U.S. insurers and climate change: The longer-term horizon is getting shorter
Most state and federal insurance regulators have historically taken a more passive role in issuing regulatory-related climate risk changes than their counterparts in Europe. However, recent events indicate just how serious they are about making this a much higher priority. Examples of shifts in attitude toward climate change in the U.S. regulatory landscape include active oversight of domestic insurers in New York, addressing disruptions of private insurance coverage in U.S. markets, building greater industry resilience to natural disasters, and leveraging the insurance sector’s ability and willingness to achieve climate risk mitigation goals.
This article identifies some of the early strategic initiatives that prompted this insurance regulatory momentum. When taken as a whole, the actions now being required of insurers may seem daunting. In future articles, we will provide additional perspective and guidance on how some carriers are already addressing these issues.
United States on the move: Recent actions
On November 15, 2021, the New York Department of Financial Services (NY-DFS) released its Guidance for New York Domestic Insurers on Managing the Financial Risks from Climate Change.1 The NY-DFS expects its domestic insurers to take specific action on two of its key areas of climate change guidance by August 15, 2022: 1) implement the company’s expectations related to board governance, and 2) have specific plans in place to implement the company’s expectations relating to organizational structure.
In September 2021, the U.S. Securities and Exchange Commission (SEC) sent a sample Letter of Comment to companies regarding climate change disclosures.2 This followed the request by the Federal Insurance Office (FIO) in August 2021, which was in response to President Biden’s May 2021 executive order on climate change, for information and public comment on the insurance sector and climate-related financial risks.3
The National Association of Insurance Commissioners (NAIC) has an annual Climate Risk Disclosure Survey, where insurers with over $100 million in annual countrywide premiums are reporting on climate risks; this has produced responses in 15 states.4 The NAIC also has a Climate and Resiliency Task Force Solvency Workstream that meets quarterly. Rating agency AM Best Company (Best’s) has signed up as a member organization of the U.N. Environment Programme Principles for Sustainable Insurance (PSI), whose goal is to promote collaboration between the United Nations and the insurance industry. In November 2020, Best’s established credit ratings that reflect environmental, social, and governance (ESG) factors.5
Playing catch-up to Europe
These U.S. movements are lagging those of the EU. For the last eight years, our neighbors across the pond have been accelerating their efforts to effect real solutions to address climate change.
Several insurance sector coalitions have developed frameworks that insurers can adopt to tackle different aspects of the climate risk challenge. These coalitions include the U.N. PSI (as noted above), the Geneva Association, and the Insurance Development Forum (IDF). The Geneva Association issued a recent study that summarizes key industry trends and recent developments with respect to climate change.6 IDF is a public/private partnership led by the insurance industry and supported by international organizations, originally established after the Paris climate summit in 2015. It aims to leverage the industry’s risk management capabilities to “build greater resilience and protection for people, communities, businesses, and public institutions that are vulnerable to disasters and their associated economic shocks.”7
At the recent 2021 U.N. Climate Change Conference (COP26), IDF announced a number of programs to connect insurance risk assessment capabilities to building resilience to climate change. Two main initiatives included: 1) the creation of the Global Risk Modelling Alliance (GRMA), which will deliver improved risk and resilience underwriting through a public/private partnership and 2) the establishment of the Global Resilience Index Initiative (GRII), which will provide an open-sourced, globally consistent model for the assessment of resilience. (Milliman’s Chairman is a member of the steering committee of the IDF and the firm is an active collaborator on a number of the initiatives mentioned above).
The Financial Stability Board (an international body that monitors and makes recommendations about the global financial system), set up the Task Force on Climate-related Financial Disclosures (TCFD) in December of 2015.8 The U.N. PSI—a group including the U.N. and 22 leading insurers—issued a 2017 report of TCFD recommendations, and piloted these recommendations in January 2021.9 Over 2,600 companies have announced support for TCFD. The TCFD’s recommendations are structured around four thematic areas that are core elements of how organizations operate (and are consistent with NY-DFS guidance):
- Governance
- Strategy
- Risk management
- Metrics and targets
The Institute of Risk Management (IRM) in the UK has issued a practitioner’s guide to integrate climate change risk into enterprise risk management (ERM). This guide advises risk managers on how best to identify, manage, and report climate change risks to boards, including the benefits of an improved risk appetite framework and risk mitigation strategies, and use of consistent methods for risk management.
