Climate change governance and strategy requirements: How might New York insurers comply with them
Examples of shifts in attitude toward climate change in the U.S. regulatory landscape.
Background
Domestic insurers have until August 2022 to begin complying with two specific action steps related to the recent New York Department of Financial Services (NY-DFS) Guidance for New York Domestic Insurers on Managing the Financial Risks from Climate Change.1 These two steps are:
- Implement the company’s expectations related to board governance
- Have specific plans in place to implement the company’s expectations relating to organizational structure
Previously, I wrote an article2 primarily focused on providing background and context leading up to this guidance, which largely drew from collaborative and strategic global alliances and recent best practice efforts in the United Kingdom (UK) and European Union (EU).
New York domestic insurers have several organizational and operational actions to consider regarding the guidance. After summarizing the various NY-DFS expectations for board governance and organizational structure,3 this article offers some best practice implementation examples and practical advice for U.S insurers as the NY-DFS’s August deadline draws nearer.
Board governance
The NY-DFS guidance specifically references how the National Association of Insurance Commissioners (NAIC) Financial Condition Examiners Handbook lays out an effective corporate governance program. Organizations in the UK and EU have begun implementing similar programs in a variety of ways.4,5 We believe that board governance guidance is centered on ensuring that functions and controls are in place and that the financial and operational considerations surrounding risks imposed by climate change are prevalent when decisions are made. Below are four areas of consideration for integrating climate risks into your board governance.
I. Board ownership and responsibility
The DFS expects the board of each insurer to understand relevant climate risks, including their distinctive nature and long-term impact. The insurer should designate a member of the committee(s) of its board as being responsible for the oversight of the management of the insurer’s climate-related risks.
Best practices include:
- Establish clear roles as part of board responsibilities via updates of board governance committee rosters.
- Allocate the responsibility for identifying and managing climate-related financial risks to the relevant senior management. Document in enterprise risk registry.
- Ensure governance approach for climate risks is integrated within existing enterprise financial risk framework.
II. Management ownership and responsibility
NY-DFS expects each insurer to designate one or more members of its senior management as responsible for the insurer's management of climate risks.
Best practices include:
- Assign responsibility for climate change management to an existing senior role, such as the chief risk officer (CRO), chief financial officer (CFO), or chief investment officer (CIO). These responsibilities should be detailed in the manager’s performance requirements.
III. Board and management understanding
The board and senior management should stay abreast of evolving climate risks, and regularly assess the assumptions and materiality of, and the company’s exposure to, those risks.
Best practices include:
- Assess the materiality of climate risks in short-, medium-, and long-term scenarios via climate risk workshops to identify exposures.
- Establish a board-approved climate strategy, including a risk appetite/tolerance statement that details key metrics, tests, probabilities, and uncertainties along with a long-term view of financial risks, beyond standard business planning horizons.
- Consider appointing a climate risk expert or creating a climate risk advisory committee comprised of internal experts and at least one external expert.
- Conduct a tailored climate risk training program for those directly involved in risk management. There are multiple opportunities for training, including the U.S. Climate Resilience Toolkit.
IV. Board oversight and commitments
The insurer’s board should also oversee management’s progress toward meeting any announced climate commitments and ensure that related strategies are being employed and evaluated for effectiveness. Material climate risk mitigation commitments that would meaningfully impact capital spending should be built into the insurer’s risks and controls systems. These commitments should be clearly reflected in the insurer’s financial statements and budgets and overseen by the insurer’s board or audit committee.
Best practices include:
- Ensure financial risk from climate change is a regular board agenda item. Hold active board discussions on climate risk management information.
- Oversee and address climate change risks within the business strategy and risk appetite via established management reporting metrics. Ensure climate risk considerations are incorporated into the strategic plans and business models. Manage climate risk results versus targets.
