms or heatwaves, could prevent brokers from performing key reconciliation or segregation processes within the tight regulatory timeframes, particularly if these are outsourced to regions with increased risk of such events occurring.
Insurance brokers who rely on carbon-intensive industries as clients and/or are exposed to potential supply chain risks through, for example, third party providers based in high-risk areas, may therefore want to explore their potential capital and operational exposures to transition risk in more depth. They could, for example, explore how results of relevant insurance stress tests and scenario analysis would affect their own business model. Industry-wide insurance stress tests are likely to provide useful starting points or benchmarks for brokers stressing their financial and operational exposures to climate risks.
Additionally, brokers may want to explore the extent of financial and operational risks from climate change posed to some of their key counterparties, including for example banks that hold their client money. The FCA’s Client Assets Sourcebook (CASS), requires firms, when considering where to place client money, to consider taking into account, among other things, the capital of the bank, the credit rating of the bank, and the level of risk in the investment and loan activities undertaken by the bank and its affiliated companies. Brokers who wish to hold client money as designated investments are also required to consider whether these are held in line with an appropriate credit and liquidity strategy. In both instances, banks’ climate-related disclosures could provide information to help brokers manage credit risks more effectively.
- Disclosure – the reputational risks are material
Climate-related financial disclosures remain top of regulators’ minds and one of the few areas where regulators have been outspoken in relation to the broker market. The FCA has stated that “[l]arge commercial insurers, Lloyd’s and the broker market along with reinsurers may be (…) directly contributing to climate change risk and so should be working toward disclosing how they are understanding, managing and responding to both risk and opportunity”. The FCA has also stressed that brokers should “disclose what they are doing to start to develop a longer term modelled view of how physical risks but also transition and litigation risks might affect their businesses in the face of a successful or unsuccessful transition to a net zero carbon economy by 2050.”
Though many of the disclosure initiatives are currently not mandated by regulators, there are potentially reputational risks for firms who do not comply with them, even on a voluntary basis. Brokers should therefore consider signing up to some of these as they develop their climate change strategies, as a means of holding themselves accountable to tangible goals and responding to growing regulatory pressures and client demand for “green” products and services.
Brokers could also guard against reputational or credit risk by establishing processes to interpret climate-related disclosures by third parties as part of the client take-on process. They could, for example, consider insurers’ climate disclosures as part of Terms of Business Agreements (TOBAs), and as part of ongoing monitoring to ensure they are recommending the right product for clients.
Although climate change poses a number of important risks for brokers to consider, including greenwashing, operational and financial resilience, and wider reputational risks from failing to disclose climate risks, it also creates many commercial opportunities. Most importantly, brokers should consider expanding their advisory role to include climate-related due diligence, and work collaboratively with insurers to invent new products to close the climate protection gap.
 Other types of brokers, including e.g. retail (most global brokers will have both retail and wholesale operations), life, pensions brokers or Managing General Agents (MGAs) are also potentially materially affected by climate change. Retail brokers may find our report on Climate change and asset management useful.
 Marine, aviation & transport, energy and motor represented 15% of total GWP at Lloyd’s of London in 2019: https://s3.eu-west-2.amazonaws.com/uploads-7e3kk3/31276/annualreport_2019_full_v41.1383287c4587.pdf
 https://www.handbook.fca.org.uk/handbook/CASS/5/?view=chapter. CASS 5.5.45G
 https://www.handbook.fca.org.uk/handbook/CASS/5/?view=chapter. CASS 5.5.14R and CASS 5 Annex 1 R
"Brokers find themselves in a unique position whereby they are both affected by climate-related regulatory expectations for insurers given their roles as intermediaries, and at the same time, facing increasing scrutiny of their own management and disclosure of climate risk exposures."