As concerns about the ecological and financial impacts of climate change have grown in recent years, so has the interest of insurance regulators in the exposure of the insurance industry to the risks raised by climate change for both the liability and asset sides of the balance sheet. While some insurance regulators began requiring climate risk disclosure over a decade ago, there has been a growing call in recent months for those disclosures to meet the detailed disclosure framework set forth by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), a global standard that is gaining traction among public companies across the developed world. At its Spring 2022 meeting, the National Association of Insurance Commissioners (NAIC) adopted chnages to its annual Climate Risk Disclosure Survey that will require most of the US INsurance industry to engage in TCFD reporting by November 2022.
Insurer climate change disclosure requirements
The insurance industry has faced greater calls for reporting on and management of climate change risks over the past decade. For the property casualty insurance industry, the increased frequency and severity of storms and other weather-related events have highlighted the exposure of industry participants to the physical risks of climate change. For the life insurance industry, the longer-range risks inherent in investments in carbon-based industries (frequently referred to as “transition risks” that arise as economies transition to greener energy sources) have attracted the attention of regulators, and risks inherent in real estate investments and industries that bear more attenuated climate-change risks has come into greater focus, in terms of both physical risks and transition risks.
The Insurer Climate Risk Disclosure Survey was adopted by the (NAIC) in 2010 as an insurer reporting mechanism to provide regulators with rudimentary information on how insurers across all lines of insurance assess and manage risks related to climate change. What was then an eight-question survey asked insurers to provide a description of whether and how they incorporate climate risks into their mitigation, risk-management and investment plans. Insurers are asked to identify steps taken to engage key constituencies and policyholders on the topic of climate change. In 2010, approximately two dozen states surveyed their domestic insurance companies that write more than $500 million in direct premium, and the data was aggregated. Since then, California, joined in 2012 by the states of New York and Washington, has surveyed all companies writing $300 million in premium, making the survey mandatory and the results public. In 2013, the threshold was lowered to $100 million and the multistate group expanded.
Beyond this broad reporting, in 2016 the California Insurance Department requested that all insurance companies doing business in California voluntarily divest from investments in thermal coal by making no new investments, not renewing any existing investments, and selling or withdrawing from existing investments in thermal coal. In connection with this initiative, the Department initiated a data call that requires insurance companies to disclose annually their carbon-based investments, including those in oil, gas and coal. This data was used by the Department to perform scenario testing, as it said the TCFD had recommended that financial institutions do so on their portfolios to assess financial risks related to climate change. The goal of the scenario analysis was to assess California insurers’ exposure to transition risk, individually and as a whole, based on the evolution of production and assets in the real economy.
The NYSDFS, the successor to the New York State Insurance Department, has also become active in climate-related issues, most recently creating a Climate Risk Division, with an Executive Deputy Superintendent for Climate Risk reporting directly to the Superintendent. In addition to participating in the NAIC Insurer Climate Risk Disclosure Survey, in September 2020, the NYSDFS released a Circular Letter outlining its expectations for the industry related to addressing the financial risks from climate change. Building on the principles discussed in the Circular Letter, on November 15, 2021, the NYSDFS released Guidance for New York Domestic Insurers on Managing the Financial Risks from Climate Change, outlining a robust regime for risk management and reporting. In addressing the importance of public reporting, the NYSDFS noted its expectation that insurers “engage with the TCFD framework and other similar initiatives, including the tools and case studies that they provide, in developing their approach to climate-related financial disclosures.” The NAIC Climate Risk Disclosure Survey allowed a TCFD report to be submitted in lieu of responding to the survey in its 2020 cycle.
On June 8, 2021, Insurance Commissioners Mike Kreidler of Washington and Ricardo Lara of California jointly put out a release formally asking all insurers that are currently required to report to them annually on climate change to start reporting their climate risks in alignment with the TCFD standards, noting that “TCFD is rapidly becoming the global standard for such reporting for all industries worldwide.”
The efforts of these individual state insurance regulators culminated at the Spring 2022 meeting of the NAIC, when it adopted changes to its annual Climate Risk Disclosure Survey to require TCFD reporting by November 2022. Fifteen states, including California, Connecticut, Delaware, District of Columbia, Maine, Maryland, Massachusetts, Minnesota, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Vermont and Washington, have committed to use the NAIC survey in 2022 for insurance companies licensed in their jurisdictions, representing nearly 80 percent of the US insurance market. While 28 insurance companies provided TCFD-compliant reports in 2021, this list will grow to nearly 400 insurance companies and groups in 2022.
What is The Task Force on Climate-related Financial Disclosures?
The TCFD was created in 2015 by the Financial Stability Board, a nongovernmental international body that monitors and makes recommendations about the global financial system. The Task Force was established to help identify the information needed by investors, lenders and insurance underwriters to appropriately assess and price climate-related risks and opportunities. It is composed of representatives from organizations with an interest in its work, including banks, insurance companies, asset managers, pension funds, large nonfinancial companies, accounting and consulting firms, and credit rating agencies. The TCFD developed a series of detailed recommendations on climate-related financial disclosures structured around four thematic areas: governance, strategy, risk management, and metrics and targets.
