On December 8, 2020, the Monetary Authority of Singapore (MAS) published the Guidelines on Environmental Risk Management for Insurers. These guidelines are aimed at improving the management of environmental risks by all insurers, in line with the expectations of the MAS.
The primary objective of the guidelines is to enhance the insurance sector’s resilience to and management of environmental risk through setting out sound risk management practices.
The guidelines are applicable to insurers’ underwriting and investment activities, and other activities that expose insurers to material environmental risk, including insurers carrying on business in Singapore under a foreign insurer scheme established under Part IIA of the Insurance Act (Cap. 142).
Banks face several risks such as
· Environmental risks: These include physical risks (from weather events and widespread, long-term environmental changes) and transition risks (related to adjusting to an environmentally sustainable economy with the requisite changes in public policy, technology, and consumer and investor preferences).
· Financial risks: The financial impact on insurers’ activities can arise through physical and transition risk channels, including:
o Market risk: Insurers may be exposed to a decline in valuation and increased volatility in their investments (particularly in carbon-intensive sectors and companies that have contributed to significant environmental degradation) as a result of shifts in investor preferences.
o Operational risk: Severe extreme weather events can disrupt business continuity by negatively impacting the insurer’s infrastructure, systems, processes and staff.
o Insurance risk: Environmental changes can have a direct impact on general insurers as more frequent and severe natural catastrophe events can result in higher claims and underwriting losses. Life insurers are also impacted by such environmental changes through climate change effects (e.g. higher water/air temperature, increase in carbon dioxide levels) on morbidity and mortality risks. Environmental risk may also lead to higher liability risk, which include the risk of environmental-related claims under liability policies as well as direct claims against insurers for failing to manage environmental risk. For instance, insurers may be exposed to greater liability risk stemming from directors and officers policies, where the management of the insured may not have considered or responded to the impacts of climate change and environmental risk.
o Liquidity risk: Natural disasters can cause widespread damage on physical property and incur significant costs (e.g. construction and repair), when the insurance risk materialises, leading to a surge in need for funds, and exacerbating liquidity stresses in insurers. Insurers may also experience difficulties in liquidating assets impacted by weather events, or stranded in the transition towards an environmentally sustainable economy. Investors, who are increasingly environmentally-conscious, may also cut back on sources of funding for insurers that underwrite activities with a negative impact on the environment.
· Reputational risk: These come from insurers providing insurance coverage for customers that carry on business activities which have a negative impact on the environment. Negative perception of such underwriting activities can adversely affect insurers’ abilities to maintain or establish business relationships.
Environmental risks stem from the possible impact of environmental changes on economic activity and the well-being of people. These changes could include land use changes, pollution, and loss of biodiversity. The guidelines address environmental risks across five pillars.
- Governance and strategy: The guidelines clarify that the board of directors (Board) and senior management are required to identify environmental risks and opportunities over the short and long term, and to evaluate the actual and potential impact of these risks and opportunities on the insurer’s strategies and business plans. They must maintain effective oversight of the insurer’s environmental risk management and disclosure. They should also oversee the integration of environmental risks into the insurer’s enterprise risk management framework.
As per the guidelines, the Board, or a committee delegated by it, is responsible for:
- Approving an environmental risk management framework and policies to assess and manage the insurer’s environmental risk exposures on an ongoing basis
- Ensuring that environmental risk, where material, is addressed in the insurer’s risk appetite framework
- Setting clear roles and responsibilities of Board and senior management
- Ensuring that directors have adequate understanding of environmental risk
- As per the guidelines, the senior management is responsible for
- Ensuring the development and implementation of an environmental risk management framework and policies, as well as tools and metrics to monitor exposures to environmental risk
- Regularly reviewing the effectiveness of the frameworks, policies, tools, and metrics, as well as making appropriate revisions
- Establishing an internal escalation process for managing environmental risk, and ensuring that appropriate and timely actions are taken to address the risk
- Updating the Board on material environmental risk issues in a timely manner
- Allocating adequate resources with appropriate expertise
- Risk Management:
Policies and Procedures
- An insurer should have in place an enterprise risk management (“ERM”) framework which provides for the identification and quantification of relevant and material risks, including environmental risk.
