The Task Force on Climate-Related Financial Disclosures (TCFD) recommendations are fast becoming the global standard to hold companies to account for their carbon emissions. They will have far-reaching effects on insurance asset management and will strengthen over time.
The Financial Stability Board created the TCFD to provide markets with information that highlights material risks associated with companies, such as the potential costs of transitioning to low-carbon production methods.
Reporting is designed to provide investors with transparency when comparing investments, facilitating more informed choices. It also provides insight into climate-related risks to the financial system.
The UK PRA in April 2019 stated it expects firms to consider engaging with the TCFD framework. In November 2020, the UK government made it unambiguous that it expects large asset owners to make TCFD-aligned disclosures.
As the guidance is agnostic to underwriting and investing practices, both should be considered through the same lens.
“It’s clear that insurance investors will be operating in a TCFD-aligned environment going forward,” says Colin Tipping, partner, global head of insurance solutions at Mercer.
Certainly, TCFD will mean more data is required. “This includes measuring climate risk and other levels of granularity such as asset location data or look-through into alternative assets or fund vehicles,” says Tim Antonelli, multi-asset insurance strategist at Wellington Management.
It will also require a consistent roll-out across all business functions. “As the guidance is agnostic to underwriting and investing practices, both should be considered through the same lens,” says Antonelli, noting it will require teams to work together. “Illiquid assets will require even more data to determine exposures, which could be challenging for smaller managers.”
Andrew Douglas, director, institutional business at AXA Investment Managers says: “Insurers globally already recognise that climate change and related risks have truly significant implications for their underwriting, investment and even operational activities.”
At this stage, TCFD disclosures are voluntary. “However, insurers are already assessing and reporting in line with TCFD recommendations such as the carbon intensity of their investment portfolios and defining a plan to align with net-zero over time,” says Douglas.
“Insurers are actively partnering with investment managers to collate and understand the information to report in-line with TCFD recommendations, and to consider what changes may be required to create ‘climate-aware’ portfolios.”
Portfolio Strategies
As TCFD is primarily about disclosure, insurers will first need to disclose climate change strategy, governance, risk management and related metrics. “This will require development of reporting solutions, including additional metrics beyond weighted average carbon intensity (WACI),” says Tipping.
However, the impact of TCFD will be greater than just reporting; it will drive insurers to enhance their portfolio strategy to improve the metrics and risks they report. “A range of insurers have committed to reducing corporate bond portfolio emissions by 2030 and set an objective to ensure their entire portfolio is net-zero by 2050,” he says.
Increasing numbers of insurers are publicly committing to initiatives such as science-based targets (SBTs) and developing challenging plans to decarbonise both their investments portfolio and operations, he adds.
Insurers are likely to settle on a single climate risk data provider to ensure consistency across assets and underwriting – which would mean it could only work with external managers that can conform to its standards.
There will be a greater focus from regulators on insurers to provide evidence of specific metrics and performance of scenario analysis, to evidence that their investment portfolios are appropriately positioned.
Disclosure should also detail action plans for risks and opportunities. “KPIs will be critical, and insurers will need to determine how they define success. The feedback loop will be essential, as investors and regulators will be able to follow an insurer’s progress,” says Antonelli. “Developing reporting dashboards for internal consumption and externally-friendly versions is a great first step.”
Insurers should take a holistic view of climate change risks, according to Douglas, noting this is a view shared by many of the global regulators. “How the balance sheet will perform under different scenarios is particularly important. Many will need their asset manager partners to stress-test assets and report key metrics,” says Douglas. “We expect allocations to shift away from companies unaware or unprepared for the transition.”
While insurers are not typically long-term investors like pension funds, they cannot avoid the immediate consequences of far-off events. “Just because the full manifestation may happen outside of the maturity window of their positions, it doesn’t mean that asset prices won’t feel the effects long before,” says Antonelli.
This is partly because credit agencies will integrate climate risk into ratings, so prices are likely to move in tandem. “Insurers can be forced sellers of positions that downgrade to a certain level or risk impairing the asset,” warns Antonelli. In addition, news of climate-related litigation may cause markets to move.
Insurers have a range of liability profiles, which define investment portfolio design. “From short-tail health and P&C insurers to very long-dated life insurers, there are different considerations in terms of climate change risk and opportunities,” says Douglas.
While physical risks have a greater impact over a longer time horizon, transition risks, such as the abrupt introduction of new policies, investor momentum and consumer behaviour, will be felt over much shorter time periods.
When investing longer term, according to Douglas, climate should be integral. Short-dated liabilities are often evergreen, with insurers rewriting annually, so TCFD recommendations should still be considered. Fixed income investments could otherwise experience downgrades and defaults.
Costs & Benefits
The PRA has stated that climate change is a material risk for insurers, so should be integrated in pillar 3 reporting. This is straightforward for developed equities but challenging for illiquid assets. “Insurers may need to commit additional resources to develop this,” notes Tipping.
Other regulators will have different expectations. “As a baseline, including climate risk through the same lens as the rest of an insurer’s ORSA should be the standard,” says Antonelli. Regulators have not been overly prescriptive, opting for a ‘best effort’ approach, but he says they will later roll out custom scenario analysis and stress tests.
Douglas adds: “There will be a greater focus from regulators on insurers to provide evidence of specific metrics and performance of scenario analysis, to evidence that their investment portfolios are appropriately positioned.”
A broader and deeper level of reporting means that key stakeholders can fully appreciate how they will be impacted by the physical and transition risks of climate change. “Investors can use this reporting to monitor portfolio performance and make any necessary changes,” says Douglas.
While TCFD disclosures certain increases the data management workload, it brings with it a wealth of useful information. “Rather than view it as a ‘data-heavy chore’, the portfolio intelligence it generates can help insurers better understand their investments – knowing their bond holdings’ carbon emissions will help establish a plan to decarbonise,” says Tipping.
Disclosure means a greater understating of a company’s exposure to climate risks, which in turn should be reflected in their perceived value to investors. “An insurer could get ahead of these risks by making sure that their investment portfolio is predicated on a robust fundamental analysis of all issuers inclusive of climate and ESG broadly,” says Antonelli.
“The real key is to focus on the most material of exposures first and the direct climate impacts, then broaden the scope to look at less material direct exposures and indirect knock-on effects. This will provide a great foundation to operate in a glidepath-like construct moving ahead.”
