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Closing the Disclosure Gap

U.S. state regulators/lawmakers are becoming increasingly concerned about how well insurers are managing climate-related risks.

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U.S. state insurance supervisors say they expect climate-related risks to increase for carriers in the next five to 10 years. It’s a trend that’s likely to prompt a regulatory response around insurers’ climate risk disclosure. And with weather-related catastrophes growing in frequency and intensity, there’s added pressure on insurers to report more, sooner.

A new white paper from Deloitte, “Climate risk: Regulators sharpen their focus,” says that U.S. state regulators and lawmakers are watching the implications of climate-related risks very carefully and are becoming increasingly concerned about how well insurers are at managing them.

More than half of the 27 regulators who responded to Deloitte’s survey indicated that climate change was likely to have a big impact on coverage availability and underwriting assumptions.

One-third of the responding regulators said they did not know whether current insurer risk models were up to the challenge of capturing and testing climate-related risks. Among those who said they did know, eight regulators said the models were “good” while only two said the models are “very good.” Not one respondent rated them as “excellent.”

Correspondingly, one-third of responding regulators said they did not know how well carriers are prepared to deal with the potential impacts of climate-related risks on financial stability. Among those who were aware, only up to four respondents answered that insurers were largely or fully prepared.

“There is no doubt that more information — through more effective disclosure — would help regulators in assessing the effectiveness of insurer actions to mitigate climate-related risks. And that could very well be the starting point of increased climate risk regulations,” Deloitte says in its report.

Insurance supervisors have been extremely active in helping the public and carriers following disaster events like flooding and wildfires, building a bridge between the industry and the consumer, David Sherwood, Managing director, Risk and Financial Advisory, Deloitte & Touche LLP, tells Reactions. “But they need a better line of sight – data – in terms of the risk and how insurers see it from a solvency and capital perspective, as well as the impact on consumers.”

Greater climate risk disclosure

Most regulators surveyed said they expect to bring in more disclosure in the next two to five years; eight said their state insurance departments were somewhat or very likely to increase reporting requirements around climate-related risks.

In the meantime, a significant majority of state regulators feel it is of high importance for insurers to provide disclosures in accordance with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations. TCFD was established by the Financial Stability Board (FSB) in 2015 with the goal of developing a set of voluntary climate-related financial risk disclosures that can be adopted by businesses so that those companies can inform investors and other members of the public about the risks they face related to climate change.

Additionally, Deloitte thinks that regulators in the U.S. may also want to probe the disclosures to test the soundness of the assumptions underlying the scenario analyses and insurer expectations of potential losses.

“It is thus likely that regulators will at some point start requiring more of insurers in the way of disclosure and its components and assumptions, including stress tests of a wide range of plausible climate-change scenarios and a determination of how climate data is used in risk modeling for pricing and underwriting decisions,” the report says.

Global transparency trend

Supervisors in other countries are already calling for increased disclosure around climate risk. The UK’s Prudential Regulatory Authority and Australia’s Prudential Regulation Authority (APRA) have both put in place more stringent requirements for enhanced disclosure from financial institutions on actions taken to mitigate climate-related risks.

In its policy statement published last year, the UK’s PRA said it recognises that firms need time to develop an effective approach to disclosure, but “firms should recognise the increasing possibility that climate disclosures will be mandated in more jurisdictions, and prepare accordingly.”

Deloitte’s David Sherwood says that regulators around the world are now at different points in their approach to climate risk: “I wouldn’t say the U.S. is behind – climate risk is high on the National Association of Insurance Commissioners’ agenda. The NAIC has established a working group on climate and certain states have harmonised around the NAIC guidelines, for example around disclosure.”

Insurers in the U.S. started disclosing climate risk after the NAIC adopted the Insurer Climate Risk Disclosure Survey in 2010. Only a handful of states have continued with the survey, however. Today, a multi-state group comprising California, New York, Washington, Connecticut, Minnesota, and New Mexico administer the survey to all insurance companies licensed in these states that write at least $100m.

Between them, the group surveys more than 1,000 companies capturing around 70% of the entire U.S. insurance market. The results are maintained on the California Department of Insurance's website, allowing other regulators, insurance companies and interested members of the public “to identify trends, vulnerabilities and best practices by the insurance industry with respect to climate change.”

The eight-question survey asks insurers to provide a description of how they incorporate climate risks into their mitigation, risk-management and investment plans. Insurers are asked to identify the steps they’ve taken to engage key constituencies and policyholders on the topic of climate change.

Cynthia McHale, Senior Director for Insurance at CERES, a non-profit that works with some of the world’s biggest investors on tackling sustainability challenges, thinks that more needs to be done by insurers and state insurance departments.

Although she was disappointed that only 27 out of 56 jurisdictions responded, McHale says she welcomes the Deloitte report because it examines climate risk from the perspective of U.S. insurance regulators.

“At Ceres, our perspective is from a long-term, institutional investor’s point of view,” she explains. “All types of risks, including climate risk, should always be disclosed within the standard financial documents that every public company is required to put out and the FSB has made it clear that climate risk should be embedded in those disclosures.

“Insurers have the available TCFD framework on what and how climate risk should be disclosed, with insurance company specifics,” McHale adds, but she believes there is a big gap between what most insurance companies are disclosing today in this area and what is going to be needed from investors.

“Regulators acknowledge they do not have a good enough understanding of insurers’ climate risk and believe there are opportunities for insurers to better disclose,” she says. “I’d like to hear what they are going to do to rectify the situation.”

McHale said supervisors are responsible for the oversight of insurers but they are also responsible for maintaining an effective, functioning insurance marketplace. “It’s their responsibility to make sure people can obtain insurance when they need it and at a price they can afford,” she adds. “Understanding insurers’ climate risk isn’t really optional; it’s part of their mandate.”

Getting a better understanding of climate risk can only be good for insurers looking to future-proof their business, according to Kristen Sullivan, Partner, Americas Region Sustainability Services leader at Deloitte & Touche LLP.

“Disclosure is critical and transparency is a tool – but the opportunity for carriers is how it helps to integrate climate risk into enterprise risk management and strategic decision-making. The TCFD has been a tremendously constructive tool to help carriers organise their dependencies and impacts in that context,” she says.

“Climate risk is a strategic opportunity … insurers need to ask themselves, ‘What is our appetite?’ and strategically, what are the opportunities to move into the climate risk space and provide better protection to consumers?” Sullivan adds.

McHale offers a more apocalyptic warning. “The U.S. is already today being significantly affected by the physical impacts of climate change and severe weather, especially flooding, wildfires and windstorms. If insured losses resulting from floods or a hurricane or a series of events are sufficiently large and concentrated, they could lead to distress or failure of insurance companies.

“That’s on top of the climate transition and investment risks they face,” she adds. “Insurers need to tell regulators and investors exactly how they are planning to survive.”

This feature originally appeared in Reactions.