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Climate risk becomes urgent ESG issue for insurance industry

House and Senate bills would require disclosure standards

A bill sponsored by Illinois Rep. Sean Casten would direct the SEC to set disclosure standards for climate risk.
A bill sponsored by Illinois Rep. Sean Casten would direct the SEC to set disclosure standards for climate risk. (Tom Williams/CQ Roll Call file photo)

Climate risk, a growing focus for environment, social and governance-minded investors, has morphed into an urgent issue for insurers as wildfires ravage the U.S. and Europe and natural disasters destroy property and cost lives worldwide.

In the U.S., more than 2.4 million acres have burned in more than 100 large fires and complexes in 12 states this year, according to the National Interagency Fire Center. Wildfires also are raging across Greece, Turkey, Italy, Spain, Russia and Lebanon, fueled by some of the hottest temperatures in recorded history. 

A report this month from the UN Intergovernmental Panel on Climate Change found that human-produced greenhouse gas emissions are responsible for the rise in extreme weather, heat waves and drought.

On the hook for more claim payouts, the insurance industry should be doing more to prepare for climate-related risk, according to Dave Jones, California’s insurance commissioner from 2011-19. Jones is now director of the Climate Risk Initiative at the Center for Law, Energy and the Environment at the University of California, Berkeley Law School.

“The role of insurance commissioner is to protect consumers and supervise the financial stability of insurance markets,” Jones said in an interview with CQ Roll Call. Insurance is essential for consumers and businesses, but the industry faces climate-driven physical risk to covered assets as well as transition risk in their reserve portfolios, he said.

The risks include investments in fossil fuel companies and other greenhouse gas emitting industries that are expected to decline amid the carbon transition and could become stranded assets, he said. During his tenure in California, he was the first financial regulator to evaluate insurance companies’ reserve portfolios for climate risk.

As commissioner, Jones asked companies to voluntarily divest holdings in thermal coal based on economic indicators that projected its decline. He mandated that insurers within the state disclose investments in oil, gas, coal or utilities that are more than 50 percent derived from those sources.

“As an insurance regulator, one of my responsibilities was to ensure companies were investing in assets that retain value, so they have adequate reserves to pay claims,” Jones said.

While it was also the right thing to do for the climate, the decision to ask for divestment and disclosure was based on the financial risk facing these investments, he said.

Jones’ office monitored insurers’ reserve portfolios, applied different climate-risk scenarios and performed stress tests to examine how certain investments might perform under various future greenhouse gas emission policies, he said.

Regulators in the U.S. don’t generally scrutinize insurers’ reserve portfolios for climate risk, but those practices are more common in other countries, he said.

“Those climate risk regulatory practices are the standard among financial regulators in Europe and Asia,” he said. “By and large, both the U.S. insurance industry and state insurance regulators are behind the curve.”

Climate risk assessments are something that more companies and regulators in the U.S. “ought to be doing,” Jones said.

The practice may be gaining some traction. New York’s Department of Insurance is considering climate-risk regulations and the Commodity Futures Trading Commission published a comprehensive report on climate-financial risk last year that included recommendations to assess insurance reserve portfolios on climate risk, according to Jones.

President Joe Biden in May issued an executive order urging federal agencies to take into account climate-related financial risks.

The House is considering a bill that would require the Securities and Exchange Commission to establish rules on climate-risk disclosure with tailored requirements for various sectors of the economy, including insurance. Companion legislation has been introduced in the Senate.

Rep. Sean Casten, D-Ill., who sponsored the House bill, tied it to the need for transparency in free markets.

“When it comes to making the transition from fossil fuels to cleaner, cheaper energy, markets are some of the most powerful tools we have,” Casten said in a statement. “But for markets to work efficiently, investors need transparency. By requiring publicly traded companies to disclose all climate-related risks, my bill will empower investors to make smarter decisions and harness the power of the free market to help us win the race against the climate crisis before it’s too late.”

SEC Chair Gary Gensler has also indicated his support for climate-risk disclosure rules and placed the effort on the agency’s near-term agenda.

Outside of Washington, insurers and regulators could be motivated to more seriously embrace sustainability now that several regions of the country are experiencing frequent and severe natural disasters. It also coincides with deteriorating climate projections from the international scientific community.

IPCC’s sixth climate change assessment was published on Aug. 9, and its conclusions were stark. UN Secretary-General António Guterres called the report’s findings a “code red for humanity.”

“The alarm bells are deafening, and the evidence is irrefutable: greenhouse‑gas emissions from fossil-fuel burning and deforestation are choking our planet and putting billions of people at immediate risk,” Guterres added. “Global heating is affecting every region on Earth, with many of the changes becoming irreversible.”

‘It’s unsustainable’

Granville Martin, director of U.S. policy and outreach at Value Reporting Foundation, said the specter of rising payouts from environmental catastrophes demonstrates the need more robust climate disclosure.

“It’s unsustainable,” Martin said, noting that California’s property and casualty industry paid out more than $26 billion in claims in 2017-18. Since then, officials have been expanding fire risk maps and the amount of destruction caused by wildfire appears to be worsening, he added.

Affordable and reliable insurance is essential to managing risk and touches on every sector of the economy, Martin said.

Martin’s Value Reporting Foundation formed in June in a merger of the International Integrated Reporting Council and the Sustainability Accounting Standards Board. The group develops international standards for ESG disclosure.

Martin says companies in vulnerable sectors, including insurance, are more attuned to environmental risks, but there still aren’t adequate methods for tracking this information.

“We need standards so investors can understand the prospects of particular companies but also so they can understand the sector-wide implications of climate risk,” Martin said.

Elizabeth Bieber, an attorney at Freshfields Bruckhaus Deringer LLP in New York, said an investor’s attention to climate risk often depends on their time horizon. Bieber is head of shareholder engagement and activism defense for the firm.

“There’s a tension between long-term and short-term investors on the relative importance of environmental factors,” Bieber said in an interview.

Institutional investors are more concerned with companies’ long-term financial risks, including sustainability factors, she said. On the other hand, short-term investors are less willing to consider longer time horizons and would prefer immediate financial returns over significant long-term investment.

A significant push by large institutional investors in recent years elevated ESG issues to the top of the agenda, Bieber said.

Anticipating regulations on ESG disclosure from the SEC, Bieber said companies and investors have opportunities to participate in shaping the debate but the growing concern over long-term sustainability isn’t going to fade.

“I don’t think the demand for additional information from companies is going away,” Bieber said.

Jones, the former California insurance commissioner, also predicted climate risk will play an increasingly important role in financial risk considerations, especially as insurers and other sectors face more imminent impacts.

“To those who continue to deny the science of climate change: Look around you,” Jones said. Multiple regions in the U.S. are suffering from climate-driven catastrophic natural disasters, he said, pointing to severe wildfires, floods, drought, hurricanes and extreme weather around the world.

“I don’t think one can any longer deny this is occurring; the question is will we act quickly and strongly enough to reduce the impacts of climate change which we’re already seeing alll around us,” Jones said.

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