Disclosing climate risk
2023 is not yet over and already we’ve seen several record weather events take place. July was the hottest month on record followed by August, with September emerging as the highest departure from average warming for any month dating back to 1850.
Climate change, driven by greenhouse gas emissions that trap heat in the atmosphere, has increased global temperatures—and with it, the frequency and intensity of extreme weather events. Whether they are floods, droughts, hurricanes, or forest fires, the world is seeing extreme weather events taking place that are causing enormous damage.
In the US this year, as of early December there had been 25 weather and climate disasters with losses exceeding $1 billion, setting an annual record, according to NCEI/NOAA.
In many ways, insurers are on the front lines of dealing with the risks and fallout of climate change. There is growing recognition of the risks of climate change to insurance operations, underwriting, and investment portfolios. It was against this backdrop that the Bermuda Monetary Authority (BMA) released a discussion paper in September outlining a proposed set of disclosure requirements for commercial insurers on climate change.
The BMA’s discussion paper sought industry input on a proposal for how insurers can publicly disclose their climate risk exposure, mitigation, and monitoring activities. The proposal was aligned with the (now disbanded) Task Force on Climate-Related Financial Disclosures (TCFD) framework.
What was the TCFD? Launched in 2015 by the Financial Stability Board (FSB), the TCFD published a framework for companies to disclose how the financial risks and opportunities of climate change could impact their business. The goal of TCFD was “through widespread adoption, financial risks and opportunities related to climate change will become a natural part of companies’ risk management and strategic planning processes”.
The TCFD provided 11 recommended disclosures across four categories: governance, risk management, strategy, and metrics and targets. While the TCFD itself was a voluntary framework, several global regulators and standard-setters have introduced reporting requirements that align with it, including the US Securities and Exchange Commission (SEC), Canada’s Office of the Superintendent of Financial Institutions (OSFI), the European Commission, and the International Sustainability Standards Board. The BMA is the latest to do so. The FSB has now asked the IFRS Foundation to take over the monitoring of the progress of companies’ climate-related disclosures.
By using TCFD as the basis for its disclosure proposal, the BMA seeks to cover both physical and transition risks of climate change. Physical risks are those that arise through the impacts of a warming climate and are categorised as either acute (event-driven, such as floods, hurricanes, and forest fires) or chronic (long-term changes such as rising sea levels).
Transition risks come from the shifts towards a low-carbon economy: new regulations or carbon taxes, emerging technologies, litigation, changing consumer expectations, or market changes such as the price for commodities.
Why seek disclosures from insurers on these issues? The BMA’s position is that transparent disclosures on the material risks of climate change will benefit external stakeholders as well as the insurers themselves.
In the discussion paper published in September 2023 the BMA said: “The BMA is of the view that climate disclosure information is pivotal to addressing climate risk, acknowledging both the transversal and long-term nature of this risk. Disclosure aims to protect the policyholder and ensure the viability and soundness of the insurance sector over the longer term, which is at the heart of the BMA’s work.
“More transparent, high-quality disclosure from all companies on how they are managing climate-related financial risks and opportunities will allow them to provide external stakeholders with the information they require as well as helping them to make more informed decisions internally.”
Good governance and metrics
The TCFD framework’s first pillar is governance. Insurers disclosing according to the BMA’s framework will need to comprehensively describe the board’s oversight role and management’s assessment and management of climate risk and opportunities. Specifically, the BMA “expects that insurers’ boards and management teams are able to understand, assess and manage the financial risks of climate change”.
“They should also be able to show how these risks have been considered in other elements of operations, such as strategic and financial planning.” If insurers have not yet integrated climate risk across their governance framework, the BMA says they should have a plan to do so “within a reasonable timeframe”.
For disclosures on strategy, insurers are expected to report on how they view and assess different climate risks over different time horizons: short, medium, and long term. A key component is undertaking scenario analysis, looking at the resilience of their strategy against a range of climate change scenarios. For example, how would the business fare in a scenario where the world aggressively moves to reduce greenhouse gas emissions, impacting the viability of oil and gas companies?
Alternatively, what if emissions are not reduced, and climate change events become more extreme and damaging? Scenario analysis is generally considered the most challenging of the TCFD recommendations; the BMA’s expectation is that insurers will improve their capabilities over time.
Risk management disclosures are to outline how an insurer identifies, assesses, manages, and monitors climate risks, in addition to providing insight into how they are integrated into the overall risk management process. The BMA notes that the level of detail in the disclosure is not to be as granular as that reported in the Commercial Insurer’s Solvency Self-Assessment.
Reporting on metrics and targets is an essential part of the TCFD framework. The BMA gives specific emphasis to this point, stating that “metrics and targets are seen as a vital step in showing a consistent view of insurers’ climate-related risks and their management and evolution”.
What kinds of metrics does the BMA expect insurers to disclose? The first are greenhouse gas emissions: Scope 1, 2 and 3. For an insurer, Scope 3 emissions—which include those associated with investments—will be the largest and most material. These are known as financed emissions: apportioning a share of an investee company’s emissions to the insurer based on the size of the loan or investment relative to the size of the company value.
In future, the BMA expects insurers to report on Scope 3 emissions for underwriting once methodologies are commonly agreed upon.
Period for compliance
The BMA’s climate disclosure proposal is to apply to all commercial insurers and insurance groups regulated by the BMA. A subsequent consultation paper on disclosures will follow the discussion paper phase. If the proposal moves ahead, there will be a phased approach for compliance. Groups will be required to publish their first report starting year-end 2024, with class 4 and class E Commercial Insurers reporting at year-end 2025, and all others being allowed one additional year.
While the discussion paper outlines minimum expectations for reporting, the BMA recognises that the detail and length of disclosures should reflect the size and complexity of each insurer, and that data quality will improve over time.
The BMA’s proposed climate disclosure regulations are the latest in a series issued by global regulators moving to require mandatory disclosure of climate risk in the insurance industry. Responses to the BMA’s discussion paper were due by December 15, 2023.
Kevin Quinlan is senior director, climate and climate strategy at SLC Management. He can be contacted at: kevin.quinlan@slcmanagement.com
To learn more about SLC Management, visit www.slcmanagement.com or email Barton R. Holl, head of insurance strategy, SLC Management. He can be contacted at: barton.holl@slcmanagement.com
