New York Department of Financial Services announces creation of new Climate Risk Division and issues guidance on managing the financial risks from climate change

Eversheds Sutherland (US) LLP

Eversheds Sutherland (US) LLPOn November 3, 2021, the New York Department of Financial Services (DFS) announced the creation of a new Climate Risk Division (the Division) that is tasked with integrating climate risks into DFS’s supervision of regulated entities, supporting the industry’s growth in managing climate risks, coordinating with international, national, and state regulators, developing internal capacity on climate-related financial risks, supporting the capacity-building of peer regulators on climate-related supervision and ensuring fair access to financial services. The Division will be led by Dr. Yue (Nina) Chen, DFS’s Director of Sustainability and Climate Initiatives, who was appointed Executive Deputy Superintendent.

With the announcement of this new division, DFS continues its push to be at the forefront of climate change-related financial regulation. DFS was one of the first states to participate in the NAIC Climate Risk Disclosure Survey (preceded only by California), and over the last several years, DFS has issued a number of industry letters and hosted webinars on the financial risks presented by climate change.

Most recently, on November 15, 2021, DFS issued final guidance for New York domestic insurers on managing financial risks from climate change (the Guidelines). With the announcement of the Division and the Guidelines, New York domestic insurers can expect DFS to have an increased focus on climate change-related issues during examinations and during its review of filings, such as Own Risk and Solvency Assessment (ORSA) filings, enterprise risk reports and Corporate Governance Annual Disclosure (CGAD) filings.

Guidance on managing financial risks from climate change

At a high level, the Guidelines lay out DFS’s expectation that every New York domestic insurer should:

1. Integrate the consideration of climate risks into its governance structure at the group or insurer entity level, including that the board of directors have responsibility for understanding climate risks and overseeing their management within the insurer’s risk appetite and organizational structure.

  • This includes (1) adoption by the board of a written risk policy describing how the insurer monitors and manages material climate risks in line with its risk appetite statement, and (2) designation of a board member or committee of the board as responsible for the oversight of the insurer’s management of climate risks, as well as one or more members of senior management as responsible for the insurer's management of climate risks.
  • Insurers are expected to implement these governance requirements by August 15, 2022.

2. When making business decisions, consider the current and forward-looking impact of climate-related factors on its business using time horizons that are appropriately tailored to the insurer, its activities, and the decisions being made.

  • This includes documenting how its analysis is considered in its strategy-setting process, risk appetite framework and risk management and compliance processes.

3. Incorporate climate risks into its existing financial risk management, including by embedding climate risks in its risk management framework, analyzing the impact of climate risks on existing risk factors (including credit, legal, liquidity, market, operational, pricing and underwriting, reputational and strategic risks), and considering climate risks in the company’s ORSA.

4. Expand current scenario analysis practices to consider physical risks (i.e., risk relating to acute weather events like hurricanes and chronic shifts in weather patterns like droughts) and transition risks (i.e., risks relating to society’s transition to a low-carbon economy), multiple carbon emissions and temperature pathways, and short, medium and long-term horizons. Scenario analyses should inform business strategies and risk assessment and identification.

5. Publicly disclose its climate risks, including how the risks are integrated into its corporate governance and risk management, and the processes used to assess whether these risks are considered material. Each insurer should consider the Task Force on Climate-related Financial Disclosures (TCFD) framework and other initiatives when developing its disclosure approaches.

The Guidelines state that “over the next two to three years, insurers should start specifying key considerations that inform their assessment of the materiality of climate risks for their businesses,” paying attention to both internal and external factors. If an insurer determines that climate risks are immaterial, the insurer is expected to publicly disclose this assessment, along with its qualitative or quantitative justification and key underlying assumptions.  If an insurer determines that climate risks are material, the insurer is expected to publicly disclose related figures, metrics, and targets as well as the methodologies, definitions, and criteria used to make that determination.

When assessing “materiality” insurers may use the materiality benchmarks in the NAIC Financial Condition Examiners Handbook (e.g., 5% of surplus or one-half of 1% of total assets), subject to adjustment based on professional judgment and circumstances. Risks may also be considered “material” where knowledge of the risk could influence the decisions or judgment of an insurer’s board, management, regulators, or other relevant stakeholders. Materiality assumptions are to be assessed at least annually.

The Guidelines acknowledge that each insurer’s identified actions to mitigate climate risks should be proportionate to the nature, scale and complexity of the insurer’s businesses, but provides that all insurers, regardless of size, are expected to analyze their climate risks. DFS expects that, over time, an insurer’s analysis of climate risks and materiality assessments should shift from a qualitative approach, using simple models and a small set of risk factors, to a quantitative approach, relying on sophisticated models and a broader set of risk factors.

The Guidelines follow the release of proposed guidance by DFS in March 2021 and reflect revisions based on public comments from a range of stakeholders. Notable changes include:

  1. The Guidelines can be implemented at the group or entity level if: (1) the risks considered at the group level include those facing the insurer; (2) the policies, procedures and processes developed at the group level are implemented at the level of the insurer; and (3) the insurer has appropriate access to relevant climate-related resources and expertise centralized at the group level. If an insurer’s policies, procedures, or processes differ meaningfully from those of the group, the insurer should document and provide a justification for those differences in its risk management reports.
  2. DFS eased some of the more prescriptive corporate governance requirements from the proposed guidance. For example, whereas the proposed guidance assigned responsibility for management of climate risks directly to the board of directors, the Guidelines allow the board to oversee a management team responsible for complying with the climate risk management requirements.
  3.  The Guidelines contain a new section on uncertainty and data gaps, in response to industry comments on the difficulty insurers face in obtaining reliable data about the future risks of climate change and how society will respond. In the new section, DFS notes that many of the expectations in the Guidelines (such as governance and organizational structure) are not affected by the lack of certainty or data gaps, while the implementation of other expectations, such as setting risk tolerance and limits, may require a more iterative approach, with insurers updating or refining their decisions as new information is obtained. 
  4. DFS also included information on the timeline for implementing the Guidelines, stating that insurers are expected to implement requirements relating to board governance, and to have specific plans in place to implement the requirements relating to organizational structure, by August 15, 2022. Other requirements may be implemented over time.

DFS is hosting a webinar on November 22, 2021, from 9:30am to 10:30am EST to provide additional information on the changes reflected in the Guidelines and DFS’s rationale for the changes. Registration is available here with the password ClimChg112221.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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