Risk Identification and Assessment
- The insurer should identify material environmental risk (particularly for sectors with higher environmental risk) and assess the potential impact on the insurer.
- The insurer should apply risk criteria to identify sectors with higher environmental risk.
- The insurer should take a consistent approach to environmental risk and issues across different functions.
Risk Management and Monitoring
- The insurer should actively manage and monitor its environmental risk exposures.
- the insurer should engage each customer10 that poses higher environmental risk, and encourage the customer to improve its environmental risk profile and transition towards sustainable business practices over time based on its risk assessment.
- The insurer should provide all relevant information on its material environmental risk exposures to its Board and senior management to monitor progress against the insurer’s risk appetite and business strategies.
- The insurer should have in place a clear allocation of responsibilities for management of environmental risk in accordance with the three lines of defence model.
Scenario Analysis and Stress Testing
- The insurer should develop capabilities in scenario analysis and stress testing consistent with MAS Notice 126 to assess the impact of material environmental risk on its risk profile and business strategies, and explore its resilience to financial losses under a range of outcomes.
- The insurer should include relevant, short-term and long-term environmental scenarios (using conservative and regularly reviewed assumptions) into its scenario analysis and stress testing for strategic planning and risk management purposes.
- The insurer should use the results of its scenario analysis and stress testing when reviewing its environmental risk management policies and practices.
- The insurer should equip its staff, including through capacity building and training, with adequate expertise to assess, manage and monitor environmental risk in a rigorous, timely and efficient manner.
Integrating Environmental Issues
- Underwriters should be provided with the means to check the potential impact of the proposed transaction on the environment.
- Insurers should develop internal guidance for processes on risk detection and risk escalation, while taking into account its overall risk management framework and risk appetite.
Decision-Making on Environmental Risk
- The insurer should assess each customer’s environmental risk as part of its underwriting assessment, particularly for sectors with higher environmental risk.
- The insurer may refer to external ratings on environmental performance, develop its own risk assessment and rating methodology or incorporate the customer’s exposures to climate transition risk in its assessment.
- The insurer may consider imposing underwriting conditions to require a customer with higher environmental risk to take steps to manage its environmental risk within an acceptable timeframe.
- The insurer may work with its customer to establish specific and meaningful environmental performance targets.
Escalating Environmental Risk to Decision-Makers
- Transactions with higher environmental risk should be subject to the insurer’s enhanced due diligence.
Measuring and Monitoring Underwriting Exposures
- The insurer should develop quantitative and qualitative tools and metrics to monitor and assess its underwriting exposures to material environmental risk.
- The insurer may also evaluate its assessment with international climate targets and benchmarks, such as the Paris Agreement.
- Insurers should put in place appropriate processes and systems to monitor, assess and manage the potential and actual impact of environmental risk on individual investments and portfolios on an ongoing basis, where material.
- The insurer should consider environmental impacts both from a macro, top-down, as well as from a more granular bottom-up asset selection perspective to the extent practicable.
- The insurer should consider developing mechanisms and metrics that provide a reasonable indication of the environmental risk inherent in their investment portfolios.
- The insurer may use its own indicators to assess the environmental impacts from companies engaged in or related to these activities and other activities the insurer deems relevant.
- The insurer should promptly re-assess the risk and return profile of the individual investment or portfolio as applicable when there are developments that could materially affect the operations and financials of an investee company or substantially affect its broader investment portfolio.
- The insurer should undertake a comprehensive review of its investment portfolios regularly under relevant stress scenarios, to assess what the longer-term impact of environmental changes are.
- The insurer should consider appropriate changes over time to mitigate the impact of any significant risks on their portfolios.
- Promotion of Responsible Business Behaviours
- The insurer should consider engaging with companies individually and asset managers, as appropriate, to help shape the corporate behaviour of investee companies positively through engagement, proxy voting and sector collaboration.
- The insurer should consider collaborative engagement with other investors for efficiency, enhanced influence and legitimacy when engaging investee companies, and to build knowledge and skills.
- The insurer should disclose its approach to managing environmental risk in a manner that is clear and meaningful to its stakeholders at least on an annual basis.
- The insurer’s disclosure should be in accordance with well-regarded international reporting frameworks, such as recommendations by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (“TCFD”).
- The insurer should review its disclosure regularly to improve its comprehensiveness, clarity and relevance.