Insurers Brace for SEC Climate Risk Disclosure Rules

By Russ Banham

Carrier Management magazine

For U.S. property/casualty insurance carriers, the landmark proposal by the U.S. Securities and Exchange Commission (SEC) on the disclosure of climate-related risks and greenhouse gas emissions (GHG) is a complicated matter.

For several years, many insurers have voluntarily provided climate risk disclosures and pledged to reduce their investments in and underwriting of companies that produce high volumes of greenhouse gas emissions. Assuming the SEC proposal is adopted and implemented as proposed, carriers will need to show exactly when and how this will be accomplished.

Released in March, the nearly 500-page proposal, formally called “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” is based on the global standard set by the Financial Stability Board Task Force on Climate-Related Financial Disclosures. Expectations are for aspects of it to change, albeit not markedly, following the receipt of public comments through June 17.Legal challenges also are anticipated, based for the most part on arguments that the SEC is overstepping its bounds. In a sharply worded dissenting opinion, SEC Commissioner Hester M. Peirce stated that the SEC is not an acronym for the “Securities and Environmental Commission.”

Nevertheless, the Biden administration has made climate change a centerpiece issue, one that SEC Chair Gary Gensler is committed to address and enforce on behalf of investors, who have long clamored to better understand and gauge climate risks in their investing decisions. As Michael Littenberg, partner and global head of ESG and Human Rights practice at law firm Ropes & Gray, put it, “Although the final rules are likely to differ from the current proposal, there will be a rule.”

Several environmental law firms, rating agencies, audit and advisory firms, and consumer rights advocacy organizations provided comments assessing the SEC’s disclosure demands for publicly traded U.S. carriers. Carrier Management also reached out to large insurance carriers and insurance brokers for their opinions and insights. They declined the opportunity, advising commentary instead from trade association the Insurance Information Institute (III).

Sean Kevelighan, CEO of the III, lambasted the SEC proposal as a “horse race” by the federal government, with the SEC “first out of the gate” to target an industry that “is more regulated and governed than any other industry that is governed.” Kevelighan is referring to the industry’s oversight by state insurance commissioners and the U.S. Treasury Department’s Federal Insurance Office.

He cited the Own Risk and Solvency Assessment (ORSA), adopted by the National Association of Insurance Commissioners in the aftermath of the 2008 global financial crisis, as an example of this regulatory oversight. “With ORSA, we already have a strong regulatory framework that calls for supervision of climate risks related to financial solvency,” Kevelighan said. “Why now do we need to provide additional disclosures for investors?”

The answer seems to be the industry’s colossal and growing losses attributable to climate change-related natural disasters. French insurance giant AXA ranked climate change as the biggest risk confronting the global insurance and reinsurance industries in September 2021. Eight months later, a report by Capgemini and Efma affirmed this opinion, stating that insured losses from natural catastrophes like wildfires and storms had increased 250 percent in the last 30 years. With less than one-fifth of 3,500 insurance professionals in 60 countries expressing faith in public authorities to mitigate the climate crisis, a fair argument can be made that the SEC is attempting to reverse this opinion.

The Scope of Things

Undoubtedly, investors in several P/C insurance companies are fed up with the status quo. At the annual general meeting of Travelers on May 25, investors put two climate resolutions on the ballot. More than 55 percent of shares voted in favor of a resolution requesting the company to report on how and if it plans to measure, disclose and reduce the emissions associated with its underwriting and investment activities. The other resolution, requiring Travelers to halt the underwriting of new fossil fuel supplies, failed. Several climate resolutions also were filed by shareholders at the annual general meetings of The Hartford, Chubb and Berkshire Hathaway.

“U.S. insurers are among the largest insurers of fossil fuel companies in the world,” said Yevgeny Shrago, policy director for Public Citizen’s climate program. “U.S. insurers also are some of the largest investors in fossil fuel companies in the world. Although many insurers have made promises to divest or reduce these investments, it remains to be seen how well they will do that. So far, they’ve had limited success.”

Insurers and reinsurers in Europe are considered well ahead of domestic carriers in providing broad climate risk disclosures. Assuming the SEC proposal is adopted in its current form, this gap will narrow. Carrier compliance will be demanding and expensive, however, given the need to gather, verify, measure and disclose climate data.

The SEC proposal specifically requires the disclosure of Scope 1, Scope 2 and Scope 3 emissions, of which Scope 3 is by far the most complicated. Scope 1 refers to greenhouse gas (GHG) emissions produced directly by a company, and Scope 2 involves GHG emissions related to the energy and electricity the company purchases. Scope 3 are GHG emissions produced by external entities up and down a company’s value chain, if deemed material—considered reasonably likely to affect investors’ decision-making.