The European Insurance and Occupational Pensions Authority (EIOPA) has been very active in issuing numerous publications as part of its support of the European Union Commission on Sustainable Finance Strategy. EIOPA has also gone so far as to issue guidance on the use of climate change risk scenarios for insurers required to produce an Own Risk and Solvency Assessment (ORSA).10 From a more global regulatory standpoint, the International Association of Insurance Supervisors (IAIS) issued the Application Paper on the Supervision of Climate-related Risks in the Insurance Sector.
The EU’s process is continuous. Addressing climate change is a long-term endeavor, and we expect the United States to be no different. As EU organizations have found, it also requires researching, compiling, disseminating, and processing pertinent climate change information from the beginning.
What to do
As noted above, many U.S. carriers have chosen, if not been required, to address climate change risk already. It’s not easy, given the lack of historical data, the technical nature of the risks (both physical and transition), and the long-term horizon of potential effects. But understanding the various components of these risks, and being able to anticipate, measure, and communicate them to a variety of stakeholders, is key. At a high level, the entire process is driven by a rather simple question, the answer for which must coexist with your company’s mission: What is your ambition with respect to climate change?11
The very beginnings of integrating climate into a risk framework align with the NY-DFS guidance that requires an insurer’s board of directors to understand and oversee climate risks through a designated board member or board committee. In the UK, many companies have begun implementing processes that allow climate risks to be addressed at relevant levels within an insurer, including at the board level, through appropriate governance, strategic, and operational frameworks and policies. The board training includes topics such as what their responsibilities are, how they need to engage, and what information they should be expecting from management.
Some companies have hired an outsourced chief risk officer (CRO) to assist in integrating climate risks across lines of insurance businesses and operations, including underwriting and investment activities, risk management functions, and internal controls. This role has also been structured as a chief sustainability officer (CSO), whose role is to develop a strategic plan, ensure adequate data is collected, and create a foundation for tracking performance. This also typically includes a gap assessment: helping this executive identify and close the company’s gaps in terms of the required regulations. This person will likely also need to bring in other experts and consultants to advise on best practices and to build the skills and capabilities of practitioners with respect to climate risk issues. That person should ensure that the company is able to utilize relevant climate-related risk information in its day-to-day activities.
Climate change risk management experiences overseas can give us insight into what the future holds for organizations in the United States. We plan to continue to explore how that relates to the recent NY-DFS guidance in future articles.
1 NY-DFS (November 15, 2021). Guidance for New York Domestic Insurers on Managing the Financial Risks From Climate Change. Retrieved December 14, 2021, from https://www.dfs.ny.gov/system/files/documents/2021/11/dfs-insurance-climate-guidance-2021_1.pdf.
2 SEC (September 2021). Sample Letter to Companies Regarding Climate Change Disclosures. Retrieved December 14, 2021, from https://www.sec.gov/corpfin/sample-letter-climate-change-disclosures.
3 U.S. Department of the Treasury (August 31, 2021). U.S. Department of the Treasury Launches New Effort on Climate-Related Financial Risks in the Insurance Sector. Press release. Retrieved December 14, 2021, from https://home.treasury.gov/news/press-releases/jy0337.
4 California Department of Insurance. NAIC Climate Risk Disclosure Survey. Retrieved December 14, 2021, from http://www.insurance.ca.gov/0250-insurers/0300-insurers/0100-applications/ClimateSurvey/#:~:text=NAIC%20Climate%20Risk%20Disclosure%20Survey.%20The%20Insurer%20Climate,risks%20into%20their%20mitigation%2C%20risk-management%20and%20investment%20plans.
5 Royal Gazette (November 23, 2021). AM Best offers insight into ESG rating. Retrieved December 14, 2021, from https://www.royalgazette.com/re-insurance/business/article/20211122/am-best-offers-insight-into-esg-rating/.
6 Geneva Association (February 2021). Climate Change Risk Assessment for the Insurance Industry. Retrieved December 14, 2021, from https://www.genevaassociation.org/sites/default/files/research-topics-document-type/pdf_public/climate_risk_web_final_250221.pdf.
7 See the IDF website at https://www.insdevforum.org/.
8 See the TCFD website at https://www.fsb-tcfd.org/.
9 TCFD. Publications. Retrieved December 14, 2021, from https://www.fsb-tcfd.org/publications/.
10 Milliman (May 2021). EIOPA Opinion: Use of Climate Change Risk Scenarios in ORSA. Retrieved December 14, 2021, from https://ie.milliman.com/-/media/milliman/pdfs/2021-articles/5-17-21-eiopa-opinion-orsa_briefing-note.ashx.
11 Cantle, Neil. (December 2021). Simplifying climate resilience strategies for insurers. Retrieved December 16, 2021 from https://www.milliman.com/en/insight/Simplifying-climate-resilience-strategies-for-insurers.