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New York advises insurers to underwrite climate risk by looking beyond business-as-usual timeframes
New York financial regulators say insurers cannot rely on typical timeframes of three-to-five years to manage climate risk because "the exact manifestations and timing" of the impacts remain uncertain.
Instead, New York Department of Financial Services (DFS)—in a first-of-its-kind guidance issued in the US—is advising insurers to be strategic and forward looking in how they assess climate risk whether they invest in fossil fuel or other clean energy assets or underwrite liabilities, particularly on the property and casualty front.
"Climate risks may not materialize within the traditional time horizon of insurers' risk appetite statements, which tends to be one to five years. Insurers should therefore formulate risk appetite statements that consider climate risks over a longer period," the regulators wrote.
DFS has given insurers until August 2022 to change their governance structures to include analysts who can assess and model climate risks. The state regulator also said it would issue further guidance to the sector on when it expects them to have plans in place to perform risk analyses that among a host of factors consider various global temperature increase scenarios.
The guidance reflects the growing recognition among global financial regulators that the insurance sector is doubly exposed to climate financial risks and can no longer ignore its impact on its business lines. That is because insurers maintain significant investments in carbon-intensive and climate-vulnerable industries, and at the same time face climate liability risks as underwriters.
New York home to most domiciled insurers
New York State's guidance coincided with the deadline given by the US Treasury Department's Federal Insurance Office to the public to comment on its role in collecting data and taking action on risks that the insurance sector faces as losses from climate-related disasters mount into the billions.
Among US states, New York was home to the largest number of insurance companies in 2020, having issued licenses to 555 companies, according to the US trade group Insurance Information Institute.
In a 15 November statement accompanying the document's release, New York Acting Financial Services Superintendent Adrienne Marsh said the guidance is meant "to support insurers' efforts to manage the financial risks from climate change, bolstering the safety and soundness of the industry and the protection of consumers."
As insurers begin to assess climate risks, DFS is advising them to not only consider a timeline that is appropriately suited to their business lines, but also to consider one that goes beyond the standard three to five years to a medium-to-long term time span that ranges from five-to-30 years.
For instance, the regulators say property and casualty insurers can consider at most a five-year time span when underwriting or pricing climate risks, while those engaged in developing a new product or in assessing a possible merger or acquisition or determining the size or composition of a product portfolio for a particular business line may need at least five years or more.
Adapting traditional risk models
Not all insurers are the same, and not all of them are engaged in the same business line. As the guidance notes, climate change will affect each insurer in different ways and to different degrees depending on the insurer's size, complexity, geographic distribution, business lines, investment strategies, and other factors.
DFS also is aware that not all insurers have the same level of resources to devote to managing climate risks and some insurers will take longer than others to develop and implement appropriate practices.
Insurers must also decide how to determine "material" risks. Where insurers lack resources and staff to model climate risks based on varying scenarios, DFS suggests relying on qualitative descriptions and, where possible, using models to get at their answers. It also suggests insurers analyze portfolio exposure to certain sectors or geographies in underwriting or investments to get a handle on material risks.
DFS also suggests using the materiality benchmarks it has supplied in its handbook, such as 5% of surplus or one-half of 1% of total assets that are subject to adjustment, based on professional judgment and circumstances.
Since many aspects of climate change and related government responses remain uncertain, the regulators are advising insurers to adapt and adjust how they identify, monitor, and manage climate-related risks arising from floods wreaked by torrential rains. The regulators say climate change has increased the likelihood of extreme events even though the short-term average loss from a natural disaster may not have shifted significantly.
Climate-related weather events have become more damaging and frequent in recent years in the US, with record damages piling up each year.
The DFS cautioned insurers that they should be mindful of the impact that direct climate impacts, such as hurricanes and wildfires, or indirect or transition risks caused by a shift in policies toward decarbonization will have on current and future investments. The guidance said both types of climate risk could lead to "potential shifts in supply and demand" for financial services, products, and instruments, such as derivatives and securities, with a consequent impact on their values.
For instance, DFS said, the transition towards a decarbonized economy could result in investment losses and lower asset values due to stranded assets, according to DFS. The investment losses could be those realized at the time, or mark-to-market losses reflecting changes in value over time.
Minimizing risk exposure
As the attorneys general of New York, Connecticut, Massachusetts, Maryland, and Oregon noted in their 15 November comments to Treasury Department's FICO, the insurance sector's level of investment exposure in the carbon-intensive fossil fuel industry "creates risk of asset stranding and devaluation as the global economy decarbonizes, threatening those portfolios and the financial stability of the industry."
They cited an August 2021 S&P Global Sustainable1 analysis, which found the US insurance industry as a whole held $582 billion in some combination of oil, gas, coal, utilities, and other fossil fuel-related activities, representing 9% of total assets.
DFS said climate change not only poses risks to insurers, but also creates the need to help especially disadvantaged communities be more resilient through inclusive and affordable insurance, while contributing to climate change adaptation and mitigation.
Commenting on the guidance's significance, IHS Markit Climate and Clean Tech Executive Director Peter Gardett told Net-Zero Business Daily that insurance companies have been leaders in building detailed models of physical climate change impacts on assets, "but have been held back from using that knowledge by a lack of regulator recognition that climate risk is already impacting financial returns."
"The New York DFS guidance," Gardett added, "frees some of the world's biggest insurers to begin merging their advanced work on physical climate risk with financial metrics as they plan for transition risk impacts on their portfolios and underwriting businesses."
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