· 10 min read
At 4C plus, much of what we can and do insure becomes uninsurable. The Arctic has warmed four times faster than the globe since 1980. Our current pathway assures us of a 5C plus trajectory. We are already at 420 ppm of CO2 and have breached seven out of nine planetary boundaries. Whilst on this track, the world’s largest asset manager, BlackRock, backtracks on Scope 3 emissions from its portfolio. With shipping and aviation outside the scope of Paris Agreement, two of the most polluting portfolios remain unleashed. Growing space launches will put more pressure on the ozone layer. Needless to mention the rising clamour for seabed mining. And now, the war makes gas and nuclear compelling. In all this (and much more) melee - the insurance industry should remember fence sitting is not the best option. The newly created International Sustainability Standards Board (ISSB) has invited feedback on its role and responsibility. Insurers ought to be in the ring.
Before venturing any further on expanding frontiers of human ‘advancement’ let us be reminded that we inject daily - to borrow from environmentalist Bill McKibben - 400,000 Hiroshima atomic bombs equivalent of heat into the planet. Some of the most damaging human actions would not be possible without insurance. In seeking unlimited growth from the planet’s limited resources, we are now witnessing Mother Earth beginning to push back Father Greed.
Picture a world that is uninsurable. As humanity lets Earth’s temperature climb ever higher and massive natural effects take place, one day we could find ourselves living in a world that is too steeped in risk to balance insurance premium costs with pay-outs. The claims are too many, and too large. By then, it’s not just the insurance system that has collapsed, but the economic system. For insurers imagining that kind of future, the word ‘sustainability’ takes on multiple meanings.
“Can insurers catalyse climate action?”
Vanessa Otto-Mentz and Marco Vet reflect on the insurance industry’s role in decarbonising the global economy, in the context of Deloitte’s report “Europe’s turning point: Accelerating new growth on the path to net zero”. My point is, why not? Rather, do they have a choice? Can ISSB facilitate ESG integration into risk management, underwriting (physical, transition & liability risks) and investment - the three key functions of insurers? It could! Thereby taking insurers out of the existential mess they find themselves in.
ESG has been a much misunderstood and often ‘maligned’ concept. Perhaps more greenwashed than rightfully applied. Any business that does not align environmental and societal aspects with its governance is unlikely to be sustainable. Needless to mention, the reactionary push will continue to question the precedence of people and planet over profits. Having said that, an ESG compliant business need not always be sustainable. Nor would a sustainable business always be ESG compliant.
Glaring disconnects
Interestingly, to pivot this right - businesses, including insurers, call for a paradigm shift in how accountants think. Accountants understand financial accounting. That is what they are trained for. Their job has been to measure the financial value created by enterprises and provide information on the effectiveness with which that is being done, for the leaders of the enterprise (management accounting) and for investors (corporate accounting). The challenge for accountants has been the massive and rapid shift in the way enterprises create value, and the way in which investors value them.
Added to this challenge has been the way in which costs are accounted for. Many costs created by the firm that were once externalised to others, such as CO2 emissions, must now be internalised, for example. Additionally, many ‘costs’ should rightly be regarded as investments, in people, for example.
Despite the long-recognised flaws in Gross Domestic Product (GDP) as a measure they have so far failed to find a good alternative. The same core issues are at the heart of the problems faced by economists and accountants, “how is value to be defined and by whom?” Today, the most important sources of value, such as reputation, are intangible.
Despite being intangible they are, nevertheless, the most material factor in determining future value creation potential. This change means accounting thinking and practice must change. If chief finance officers are unable to provide boards with information that is material to their decision making, what chance have they of telling investors what is material to their decisions, given investors are concerned with what will be material to future value creation potential?
Traditionally accountants do not look forward. They consider what 'was' and 'is' material, rather than what will be. Insurers too are conditioned alike. Climate change has to be dealt with on a prospective basis and not retrospectively. The tipping points in the earth systems have non-linear outcomes. Insurers’ obsession with linearity and predictability needs a revisit.
It is not just the accountants in particular, actuaries as well. And to get carbon out of their way, the fossil fuel industry must be distanced. Having Oil & Gas representation on insurer boards certainly justifies an ISSB oversight on the governance function, too.
ISSB consultation
The ISSB is running a consultation on proposed international standards for climate and general sustainability-related financial disclosures. Here are brief highlights from Prof. Carol Adams on what CFOs and accounting professional bodies think of the International Sustainability Standards Board Exposure Drafts:
- More technical work needed to align with other internationally recognised global standards, particularly those of the Global Reporting Initiative (GRI).
- Investors need #GRI impact reporting.
- The conceptual framing around #materiality and #enterprisevalue in the #ISSB proposals is problematic.
- In their current form they will not lead to #harmonisation - there are issues with definitions and methodologies.
- Information disclosed should lead to positive action (the current requirements will not).
- Focussing on #climate only is not enough.
Moreover, there is more to Climate Change than just Climate Risks, as EY highlights. Following are some implications they highlight that the changing climate has on financial accounting:
- There is an increased focus on the measurement and disclosure of climate-related matters in an entity’s financial statements.
- The determination of the effects of climate change on an entity’s financial statements may require significant effort and judgement.
- Entities are required, at a minimum, to follow the specific disclosure requirements in each IFRS standard.
