This article explores how (re)insurers can embed sustainability within governance frameworks and risk culture. Many of the structures underlying good governance and risk culture are already in place under Solvency II. They can be updated to incorporate sustainability strategies rather than completely overhauling a company’s governance framework.

Developing a sustainability strategy

Before diving into governance or culture or thinking about other aspects of sustainability and climate-related factors, such as materiality assessments or sustainability disclosures, it is important for companies to develop a clear sustainability strategy. A sustainability strategy allows companies to articulate their sustainability goals over the short, medium and long term. This can help reduce some of the uncertainty with regard to how things will evolve in the future. From a culture perspective, it is important for the strategy to align to the company’s mission, vision and values.

Key considerations for a sustainability strategy

A sustainability strategy should consider how to balance short-term financial performance with long-term sustainability goals, ensuring that the company remains profitable while protecting against climate-related risks and pursuing environmentally and socially responsible practices. We believe that a robust sustainability strategy should reflect on three core elements: ability, agility and alignment. Ability reflects the company’s internal competencies in understanding and managing these risks. Agility reflects the company’s ability to adjust and adapt as time and data give guidance to the uncertainties and our understanding grows. Alignment reflects not only compliance with regulations, but how the strategy aligns with the company’s mission, vision and values, and also crucially its customers’ needs.

Key considerations include:

• Climate change: Companies need to consider the risks that climate change poses to their business, in addition to how their corporate actions can impact the climate. This is referred to as the ”double materiality” assessment, looking at both ”outside-in” and ”inside-out” perspectives based on current activities. An initial risk assessment should enable the company to identify areas where current activities are misaligned with its mission, vision for the future or values. Any future changes should also be built into the sustainability strategy.
• Other sustainability factors: The sustainability strategy should be wider than just climate change. Many companies consider other environmental factors such as biodiversity risk, in addition to social factors such as fairness and financial inclusion, within sustainability strategies. The UN Sustainable Development Goals (SDGs)¹ and the UN Environment Programme (EP) Finance Initiative (FI) Principles for Sustainable Insurance² can be used as a road map to understand where (re)insurance can make a difference.
• Holistic approach: In defining the strategy, it is important to consider how the company wants to be viewed by key stakeholders, including investors, customers, suppliers and employees. Sustainability should be considered across all business units and across the organisation as a whole. It is important to ensure consistency across the organisation and business units. For example, sustainability criteria should be considered consistently within the investment, underwriting and supplier strategies to ensure business units are working towards the same common purpose.
• Focus on risks and opportunities: The strategy should consider key risks and how to mitigate against them, but also should aim to help the company identify key opportunities within the sustainability space and how to deliver on them. Some companies may decide that they want to be seen as market leaders in the sustainability space and will actively strive towards that, whereas other companies may be more comfortable taking more conservative approaches. However, as the market moves it will be important for all companies to adapt or run the risk of being left behind.

Governance under Solvency II

Insurance companies are well-placed to integrate sustainability factors into their governance and risk management frameworks, thanks to the robust risk management models established under Solvency II. The key elements for updating the governance framework to include sustainability factors are as follows:

• Competencies and communication: It is important that key stakeholders within the company, including the board of directors, are educated to ensure they understand climate-related risks and have the knowledge to assess them. It is essential that the board, committees and senior management understand and appropriately manage the risks that climate change poses, including within the strategic decision-making process. Training should include an overview of climate and sustainability-related risks, in addition to industry-specific risks. The risks faced by life, health and non-life insurers can vary widely, depending on the company’s insurance liabilities, assets and operating environment.
  
  Our understanding of climate and sustainability risks, and how to integrate them into (re)insurers, is evolving at a rapid pace. Training and competencies are not “one and done” but an annual “review and renew” for all staff. The Institute and Faculty of Actuaries (IFoA) recently published a risk alert⁴ highlighting the rapid evolution of data and risks of underestimating climate risks when using published climate scenarios. Staff need to be competent in understanding the challenges and limitations of scenarios (and all sustainability metrics) and ensure their implications are clear in internal and external communications.
• Roles and responsibilities: Defining roles and responsibilities for climate change risk is crucial for ensuring that an organisation can effectively manage these risks. “Guidance for (Re)Insurance Undertakings on Climate Change Risk,” published by the Central Bank of Ireland (CBI),⁵ specifically highlights that the CBI expects that responsibility for identifying and managing financial and operational risks arising from climate change is allocated to relevant senior managers and those duties and responsibilities are clearly documented and understood.
• Risk management: Sustainability and climate-related risks should be incorporated into the existing risk management framework. (Re)insurers have developed robust risk management frameworks under Solvency II, including board-approved risk appetite statements, risk policies and regular risk monitoring and reporting. Risk policies should be updated to reflect climate and sustainability risks as well as any related risk indicators, management information and board risk packs. This is particularly important where material risks have been identified. We recommend integrating sustainability risks into the risk management framework by understanding their role as drivers of existing risks rather than new or idiosyncratic risks. It is also important to reflect on how the uncertainties associated with climate and sustainability-related risks may manifest in the future. These uncertainties and potential key impacts need to be embedded into risk triggers, which will then need to be monitored.

