What the Governor's 'climate and other ESG issues' letter means for insurance companies

Dear Chair, Dear CEO

The CBI are turning up the heat on climate change for Boards and CEOs with an agenda going right down to the design of insurance policies.

Back in March Governor Makhlouf signalled factoring the true environmental, and indeed societal, costs of climate change into supervisory arrangements. At Climate Finance Week in October he spoke about approaching these issues with a sense of humility in that no single organisation has all the answers. He set out that as both prudential and conduct regulator, the CBI will focus on ensuring firms understand their climate risks so as not to impact the stability of the financial system, and on preventing potential conduct risk issues such as mis-selling green products.

His letter to Chairs and CEOs is the CBI's first step in terms of specific direction for insurers to make this a reality. It sets out expectations in five key areas: i) governance, ii) risk management framework, iii) scenario analysis, iv) strategy and business model risk and v) disclosures. It promises a Climate Forum to facilitate knowledge sharing and common understanding. At PwC we have already been working with our clients to decode and meet regulatory expectations. This allows insurers to focus on what really matters: delivering on sustainable outcomes for policyholders, shareholders and other stakeholders alike.

Broader sustainability agenda

There is an EU regulatory expectation that the insurance sector will play its part on climate change and sustainability.

The EU's 2018 Sustainable Finance Framework and Action Plan is designed to promote transparency and greater investment in the sustainable green economy. Recent developments from a risk perspective include amendments to the Solvency II Delegated Acts integrating sustainability risks in governance arrangements. These apply from August 2022 to allow sufficient time for firms to adapt. In parallel, ORSAs are expected to increasingly apply climate change risk scenarios in line with EIOPA expectations.

Regarding reporting, proposals for a more far-reaching CSRD (Corporate Sustainability Reporting Directive), to replace the NFRD (Non-Financial Reporting Directive), were made by the Commission in April. The tens of thousands of EU companies being brought into scope for 2023 reporting (including audit or assurance) will include many insurers. The NFRD already obliges many firms to make annual statements relating to a range of internal policies, including social responsibility, environmental protection, human rights and diversity. Next year those NFRD firms are due to disclose 2021 statistics for climate objectives under the Sustainable Finance Taxonomy. Four other environmental objectives are due to follow. Finally, there are also proposals to amend the QRT Reports.

In terms of revenue the Sustainable Finance Disclosure Regulation (SFDR) came into effect for life companies in March 2021. It aims to provide investors with "accurate, fair, clear, not misleading" ESG related information across a range of products. The Taxonomy is due to extend similar principles to NFRD insurers with statistics about eligible underwriting revenue to be disclosed in 2022 for the reporting period 2021.

Transformation

It is too easy to focus on the pea soup of regulation coming down from the CBI and Europe and not see what is really going on – a profound transformation in the broader economy.

The EU Green Deal was reinvigorated in 2020 and the Biden administration is doing likewise in the USA. COP26 has prompted a fresh wave of initiatives like net zero targets and promises to end deforestation by 2030. Even the International Energy Agency is calling for a stop to new oil, gas and coal exploration. The implications are far reaching and pervasive, not just for the energy sector but for transport, agriculture, industry, construction and so on. Closer to home, Ireland's new carbon budgets and climate action plan sketch out the shape of future changes.

Positioning

Progressive CEOs and Boards are positioning their companies in the context of what Joe Biden has described as a fourth industrial revolution.

At PwC we are working with clients in conjunction with our international colleagues. Some insurers are totally transforming their businesses, focusing on revenue and profit opportunities rather than the risk and reporting requirements. Whatever the selected approach, the first step is for the Board to set an appropriate ambition, define key metrics and targets and start monitoring.

Getting started is important from a reputation perspective because there are not only waves of regulation but also a perfect storm of political, activist, consumer, investor and societal forces.

Firms are not obliged to choose any specific strategic response but are becoming aware of increasing scrutiny from all their stakeholders. Even a minimalist approach may mean reporting on non-financial KPIs to an audit standard. Getting started makes good business sense. The scope and pace of activity can start small and measured if that is consistent with the firm's ambitions. However, it may also be necessary to at least keep pace with peers as a way to mitigate reputation risk.

Three key actions to take now

1. Inform and engage the Board and Executive stakeholders

Informing and engaging senior leaders early will enable firms to initiate the right discussions. Analyse the business model under plausible scenarios, set an appropriate ambition and define key metrics and targets. This will demonstrate clear ownership by the Board of the climate risks affecting the firm.

2. Identify a cross-functional evaluation team

Climate risks, threats and opportunities play out across the entire business, it's not just a Risk or Finance exercise. For example, subject matter experts from Product Development, Underwriting, Claims, Procurement, Actuarial, Compliance and Legal all have a vital role to play in developing a robust evaluation. Focus on in-house learning even if external input is required.

3. Review the existing risk management framework in the context of new requirements and expectations

Organisations will need to assess the impact of climate risk on the risk profile of the firm and enhance the risk management framework to cater for new risk types, longer timeframes and greater uncertainty. High-level green or brown categorisation of assets, products and underwriting portfolios may be done quickly to inform qualitative scenario analysis. This can prompt initial evaluation of faster and slower strategies to meet the firm's own ambition. Commence engagement with customers or counterparties to assess relevant data gaps.

We are here to help you

We know that aligning your climate and ESG plans with your risk management framework, risk appetite, strategic plan and the ORSA will be a challenge. Our experience in helping firms in this area, both in Ireland and further afield, means we have the knowledge to help you implement with confidence. Contact us today.