The scope of IFRS S2 is as is set out on the tin i.e. a set of disclosure requirements governing an entities climate related risks and opportunities and how these might be reasonably expected to affect an entities cashflows, its access to finance or cost of capital over the short, medium and long term.
The focus here is on climate related risks both and physical and transition, with IFRS S1 governing the broader range of ESG factors.
The standard has four broad areas of disclosure.
Governance
The first of these covers governance and includes detailing the oversight body, describing their roles and responsibilities in relation to climate-related matters, key areas of accountability and ensuring appropriate skills and competencies. Further there are requirements to evidence how the governance structure is integrating climate considerations into strategic decisions and risk management processes, overseeing target setting and monitoring progress.
Strategy
Following on from governance is strategy where disclosure involves describing identified climate-related risks and opportunities, categorising them as physical or transition risks, setting out their expected time horizons, and explaining and importantly describing a firm’s strategy both over the short and long term in respect of managing relevant risks and taking advantage of any opportunities.
Risk Management
Disclosure requirements around risk management take on a more granular view of how risks are being identified, measured and managed. This includes detailing the inputs and parameters used, such as data sources and operational scope, the use of climate-related scenario analysis, methods for assessing risks, monitoring procedures, and how these processes are integrated into the overall risk management framework.
Metrics and Targets
Lastly as we all know if you do not measure it how can you manage it. So IFRS S2 includes metrics and targets to provide insight into an entity’s performance concerning climate-related risks and opportunities, as well as its progress towards set targets. This entails disclosing cross-industry and industry-based metrics relevant to greenhouse gas emissions, climate-related transition and physical risks, opportunities, capital deployment, internal carbon prices, and remuneration linked to climate considerations.
Additionally, entities are required to disclose quantitative and qualitative climate-related targets, including metrics used, objectives, applicability, duration, base period, milestones, intensity or absolute nature, alignment with international agreements, validation processes, monitoring methods, performance analysis, and factors influencing target derivation, such as the use of carbon credits and sectoral decarbonisation approaches.
Specific guidance for insurers
Helpfully IFRS S2 comes with additional industry specific guidance – Industry-based Guidance on implementing Climate-related Disclosures, which will be welcome news to insurers who by virtue of the complexity of their business models often face into more challenges when it comes to the application of accounting standards. Here the objective wasn’t to introduce additional requirements for insurers but to set out ways they might better comply with the standard.
Why insurers are important in the context of climate risks
Before we get into the specifics, it’s worth covering briefly why all of this might be more of a challenge for insurers.
Firstly, the insurance sector by virtue of its ability to transfer, pool and or share risk, plays a significant role in the economy. Unsurprisingly climate risks and those that insurers seek to underwrite heavily intersect, catastrophe insurance is a clear example. Also, because insurers limit or eliminate risk for individuals and businesses insurance can unfortunately remove incentives to manage climate risks.
Coupled with this is the significant role that insurers play in allocating capital as part of their investment activities and the follow on opportunity this provides to help steer funding to that supports net zero goals.
Climate risks also pose risks to insurers existing portfolio of assets which can give rise to losses as a consequence of stranded assets, or investments that are not resilient to changes in the environment.
So let us take a look at some of the standout areas for insurers in the industry specific guidance.
ESG factors and investment decisions
In relation to the asset side of a firms balance sheet insurers might consider disclosing their approach to incorporating environmental, social, and governance (ESG) factors into their investment management process. This encompasses aligning with definitions provided by initiatives like the Global Sustainable Investment Alliance (GSIA) and the PRI Reporting Framework, with specific consideration given to various approaches such as screening, sustainability-themed investment, integration of ESG factors, or a combination thereof.
Further, insurers are encouraged to elaborate on the day-to-day implementation of ESG factors, including responsible parties, research approaches, and integration methods. Discussion might be expanded to governance structures, accountability mechanisms, and any scenario analysis or modelling conducted to assess future ESG-related risks at the portfolio level.
Consideration of ESG factors is also encouraged, in particular those that influence strategic asset allocation, risk-return profiles, and selection of external fund managers, with a focus on asset class distinctions, investment strategies, and the impact on various types of investments.
Policies designed to incentivise responsible behaviour
Acknowledging the role insurers have in influencing customer behaviour the guidance sets out where their actions in terms of product design and offering are helping to drive net zero goals. Insurers might consider disclose of net premiums written for policies related to energy efficiency and low carbon technology, covering areas such as renewable energy insurance, energy savings warranties, and carbon capture and storage insurance. This includes policies that absorb environmental risks to support sustainability-related projects and technologies. Renewable energy insurance encompasses protection against natural hazards and mechanical breakdowns, while energy savings warranties insure guaranteed energy savings for projects like building retrofitting.
Further, it is encouraged that insurers describe how they incentivise health, safety, or environmentally responsible actions or behaviours through clauses in insurance policies and pricing structures, with a scope covering consumer and commercial segments in property, casualty and life insurance. Firms might also cover aspects of traditional products that incentivise positive behaviours, including premium discounts for green buildings, resource efficiency improvements, low-emission vehicles, safer driving, and healthy behaviour.
Physical exposure risk
With climate change increasing the likelihood and potential severity of weather events insurers are subject to much greater physical exposure risks. With this in mind insurers the guidance covers potential disclose of the Probable Maximum Loss (PML) of insured products resulting from natural peril catastrophe events, defined as the anticipated value of the largest monetary loss from weather-related natural catastrophes based on catastrophe modelling and exceedance probability. This includes events like hurricanes, tornadoes, floods, and extreme weather, with disclosure of PML across various likelihood of exceedance scenarios and geographical locations, both gross and net of catastrophe reinsurance.
Additionally, consideration is given to the total amount of policyholder benefits paid and claims incurred from modelled and non-modelled natural peril catastrophe events, with disaggregation by type of event, geographical segment, and gross and net of catastrophe reinsurance.
Disclosure might be expanded to outline approaches to incorporating environmental risks into both individual policyholder contracts and entity-wide risk assessments, including processes for identifying and assessing climate-related risks on insurance and reinsurance portfolios. This encompasses physical, transition, and liability risks over short, medium, and long-term horizons.
