Financial impacts from environmental changes over the last five years has been a wakeup call for both regulators and financial services industry, particularly insurance. Climate change has now become the leading strategic risk organizations face. This is due to the breadth of risks and impacts environmental changes create. In 2021 APRA developed a guide on understanding and managing financial risks of climate change (CPG 229) with the promise of more supervisory attention to understand the full risks and deeper supervisory assessments. Whilst the information which was gained from industry surveys and the financial vulnerability assessments, emerging environmental risks were progressing at a rate that far exceeded most requirements or mitigation actions
This has led organizations to focus on Environmental, Social Governance ESG polices and strategy
What do we know so far?
Environmental, Social Governance (ESG) refers to frameworks in place for organizations to manage risks and opportunities By Alison Cameron, Head of Governance, Risk & Compliance, Youi Insurance Alison Cameron NEW RISK EXPOSURES FACING INSURERS TACKLING CLIMATE CHANGE 27 December 2023 related to environmental, social and governance criteria. It should be considered as part of a holistic sustainability strategy. ESG is commonly used for investment and capital allocation decisions, as a company’s corporate policies relating to addressing climate change, community relationships and ethical practices plus internal controls and audits.
Organizations can determine their ESG risk through an ESG risk score. This measures the level of exposure to environment, social and governance risks. Most commonly a 100-point scale is used to rate the company’s ability to balance its financial performance against sustainability risks.
ESG has three risk categories:
Environmental risks – impact on the environment such as Carbon footprint; Waste management; Water usage
“To develop an effective strategy, it is critical to have a full understanding of the company’s current status and identify exposures”
Social risks – Ethical practices and the company’s relationships with stakeholders. For example, impacts on communities in which it operates and supply chains, labor practices, equality, and diversity
Governance risks – decision making and governing policies. How a company communicates to shareholders and stakeholders; structures, ESG disclosures
Addressing Climate change risks
To develop a risk management strategy to address Climate change risks, it is important to consider the broader context of environmental and sustainability risks, so they can be assessed against the organizational risk profile. Climate related financial risks can be broken down into the following:
• Physical risk – this looks at the changing climate conditions and direct impacts
• Transition risk – innovation from technology and social adaptation within the economy
• Liability risk – defined as the risk of no action and regulatory enforcement
Organizations who have already developed ESG frameworks and climate risk working groups may have implemented targets. This can be effective in developing measures and monitoring actions. For instance, companies who are looking to support low – carbon economies with set targets can conduct audits to demonstrate tracking and improvement activities.
Physical risks can be further described as natural peril events, sea level and temperature impacts
Transition risks focus more on policy and legal requirements (emissions reporting or cost to transition to lower emissions; carbon tax); technology; supply chain and reputational damage.
Liability risk is the cost of exposure to fines or regulatory enforcement actions, or losses suffered as part of inaction
Plan of action
To develop an effective strategy, it is critical to have a full understanding of the company’s current status and identify exposures. A climate risk assessment will evaluate organizational readiness and awareness of climate related risks and build the foundation for effective climate risk management.
