Insurance Regulators Turn up The Heat on Climate Risk Disclosure

Regulators are ramping up their oversight of insurers’ climate risk against a background of more severe and frequent costly weather events. As well as looking for more reporting and disclosure around underwriting, regulators want insurers to take an enterprise-wide risk management approach to the challenges created by climate change.

Brandan Holmes, vice president and senior credit analyst at Moody’s in London, says that a growing number of regulators are interested in insurers’ strategy/business model and risk management: “In focusing on strategy, regulators seek to understand how insurers are adapting their business models to the growing effects of climate change, including both physical risk and carbon transition risk.

“The risk management focus tends to be on ensuring that insurers have a detailed understanding of their exposures to climate risk, the range of financial impacts, and credible plans to manage and mitigate this. One way authorities are doing this is through the introduction of climate related stress tests which require insurers to model impacts from a defined set of assumptions.”

Michelle Adcock, sector lead within KPMG’s Regulatory Insight Centre, agrees that risk oversight could cover a wide spectrum: “Climate-related financial risk could result in a sudden loss in value of the assets backing portfolios, particularly annuity portfolios due to their long-term nature. There is business model risk as markets change rapidly e.g. around the shift to electric vehicles and transport as a service.

“On the conduct side, there is increasing focus on the potential impacts of climate risk on insurance customers, for example the inability of customers to access insurance, or to access it at a reasonable price and insurers exiting certain markets. All of these feed into the overarching strategy of firms.”

A number of regulators around the world are actively widening the scope of their oversight, according to Moody’s Holmes and are at various levels of development in their approach: “While UK and European regulators (including the Bank of England and the Banque de France) have been at the forefront of these developments; other regulatory bodies are making significant strides, including some US state regulators such as the New York Department of Financial Services.”

Denise Eastlake, legal director at law firm Kennedy’s says that disclosure is the key focus for regulators, across banks and insurers: “The UK and Europe are way ahead on this. The UK Government and the EU want to understand the risks to the economy. As Mark Carney said early on about resilience, ‘What gets measured gets managed’.”

A more effective framework for disclosure that could promote informed investment, credit, and insurance underwriting decisions was produced by the Financial Stability Board’s Task Force on Climate Related Financial Disclosures (TCFD). Building on that, new draft proposals in the UK as part of the FCA’s Sustainability Disclosure Requirements for asset owners and asset managers will expand existing TCFD requirements and align with new corporate reporting standards from the International Sustainability Standards Board (ISSB).

New UK Financial Conduct Authority rules on climate-related financial disclosures that involve insurers came into effect on 1 January 2022, Duncan Strachan, partner in law firm DAC Beachcroft’s global insurance practice, points out: “A key requirement of the new FCA rules is for issuers of standard listed shares or global depository receipts to state whether their disclosures align with the recommendations of the TCFD and if not, explain why.

“Asset managers are also required to publish two annual reports that show how climate-related risks are considered in the management of their investments and that they disclose the Scope 1, 2 and 3 emissions of their products,” Strachan says.

The EU is also looking to expand reporting obligations known as “the Green Rules” (contained in the Non-Financial Reporting Directive) to unlisted companies, regardless of size, Strachan adds: “The authorities are pushing for more expansive and stricter rules, even though it is reported that many of the large corporates affected by the current regime remain unprepared for, or unaware of, current requirements.

“The European Commission also continues to develop its classification of sustainable economic activities, known as the “green taxonomy”, as part of its action plan for financing sustainable growth. A similar classification system is being developed in the UK, and may well become the gold standard for other countries to follow,” Strachan says.

Greater solvency specific transparency is on the cards. Last year, the European Union financial regulatory institution EIOPA set out its expectations for EU national supervisors around climate-change scenario analysis as part of insurers’ own risk and solvency assessment (ORSA). It’s likely that further disclosures will be mandated as the quest for transparency continues, KPMG believes.

“The UK PRA expects insurers to incorporate climate transition scenario analysis to better understand the resilience and vulnerabilities of their business model. Increasingly firms are performing this analysis as part of their own risk and solvency assessment (ORSA),” says Matthew Francis, insurance prudential regulation director at KPMG UK. “Last year, selected large insurers submitted analysis of how three different climate scenarios would impact their current balance sheets in response to the Bank of England’s Climate Biennial Exploratory Scenario.”

Moody’s Brandan Holmes adds that in the future regulators will likely require insurers that perform poorly in climate stress tests to hold additional capital or adjust their exposure to increase resilience and that climate considerations will form part of regulatory capital requirements over time.

It’s a logical development, Kennedy’s Eastlake says: “If you don’t know the level of your exposure how can you be sure you have the necessary capital reserves? While there is a lot of historical information available it is very quickly becoming irrelevant and so scenario-based modelling is taking on a new importance for insurers.

“EIOPA has similar concerns and it is also looking at risk data sharing across companies and jurisdictions.”

Regulators are not the only ones keeping a close watch on insurers’ behaviours. Climate activists are acutely aware of the role risk carriers play in supporting polluting industries, through underwriting or investing. Trans Mountain’s proposed extension of an oil pipeline in Canada and the Carmichael coal mine in Australia have both been targeted by activists seeking to stop the financing and underwriting of the most polluting industries; last year protesters from Insurance Rebellion took direct action at Lloyd’s iconic HQ, letting off stink bombs and also spilling fake oil on its doorstep.

As headline grabbing protest actions ramp up, litigation isn’t far behind, according to KPMG’s Matthew Francis: “Insurers should be monitoring their potential exposures to climate-related litigation and identifying strategies to manage these. Insurers are not immune to claims brought by investors and activist shareholders in relation to the climate impacts of their investment and underwriting activities. In recent years, advocacy organisations have called out named insurers putting pressure on them to enhance climate change disclosures in their annual reports.”

Hannah Williams, partner at Kennedys, says that as listed companies, insurers have a duty to protect their shareholders’ interests and to have risk management measures in place: “As investors and risk carriers, insurers must be seen to work with businesses that are closely aligned with their own strategies. It’s why some insurers are stating they will not associate with big mining companies or coal projects.

“We’re seeing D&O claims at companies where reality hasn’t matched the pledges they made in sustainability reports; it could equally happen to insurers at board level. So, when insurers put out their own ESG reports, they should recognise how they could open themselves up to D&O claims.”

Overall, the risks presented by climate change outweigh the opportunities for insurers — but climate change could help some gain competitive advantage, according to Moody’s Brandan Holmes. “For example, those insurers that are able to develop insurance products that are able to address emerging technologies and risks related to managing climate change will be better positioned for the shift towards a net zero carbon economy. Insurers that derive significant revenue from brown industries and are not focused on transitioning their business/client mix could be at a disadvantage.”

Kennedys’ Hannah Williams agrees: “Forward looking insurers have always done better and taken steps to examine their climate risk exposure and others not so much — and they risk being left behind.”