Organizational structure
Ultimately, an organization must be structured in a manner conducive to making effective decisions. In this regard, the NAIC Handbook indicates that an organization must strike a proper balance of being able to monitor the company’s decisions, but not be so complex as to inhibit such decisions. While it may be implied by the risk management framework, a company must now ensure that its decision-making explicitly considers climate change risks in practice. The following three items are necessary considerations for implementation:
I. Risk management structure
Climate risks are managed through existing enterprise risk functions.
Best practices include:
- Treat climate change as a driver of existing risk types (i.e., “cross-cutting”), not as a new, standalone risk. Existing risk framework documentation should be updated to include guidance about climate change-related impacts on each risk type (as opposed to creating a climate risk policy).
II. Roles and responsibilities across the organization
Ensure that the organizational structure clearly defines and articulates roles, responsibilities, and accountabilities, and is reinforced by a risk culture that supports accountability in risk-based decision-making in setting climate risk limits and overseeing their implementation.
Best practices include:
- Charge senior managers with embedding climate risk into governance frameworks, and with linking climate risk strategy to company strategy
- Update risk policies to ensure that responsibilities for the consideration of climate change impacts on risks are clear, including the setting of risk tolerance limits
- Drive culture from the top down, and encourage staff to be accountable
III. Risk management processes
The NY-DFS guidance on risk management processes requires a multifaceted approach. After noting NY-DFS guidance below, we follow each with a recommended best practice:
Implement reliable risk management processes across lines of business, operations, and control functions.
- Best practice: Determine the tools needed to identify and assess physical and transition risks. Develop a uniform risk taxonomy and risk categories.
Explicitly consider climate risks in enterprise risk reports and Own Risk and Solvency Assessment (ORSA) summary reports.
- Best practice: The risks associated with climate change are complex and prone to sudden change. Conduct regular scenario analyses over short, medium, and long time horizons to understand potential impacts on the business and potential actions available to mitigate them. Report these scenarios through the ORSA and other risk reporting.
Conduct objective, independent, and regular internal reviews of the functions and procedures for managing climate risks. Report the findings of the reviews to the board.
- Best practice: The business risk function is responsible for translating risk policy requirements into business policies and procedures. Regularly review the effectiveness of meeting the requirements of the risk framework, and report to the board.
Develop the skill, expertise, and knowledge required for the assessment and management of climate risks at the level of the board and employees.
- Best practice: Retain the services of an external expert(s) to fill in the internal knowledge and expertise gaps.
Consider implementing remuneration policies to align incentives with the strategy for managing climate risks and with performance against climate risk metrics.
- Best practice: Create incentives consistent with the stated strategy in relation to climate change and do not encourage behaviors that are incompatible.
We will continue to monitor NY-DFS climate change pronouncements and offer further insights related to risk management expectations set out for its domestic companies.
1NY-DFS (November 15, 2021). Guidance for New York Domestic Insurers on Managing the Financial Risks from Climate Change. Retrieved February 8, 2022, from https://www.dfs.ny.gov/system/files/documents/2021/11/dfs-insurance-climate-guidance-2021_1.pdf.
2DiCenso, S.R. (December 16, 2021). U.S. Insurers and Climate Change: The Longer-Term Horizon Is Getting Shorter. Milliman Insight. Retrieved February 8, 2022, from https://us.milliman.com/en/insight/US-insurers-and-climate-change-the-longer-term-horizon-is-getting-shorter.
4Lehane, O. & Clarke, S. (January 28, 2022). Climate-Related Risk: What Are the Expectations for Irish (Re)insurers? Milliman Insight. Retrieved February 8, 2022, from https://us.milliman.com/en/insight/climate-related-risk-what-are-the-expectations-for-irish-re-insurers.
5Cantle, N., Chaudhry, A., Clarke, S. et al. (November 2021). Climate Risk Management for Life Insurers. Milliman Report. Retrieved February 8, 2022, from https://us.milliman.com/-/media/milliman/pdfs/2021-articles/11-29-21-climate-risk-management-for-life-insurers-a.ashx.