The New York Department of Financial Services (NYDFS) has announced that it expects all insurers in the state to incorporate and consider the financial risks from climate change in their governance frameworks, risk management processes, and business strategies.
In a circular letter issued by the NYDFS on September 22, 2020, the insurance regulator stated: “Climate change poses wide-ranging and material risks to the financial system, especially for the insurance industry, as physical and transition risks resulting from climate change affect both sides of insurers’ balance sheets – assets and liabilities – as well as their business models.
“Climate change is one of the most critical risk-management issues of our generation. To continue to thrive in the face of global competition, it is essential that New York insurers manage the financial risks from climate change. Financial risks from climate change are unprecedented. Unlike other financial risks, they are global in scale and scope and cannot be contained regionally or diversified away.”
The NYDFS, which supervises and regulates nearly 1,800 insurance companies with assets of more than $4.7 trillion, ranging from global publicly traded companies to family-owned small businesses, has asked insurers to designate a board member or a committee of the board, as well as a senior management function, to oversee the assessment and management of the financial risks from climate change. It is also beginning to develop some requirements for key financial metrics, which insurers may have to disclose in the future.
While the NYDFS is ahead of the curve when it comes to addressing climate change, insurers across the country are facing similar pressures and requirements on wide-ranging environmental, social and governance (ESG) issues – and that’s just in terms of how they operate as businesses. Insurers must also manage these exposures via their core functioning as risk transfer and management agents.
“Some might describe general insurers or commercial insurers as a lubricant to the economy at large, and a necessary element of a developed economy’s ability to function effectively,” said Matt Adams, PwC’s US insurance practice leader. “Insurers that are providing general liability and financial lines coverages to companies could see their risk profiles affected as litigation becomes more targeted at corporations [depending on] how they’re responding to climate risk and other ESG issues. That will likely impact insurers’ decisions around risk selection, underwriting and pricing.
“On the property side, some argue that climate change is going to increase the frequency and severity of major storms, and of course, property insurers are in place to help pick up the pieces after events like that. I think property insurers will continue to have to monitor how climate change is affecting their underwriting and pricing decisions, and where they decide to do business. Generally, I think property insurers will also be working harder on influencing how governments react to mitigate and monitor drivers of climate risk, like carbon emissions.”
In recent months, multiple global credit rating agencies – including Fitch Ratings and DBRS Morningstar – have started to take more formal approaches to how they incorporate ESG factors into their rating processes. As such, insurers are being more closely scrutinized on their exposure to (ESG) risks and their potential impacts on their investment portfolios and lending policies.
“Financial services companies are different from industrials and other service companies in that they tend to have substantial invested asset portfolios,” Adams commented. “As their investment guidelines and preferences change - perhaps in response to a credit agency influence, but I think more in response to increasing investor pressure and investor priorities putting more weight on ESG related matters - I think we’ll continue to see insurers evolving in terms of how they think about where they invest their money.”
Insurers are also starting to focus more on how to gather data – for example, on their carbon footprint – that will enable them to report key metrics of relevance to their stakeholders. As a result, a lot more organizations are tracking certain ESG-related indicators and reporting them publicly. “I think we’ll gradually see more focus on specific and consistent reporting,” said Adams, “especially once companies are more confident in measuring and monitoring the [ESG-related] impacts of their actions, objectives and priorities.”