After a variety of promises concerning climate change-related regulatory development activity last year, forward movement has been relatively slow. The leading exception has been the New York Department of Financial Services (NYDFS), which, last year, became the first US financial regulator to develop and finalize a comprehensive climate change risk regulatory framework for “domestic” insurers (for which it is the primary solvency regulator). However, all this changed a week ago.

IN DEPTH

On March 21, 2022, the US Securities and Exchange Commission (SEC) proposed new standardized climate change-related disclosure rules. With the release of the proposed rules, are we about to see a reacceleration of climate change regulatory activity in the United States or will the SEC’s action be simply an isolated “one step forward” to be followed by one or more steps backward? As always, time will tell. We’ve been waiting to see when federal banking regulators would begin to publish their climate change risk regulatory frameworks and whether they would act via joint rulemaking or would individual regulators proceed at different speeds and develop individualized rules that reflect, for example, the considerable financial and operational differences between credit unions and money centers/larger regional banks? It appears that the latter will be the case, however, all we’ve seen to date are high-level statements of principles from federal banking regulators.

Perhaps of most interest to insurers is the US Department of the Treasury’s (Treasury) Federal Insurance Office’s (FIO) August 31, 2021 Notice in which it summarized its climate change risk analysis tasks as (1) conducting a gap analysis of state regulation with respect to climate change, (2) assessing the potential for major disruptions in areas susceptible to the impacts of focusing on mitigation and resilience and (3) “leverage[ing] the insurance sector’s ability to help achieve climate-related goals.” However, questions remain. When will insurers see an official report from the FIO? How will the SEC’s proposed rules as well as additional anticipated federal rulemaking and related activity impact future state insurance regulatory activities? Will state insurance regulators be able to create a national consensus with respect to devising a regulatory framework to integrate climate change risks?

The pace of change has been considerably brisker outside Washington, DC, and state capitals. Barely a day passes without a climate-related announcement from a bank, insurer/reinsurer or a fund manager as to the latest climate change pledges, goals or timetables to stop insuring new (or any) coal- and oil and gas-related operations or to achieve “net zero” by a specific target date. On the investment side, in a recent report from Conning, 79% of insurers surveyed said that during the past two years they started to incorporate environmental, social and corporate governance (ESG) factors into investment decisions while 67% said they had already done so. Why? Corporate reputations. Of those surveyed, 92% of respondents said reputation was an important or very important motivator.

The leading rating agencies for the insurance industry have all jumped on the climate change bandwagon and will continue to add their scrutiny and voices to the marketplace of climate change analysis and debate. Whether insurers are subject to SEC reporting or required to file annual National Association of Insurance Commissioners (NAIC) Climate Risk Disclosure Surveys has yet to be determined, however, rating agencies (and others) will be watching, analyzing and assessing company-specific developments with respect to climate change risk management—primarily on the underwriting side but also with respect to the investment activities of insurers.

Acknowledging the leading role that international re/insurers will continue to play on the underwriting side with respect to assessing the varying evolving impacts of climate change on books of business, the impact that insurers might have with their climate change investment decisions need to be kept in some perspective.

First, at some point, regulators will presumably be concerned that individual insurers (or types of insurers) might need to temper the elevated levels of enthusiasm they have for climate change “impact” investments to mitigate the effects of climate change or support adaptation efforts—bearing in mind that insurer investments must not jeopardize claims-paying ability. Regulators will presumably pay attention to differing investment horizons for property/casualty insurers versus life and annuity insurers.

Second, the amount of funds available for insurers to invest in “green” funds or in projects to mitigate the effects of climate change or adapt to it pales in comparison to the significant sums of investable cash held by the largest fund managers. According to the Insurance Information Institute, at year-end 2020, the nearly 3,000 US property and casualty insurers had about $2 trillion in cash and invested assets. The country’s 1800+ life and health insurers held $4.7 trillion (plus $3 trillion in life insurer separate accounts). In contrast, consider the assets maintained at the following:

• BlackRock, Inc. is approaching $10 trillion.

• Vanguard is at $7.1 trillion (in 2020).

• Charles Schwab Corporation is at nearly $7.6 trillion.

• Fidelity Investments is at $4.2 trillion (among many others with more than $1 trillion of investable assets).

