Climate change and related risks have truly significant implications for underwriting, investment, and even an insurer’s operational activities.
Ever since the formation of the Taskforce on Climate-related Disclosures (TCFD) in 2015 and the publication of their first set of recommendations 2 years later, there has been rapid and significant buy-in from organisations across the financial services spectrum.
This is as it should be — climate change risks are increasingly recognised as one of the key issues facing economies and communities today. Climate risks have been identified by the World Economic Forum as the top threat facing us for the past 4 years consecutively, with WEF recently making the critical observation that “climate change is striking harder and more rapidly than many expected”. COVID-19 highlights that natural processes can create previously unimaginable economic and social disruption, whether abruptly or cumulatively.
Action is gathering momentum. Some major institutional investors, for example, are making bold moves. BlackRock CEO Larry Fink has put climate change at the centre of his firm’s investment strategy1, while Goldman Sachs has pledged US$1 trillion of financing and investment in areas that focus on climate2.
Today, more than 900 organisations support the TCFD publicly, with the recommendations becoming the global standard for climate-related disclosures. The rationale is clear. As TCFD chair Michael Bloomberg put it, “increasing transparency makes markets more efficient, and economies more stable and resilient".3
The TCFD recommendations consist of four pillars — Governance, Strategy, Risk Management, and Metrics & Targets — with suggested disclosures against each one. There isn’t space to go into detail on each of these here, but suffice to say they pack a punch.
Take this 22-word recommendation in the Strategy pillar: “Describe the resilience of the organisation’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario”. This arguably represents the most complex disclosure recommendation ever made. For example, with no historical data to reference against, no commonly agreed set of climate scenarios/pathways nor consistency in methodologies for the assessment and quantification of climate-related impacts (e.g. how to integrate climate science, macroeconomic and actuarial models) fulfilling this requirement poses a huge challenge. Again, COVID-19 will provide relevant reference points for assessing a sustained decline in the global economy.
Today, more than 900 organisations support the TCFD publicly, with the recommendations becoming the global standard for climate-related disclosures.
Clearly, insurers recognise that climate change and related risks have truly significant implications for their underwriting, investment, and even operational activities. The TCFD recommendations mean that all categories of insurers have issues that they need to grapple with and resolve.
Of note, the TCFD also provides supplemental guidance for insurance companies and asset owners that will need to be taken into account.
Then there is the investment side. Insurance companies are major institutional investors in their own right. While there is no prescription in the TCFD recommendations on what stocks or activities it is acceptable to invest in, there is supplemental guidance under the Metrics & Targets pillar for asset owners to disclose the carbon footprint of their investment portfolios. Although the TCFD acknowledges that a carbon footprint does not necessarily represent a risk measure, and is subject to various data and methodology constraints, such disclosures could inevitably lead to a greater focus and increased questioning on whether an institutional investor is putting its money behind green and sustainable businesses and enterprises.
So, where does all this leave insurers and what does the journey ahead look like? In short, it could soon begin to get much harder.
Could the recommendations become mandatory?
At the moment, the TCFD recommendations are voluntary — but Mark Carney, former Governor of the Bank of England, and others have indicated that they would like to see them become mandatory, especially in regulated sectors6. Securities regulators and stock exchanges are taking TCFD very seriously, alongside industry regulators.
Financial sector regulators tend to focus on stress testing — requiring companies to model the impacts of a single event at a point in time. The TCFD recommendations, however, place more emphasis on the broader concept of scenario analysis — where businesses need to model the effects of multiple variables over an extended period of time. This is a more challenging proposition.
If voluntary TCFD implementation gathers pace and regulators in fact get behind making TCFD mandatory, then we could see a significant acceleration in timelines. Many clients are currently working on a 3-year plus timeline for implementation of TCFD — focusing first on qualitative disclosures, with scenario analysis disclosures further down the track. They would need to accelerate their programs significantly if regulators up the tempo.
Location of disclosures also matter. Currently, reporting is voluntary and is generally a hybrid of detailed disclosures in a sustainability report and summary information in the Annual Report. Mandatory disclosure would likely see more length and detail having to be given in Annual Reports.
But another major challenge is almost a philosophical one. In 2019, there were global losses of around US$150 billion from catastrophic events — but only US$50 billion of that was covered by insurance. Are we, as societies, happy that up to two thirds of these costs are effectively covered by governments (and so, taxpayers) through emergency funding? Are we prepared as individuals to directly or indirectly bear these growing uninsured losses?
This is a question that is likely to come increasingly into focus in coming years as climate change impacts grow. As an industry, insurers need to be on the front foot, engaging with governments, regulators and stakeholders, providing product innovations, and supporting clients and broader communities.
As with the battle against climate change itself, there is plenty for insurers to do and only limited time.