Made to measure in 2023: A key step towards Net Zero for the insurance industry
Recent developments in emissions measurement and Net Zero target setting methodologies for the insurance industry mean the time to take credible action on climate change is now.
The industry has long recognised the financial risks from climate change, including the impacts from rising natural catastrophe losses. However, despite being at the forefront of modelling, measuring, and pricing of climate risk for the real economy, the industry has lagged behind in measuring its insurance-associated emissions and setting meaningful Net Zero targets that cover its underwriting portfolios.
Prior to November 2022, the lack of a commonly accepted methodology for measuring carbon emissions of underwriting portfolios and setting a Net Zero target precluded insurers from doing this. However, recent developments from the Partnership for Carbon Accounting Financials (PCAF), the Net-Zero Insurance Alliance (NZIA), the Transition Planning Task Force (TPT) and the Glasgow Financial Alliance for Net Zero (GFANZ) mean that the foundations are in place, so insurers can have no justifiable excuses and must take action.
As outlined in our previous blog, the three key elements of an insurer’s scope 3 emissions are their internal operations, investments and underwriting portfolio. While insurers have made progress against investments and operational GHG emissions measurement and target setting, less than 10% of the world’s largest insurers set credible Net Zero targets that cover their underwriting activity.1 The real-world impact of insuring, and thereby facilitating, high carbon activity vastly outweighs efforts to decarbonise internal operations and office buildings.
Firms that promulgate a public ESG or Net Zero strategy will be increasingly susceptible to greenwashing accusations if these not supported by credible interim and long-term decarbonisation targets that include scope 3 portfolio underwriting emissions. Increasing regulatory requirements around setting transition plans mean that insurers will need to carefully consider how they set and disclose plans to meet Net Zero targets.
We set out here two of recent developments from PCAF and the NZIA that will allow insurers to progress on their measurement and target-setting journeys.
1) Baselining insured emissions – PCAF
Setting a meaningful Net Zero target requires baselining your carbon emissions. Launched during COP27, PCAF’s recent standard for insured emissions was as a step change for the industry. The standard sets a globally recognised methodology for calculating and disclosing the GHG emissions associated with re(insurance) portfolios.
Covering commercial and personal motor lines of business, the standard marks an important starting point for the industry to measure and attribute emissions to many of the material lines within an underwriting portfolio. The standard is in its first iteration and currently excludes certain lines of business, such as commercial treaty reinsurance and construction. PCAF, however, acknowledge that the standard will be enhanced as methodologies and emissions data from the real economy improves.2 Debates over whether to include of scope 3 emissions remain but all parties should recognise that this is a first step on a challenging long-term journey, particularly when considering how long modern financial accounting standards took to develop.3
2) NZIA target setting protocol
Since PCAF, Net Zero Insurance Alliance (NZIA)’s recently published target setting protocol outlines how an entity committed to Net Zero can set a meaningful science-based target. Inspired by the SBTi’s Financial Sector Science Based Targets Guidance, the protocol outlines three key target categories and five sub-categories for members of the NZIA to set (see below).
The 29 members of the NZIA, which includes Lloyds of London, must set and disclose their first target by 31 July 2023. The remaining targets in each of the three categories must be set by 31 July 2024.
NZIA Target Setting Protocol
Science aligned: NZIA members are expected to independently set targets in line with the latest climate science.
Protocol structure: The Protocol suggests five target types, split into three differentiated target categories: Emission reduction targets (Emission reduction targets, Sectoral decarbonisation targets), Engagement targets (Portfolio coverage targets, Focused engagement targets), Other targets (Re/insuring the transition targets). All targets should be aligned with 1.5C climate goal.
Minimum requirements: By 31 July 2023, NZIA members should select at least one of the five target types. By 31 July 2024, at least one target type in each of the three target categories should be selected. As far as possible, members should look to encompass the broadest scope of their re/insurance portfolios, where reliable data is available. Members will have to explain the rationale behind their choice of portfolio target boundaries, depending on what each member considers is material and relevant in its portfolio. Members will be expected to expand their initial portfolio target boundaries over time.
Scope of business: Business lines in scope include Commercial insurance lines (Property, Liability/Casualty, Commercial motor, Marine, Aviation, Agriculture, Trade credit) and all Personal Motor lines. These include directly insured and facultative reinsurance covers.
Interim targets: NZIA members should adopt a target year no later than 2030 for their near-term targets and are expected to publish interim targets every five years in 2035, 2040, and 2045.
Next steps and additional considerations
The insurance industry now has the tools to begin baselining underwriting emissions and set meaningful science-based Net Zero targets. Three next steps for the industry to consider as they start on the journey in using these evolving tools are:
- Begin a pilot exercise for baselining insurance associated emissions for the entirety or portion of their books covered by the recent PCAF standard.
- Build on existing data and models used for financed emissions in investments to identify the significant data requirements that will underpin disclosure against these standards.
- Engage with stakeholders, including customers and brokers, on latest developments to assess the potential impacts on lines of business and identify key clients that will require focussed engagement in the transition.
Conclusion
Mark Carney helped launch the NZIA target setting protocol at Davos. Eight years on from his ‘Tragedy of the Horizon speech’ delivered to Lloyds of London, the insurance industry has significantly enhanced its ability to measure, mitigate and price climate change financial risk.1
However, to enhance its role as a credible partner to the real economy and show leadership in the move to a low-carbon world, the industry must take the first steps towards baselining emissions and setting meaningful, credible and science-based Net Zero targets. Insurers now have the tools and methodologies at their disposal to do this.
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[4] https://www.bankofengland.co.uk/speech/2015/breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability
