30 September 20205 minute read

New York Department of Financial Services issues circular on climate change and financial risks

The New York Department of Financial Services (NYDFS) is one of the leading and most committed state insurance regulators to address climate change and the impact it will have on the financial condition of the domestic and foreign insurance companies in New York. As a result of the decision by the US to withdraw from the 2015 Paris Agreement, the NYDFS emphasized that it is more important than ever for states to take the lead in ensuring the financial stability of the institutions that they regulate in face of climate change.  As the NYDFS said, physical risks arising from increased frequency and severity of hurricanes, floods and wildfires as well as chronic changing weather patterns directly affect the liabilities of property/casualty insurers and potentially the long-term viability of certain business lines.

In September 2019, the NYDFS became the first US financial regulator to join the Network for Greening the Financial System (NGFS), a global network of central banks and supervisory authorities advocating for a more sustainable financial system, which in May 2020 released its "Guide for Supervisors: Integrating Climate-related and Environmental Risks into Prudential Supervision."  The Guide incorporates current supervisory practices and new analysis to produce a comprehensive approach for banking and insurance supervisors to integrate climate-related risks into their supervision. The NYDFS also joined the United Nations Environment Programme Sustainable Insurance Forum (SIF), an international network of insurance supervisors seeking to find collaborative ways to help the global insurance industry meet the challenges posed by climate change. The NYDFS encourages the insurance industry to address climate change by requiring those regulated insurers to have business continuity plans and submit annual disaster preparedness response plans to safeguard their operations.

Building on these efforts, the NYDFS on September 22, 2020 issued a circular letter announcing a number of further changes and implemented several new initiatives to address these climate-related financial risks. The NYDFS called on insurers to begin to integrate their practices into their risk management and business strategies. Climate change poses wide-ranging and material risk to the insurance industry as a result of both physical and transition risks impacting both sides of insurers’ balance sheets and also their business models. Financial risks from climate change are unprecedented. Unlike other financial risks, they are global in scale and cannot be contained regionally or through diversification.

In this circular letter, the NYDFS outlines its expectations for the industry. The NYDFS expects insurers to start integrating the consideration of financial risks from climate change into their governance framework, risk management processes and business strategies, and to analyze how climate change affects their investments, liquidity, operations, reputation, business strategy and underwriting. For example, insurers are expected to designate a board member or committee of the board, as well as a senior management function, to be accountable for the company’s assessment and management of the financial risks from climate change. Insurers are also expected to address climate change as a reasonably foreseeable and relevant material risk through their enterprise risk management function and ORSA (Own Risk and Solvency Assessment) process.

The NYDFS intends to publish detailed guidance consistent with international best practices on climate-related financial supervision and plans to incorporate questions on insurers’ approach and activities related to climate change in its examination process starting in 2021. In this process, each insurer is expected to take a proportionate approach that reflects its exposure to the financial risks for climate change and takes into account the nature, scale and complexity of its business.

To establish greater focus on this critical issue, the NYDFS has created and appointed its first-ever Sustainability and Climate Initiatives Director, whose mandate consists of developing the Department’s portfolio of policy initiatives involving sustainability, green financing and climate mitigation. The Director will engage with the industry and develop guidance in this area.

As part of these initiatives, the NYDFS has also become a supporting institution of the United Nations Environment Programme Finance Initiative Principles for Sustainable Insurance in order to publicly demonstrate its support for sustainable insurance aims. Further, under a Memorandum of Understanding,  the NYDFS and the New York State Energy Research and Development Authority will work together to address the effects of climate change and support New York’s climate goals by leveraging the state’s financial sector by creating insurance and financial products to speed up the development of low-carbon technologies and by providing technical support, regulatory guidance and facilitating market access.

Although the NYDFS Superintendent in its circular acknowledged that the US is behind its European counterparts in terms of climate-related supervision, the Superintendent said that "we have learned from their experience, can take advantage of the supervisory tools that they have developed, and will continue collaborating with them in this area going forward." She continued, "Mitigating the financial risk from climate change is a critical component of creating a stronger industry." [1]

By setting out its expectations for the insurance industry, the NYDFS will be requiring insurers in New York to be more proactive in addressing, analyzing and assessing the impact of climate change and to establish a governance and risk management program that more accurately reflects the potential financial consequences.

Learn more about these developments and their implications for your business by contacting any of the authors.

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