Through their influence as both risk underwriters and institutional investors, insurers are uniquely positioned to make a significant contribution towards a sustainable, low-carbon future.

This article provides an overview of the accounting for Insurance-Associated Emissions, which are a type of scope 3 emission associated with an insurer or reinsurer’s underwriting activities.

Accounting for greenhouse gas emissions

If insurers are to contribute to the reduction in greenhouse gas (GHG) emissions, they need to be able to accurately account for their emissions: that is, they must be able to measure and report the impact of the emissions they produce and the emissions of others that they might have some responsibility for or otherwise enable. Only by doing so, can they then establish clear targets to reduce emissions, implement focused actions to deliver against the targets and then monitor the effectiveness of those actions.

For many insurers, their scope 3 emissions likely represent the largest source of their emissions. An insurer does not produce scope 1 emissions as a result of any industrial manufacturing process, but it enables others to produce emissions by providing them with insurance that might be necessary for their continuing in business.

Following from the above, an insurer’s management of its scope 3 emissions and its ability to influence others might be its most significant opportunity to reduce GHG emissions – for example, in the case of an insurer, whether to offer to a motor insurance policy that facilitates ongoing car emissions.

An insurer has scope 3 emissions on both sides of its balance sheet. On the liability side it has provided insurance (such as motor, property, health) or annuities to other parties; while on the asset side, it has invested in or financed others (for example through securities, equities, or loans) using the premiums it has received from its issued insurance policies.

There are four published standards that should help insurers account for and report their GHG emissions. In overview: The GHG Protocol Corporate Standard provides the overarching framework, including setting out what are scope 1, 2 and 3 emissions and how to account for scope 1 and 2 emissions. The GHG Protocol Corporate Value Chain (Scope 3) Accounting and Reporting Standard is a supplement that provides a framework for accounting and reporting on scope 3 emissions.

The Partnership for Carbon Accounting Financials (PCAF) has published two further standards to supplement the GHG Scope 3 standard, to provide more detailed methodologies to account for GHG emissions and disclosure requirements. The Global GHG Accounting and Reporting Standard for the Financial Industry: Finance Emissions“ is for financed emissions (ie the asset side of the balance sheet); and “Insurance-Associated GHG emissions (IAEs)” (PCAF Insurance Standard) is for insurance or reinsurance products (ie the liability side). PCAF methodology for Insurance-Associated Emissions

The PCAF Insurance Standard provides a methodology to measure and disclose scope 3 GHG emissions for two lines of business: personal motor lines and commercial lines.

Measurement methodology

The GHG Scope 3 Standard recognises that it is not always possible to accurately determine the scope 3 emissions directly attributable to an entity or product, and that some form of allocation may be required. For example, providing commercial property insurance does not in itself produce emissions, but it enables a business to be carried on from the building that may house manufacturing processes that emit GHG. Key considerations include finding an allocation approach that fairly reflects the relationship between the emissions and the entity’s (in this case insurer’s) responsibility or influence and that can be applied consistently.

In the case of category 15 scope 3 emissions, the GHG Scope 3 Standard suggests using some form of economic allocation, based on the entity’s proportional share of equity or debt. This approach does not work for insurance products, as unlike equity or a loan, an insurance product does not represent an ownership stake or a part of the balance sheet: premiums are a (typically annual) cost to the insured.

The PCAF approach builds on but adapts the approach in the GHG Scope 3 Standard. The Insurance-Associated Emissions (IAE) of the insurer are an allocation (or attribution) of the emissions of the insured (IAE = Attribution factor x Emissions). The standard goes on to define the attribution factors to calculate the insurer’s share of an insured customer’s emissions – in simple terms:

• For commercial lines, the attribution factor is calculated as the ratio of the insurance premium to the customer’s revenue from sales of goods and services.
• For personal motor portfolios, the attribution factor is calculated as the ratio of the insurance premium to the annual costs associated with vehicle ownership (such as depreciation, fuel, maintenance and repairs). The standard recognises two factors could be determined: one calculated at the industry level or one at the individual insurer level if it is not possible to use the industry factor.

There are different approaches to determine the emissions of the insured entity, and which depend upon the availability and quality of the data. For example actual emissions data would be preferred, but if that is not available or is of poor quality, then estimates and proxies can be used.

Disclosures

The PCAF Insurance Standard sets out a minimum set of disclosures to report, along with encouraged ‘best practice’ disclosures. These reporting requirements are intended to complement existing frameworks such as the International Sustainability Standards Board (ISSB), and the requirements set out in the GHG Scope 3 Standard. Given the various assumptions that may be involved in measuring emissions, transparency of approaches will be essential to ensure properly informed decisions can be made.

Some challenges and issues in accounting for IAEs

Accounting for IAEs poses multiple challenges that require careful consideration. The challenges include methodological gaps and limitations, and data availability and quality.

