Climate Risk, Reinsurance Dependence and Insurer Profitability in Pakistan: Evidence from Listed Insurance and Takaful Firms

Abstract

Insurers balance their sheets due to the asset-liability risk of climate change, arising from portfolio repricing for transition on the liability side of the insurance business. The study employs an unbalanced panel of 18 listed conventional insurance and Takaful (Islamic Insurance) companies in Pakistan for the period 2013-2024 to examine the impact of physical and transition climate risks on the profitability of insurance companies. The study adjusts for unobserved factors that might affect estimates by using models that include time- and firm-fixed effects and reinsurance-channel tests. The study reveals that transition risk statistically significantly negatively affects return on equity and return on assets, and it has a substantial influence. When one-year reporting and settlement lags are added, contemporaneous physical risk is weaker but remains negative and significant. This addition implies that smaller insurance companies face greater transition risk shocks than larger ones, suggesting that capital buffers and diversification increase climate risk resilience. The level of mediation evidence is lower than seen in recent Chinese studies, suggesting that insurance companies may be able to skew risk transfer through this channel, but the results for reinsurance make sense. Finally, the paper also adds to the literature on climate finance/insurance risks by examining an emerging, climate-vulnerable market in Pakistan. These governance arrangements also have regulatory implications for the disclosure of climate risk, stress testing, reinsurance strategy and capital adequacy supervision.

Keywords: Climate Change, Insurance Profitability, Pakistan, Transition Risk, Physical Risk, Reinsurance Profit Drain, Econometric Analysis.