The TCFD recommendations have been adopted by the United Kingdom, with effective dates rolling out for different organizations between 2021 and 2025: property casualty insurers are impacted in 2021, the largest life insurers are covered in 2022 and other life insurers are covered by 2023. The recommendations also inform the EU Sustainable Finance Action Plan, including the Sustainable Finance Disclosure Regulation and Corporate Sustainability Reporting Directive. While the United States remains behind on these developments, as noted above, the TCFD recommendations have informed the California carbon-based investment initiative, and, beginning in 2020, the states requiring the NAIC Climate Risk Disclosure Survey have allowed a TCFD report to be submitted in lieu of responding to the survey.
Congress has also shown an interest in climate-related risk disclosure, with Democratic members of both houses of Congress reintroducing the Climate Risk Disclosure Act (H.R. 2570), which would require every public company to issue climate-related financial disclosures of their direct and indirect greenhouse gas emissions, identifying the total amount of fossil-fuel-related assets owned and managed and the total cost of emissions. The act would require companies to quantify the financial impact of climate risks on their bottom line, describe their overarching climate strategies, and detail board-level oversight of climate risks and opportunities, accounting for different climate change scenarios. Additionally, the act would require companies to identify specific steps taken to address climate risks—including both physical risks and transition risks—and indicate how their strategies have evolved over time. Regardless of whether the act can get through both the House and the Senate, the SEC has proposed an extensive regime of climate change risk disclosures, which SEC Chairman Gary Gensler has said is among his top priorities.
Insurance companies doing business overseas, or looking for financing overseas, are well advised to be prepared with TCFD-style disclosures. For US domestic companies, the requirement for TCFD disclosures is now just around the bend.
What is the TCFD framework?
The TCFD Framework is a set of comprehensive recommendations and guidance on climate-related financial disclosures applicable to organizations across sectors and jurisdictions. These recommendations and guidance spring from the TCFD’s recognition that climate change presents unique risks and opportunities for organizations, both of which can financially impact organizations.
Climate-related risks: Physical Risks and Transition Risks
The TCFD Framework divides climate-related risks into two major categories—risks related to the physical impacts of climate change (Physical Risks) and risks related to the transition to a lower-carbon economy (Transition Risks).
Physical Risks are further divided between acute risks that are event-driven, such as from extreme weather events, and chronic risks related to longer-term shifts in climate patterns.
Transition Risks include:
- Policy and legal risks:
- Risks arising out of policy actions to constrain actions that contribute to the adverse effects of climate change and policy actions to promote adaptation to climate change
- Litigation or legal risk around the failure of organizations to mitigate impacts of climate change, the failure to adapt to climate change and the insufficiency of disclosure around material financial risks
- Technology Risks: The risks that the impact of technological improvements or innovations that support the transition to a lower-carbon, energy-efficient economic system can have on organizations
- Market Risk: The impact on markets of climate change adaptation, including shifts in supply and demand for certain commodities, products and services as climate-related risks and opportunities are increasingly taken into account
- Reputation Risk: The risk tied to changing perceptions of an organization’s contribution to climate change or to the transition to a lower-carbon economy
In addition to risks, the TCFD identified that climate change can also produce opportunities for organizations, for example, through resource efficiency and cost savings, the adoption of low-emission energy sources, the development of new products and services, access to new markets, and building resilience along the supply chain.
The Task Force’s recommendations are based on its remit to ensure better disclosure of the financial impacts of climate-related risks and opportunities, allowing all interested parties to understand how climate-related risks and opportunities are likely to impact an organization’s future financial position as reflected in its income statement, cash flow statement and balance sheet, as outlined in Figure 1.
The recommendations and guidance The TCFD Framework consists of four climate-related financial disclosures, stating that the four thematic areas represent core elements of how organizations operate—governance, strategy, risk management, and metrics and targets. The recommended disclosures build out the framework with information that will help investors and others understand how reporting organizations think about and assess climate-related risks and opportunities. In addition, the TCFD offered guidance to support all organizations in developing climate-related financial disclosures consistent with the recommendations and recommended disclosures as well as supplemental guidance for specific sectors. The structure is depicted in Figure 2 below, and the Task Force’s recommendations and supporting recommended disclosures are presented in Figure 3.
Figure 2 Source: Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures, June 2017
Source: Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures, June 2017
Noting that users of climate-related financial disclosures are specifically interested in how insurance companies are evaluating and managing climate-related risks and opportunities in their underwriting and investment activities, supplemental guidance for the insurance industry was developed by the TCFD for certain of the recommended disclosures, specifically Strategy (b) and (c); Risk Management (a) and (b); and Metrics and Targets (a). The following discussion incorporates both the guidance for all sectors and the supplemental guidance for the insurance industry, as updated in the TCFD’s 2021 Annex “Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures.”
The TCFD guidance on Governance disclosure provides recommendations for organizations in all sectors with respect to both the board’s oversight of climate-related risks and opportunities and management’s role in assessing and managing climate-related risks and opportunities.