• Limited Scope: The PCAF Insurance Standard only provides an approach to measuring GHG emissions for two lines of business: personal motor lines and commercial lines. Notably absent are significant sectors such as personal life, health and property, corporate life and pensions, and public sector purchased products. There is a desire to add additional lines of business to the PCAF Insurance Standard. The technical challenge is identifying the relevant emissions of the insured and determining an appropriate allocation or attribution approach (for example, what are the emissions of an annuitant and what share should be attributed to the annuity provider?). Where these lines of business are material to an insurer it will need to determine whether these should be captured within the boundary of its scope 3 emissions in line with the GHG Scope 3 Standard, and if so, develop its own methodology (pending any further guidance by PCAF or others).

• Attribution Factor: PCAF uses an attribution factor approach based on data that is readily available – such as revenues and costs. This is pragmatic but includes a number of issues to be aware of, which is why it is important that there is transparency around the approaches adopted and assumptions made. For example, for commercial business lines, revenue may fluctuate based on market prices and competition, which are likely to be independent of emissions which are more likely to be associated with production volumes. For personal motor portfolios, costs may be more fixed relative to the emissions of the vehicle, but there is a judgment about the weighting (equal in this case) to be applied. Moreover, the approaches for commercial and motor are not directly comparable and so cannot be aggregated to derive an absolute level of overall emissions (see section 5.1 of the PCAF Insurance Standard for a discussion of these issues).

• Double counting: means counting the same emissions more than once and arises because emissions are not uniquely disaggregated. For an individual insurer there are different ways emissions could be double counted: when the insurer provides coverage for various lines of business, such as both car and business insurance; or when it is involved in both underwriting and investment activities with the same counterparty; or when it underwrites or invests at multiple levels within its value chain (eg it provides insurance to companies A and B, but company B’s scope 3 emissions include those of company A because company A provides electricity to Company B). At the sector level, different insurers may also share the same customers with other insurers or financial institutions. PCAF recognises that double counting is a common and inherent challenge in GHG accounting, and that instances of double counting might persist. But PCAF also indicates that double counting need not be a problem, provided that the approach gives the insurer better insight into the different ways its business is creating or facilitating emissions, and there is understanding and transparency of the approach. Moreover, PCAF’s aim is not to create a single global balance sheet of emissions.
  
  
• Data Availability and Quality: Obtaining reliable and consistent data concerning the GHG emissions of the insured customers or assets can be challenging. This issue will be particularly pronounced for small and medium-sized enterprises (SMEs) that might not report their emissions or adhere to varying methodologies and standards; or where the insurer has no ownership interest to justify asking for non-public data. To compensate, insurers might resort to estimates or proxies based on industry averages or benchmarks. However, such methods can introduce uncertainties and inaccuracies into the calculations. As data challenges are likely to persist in the short-term insurers will likely need to adopt a somewhat pragmatic approach.
  
  
• Stale Data: There is a risk that the emissions data available to insurers might be old, introducing a significant risk of relying on irrelevant or inaccurate information. The risk is exacerbated as there may be inherent time lags between the availability of data and its reporting or availability for use by others. For example, the insurer needs the emissions data of third parties in its value chain, but those third parties may also need to obtain the emissions data from companies in their value chain. This creates a challenge – how to set emission reduction targets, determine and measure the effectiveness of actions, when the actual position might be uncertain.
  
  
• Data Alignment and Aggregation: Data misalignment between the legal entities of the insured customers or assets and their emissions and revenue reporting data is another challenge. This may occur when a customer operates numerous subsidiaries or operations across different countries or regions, reporting their emissions and revenue on a consolidated basis. Insurers may need to allocate or apportion the data to align it with their underwriting portfolios. Additionally, aggregating IAEs across various lines of business, products, geographies, and time periods can pose significant challenges.
  
  
• Data consistency: over time it may be expected that data quality should improve. The data necessary to accurately measure emissions should get better, as taxonomies are defined, and processes and controls are put in place to capture and manage the data. However, as data changes, it is possibly no longer prepared on a consistent basis. This may reveal previously made decisions were perhaps not optimal or make it harder to assess the long-term effect of decisions.

Summary

The emergence of the PCAF Standard for IAEs marks a positive step forward in the insurance sector's ability to account for its emissions and should enable it to make better decisions about how best to attain a sustainable, low-carbon future.

While there are inherent limitations in the current version, this is inevitable with accounting for a new subject: a new accounting framework needs to be developed, data taxonomies need defining, and processes need to be put in place to gather and manage new data items.

It should also be recognised that the responsibility of insurance products for the emissions of the insured will vary, and that in some cases this could be limited. As a result, there is also a need to avoid overengineering (or even developing) methodologies for these products.

The potential weaknesses do not argue for delay in adopting the GHG Scope 3 and PCAF Insurance Standards, but it is crucial that they are understood, and the various standards are approached with careful consideration; and the insurance industry must continue to work towards overcoming them.