Aggregate amounts of assets managed by leading fund managers far outstrip aggregate investable assets controlled by insurers. Add in the investable funds held in hedge, family office, endowments and pension funds (and not managed by fund managers like those just named) at banks and by non-financial companies and it’s clear that insurers are in a different, lower league when it comes to financing the huge costs of achieving the Paris Agreement goal of keeping global warming to less than 2°C. above pre-industrial levels.

SEC-MANDATED CLIMATE DISCLOSURE VS. NAIC CLIMATE DISCLOSURE PLANS: COMPETITION OR COORDINATION…OR CONFLICT?

In 2013, then NYDFS Superintendent Benjamin Lawsky delivered an address at Fordham University School of Law, during which he spoke of the benefits of “a dose of healthy competition among regulators.” He was referring perhaps both to competition with federal banking regulators and with state insurance regulators throughout the country. Lawsky also stressed the advantage of a nimble, agile regulator who is able to spot situations or conditions that require attention and provide regulatory attention quicker than larger or more bureaucratic competitors. Proof of the pudding? Consider the NYDFS’ first-in-the-country cryptocurrency “bit licensing” regime, cybersecurity rules and, most recently, development of a comprehensive climate change regulatory framework. The current NYDFS Superintendent, Adrienne Harris (the first non-prosecutor in the position), recently spoke less about competition and more about the advisability of regulator coordination, particularly with respect to climate change that has national and international impacts that highlight the need for coordination and cooperation with other regulators. At the same time, however, Harris spoke about expanding the NYDFS’ climate change regulatory activities even as other financial services industry regulators (at least in Washington, DC) have yet to move beyond the very beginning stages of constructing regulatory frameworks for regulated entities that fully integrate climate change risks into enterprise management. While the NYDFS has published final climate change regulatory compliance rules for insurers, it has yet to do so for the banks it regulates.

It is fascinating to compare and contrast the SEC’s proposed “one-size-fits-all-industries” approach to climate disclosures with the evolving NAIC approach to climate disclosure, starting with a decade-old insurance industry-specific survey that is now being reinforced with Task Force for Climate-Related Financial Disclosure (TCFD) concepts and elements.

First, the timetables for both efforts seem to have converged, at least for the moment. Last week, coincidentally, the NAIC’s Climate & Resiliency Task Force met to adopt its revised climate risk disclosure framework—in development for more than a year—so that it coalesces with the TCFD’s efforts, just as the SEC’s proposed disclosure approach is patterned on the TCFD precedent.

Second, while neither approach is final, the SEC will be accepting comments on its proposed rules for at least the next 30 days before finalizing, and the NAIC’s Executive Committee and Plenary still need to approve the proposed disclosure during its upcoming National Meeting in early April. That said, it appears that both will be finalized sometime this year. However, insurers obligated to respond to the NAIC Climate Disclosure Survey will need to do so in 2022. Adherence to the SEC’s proposed rules will not be required until 2024 (assuming the rules are finalized in 2022).

Third, consider the respective scopes of application. There are roughly 110 insurers who are subject to SEC jurisdiction and will, depending on the sizes of the various entities, be required to disclose “material” climate-related factors sooner or later. For NAIC disclosure purposes, of the nearly 6000 insurers in the United States, only those (x) domiciled in one of the 15 states (plus the District of Columbia) that have, to date, required insurers to submit climate disclosures and (y) with more than $100 million in annual direct written premium will be required to file disclosures by the end of November 2022 (extended from August 31, 2022, for 2022 filings only).

The NAIC maintains that the universe of reporting companies accounts for roughly 80% of the country’s insurance premium. The California Insurance Department’s website page summarizing the NAIC Climate Disclosure Survey states that “nearly 1000 companies” respond. In short, according to the SEC’s proposed rules release, there are currently 66 insurers who will be required to comply with both the SEC’s rules and the NAIC’s requirements. For those 66 insurers, it will be critical to map SEC versus NAIC disclosure requirements. The SEC’s release asserts that “… registrants in the insurance industry may also face lower incremental costs due to their existing disclosure practices…. [A] large subset of insurance firms are required to disclose their climate-related risk assessment and strategy via the NAIC Climate Disclosure Survey. A comment by a state insurance commissioner stated that because this survey overlaps extensively with the TCFD recommendations, these firms should be able to easily switch to reporting via the TCFD disclosure framework. This is because the proposed rules are broadly consistent with the TCFD. We expect that registrants in the insurance industry may be able to adapt more easily to providing disclosure under these rules.” (footnote omitted) One can’t help but wonder if each of the 66 insurers will agree completely with the SEC’s assertion!

