SEC CLIMATE FINANCIAL RISK DISCLOSURE: RELEASE OF THE AGENCY’S REVISED REGULATION?

At some point in October 2023, the US Securities and Exchange Commission (SEC) is expected to release the long-awaited final version of its climate-related financial risk disclosure regulation, first released for public comment in March 2022. Once this regulation is finalized, expect state attorneys general and perhaps private litigants to file lawsuits seeking to invalidate the regulation. These opponents likely will argue that Congress did not explicitly delegate regulatory authority to the SEC related to climate change and climate financial risks, and therefore the SEC’s regulation violates the “major question” doctrine. The Supreme Court of the United States used the major question doctrine last year in West Virginia v. EPA to invalidate an Environmental Protection Agency regulation that would have required power plant operators to go beyond installing scrubbers and change the mix of fuels used to generate electricity in order to reduce air pollution levels.

Regardless of whether the SEC’s climate risk disclosure requirements are upheld, the SEC enforcement staff is monitoring whether regulated entities—particularly investment advisors—are telling the truth in statements about their consideration of environmental, social and governance (ESG) factors in investment recommendations and decisions. The SEC’s Climate and ESG Task Force, formed in March 2021, coordinates the agency’s ESG enforcement activities, analyzing data from all registrants to “identify potential violations including material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.

CALIFORNIA: PRO-ESG CLIMATE CHANGE FINANCIAL RISK LEGISLATION SIGNED INTO LAW

In September 2023, California’s legislature passed landmark climate financial risk disclosure legislation (S.B. 261) and greenhouse gas emission reporting legislation (S.B. 253) that will require many companies “doing business” in the state to prepare and submit climate financial risk disclosures and greenhouse gas emissions reports (audited by outside consultants). On October 7, 2023, California Governor Gavin Newsom signed both bills into law, and they will become effective in 2026 (2027 for reporting of Scope 3 emissions). Insurers (and any entity regulated by the state’s Department of Insurance) are exempt from filing the financial risk disclosure reports, since California-domiciled insurers are already required to file climate risk disclosures using either the National Association of Insurance Commissioners (NAIC) reporting template or by filing Task Force on Climate-Related Financial Disclosures compliant reports.

Interestingly, on October 8, 2023, Governor Newsom vetoed legislation (A.B. 970) that California Insurance Commissioner Ricardo Lara had championed to create the Climate and Sustainability Insurance and Risk Reduction Program to develop proof of concepts for new insurance options, focusing on communities with uninsured or underinsured climate risks. Had Governor Newsom not vetoed the bill, the state Insurance Department would have funded pilot projects in eight locales around the state to mitigate risks from flooding and extreme heat and to reduce protection gaps in these communities.

NAIC CLIMATE RISK DISCLOSURE FILINGS

Colorado will hold a hearing on October 16, 2023, to consider its proposed regulation (#3-1-18) to require all licensed insurers (not just those domiciled in Colorado) to begin filing climate risk financial disclosures in 2024, pursuant to legislation passed earlier this year. Colorado regulators would be well within the bounds of their statutory authority to broaden application of the requirement. If they do promulgate a final regulation along these lines, Colorado will be the first state to require reporting by all licensed insurers. Not even California, New York or Washington State went that far.

Comments on the proposed regulation can be submitted up to the close of business on October 19, 2023. It will be interesting to see if any regulators from the more than 20 anti-ESG states submit comments to their fellow regulators.

FINANCIAL ANALYSIS SOLVENCY TOOLS (E) WORKING GROUP AND FINANCIAL EXAMINERS HANDBOOK (E) TECHNICAL GROUP

Responding to the NAIC’s Climate and Resiliency Task Force referral from May 2022, two technical/working groups have been drafting and considering climate-related financial risk “enhancements” to the Financial Analysis Handbook 2023/2024, the guide for financial examiners when planning and executing periodic financial examinations of admitted insurers. During the working group’s meeting on October 2, 2023, regulators voted to include climate-related “material” financial risk categories in the handbook for both investment and underwriting risk.

With respect to investment risk, the handbook encourages examiners to review insurer climate financial risk disclosures in the NAIC’s climate financial risk filings, insurer disclosures in ORSA filings, SEC filings (when, and if, SEC finalizes climate financial risk disclosures) and the NAIC’s Industry Climate Affected Investment Analysis.

On the underwriting risk side, the handbook encourages analysts “to review insurer Schedule Ts to spot material concentrations of premium in cat-exposed jurisdictions and to review property and casualty insurers’ cat risk charge filings, including reviewing modeled loss outputs from an approved cat risk model (compare to California’s current regulatory prohibition on the use of cat models in rate-making).

The handbook will also encourage analysts to review insurers’ current reinsurance arrangements and future costs/availability in light of climate financial risk considerations, per this new wording: “The insurer’s reinsurance strategy may not be sustainable due to increasing cost and availability concerns on a prospective basis.”

US DEPARTMENT OF THE TREASURY REPORT: “THE IMPACT OF CLIMATE CHANGE ON AMERICAN HOUSEHOLD FINANCES”

In a report published at the end of September 2023, Treasury and other agencies studied the negative impact of climate hazards and conditions on US households. The report analyzed elements beyond the narrow (although obviously important) impact of property damage from climate/weather events. Key factors prompting preparation of the report included the following:

• From 2018 to 2022, the total cost of “major” weather and climate disasters was more than $617 billion.
• In 2022 alone, the cost was more than $176 billion.
• Of all US residents, 13% reported “economic hardship” related to climate/weather disasters.
• One-third of US counties reported “heightened” exposure to flooding, wildfire and/or extreme heat risks.
• In 2021, climate and weather hazards impacted one in 10 homes.

The key findings in this report had to do with the non-property damage impacts on households struggling to keep up, living in a “paycheck-to-paycheck” world. The report cites a 2022 Federal Reserve Board study finding that 63% of households could not cover a $400 emergency expense with cash on hand. The non-property damage impacts from cat events and climate change conditions identified in the Treasury report ranged from lost wages, delays in receiving benefit program payments, supply chain disruptions leading to higher prices and increased energy costs for cooling due to rising temperatures.