Risk culture

The aim is to demonstrate commitment to the sustainability strategy across the organisation, which is inevitably driven by the tone from the top. In its guidance on climate change risks for (re)insurers, the CBI noted that the ”tone from the top” should be one that places appropriate emphasis on the management of climate change risk.

The board and senior management team should be held accountable for the company’s sustainability strategy, including achievement of sustainability goals and targets. Regular monitoring and reporting against targets should be visible and transparent across the organisation.

There is a lot of overlap between what makes good governance structures and what drives a robust risk culture. The following should be considered when ensuring that the risk culture and tone from the top place sufficient emphasis on sustainability:

• Leadership: The company should have a defined sustainability strategy and senior management should be seen to support and take actions that are aligned with this strategy. The strength of the company’s leadership commitments to this strategy will influence the risk culture penetrating through all levels of the organisation.
• Governance: Responsibilities and accountabilities in respect of climate change and sustainability should be clearly defined. There should be policies in place to support the sustainability strategy and compliance with the policy should be monitored. Management information packs should include detail on climate and sustainability factors. The governance structure for sustainability factors should be well established and visible across the organisation.
• Competency: The company should show commitment to the strategy by allocating sufficient resources and expertise to its sustainability strategy, both through hiring and training.
• Decision-making: Climate and sustainability risks and opportunities should be sufficiently considered throughout the decision-making process, and should be visible throughout the organisation. Consideration should be given to both an outside-in and an inside-out perspective. Aligning the executive evaluation process and remuneration policy with the sustainability strategy is also crucial.

Adapting to changing goals

Climate change is a fast-evolving area, and the evolution of climate science and our broader understanding is almost certain to outpace the published financial services scenarios. Critically, scientists are now warning that temperatures are rising at a higher rate and tipping points may come sooner than initially expected.

Climate-related institutions, scientists and academics and financial professional bodies, including the Institute and Faculty of Actuaries, have highlighted this in a number of recent publications. It is important for the board and senior management to recognise that the company is on a journey and to embed an appreciation of the challenges and limitations of the models and data presented to them. The broad uncertainties mean that strategies may need to adapt quickly to new evidence and guidance. Open and transparent communication about this journey is essential to ensure that the governance structure remains robust. This is best achieved by ensuring competencies across all staff and a culture of clear communication of both outcomes and limitations. Clear, honest communication externally is also critical to avoid greenwashing whilst highlighting the positive steps to manage key risks and engage in the opportunities.

Conclusion

In conclusion, for the (re)insurance industry, embedding sustainability within governance frameworks and risk culture should involve integrating to the existing structures under Solvency II, rather than a complete overhaul. Developing a sustainability strategy and ensuring consistency across the organisation will be key to understanding the risks and opportunities and establishing a strong risk culture. A robust sustainability strategy will reflect three core elements: ability, agility and alignment.

We recommend integrating sustainability risks into the risk management framework by understanding their role as drivers of existing risks rather than new or idiosyncratic risks. By embedding sustainability factors in governance frameworks and company culture, companies will be better placed to navigate future uncertainty and changes with regard to climate change and sustainability factors.

If you are interested in discussing any of the topics discussed in this article in more detail, please reach out to the authors, or your usual Milliman consultant.

¹ UN. The 17 Goals. Sustainable Development Goals. Retrieved 16 August 2024 from https://sdgs.un.org/goals.

² UNEP FI. Principles for Sustainable Insurance. Retrieved 16 August 2024 from https://www.unepfi.org/insurance/insurance/.

³ Swiss Re. Sustainability Report 2023. Retrieved 16 August 2024 from https://www.swissre.com/dam/jcr:52d75760-2c43-4d96-be2f-0514382ac51a/2023-sustainability-report-en.pdf.

⁴ IFoA (6 June 2024). Risk Alert: Climate Change Scenario Analysis. Retrieved 16 August 2024 from https://actuaries.org.uk/media/ue4hdq3l/risk-alert-climate-change-scenario-analysis.pdf.

⁵ CBI (March 2023). Guidance for (Re)Insurance Undertakings on Climate Change Risk. Retrieved 16 August 2024 from https://www.centralbank.ie/docs/default-source/regulation/industry-market-sectors/insurance-reinsurance/solvency-ii/requirements-and-guidance/guidance-re-insurance-undertakings-on-climate-change-risk.pdf?sfvrsn=a232991d_6.