As for SEC registrants subject to filing NAIC disclosure surveys—or embraced within state-specific climate change regulatory requirements, e.g., for those SEC registrants who are domiciled in New York—it will apparently be necessary for those companies to explain the state regulatory requirements in SEC disclosures.

The fact remains that thousands of US insurers are not currently subject to climate change disclosure requirements and will not be required to provide disclosures in the future. When the FIO completes its “gap analysis” report, presumably this gap will be addressed. Having said this, insurance holding companies that must submit enterprise risk management (ERM) reports or insurers (or groups of insurers) that meet the minimum size thresholds for submitting Own Risk Solvency Assessments (ORSA) and are not otherwise required by their domicile states to prepare and submit NAIC climate risk disclosures may end up disclosing the same or similar substantive information in their ERM or ORSA reports.

So, what are some of the differences between the SEC’s proposed climate risk disclosure rules versus the NAIC’s climate disclosure requirements?

MATERIALITY

As McDermott’s recent article notes, the SEC “reaffirmed adherence to the definition of materiality set forth in both its rules and past Supreme Court of the United States opinions: Information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or, put another way, if the information would significantly alter the total mix of available information to investors.”

In contrast, the NAIC climate risk disclosure regime and the NYDFS’s November 2021 “Guidance for New York Domestic Insurers on Managing the Financial Risks from Climate Change” (NYDFS Guidance) considers materiality from the perspective of insurance regulation. In short, the relevant insurance regulatory materiality standard is 5% of policyholder surplus (or an insurer’s net worth) or 0.5% of total assets. But as the NYDFS Guidance goes on to explain, “a risk 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.” The NYDFS Guidance encourages insurers to “… regularly assess their materiality assumptions. Depending on the nature, scale, and complexity of its business, an insurer should conduct this assessment at least annually…” To be fair, the SEC’s proposed rules also reflect its appreciation of “the dynamic nature of materiality determinations that registrants must make under US securities laws, particularly with regard to potential future events.”

ATTESTATION

One of the more controversial aspects of the SEC’s proposed rules are the requirements for certain larger registrants to include third-party attestations as to the disclosure of Scope 1 and Scope 2 emissions. The NAIC Climate Disclosure Survey also calls for disclosure of Scope 1 and Scope 2 emissions, however, all NAIC respondents avoid attestation complications—at least for now.

SCOPE 3 EMISSIONS

As McDermott’s article notes, “[l]arger registrants would be required to disclose data regarding their Scope 3 emissions (those that are the result of activities from assets not owned or controlled by the registrant, but that the registrant indirectly impacts in its upstream or downstream value chains through its activities) if material to them, or if they have set a [greenhouse gas] GHG emissions reduction target or goal that includes its Scope 3 emissions.” The SEC makes clear that Scope 3 emissions can include investments, assuming investing is material to an enterprise. For many insurers, it would be difficult to imagine that investing was not material. The NAIC’s Climate Disclosure Survey simply calls for all respondents to disclose Scope 3 emissions “if appropriate.”

SCENARIO ANALYSIS

As McDermott’s article explains, if reporting companies utilize scenario analysis, they will need to describe “the scenarios used, including the parameters, assumptions, analytical choices and projected principal financial impacts.”

Compare the SEC’s stark disclosure requirements and explain with the NAIC’s gentler “best efforts” approach:

“In describing how processes for identifying, assessing, and managing climate-related risks are integrated into the insurer’s overall risk management, insurers should consider including the following:

• Discuss the climate scenarios utilized by the insurer to analyze its underwriting risks, including which risk factors the scenarios consider, what types of scenarios are used, and what timeframes are considered.

• Discuss the climate scenarios utilized by the insurer to analyze risks on its investments, including which risk factors are utilized, what types of scenarios are used, and what timeframes are considered.”

