Last week (March 25, 2021), the New York State Department of Financial Services (NYDFS) released for public comment proposed guidance for New York domestic insurers on managing financial risks from climate change (the Proposed Guidance). The Proposed Guidance is the detailed guidance that was promised by NYDFS in a September 22, 2020 circular letter, in which NYDFS stated its high level expectation that all New York insurers should begin integrating the consideration of the financial risks from climate change into their governance frameworks, risk management processes and business strategies. While the circular letter applied to all New York domestic and foreign insurance companies, the Proposed Guidance applies only to New York domestic insurers.
NYDFS describes the Proposed Guidance as the first climate-related guidance issued by a US financial regulator, and notes that it is informed by dialogue with the industry and modeled on publications issued by international regulators and networks. There has been a growing focus among regulators and organizations around the world to address climate change in the insurance sector, but concrete actions by US authorities have been relatively limited. On March 31, 2021, during a meeting of the Financial Stability Oversight Council (FSOC), Treasury Secretary Janet Yellen identified climate-related risks to the financial system as a priority for FSOC in 2021, and FSOC members described actions their agencies are taking or planning to take to address the risks posed by climate change. Currently, five states (California, Connecticut, Minnesota, New Mexico, New York and Washington) require insurers licensed in their state with annual premiums above $100 million to respond to the National Association of Insurance Commissioners (NAIC) Climate Risk Disclosure Survey. In addition, California requires that, by July 1, 2021, all California-licensed insurers with annual premiums written in California over $100 million in the 2019 calendar year must provide the California Department of Insurance with information on all green investments in California during each calendar year from 2016 to 2020. With the framework laid out in the Proposed Guidance, NYDFS is positioning itself as a leader in climate supervision in the US.
NYDFS expects the Proposed Guidance to serve as a basis for supervisory dialogue and to help insurers familiarize themselves with climate risks and develop their capacity and processes for managing those risks. The Proposed Guidance states that NYDFS will develop a timeframe by which insurers should have fully embedded their approaches to managing climate risks as outlined in the Proposed Guidance.
The Proposed Guidance states that it builds on, among other things, relevant provisions of the NAIC Financial Condition Examiners Handbook (the Handbook) and the NAIC Own Risk and Solvency Assessment (ORSA) Guidance Manual. As such, the Proposed Guidance relies heavily on risk management frameworks and corporate governance principles that are currently in place and will be familiar to insurers, and applies them to climate risk.
At a high level, the Proposed Guidance lays out NYDFS’s expectation that every New York domestic insurer should:
1. Integrate the consideration of climate risks into its governance structure, including that the board of directors have responsibility for managing climate risks, which should be reflected in the company’s risk appetite and organizational structure.
- This includes the adoption by the board of a written risk policy and the designation of a board member or committee, as well as a member of senior management, as responsible for the insurer’s assessment and management of climate risks. This designation should occur even if an insurer determines that climate risks are not material to its business.
2. Consider the impact of climate-related factors on its business environment in the short, medium and long-term when making strategic and business decisions.
- 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 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.
- The Proposed Guidance provides that while enterprise risk reports and ORSA summary reports may be completed at the group level, an insurer’s climate-related policies and procedures should be implemented at the entity level.
- If an insurer determines that climate risks are material, NYDFS expects the insurer to demonstrate how it will mitigate those risks and develop a credible plan for managing exposure.
- Relatedly, on March 31, 2021, NYDFS also issued a proposed amendment to 11 NYCRR 82 (Insurance Regulation 203) that would include climate change among the “reasonably foreseeable and relevant material risks” that should be addressed by a New York-licensed insurer’s enterprise risk management function.
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, the fact that climate risks may not be reflected in historical data, and short, medium and long-time 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 Proposed Guidance acknowledges 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.
As part of this analysis, the Proposed Guidance indicates that each insurer should assess the materiality of climate risks to its business. NYDFS expects that over the next two to three years, insurers should begin specifying key considerations that inform such assessment. The Proposed Guidance states that an insurer may reference the Handbook’s materiality benchmarks in its assessment (e.g., 5% of surplus or one-half of 1% of total assets), and that, after a thorough assessment, some insurers may determine that climate risks are not material to their business. However, the Proposed Guidance cautions that certain risks may be material regardless of numerical impact, and generally frames climate change as one of the most critical risk management issues of our generation, describing climate risks as wide-ranging, material and unprecedented. If an insurer deems climate risks to be immaterial, NYDFS expects the insurer to disclose this assessment, along with its qualitative and quantitative basis.
NYDFS 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 Proposed Guidance also references the disproportionate impact of climate change on disadvantaged communities, and states that, although the Proposed Guidance is focused on the financial stability of insurers, insurers should also contribute to climate adaption and mitigation efforts, support the resilience of communities, and work with the public sector to ensure the availability and affordability of insurance.
The Proposed Guidance will be finalized following a 90-day public comment period, and interested parties must submit comments to the NYDFS by Wednesday June 23, 2021. The NYDFS will host a webinar to provide an overview of the proposed guidance on April 8, 2021, at 11 a.m. Interested parties can register for the webinar via the link and password in the NYDFS press release.