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09 Jun INSIGHTS | How insurance can contribute to a sustainable economy: the case of China [Part 2]
Green insurance is an important component of China’s green finance. Chinese government and regulators have published a series of policies to guide the development of green insurance and build a comprehensive green insurance system. By 2020, the total premium of green insurance in China amounted to RMB18.3tr. As the market is still at an early stage of development, there are opportunities to learn from green insurance models from more advanced markets overseas.
Part 1 of this article presented an overview of green insurance and its development in China. This article will focus on the green insurance industry worldwide and draw lessons for the development of the Chinese green insurance market.
Global Green Insurance Practice: Examples
Countries worldwide have developed different modes of green insurance systems, which can be generally categorized into compulsory insurance and voluntary insurance. Compulsory green insurance is a type of environmental insurance that a government urges enterprises to purchase through legislative enforcement, while voluntary green insurance is a green insurance product purchased on a discretionary basis by an entity with less intervention from the government.
Compulsory Insurance Model: The United States
The US has developed a mature green insurance market over the past half century. In 1976, the Resource Conservation and Recovery Act (RCRA) marked the start of the US compulsory insurance model. The RCRA expected a compulsory finance system for liability for environmental damages from toxic wastes. To keep up with the RCRA, US insurance firms began to offer environment-related insurance separate from public liability insurance. The RCRA also defined environmental pollution caused by toxic waste and tighten the corresponding management standards and penalties. As a result, all companies exposed to liabilities from toxic waste pollution had to purchase independent new insurance to transfer their environmental risks and risks of penalty. In 1980, the US policymakers issued the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). The Act determined the liabilities of each party in breach of environmental laws. Consequently, the Hazardous Substance Response Trust Fund was launched in response to the CERCLA to lower the premium of green insurance, which encouraged more parties to invest in green insurance.
In summary, compulsory insurance in the US has three characteristics: First, comprehensive legislation clearly defines environmental liabilities and further promotes the development of compulsory insurance. Second, the governmental fund reduces the premium of environmental liability insurance, which encourages enterprises to actively seek risk transfer means to reduce their environmental risks. Third, the government spending set up special policy insurance institutions that are government-controlled and non-profit-driven.
Compulsory + Voluntary Insurance Model: The United Kingdom and France
In 1974, the London insurance market traded the first insurance contract for one-off, repetitive, or continuous environmental incidents for voluntary enrollment. This started the development of the UK green insurance market. Similarly, France began to offer similar insurance in 1977. As members of the International Convention on Civil Liability for Compensation for Oil Pollution Damage, the UK and France both require companies to implement compulsory insurance only when they are either already or likely to be involved in marine oil pollution incidents. In addition to marine oil pollution risks, the UK also mandates compulsory insurance for nuclear reactor accident liability.
The UK and France have both adopted a combination of voluntary and compulsory insurance. This model provides entities with flexibility because the insured company can manage its plans based on its environmental risks, unless the entity is exposed to risks from significant environmental incidents, such as marine oil pollution in the case of France and the UK, and nuclear incidents in the UK.
Global Initiatives for Green Insurance Development
The Principles for Sustainable Insurance (PSI) was launched in 2012 to help the insurance sector deal with ESG risks and opportunities by setting globally recognized standards. In 2020, the PSI initiative published its first guide for global insurance companies to integrate ESG risks and climate change into their insurance underwriting.
Launched in 2016, the Sustainable Insurance Forum (SIF) is a global network for insurance supervisors and regulators to work on climate-related issues. In 2018, it recognized the impact of climate change on insurers from regulators‘ perspectives and helped insurers adopt the TCFD framework in 2020.
The Net-Zero Insurance Alliance was launched at the G20 Climate Summit in 2021, by eight insurance and reinsurance giants worldwide. It promised to embrace more insurers in the green transition and fulfill the net-zero commitment under the head companies’ lead.
Lessons for China’s Green Insurance Development
From a legislative standpoint, explicit and compulsory requirements for environmental pollution liability are key to the implementation of green insurance. In this regard, there are currently two shortcomings in China’s legal system for the insurance industry. One is that relevant policies in China are mainly in a form of official guidelines, which provide high-level instructions and delegate the legislative responsibilities down to local authorities. However, national-level laws are normally used as key references in court. The absence of national law on liabilities from environmental violations may lead to a lack of a coherent baseline when dealing with environmental breaches across the country. The other problem is that inadequate law enforcement for environmental law violations has led to the low cost of environmental liabilities and weakened corporate willingness to participate in environmental pollution liability insurance. According to Greenpeace, less than 5% of all industrial companies use environmental liability insurance. Therefore, the improvement of the law is vital to the development and expansion of green insurance in China.
For the insurance industry, industry associations can seek strategic partnerships with the government. Insurance providers are encouraged to utilize financial incentives when available, in order to reduce the insurance price and attract more clients. Research from Belozyorov, S. and Xie, X. in 2021 showed the positive outcomes of such partnership, finding that government funding for pollution insurance contributes to an overall expansion in green insurance adoption, and the scale of green insurance is positively correlated to the national GDP. On the other hand, insurance firms and associations may promote the idea of green insurance to their client base and encourage them to invest in green insurance through initiatives, workshops, and public outreach.
Digitalization, innovation, and globalization are three steps for insurance companies toward greener development. Digitalization pushes insurance companies to establish green insurance databases and analyze potential demand with the help of advanced technologies such as big data, artificial intelligence, cloud computing, and the Internet of Things. With upgraded technologies, insurance firms will be able to evaluate risks and price insurance contracts more accurately. Insurance companies should also innovate and develop more green products, as the current market share of green insurance products remains small and great potential demand needs to be met. Lastly, Chinese insurance firms should embrace globally aligned strategies and actively participate in global green insurance initiatives. Currently, only 4 out of 121 PSI signatory companies are Chinese insurance companies. Moreover, in compliance with globally recognized standards and guidance, the Chinese insurance sector can show its global responsibilities in the net-zero transition via transparent insurance reporting and ESG integration.