Upstream activities are defined in the proposal as purchased goods and services, capital goods, waste generated from operations, and employee business travel and commuting; downstream activities are stated to include the transportation and distribution of products, a third-party’s use of those products, and a company’s investments.

An insurance company does not produce much if any GHG emissions, and the electricity purchased for office buildings by carriers is a relatively simple matter to measure and disclose. “Scope 3 is where the rubber hits the road for an insurance organization,” said Thomas Kelly, a partner at Big Four audit and advisory firm KPMG, who specializes in insurance and reinsurance.

Other interviewees share this perspective. “Scope 1 and 2, for insurers, are irrelevant,” said Patricia Kwan, a director at S&P Global Ratings. “Scope 3 is the challenge, as it may extend well beyond the supply chain to include customers, brokers and agents.”

Although the proposal does not specify that publicly traded insurers disclose the GHG emissions data of the businesses they underwrite and sell insurance policies to, the SEC does require disclosure of “reputational impacts (including those stemming from a registrant’s customers),” the proposal states.

The wording infers that the reputation of a company underwriting the risks of a new coal project, for example, could be damaged in ways that cause investors, customers and employees to cut ties with the company, producing a negative impact on its consolidated financial statement. Coal is the largest source of carbon emissions, and to stay on track to reach the 1.5°C climate target in the Paris Agreement, consumption of coal must decrease by 9.5 percent annually (according to a report by the Fossil Fuel Non-Proliferation Treaty Initiative).

This is just an interpretation, since the proposal is ambiguous on insurers’ need to disclose customer GHG emissions data. Still, several interviewees believe this was the SEC’s intent.

“We imagine that [an insurer’s] customers are considered part of their value chain for Scope 3 disclosure purposes, the same as any other customer,” said Shrago. “To be sure, we’ve asked in our comments to the SEC to lay the groundwork for insurance-associated emissions. The calculations are admittedly complicated, and there’s a need for a good methodology, but many insurers in Europe are already disclosing this and American insurers should follow suit.”

Kelly offered a similar observation. “In the comment period, questions like whether an insurer’s customers…are in the value chain are likely to be asked,” he said. “Until then, carriers need to begin thinking about how they would measure the disclosures in terms of materiality.”

On that matter as well, the SEC does not provide unambiguous guidance, said Kelly, whose long career at KPMG included 13 years in Bermuda providing audit services to insurers. “Going back to my roots as an auditor, without additional guidance from the SEC, it will be challenging for an insurer to calculate the CO2 measurements for potentially thousands of companies in different industry sectors buying layers and layers of many different products,” he said. “The dilemma is how to measure which policyholders with which products are material to investors. Without clear guidance or a methodology [to assess materiality], this will be difficult at best.”

Portfolio Permutations

The SEC proposal is clearer about the need for carriers to disclose the climate-related data of the companies in their investment portfolios, assuming this data is material. “For insurers, where the majority of their Scope 3 emissions will come from is their investments, as per Category 15,” said Public Citizen’s Shrago.

He’s referring to Category 15 in the Greenhouse Gas Protocol, a leading accounting and reporting standard for GHG emissions. “Chapter 15 would require information from investees [the entity in which an investment is made] on the formula they used to calculate their emissions, in addition to the insurer’s recalculation of these emissions insofar as their materiality,” said S&P Global’s Kwan.

Determining materiality for each investee is a daunting task since the SEC does not provide a bright line standard. The SEC proposal states, “We are not proposing a quantitative threshold for determining materiality, [but] we note that some companies rely on…a quantitative threshold such as 40 percent when assessing the materiality of Scope 3 emissions.”

The statement appears to suggest that a 40 percent threshold is an appropriate yardstick. Further on, however, the proposal states that Scope 3 emissions “may make up a relatively small portion of…emissions but still be material…if there is a substantial likelihood that a reasonable [investor] would consider it important.”

The statement infers that the decision depends on a company’s discernment of what their investors might consider material, arguably a tough nut to crack. “Absent the provision of a methodology on a materiality threshold, there’s really no way to measure this at the moment; perhaps after the public comment period concludes, this will be clearer,” Kwan said.

Other interviewees agreed. “The SEC proposal leaves a lot of leg room for publicly traded insurers to determine materiality, which is good and isn’t so good,” said , partner and vice chair of the Environmental Practice Group at law firm Goldberg Segalla. “It’s a fine line trying to figure this out. There’s risk in getting it wrong.”

