The Role of Insurance in Net Zero
With more than USD 6 trillion in global premium volume and USD, 36 trillion in assets under management, the insurance industry’s balance sheets hold a significant portion of global economic assets and liabilities. Through key activities such as risk management, risk transfer, and investment, the insurance industry has the ability to support the transition to a resilient, net-zero future.
In line with the carbon accounting standards for financed emissions (which covers lending and investment activities), to account for the role of re/insurer’s underwriting activities, a global, standardized approach for measuring the greenhouse gas (GHG) emissions associated with insurance and reinsurance underwriting portfolios is needed. Such a standard can empower insurers to consider the climate impact and transition path of their underwriting portfolios and inspire action through innovative decarbonization interventions, products, and policies. All this, while underpinning reporting consistency and promoting transparency. More importantly, the carbon footprint of insurance-related activities can inform underwriting decisions and catalyze decarbonization at the portfolio level through target setting, scenario analysis, and strategy development.
“Follow The Risk” Principle
When it comes to financed emissions, the “follow the money” principle is applied, meaning that the money should be followed as far as possible to understand and account for the climate impact that financial assets have in the real economy. The GHG Protocol bases organizational boundaries on what is owned, controlled, or financed by a reporting company.
In the context of underwriting, the nature of the relationship between the financial institution and the client is fundamentally different. Underwriting seeks to mitigate risks associated with economic activity but does not finance this activity nor suggest any form of ownership. Therefore, the concept of organizational boundaries as specified above does not apply to re/insurers as they do not hold capital interest in the client operations, and no financial or direct operational control is exerted.
The absence of ownership or control over the client's activity impacts the influence an insurer can have on the decisions made by the client in terms of decarbonization. Therefore, in the case of insurance-associated emissions, the principle applied is “follow the risk” instead of “follow the money.”
A New Standard
The Partnership for Carbon Accounting Financials (PCAF) led the drafting of a scoping document that set out the guiding principles for developing a GHG accounting methodology for insurance and reinsurance underwriting. The key objective of the scoping paper was to initiate wider engagement on insurance-related emissions and through feedback obtained, inform the consultation paper on the proposed approach. The scoping paper was, therefore, broad in remit as it considers various potential approaches.
On November 16, 2022, the much-anticipated PCAF standard on insurance-related emissions was published and constitutes the next step toward accounting for emissions related to underwriting activities.
What does this mean for re/insurers?
To date, the absence of a global standard for insurance-related emissions meant that re/insurers were only able to measure, manage, and disclose emissions related to their operations (in line with the Greenhouse Gas Protocol (GHGP) and investment activities (in line with PCAF’s financed emissions standard). The publication of the new standard has therefore set in motion a number of changes conducive to achieving net zero across the insurance sector.
Holistic measurement: The disconnect between the mounting expectations around committing to net zero targets across operations, investments, and emissions associated with insurance and reinsurance underwriting portfolios is being bridged with this latest PCAF release. The re/insurance industry now has an agreed-upon methodology to tackle the challenge holistically and develop credible and actionable decarbonization plans.
Internal & external buy-in: Creating transparency for stakeholders is another business goal that can be enabled. Externally, re/insurers can inform the market of their climate impacts through disclosures made in line with TCFD (Task Force on Climate-related Financial Disclosures), CDP, as well as a range of other mandatory and voluntary methods. Internally, informing stakeholders of their organization’s impact can increase trust among internal stakeholders, as well as inspire new engagements and product offerings with clients and business partners.
Actionable insights: Carbon accounting can further help re/insurers manage their own climate-related transition risks by building an understanding of the exposure embedded in their underwriting portfolios. For example, identifying carbon-intensive underwriting activities in specific high-risk sectors can help identify areas that might be adversely impacted by the introduction of carbon taxation.
Sustainable business growth: Climate-related opportunities for innovation and sustainable product development across resource efficiency, energy sources, products and services, markets, and resilience are opportunities for re/insurers. With the transition to a low-carbon economy, re/insurers can independently develop innovative products and services that enable their clients to decarbonize their business activities. Through carbon accounting, re/insurers can see which sectors and businesses in their own portfolios require the most help in their decarbonization efforts and play an active role in their transition.
What is the scope of the standard?
Underwriting products tend to be classified by the Line of Business (LoB) for which risk coverage is offered. Although there might be differences in semantics across institutions and geographies with respect to product classification, the new standard will cover:
- Commercial lines insurance (i.e., all types of insurance purchased by companies) and
- Personal motor insurance (the insurance of vehicles purchased by private individuals or households).
Exclusions at this point in time include:
- Insurance contracts purchased by public entities (e.g., government agencies, municipalities, etc.). These will be covered in future versions of the Standard, potentially leveraging ongoing work for financed emissions from sovereign bonds.
- Other personal lines (e.g., homeowner insurance), any life or health insurance (including corporate life and pensions), and personal accident.
A complete list of LoBs covered by the standard can be found in table 5-1, on page 30 of the new standard.
How are emissions attributed?
Two different attribution approaches are put forward based on the LoB in question: Commercial lines and Personal motor.
For commercial portfolios, the re/insurer accounts for a portion of the annual emissions of the customer. This portion is determined by the ratio between re/insurance premium for that customer (numerator) and revenues generated by the customer (denominator).
Source: Carbon Accounting Financials
PCAF distinguishes three options to calculate the insurance-associated emissions for commercial lines portfolios, depending on the emissions data used:
- Option 1: reported emissions
- Option 2: physical activity-based emissions
- Option 3: economic activity-based emissions
For personal motor portfolios, attribution can be calculated by considering attributes that relate to the vehicle’s use throughout its operational life while being insured. The most commonly cited elements for a vehicle’s operation include:
- Vehicle depreciation costs – the car owner, manufacturers and dealers may be represented by these costs
- Fuel costs – gas stations may be represented by these costs
- Maintenance – tow services, wreckers, repair shops, etc. may be represented by these costs
- Registrations/taxes – roads and government infrastructure may be represented by these costs
- Parking, tolls, etc. – more relevant in some jurisdictions versus others
The insurance-associated emissions are determined by the ratio of the insurer’s revenue received from the insured (i.e., the insurance premium) to the revenues of all other factors that are part of a vehicle’s ownership. For simplification of calculation, this value is approximated by the cost of insurance related to the annual running costs of a passenger vehicle.
Source: Carbon Accounting Financials
The insurance-associated emissions from motor vehicle policies can be calculated in several ways depending on the availability of data to derive the emissions of the insured vehicle:
- Option 1: actual vehicle-specific emissions
- Option 2: estimated vehicle-specific emissions and local distance-driven averages
- Option 3: estimated vehicle-unspecific emissions and continental distance-driven averages
Where do we go from here?
Being the only SaaS platform that has codified the GHG Protocol and PCAF standard for financed emissions, we have already taken steps toward scaling our product to meet the new PCAF standard and enable our re/insurance customers to start accounting for their insurance-related emissions as early as Q2 2023. We aim to be able to continue to support global decarbonization through the provision of our agile and adaptable platform, which will be scaled to cater to the complex needs of the insurance sector. If you would like to find out how the Persefoni platform can automate your alignment with PCAF and the GHG Protocol you can schedule a demo here.