- Entities are required to carefully evaluate whether users of financial statements are able to assess the effects of climate change on their financial position, financial performance and cash flows.
Professor Robert Eccles pitches hard for sustainability in the Harvard Business Review:
- Sustainability is going mainstream in the corporate and investment communities, and the ISSB will help to further accelerate this.
- It will give us the same high-quality standards for measuring and reporting on sustainability performance that we have for financial performance.
- Along with this will go much higher-quality internal control and measurement systems and, ultimately, the same degree of internal and external audit rigor that goes into the financial statements.
- Finally, financial and sustainability reporting will be on par in terms of quality and relevance. This will enable true integrated reporting. Companies and investors will be able to rigorously understand how sustainability performance and financial performance contribute to each other.
Dr. Shiva Rajgopal alludes to climate reporting as “the third best option”. He believes Carbon tax and Environment Protection Agency (EPA) look seemingly unviable. ISSB thereby might become the default standard setter for the world in the area of sustainability unless the SEC can push through the climate disclosure rule in some form or the other.
“Regulation, enforcement and awareness of greenwashing issues has increased and that to me is a welcome development. Some of the charlatans that entered the space will leave. ESG 2.0 will, at the very least, move the conversation forward with greater rigor and authenticity” he says. Shouldn’t insurers leverage this opportunity?
Carbon dilemma
The price of carbon may be zero in many places today, but it’s unlikely to remain zero for long. That means that many companies have hidden liabilities on their books, says a recent HBR. Economic models and the experience of the EU Emissions Trading System suggests that a price could likely be between $50 and $100 per ton of CO2 in the near term and rise from there. At $100 per ton that would represent five percent of the global economy. Five percent of the global economy is a huge number. But where does this liability sit? With the world’s corporations. The Bank of England increased its #carbonprice forecast to $150 per ton by the end of the decade and warned banks that they face a tipping point similar to a “Minsky moment” if they fail to prepare.
The European Central Bank (ECB) recently announced the results of its climate stress test, indicating that banks urgently need to accelerate the incorporation of climate risk into their risk management frameworks, and that banks remain heavily exposed to emissions-intensive industries. The International Association of Insurance Supervisors (IAIS), having abdicated this responsibility, cannot ignore this any longer.
Exxon Mobil case study
In 2020 Exxon Mobil released 112 Mn metric tons of CO2 ‘equivalent’ (other GHGs including methane). At $100/ ton they would owe $11bn annually on their own emissions. Since the company has earned only $ 8 bn on average over the past 5 years this means they would rapidly be bankrupt. That surely is a good way to finally get the attention of their board. Add in company’s share of the annual $ 60 bn from pricing the roughly 600 Mn metric tons of its Scope 3 emissions (it’s not clear how much they could pass on to purchasers) and the situation is even more dire. This case study from Dr. Eccles ought to be a revelation for insurers in a business-as-usual mindset.
‘BES’ and Colonialism
While the disconnects between insurers and sustainability make a long list, the intent here was to put spotlight on a few critical ones. Nature has never had the attention and significance it merits. Biodiversity and Ecosystem Services (BES) which account for half the global GDP can be ignored only at our peril. “TNFD (Task Force on Nature Related Financial Disclosures) needs to be integrated into investors’ financial strategies to test & understand how to assess nature-related risks”, reminds Antoine Denoix CEO, AXA Climate. The bean-counters in the insurance industry need to also internalise this compelling reality. Mind you this is not about green taxonomy. With this backdrop it would at best be a lip service.
Last but not the least, the just-published Lancet Planetary Health study highlights how "Existing climate mitigation scenarios perpetuate colonial inequalities". Perhaps the only room for manoeuvre is to address where the IPCC climate scenarios fail to take Global North / Global South inequities into account. Global South, therefore, deserves a longer runway, says Bill Baue.
In conclusion
Notwithstanding the glaring disconnects discussed here, it is possible for insurers to drive sustainability and be ESG compliant. Likewise, to be ESG compliant as well as sustainable. Having said that, ESG ought to be integrated into Risk Management, Underwriting & Investments. That is how insurers can drive the money-pipeline towards de-carbonisation. “90% of all known fossil fuel reserves and resources held by all companies must stay in the ground to limit global warming to 1.5°C. But if more than 40% of reserves are extracted and burned the world will comfortably pass 2°C, with devastating consequences”, warns Mark Campanale.
While the war in Europe has taken its toll and has given a ‘life line’ to fossil fuel, the regulatory actions from SEC, BaFin to FCA and the likes will catch up with insurers. So would climate litigation. Insurers have to learn to deal with physical, transition and liability risks not just in context of protecting their respective balance sheets but also the Planet. The way forward is not about mere lip service to NetZero Insurance Alliance (NZIA) but to demonstrate real intent for fulfilling sustainability and ESG.
Insurance providers play a role as protectors - safety nets for society. Today, they are acutely aware that this role extends to responding to climate change. They too are challenged - by clients, shareholders, competitors and society itself - to help secure all of our futures… around the world. They’re compelled to rise to the challenge, and starting to figure out how best to accelerate action and make a positive impact. What the Principles of Responsible Investments (PRI) and Principles of Sustainable Insurance (PSI) failed to achieve, can we ensure the ISSB succeeds?
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