With respect to the board’s oversight, the TCFD recommends that organizations consider a discussion of:
- processes and frequency by which the board and/or board committees are informed about climate-related issues
- whether the board and/or board committees consider climate-related issues when reviewing and guiding strategy, major plans of action, risk management policies, annual budgets, and business plans, as well as when setting the organization’s performance objectives, monitoring implementation and performance, and overseeing major capital expenditures, acquisitions and divestitures
- how the board monitors and oversees progress against goals and targets for addressing climate-related issues
With respect to the role of management, the TCFD recommends that organizations consider a discussion of:
- whether the organization has assigned climate-related responsibilities to management-level positions or committees, and, if so, whether such management positions or committees report to the board or a committee of the board and whether those responsibilities include assessing and/or managing climate-related issues
- a description of the associated organizational structure(s)
- processes by which management is informed about climate-related issues
- how management (through specific positions and/or management committees) monitors climate-related issues
The TCFD guidance on Strategy disclosure provides recommendations for organizations in all sectors, and specifically for those in the insurance sector, with respect to disclosure of the actual and potential impacts of climate-related risks and opportunities on an organization’s businesses, strategy and financial planning. These recommendations consist of (a) a description of the climate-related risk and opportunities the organization has identified over the short, medium and long term; (b) a description of the impact of climate-related risks and opportunities on the organization’s businesses, strategy and financial planning; and (c) a description of the resilience of the organization’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario.
In addition to a general discussion of these matters recommended for all organizations, the TCFD recommends specific disclosure for insurance companies pertaining to the potential impacts of climate-related risks and opportunities, and provide supporting quantitative information where available on their core businesses, products and services, including:
- information at the business division, sector or geography levels
- how the potential impacts influence client or broker selection
- whether specific climate-related products or competencies are under development, such as insurance of green infrastructure, specialty climate-related risk advisory services and climate-related client engagement
Additionally, the TFCD recommends that insurance companies that perform climate-related scenario analyses on their underwriting activities should provide the following information:
- a description of the climate-related scenarios used, including the critical input parameters, assumptions and considerations, and analytical choices; in addition to a 2°C scenario, insurance companies with substantial exposure to weather-related perils should consider using a greater-than-2°C scenario to account for physical effects of climate change
- time frames used for the climate-related scenarios, including short-, medium-, and long-term milestones
The TCFD guidance on Risk Management disclosure provides recommendations for organizations in all sectors, and specifically for those in the insurance sector, with respect to disclosure of how the organization identifies, assesses and manages climate-related risks. This includes a description of (a) the organization’s processes for identifying and assessing climate-related risks; (b) the organization’s processes for managing climate-related risks; and (c) how the processes for identifying, assessing and managing climate-related risks are integrated into the organization’s overall risk management.
In addition to the disclosures relevant to all organizations, the TCFD makes specific recommendations for insurance companies’ disclosures with respect to risk management. These include that insurance companies should describe the processes for identifying and assessing climate-related risks to re-/insurance portfolios by geography, business division or product segments, including the following risks:
- physical risks from changing frequencies and intensities of weather-related perils
- transition risks resulting from a reduction in insurable interest due to a decline in value, changing energy costs or implementation of carbon regulation
- liability risks that could intensify due to a possible increase in litigation
Additionally, insurance companies should describe key tools or instruments, such as risk models, used to manage climate-related risks in relation to product development and pricing, and should also describe the range of climate-related events considered and how the risks generated by the rising frequency and severity of such events are managed.
Metrics and Targets
The TCFD guidance on Metrics and Targets disclosure provides recommendations for organizations in all sectors, and specifically for those in the insurance sector, with respect to disclosure of the metrics and targets used to assess and manage relevant climate-related risks and opportunities. This includes disclosure of (a) the metrics used by the organization to assess climate-related risks and opportunities in line with its strategy and risk management; (b) Scope 1 (direct emissions), Scope 2 (indirect emissions-owned) and, if appropriate, Scope 3 (indirect emissions-not owned) greenhouse gas emissions, and the related risks; and (c) the targets used by the organization to manage climate-related risks and opportunities and performance against targets.
Beyond the disclosures recommended for all organizations, insurance companies should:
- provide aggregated risk exposure to weather-related catastrophes of their property business (i.e., annual aggregated expected losses from weather-related catastrophes) by relevant jurisdiction
- describe the extent to which their insurance underwriting activities, where relevant, are aligned with a well-below-2°C scenario, using whichever approach or metrics best suit their organizational context or capabilities and also indicate which insurance underwriting activities (e.g., lines of business) are included
- disclose weighted average carbon intensity or greenhouse gas emissions associated with commercial property and specialty lines of business where data and methodologies allow
Where to go from here . . .
Insurers subject to climate-change risk reporting to any of the 15 states utilizing the NAIC Climate Risk Disclosure Survey must transition their climate risk reporting to conform to the TCFD Framework by the November 2022 deadline. Additionally, for insurers not subject to that reporting regime, the TCFD Framework can provide a good framework for other risk reporting regimes, including an insurer’s Own Risk and Solvency Assessment (ORSA).