Assessing the impact of climate policies on equity risk under sustainable insurance: Cap-and-trade regulation, energy-saving technology subsidies, and carbon tariffs

Abstract

The paper presents a capped-call option framework for climate policies, highlighting cap-and-trade regulation, energy-saving technology subsidies, and carbon tariffs. It involves a life insurer providing green finance to a carbon-intensive manufacturer, examining their procurement of carbon allowances and export activities under cap-and-trade and carbon tariff systems, respectively. The main results reveal that manufacturer exports increase manufacturer equity risk, while stricter cap policies partially mitigate this effect, especially with higher carbon tariffs. Conversely, elevated carbon tariffs directly amplify manufacturer equity risk, but this is alleviated somewhat by a stricter cap-and-trade system. Energy-saving technology subsidies reduce manufacturer equity risk. Higher exports are associated with reduced insurer equity, while a stricter cap-and-trade regime enhances insurer equity, particularly with higher carbon tariffs. Carbon tariffs positively impact insurer equity, whereas subsidies for energy-saving technology for manufacturers have a negative effect. In the paper, the integration of both mechanisms within a capped-call option framework can advance sustainability efforts and help mitigate financial risks for the carbon manufacturer and the fund-providing insurer. This alignment corresponds with the objectives of environmental responsibility and economic stability in the face of climate change challenges.