The author is a member of Public Voices of the OpEd Project and the Yale Climate Change Communication Program.
Four powerful men at the heads of the world’s biggest tech companies sat outside Congress last month for a six-hour grilling on how they chased and protected their dominance. In the not-so-distant future, a similar hearing could be held with insurance company executives on their knowledge of climate change and what little they have done to encourage solutions.
Insurers should not bear such a burden on their own, but they should lead by example in carbon mitigation. And it doesn’t have to be a financial burden. Changes to existing financial instruments can have a significant impact. Take covenants – financial tools used by lenders to impose additional conditions on borrowers. Although they usually deal with financial matters, there is nothing to say that they owe. Why not use them as a climate change mitigation tool?
In fact, there is already an example of this. Last year, Italian utility company Enel issued the first general purpose bond linked to the SDGs. In plain language, this means that the company issued a bond for its regular financing needs (not specific to a particular project) that was linked to Enel’s goal of advancing the United Nations Sustainable Development Goals.
The bond received $ 4 billion in orders for a $ 1.5 billion issue, of which 70% went to investors focused on environmental, social and governance issues. The covenants tied the coupon to the target of making 55% of the total installed capacity of the renewable energy company by the end of 2021. If this target is not met (as reported by an independent auditor ), the interest on the bond increases by 25 basis points.
The UN hailed the first such SDG link. Some bankers have risked making this the new industry standard. So far, no one has followed suit. But given that we are in the midst of a pandemic, it is too early to say that this format will fail.
This new contract linked to a target should be used in particular in catastrophe bonds. Cat bonds are, in effect, insurance policies against climate change, bought by governments, insurance companies and reinsurance companies. In the event of a natural disaster, the proceeds are paid to the borrower and interest payments are waived, along with the principal. If there is no natural disaster, the borrower pays interest and principal as scheduled, as with regular bonds.
Catastrophe bonds have become more popular as the cost and frequency of weather catastrophes increase. According to insurance broker Aon, there were 409 natural disasters in 2019, totaling losses of $ 232 billion, of which only $ 71 billion was insured. Cat bonds are the only source of catastrophe protection for the reinsurance industry and are attracting interest from sovereign issuers as more developing countries face rising weather costs.
Reinsurer Swiss Re estimates that while advanced economies cover 35 percent of their estimated catastrophe risks, the figure is only 6 percent for emerging economies. It is a market with enormous needs to be met. As the demand for catalytic bonds increases, the requirements on issuers are also expected to increase. Insurance companies that purchase this type of protection know better than anyone the scale of the economic and human costs of future disasters. They need to show leadership in risk mitigation.
ESG investors should adopt this format as they did with Enel’s SDG obligation. Their goals would be achieved by requiring a reduction in the carbon footprint as a prerequisite for the issuer’s eligibility to receive the funds in the event of a disaster triggered by a disaster.
The conditions are to be negotiated. The issuer may not reverse the principal if it does not meet the target. The level of carbon footprint reduction that it is reasonable to demand is also debated. Such details are of course not trivial. But it’s time to let the negotiations begin.
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