One way to get it right is to consider all GHG emissions, in an insurer’s value chain and across its investees, to be material. “The SEC should make Scope 3 emissions material for large companies, since for most large firms they are almost certainly material,” said Shrago. “Even if an insurance company has what it considers to be low Scope 3 emissions, this is still material information that investors would want to have.”

He added, “At a minimum, the SEC should require companies that say their Scope 3 emissions are not material to explain their reasons.”

If there is good news with regard to the inherent difficulties in disclosing investee emissions, it is that insurers “tend to invest in a lot of government bonds, with equities making up a very small portion of the portfolio,” said securities attorney Littenberg.

When the SEC releases its final version of the climate rules later this year, the hope is that the varied Scope 3 disclosure questions will be resolved for insurers and other publicly traded companies. Cognizant of the steep Scope 3 disclosure challenges, the SEC has provided an additional phase-in period for compliance (compared to Scope 1 and Scope 2 compliance) and a limited safe harbor from liability, except in cases of fraud.

Getting Ready

In the interim, Littenberg advised insurers and other publicly traded companies to integrate the GHG Protocol standards and the TCFD (Task Force on Climate Financial Disclosure) framework into their climate-related oversight, management, processes and reporting. TCFD has developed a set of voluntary climate-related financial risk disclosures, and the GHG Protocol includes a set of standardized frameworks to measure GHG emissions produced in a company’s value chain, an important step toward addressing the proposed Scope 3 disclosures.

“Guidance also is available from state insurance regulators,” Littenberg said, pointing to the NAIC’s March 2022 proposed climate reporting requirements, which would require affected insurers to disclose climate-related risk assessments, including Scope 3 GHG emissions in some cases, at the board and C-suite level.

It is expected that many publicly traded companies will rely on external audit, consulting, research and other third-party firms to provide services related to gathering and measuring Scope 3 emissions data. “Tons of consulting firms are out there running greenhouse gas emissions models, including for insurance companies,” Littenberg said.

He advised carriers to put in place climate risk management teams in management and on the board to provide necessary oversight, guidance and uniform, consistent and transparent public communication. This seems prudent since the proposal calls for boards to identify both board committees and members responsible for climate-related oversight. The proposal states that the oversight could be performed by an existing standing committee like the audit or risk committees or by a separate committee focused exclusively on climate risk disclosures. Approximately 13 percent of boards have created a separate ESG sustainability committee, according to the Deloitte Center for Board Effectiveness.

Insurer Financial Strength

Neither S&P Global nor AM Best consider the SEC proposal, if implemented in its current form, to seriously jeopardize the financial strength and stability of publicly traded U.S. insurance companies.

“If adopted as is, we believe that compliance with the Scope 3 emissions requirements will be very challenging, introducing considerable costs to gather, verify and report accurate climate data,” said Maura McGuigan, an AM Best senior director. “Obviously, these costs could impact the bottom line, but we think it unlikely to impact insurers’ financial strength, in and of itself.”

Kwan offered a similar perspective. “Most big companies can digest some of these upfront costs and the expenses related to ongoing due diligence and surveillance,” she said. “The SEC will require disclosures on a year-over-year basis, which will result in a lot of scrutiny from the investor base to make sure the data is reliable and consistent.”

While large insurers are more likely to absorb these added operational expenses, Kwan’s colleague John Iten, senior director and Property/Casualty Insurance sector lead in North America, said, “For smaller companies that file to the SEC, the additional expenses may be more material.”

McGuigan agreed. “Clearly, the expenses will be more onerous for insurers with tighter margins.”

Certainly, change is in store for publicly traded insurers and even private ones. “Companies that don’t transition toward net zero greenhouse gases, or who are perceived as not having taken sufficient steps to do so, may be subject to reputational risk, as we saw with the protests by climate activists at Lloyd’s of London in April,” said Jessica Botelho-Young, associate director at AM Best. She’s referring to a group calling itself “Insurance Rebellion” that dumped a large pile of fake coal in front of the venerable insurance institution’s One Lime Street headquarters in London.

Indeed, several interviewees commented on the unique role played by insurance carriers to effect positive climate actions. “The industry has tremendous influence and power in regard to the policyholders and investors that carriers choose to do business with,” said Buermann. “By choosing not to do business with a company that doesn’t live up to what it should be doing to achieve sustainability and other ESG goals or by charging such companies significantly higher premiums than their competitors pay, carriers can effect positive climate actions sooner than later.”

It’s a lot to demand of the insurance industry. Time will tell.

Russ Banham is a Pulitzer Prize-nominated journalist.

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