How regulation is adapting to reflect climate risk

The summer of 2023 was the hottest in human history, with extreme weather events ranging from wildfires in North America to flooding in Libya, causing costly damage. Only about a quarter of the damage from extreme weather in Europe is covered by insurance. As climate change leads to more severe weather, increasing both risks and the difficulty of accurately predicting risks, higher premiums could widen the insurance gap.

Insurance can play an important role in managing risks related to climate change by incentivizing investment in risk reduction measures, such as flood defenses or early warning systems. However, if it is to play its full part there needs to be consistent public-private collaboration. In our recent survey of sustainability executives, we found that public policy rivaled technological innovation as the most important driver of climate action – a result that held consistent across sectors and geographies.

The regulatory landscape

National governments have a range of policy levers at their disposal, including carbon prices, taxes, subsidies, guarantees, product standards and procurement requirements. Clear policy objectives and timelines – for example, for phasing out emissions-heavy technologies – can drive innovation and create new markets. Building codes and land use planning requirements can drive developers to account for how risks may change over the expected lifespan of a building.

However, regulatory approaches to the climate crisis are still at an early stage in most jurisdictions. Policy action can be held back by a range of factors, including the rapid pace of evolution in technological approaches, economic shocks such as energy price spikes, and related swings in public opinion about the trade-off between prioritizing cheaper and dirtier technologies in the short-term versus the longer-term climate impact of investing in greener solutions.

Arguably the biggest challenge to effective regulation, however, is the lack of good data. After the Paris Agreement in 2015, when governments made commitments to reduce national emissions, a range of private sector entities and local governments also made their own climate-related pledges. It quickly became clear that in the absence of comprehensive criteria against which to report and assess progress, these commitments brought a high risk of greenwashing and misinformation.

The Task Force on Climate-Related Financial Disclosures, which made its first report in 2017, paved the way toward tackling this problem by providing a framework for reporting. It forms the basis of standards laid out earlier in 2023 by the International Sustainability Standards Board – part of the IFRS standards for accounting – and inspired the Task Force on Nature-related Financial Disclosure, which also made its recommendations this year.

Voluntary frameworks for reporting risks

Experience shows that climate-related reporting standards typically start out as voluntary, then gradually become expected best practice, before some countries finally begin to codify them into law. Jurisdictions that are introducing some form of mandatory reporting account for nearly half of global GDP – including the EU, UK, Japan, China, South Africa, Kenya and India. The new IFRS sustainability standards are expected to be adopted by many countries in the coming years.

As argued by a recent report of a UN-convened expert group, “voluntary commitments can only take us so far,” and a push to translate them into regulation is needed to establish “ground rules for the economy overall.” When reporting frameworks are standardized internationally, they enable like-for-like comparisons across companies, sectors and supply chains, and minimize scope for confusion, loopholes and forum shopping, or moving operations to jurisdictions with lax regulations.

Much more remains to be done, however, to harmonize voluntary frameworks that can be transformed into binding regulations. The UN is working toward clearer standards for emissions pledges to tackle the problem of greenwashing, while the Financial Stability Board is among the organizations calling for additional work to standardize definitions and data sets in areas such as physical risks, transition risks and liability risks.

Beyond high-profile international summits such as COP28, meaningful progress toward aligning regulations is also being driven by sectoral bodies – such as the International Civil Aviation Authority – and groupings of countries. The nations of the G20, for example, have agreed to phase out funding for new coal-powered energy generation, while the EU legally obliges its member states to meet their emissions goals.

The power of regulation

In these multiple and overlapping efforts to push toward realizing the power of regulations to drive progress, public and private actors need to work together to improve understanding of climate-related risks. Insurers offer expertise in risk modeling and scenarios that can help public policymakers to identify priorities. Regulation and insurance together offer the potential for sustainable risk management practices that can further long-term economic stability.

As our Accelerating the Climate Transition report concludes, policy certainty is one of the most critical factors in advancing the net-zero agenda, as well as building the resilience of economies and societies to the changing climate. Clear standards and timelines, aligned through collaboration across borders and industries, create the incentive and impetus for effective climate action.