What US Insurers Should Keep in Mind about Climate Change Regulations

Temperatures Rising: What US Insurers Should Keep in Mind about Climate Change



There has been a marked increase in public announcements from regulators in recent months, both in the United States and internationally, relating to climate change and about embedding consideration of climate change-related risks into regulation of financial institutions. To be sure, converting rhetoric, aspirations and proposals into tangible policy changes and new regulatory compliance requirements will take time, probably years, but now, in the wake of another year full of climate change news and severe weather events of all kinds around the country and world, that there is a trend seems clear enough. (And the Biden administration has signaled in recent days that climate change considerations will be included in the policymaking activities of every federal department and agency.) While some insurers have well-developed, robustly funded and staffed functions to monitor and address climate change-related risks in their businesses, others that do not (particularly insurers that fall into the category of internationally active insurance groups (IAIGs)) would be well-advised to “kick it up a notch” at this time.

In Depth

Indeed, “kicking it up a notch” may well be the central climate change message in 2021 for ALL businesses. The Economist’s September 19 “Special Report on Business and Climate Change” summarized the answer to the question “Why should businesses care about all of this” with these four points:

  1. The immediate impact of climate change on business operations
  2. Expected and ever more intense regulation, driven both by governments and by the demands of customers
  3. The growing risk of litigation over climate change and
  4. Technological change that will create opportunities as well as costs—opportunities that their competitors may be the first to exploit.

So, what exactly is going on with respect to insurers? This short report seeks to summarize the recent significant insurance regulatory initiatives, developments and announcements regarding climate change-related risks, starting with international climate change financial disclosure initiatives that cut across industry sectors:

  • Financial Stability Board (FSB)—In 2015 the FSB, the international coordinator of national financial regulators in 24 jurisdictions and the premier international standard-setting body, created the Task Force on Climate-related Financial Disclosures (TCFD) to “develop a set of voluntary, consistent disclosure recommendations for use by companies in providing information to investors, lenders and insurance underwriters about their climate-related financial risks.” The TCFD, chaired by former New York City Mayor Michael Bloomberg, published its initial status report in 2017 and released its third such report in late October 2020. The FSB has asked the TCFD to prepare another status report in September 2021. The FSB itself, along with other financial regulators (see the Federal Reserve System item below) is currently assessing the channels through which certain climate change-related risks might impact the financial system and how they might interact, as well as what “amplification mechanisms and cross-border effects” might exist or develop in the near future.
  • International Association of Insurance Supervisors (IAIS)—In an October 2020 “Application Paper on the Supervision of Climate-related Risks in the Insurance Sector,” the IAIS continues its work, in conjunction with the United Nations’ (UN) environment program and through the Sustainable Insurance Forum, to integrate sustainability factors into the regulation of insurers. Recognizing that rising air and water temperatures and rising sea levels, combined with increasing frequency and severity of natural catastrophe (nat cat) events present financial risk both to the resilience of insurers playing critical roles in the management of climate-related risks as underwriters and investors and to the stability of financial markets generally. The paper focuses on supervisory review and reporting, corporate governance, risk management, investments and financial disclosures. The IAIS aims to help national regulators identify risks and to assess the materiality of those risks for insurers—again looking at underwriting, investments, liquidity, operations, reputational and strategic risks.
  • Federal Reserve System (FRS, the Fed)—In its November 2020 Financial Stability Report, the Fed included a short piece on climate change-related risks as they relate to financial institutions, noting that analysis of the impact of climate-related risks on financial institutions is at an early stage. Staff at the Fed is currently focused on identifying and assessing the channels through which climate change risks will impact regulated entities. Federal Reserve Board Governor Lael Brainard (someone mentioned as a candidate to be the next Treasury Secretary) released an accompanying statement that is worth quoting at length:
    • “I welcome the introduction of climate into the FRS. Climate change poses important risks to financial stability. A lack of clarity about true exposures to specific climate risks for real and financial assets, coupled with differing assessments about the sizes and timing of these risks, can create vulnerabilities to abrupt repricing events. Acute hazards, such as storms, floods or wildfires, may cause investors to update their perceptions of the value of real or financial assets suddenly. Chronic hazards, such as slow increases in mean temperatures or sea levels, or a gradual change in investor sentiment about those risks, introduce the possibility of abrupt tipping points or significant swings in sentiment. Supervisors expect banks to have systems in place that appropriately identify, measure, control and monitor their material risks, which for many banks is likely to extend to climate risks. At present, financial markets face challenges in analyzing and pricing climate risks, and financial models may lack the necessary geographic granularity or appropriate horizons. Increased transparency through improved measurement and more standardized disclosures will be crucial. It is vitally important to move from the recognition that climate change poses significant financial stability risks to the stage where the quantitative implications of those risks are appropriately assessed and addressed.” [footnotes omitted][emphasis added]
  • National Association of Insurance Commissioners—The NAIC has established a new Executive Committee level “Climate Change and Resiliency Task Force” that will be active during 2021 with an array of workstreams to develop the NAIC’s overall approach to policy and recommendations but also to address: (i) solvency issues (including investments), how to modify own risk and solvency assessment (ORSA) requirements as well as developing stress testing scenarios; (ii) insurer financial disclosures (in line with TCFD guidelines); (iii) pre-disaster mitigation; (iv) technology; and (v) innovation (new insurance products).
  • California Department of Insurance—Climate change and the risks it poses both on the underwriting side as well as to investments has been on the radar screen of at least some US regulators since 2009, when California started its Climate Risk Survey. This year approximately 1,000 insurers are expected to respond to the Survey. Last year, two-thirds of respondents affirmed that they have a climate change policy with respect to risk and investment management. Sixty percent (60%) said they are taking action to manage climate change risks. But one-third of respondents said they did not factor climate change into their investment management guidelines.
  • Washington State Insurance Department—Recently re-elected Insurance Commissioner Mike Kreidler started the NAIC’s Climate Risk and Resilience Working Group in 2007 and was the chair for many years. He joined the Sustainable Insurance Forum in 2016. The state participates in the Climate Risk Survey. In October 2020 he hosted the state’s fourth climate summit, bringing together regulators, scientists, policymakers and insurers.
  • New York Department of Financial Services (NYDFS)—Like California and Washington State, New York participates in the Climate Risk Survey but is now devoting more attention and resources, including the appointment of a Director of Sustainability and Climate Initiatives, to speed the integration of climate change considerations into supervision of insurers (and banks). In September 2020 the NYDFS published Circular Letter #15 announcing that:
    • “At a high level, DFS expects all New York insurers to start integrating the consideration of the financial risks from climate change into their governance frameworks, risk management processes and business strategies. For example, insurers should designate a board member or a committee of the board, as well as a senior management function, as accountable for the company’s assessment and management of the financial risks from climate change. An enterprise risk management function and the Own Risk and Solvency Assessment process should address climate change as a reasonably foreseeable and relevant material risk and should consider how it impacts risk factors such as investment risk, liquidity risk, operational risk, reputational risk, strategy risk and underwriting risk. In addition, insurers should start developing their approach to climate-related financial disclosure and consider engaging with the Task Force for Climate-related Financial Disclosures framework and other established initiatives when doing so. Questions pertaining to an insurer’s approach and activities related to the financial risks from climate change will be integrated into DFS’ examination process starting in 2021.”
    • In a welcome caveat, the DFS stated that insurers “should take a proportionate approach that reflects [each insurer’s] exposure to the financial risks from climate change and the nature, scale, and complexity of its business…depending on the insurer’s size, complexity, geographic distribution, business lines, investment strategies and other factors.”

Insurers should appreciate that countries other than the United States are more advanced in efforts to devise processes to monitor and share information on climate change-related risks and to embed climate change-related risks within supervisory regimes. Canadian, French, Japanese, German, Dutch and other regulators have all been more active than US regulators in developing data, asking climate change-related questions during periodic financial examinations, conducting thematic examinations, delving into board and management oversight with respect to climate change-related risks and asking whether certain insurers ought to appoint Chief Climate Risk Officers. The IAIS and the NAIC provide ways and means for US state insurance regulators to accelerate their supervision of climate change-related risks. US-based insurers should expect the temperature of the regulatory environment with respect to climate change-related risks to rise more rapidly in the months and years to come.