What Is the Task Force on Climate-related Financial Disclosures?

An introduction for actuaries Max J. Rudolph

Although climate change has been discussed for many years, companies have not been consistent in reporting on its impact. The Task Force on Climate-related Financial Disclosures (TCFD) is an international effort to remedy this shortcoming through advocacy of voluntary standards for reporting and peer pressure from investors, lenders and insurance underwriters. By implementing a consistent reporting framework, stakeholders will be able to achieve more timely, accurate and comprehensive assessments of systemic climate risk.

The Financial Stability Board (FSB) created the TCFD. Its initial recommendations were released in 2017, along with implementation details and a supplement on scenario analysis. These guidelines are relevant across industries, particularly for organizations issuing public debt and equity. An improved climate-risk awareness culture helps align strategic planning efforts, providing competitive advantages and improved access to capital. The process will continue to evolve over time as experience is gained and peer pressure incentivizes additional improved disclosures.

Within the financial sector, institutions the TCFD targets include banks, insurance companies, asset managers and asset owners. Examples include disclosures about credit or equity exposure to fossil fuel producers, financial impact of increasing weather-related natural disasters and the transition to a lower-carbon economy.

Actuaries in general may be interested in this information, but some who participate in financial reporting will be asked to develop a process that complies with the TCFD recommendations. Through its Catastrophe and Climate Strategic Research Program, the Society of Actuaries (SOA) is making actuaries aware of existing initiatives that can be leveraged, as well as identifying potential research projects to fill in gaps.

Scenario Analysis

Earth’s climate is a complex adaptive system1 interconnected with the atmosphere, oceans and land surface. Greenhouse gas emissions from our power generation, transportation and agriculture systems, along with increased urbanization, jeopardize that balance within the ecosystem. The resultant systemic risk of climate change impacts all lives, both directly and indirectly. More droughts, wildfires, storms and floods are hugely disruptive risks to our livelihoods, property and environment.

In the face of these uncertainties, the TCFD recommends that organizations use scenario analysis to make sense of future possibilities. Scenarios comprise plausible future outcomes and are not forecasts. They are not representations of a single event from a lone perspective, but rather they provide a view of the aggregated outcome of our interrelated natural and human systems. Scenarios address both physical risks, like damage from hurricanes or sea level rise, and transition risks like fossil fuels, which may become stranded assets as consumer preferences transition to a lower-carbon economy, or liabilities as those harmed by climate change seek compensation.

At a minimum, the TCFD suggests two scenarios:

  1. A transition aligned with the Paris Agreement2 (temperature rise in this century below 2 degrees Celsius above preindustrial levels) with greater transition risk/lesser physical risk
  2. A set of more limited (business-as-usual) climate policy actions, with greater physical risk/lesser transition risk

Ultimately, the scenarios a specific organization uses will depend on its unique risk profile.

Impact on Actuaries

Leveraging their training and experience, actuaries are developing a toolkit to identify, assess and manage climate risks; conduct analysis; report results; and discuss climate impacts on their organization. In addition to direct analysis for organizations like insurers that accept climate risk, actuaries also may act as reporters of indirect risks as an asset owner.

The TCFD recommendations have many similarities with enterprise risk management (ERM) and the Own Risk and Solvency Assessment (ORSA) concepts, seeking to improve transparency and decision-making. They cover governance, strategy, risk management, and metrics and targets. They permit organizations the flexibility to make context-dependent disclosures that are best suited to their unique exposures, culture and risk tolerance.

Among insurers, multiline and multinational insurers have been the early adopters of the recommendations. The change agents have been the insurance regulators that are affirmed TCFD supporters. Starting in 2020, in response to the demands of some state regulators, the National Association of Insurance Commissioners (NAIC) agreed to accept TCFD reports in lieu of submitting the Climate Risk Disclosure Survey.

In Canada, the Ministry of Finance has encouraged investors and state-owned entities to adopt the TCFD recommendations. More recently, access to COVID-19 economic aid by large businesses (excluding the financial sector) was made contingent on climate impact disclosures and commitment to make environmentally sustainable decisions.

The role and work product of actuaries will vary within traditional organizations based on their exposure to physical risks (property & casualty insurance), a combination of physical and transition risks (life/health insurers, property & casualty insurers and pension funds) or implications for investment returns (life insurers, pension funds and asset managers). Reinsurance companies may seek ways to diversify a concentration of physical risks. An actuary working at a nontraditional organization also could see wide-ranging opportunities to participate in this space.

Many actuaries have experience with the methodologies underlying climate change scenario analysis, an effective tool for explaining physical and transitional risks. They may be involved as preparers of climate-related risk reporting, as well as being users of the information provided.  Although good practices are emerging, there is no consensus yet around what constitutes best practice. It is not too late for actuaries to have input on these disclosures.

Actuaries interested in knowing more about the TCFD can:

  • Visit the TCFD Knowledge Hub.
  • Find examples of initial TCFD efforts of financial firms in the TCFD Pilot Projects from the United Nations Environment Programme Finance Initiative.
  • Read recently produced issue papers from the International  Association of Insurance Supervisors (IAIS), which provide specific information for the insurance sector, including a section on disclosures.
  • Read the complete report and listen to the podcast about TCFD written by the SOA’s Catastrophe and Climate Strategic Research Program.
Max J. Rudolph, FSA, CERA, CFA, MAAA, is a principal at Rudolph Financial Consulting, LLC.

References:

  1. 1. National Research Council. 2010. Advancing the Science of Climate Change. Washington, D.C.: The National Academies Press.
  2. 2. The Paris Agreement. United Nations Framework Convention on Climate Change (accessed September 28, 2020).

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