TARGETS AND GOALS

McDermott’s article notes that for SEC reporting companies that have publicized “climate-related targets or goals”—as so many insurers have done and continue to do—they will have to explain:

• “The scope of the activities and emissions included in the target, the defined time horizon by which the target is intended to be achieved and any interim targets.

• How the registrant intends to meet its climate-related targets or goals.

• Relevant data to indicate whether the registrant is making progress toward meeting the target or goal and how such progress has been achieved, with updates each fiscal year….”

The NAIC Climate Disclosure Survey requires simply to: “[d]escribe the targets used by the insurer to manage climate-related risks and opportunities and performance against targets.”

REGULATORY CONFLICT?

As to the possibility of “conflict” between and among regulators and policymakers, consider the following recent developments:

In mid-March, US President Joe Biden withdrew Sarah Bloom Raskin’s nomination to be Vice Chair of the Federal Reserve Board, primarily because of her well-known views with respect to the systemic risks for financial institutions posed by climate change.

European commentators began to discuss the impact of inflation on investment in climate change mitigation and adaptation projects.

The obvious negative impacts of Russia’s invasion of Ukraine for international cooperation in a variety of areas, including ESG generally and climate change.

Last week, Texas Comptroller Glenn Hegar sent a letter to some 19 large asset managers, seeking information about their investment policies vis-à-vis fossil fuels, specifically inquiring as to alleged boycotts of new investments in such companies. It is said that letters to an additional 100 asset managers are to follow. At stake? Access to managing hundreds of billions of dollars in Texas pensions and similar funds.

Governor Jim Justice (R-WV) just signed a bill into law that will create a Mining Mutual Insurance Company, designed to ensure that West Virginia coal mine operators (existing and future) are able to procure the performance bonds needed to obtain and maintain licenses to mine coal.

While publication of authoritative reports by climate scientists, such as the United Nations’ most recent comprehensive and massive Intergovernmental Panel on Climate Change (IPCC) report card on the state of the global environment, always prompt commentary and discussion, the effects seem to be transitory. Should regulators be able to redirect investment flows away from coal and oil and gas producers and users or should they be able to force banks to withhold credit or insurers to not to do business with such companies? These are the questions that will occupy governments on both sides of the Atlantic for years, probably even decades, to come.

STATE LEGISLATION

Finally, most climate change regulatory commentators tend not to focus on the states. Yet, for insurers, what states think and how they approach climate change in general and climate change regulatory compliance specifically matters greatly. While the 2022 state legislative season is nearing an end and with mid-term elections coming up in less than eight months, we will likely see a fair amount of climate-related legislative activity in 2023. States such as Kansas, West Virginia and Wyoming recently considered (but did not enact) legislation to bar financial institutions from using ESG scores or metrics. There is reportedly a group of state financial officers from 15 states, organized by West Virginia Treasurer Riley Moore, that seeks to cut back—possibly to zero—business with banks that “adopt corporate policies to cut off financing for the coal, oil and natural gas industries.” Legislation that is consistent with Texas Comptroller Hegar’s recent letter writing campaign to establish whether the largest asset managers have policies vis-à-vis fossil fuel producers is expected.

On the opposite side of the ledger, there will likely be state legislative calls for expanded climate risk disclosure, at least by larger companies and some insurers. In 2022, California Senate Bill (S.B.) 449, still under consideration, would require companies with a license or certificate to operate in California with more than $500 million in revenue to annually file a climate risk disclosure report that addresses “material risk of harm to immediate and long-term financial outcomes due to climate change, including, but not limited to, risks to corporate operations, provision of goods and services, real estate, supply chains, employee health and safety, capital and financial investments, institutional investments, financial standing of loan recipients and borrowers, shareholder value, insured assets, consumer demand, and financial markets and economic health.”

More focused is California S.B. 1694, introduced by California State Assemblyman Marc Levine who coincidentally is challenging incumbent Insurance Commissioner Ricardo Lara for the Democratic nomination for Insurance Commissioner. If enacted, the bill would require the approximately 1500 insurers with licenses in the state to disclose the underwriting of and investments in fossil fuel companies and projects.