A report from the New York State Department of Financial Services (NYDFS) and the 2 Degrees Investing Initiative (2DII), “An Analysis of New York Domestic Insurers’ Exposure to Transition Risks and Opportunities from Climate Change,” examines the risk that the transition to a low-carbon world may pose to the asset side of New York insurers’ balance sheets.
To date, the public has largely thought about the impact of climate change on insurance as a problem for the liability side of insurers’ balances sheets – how climate change will affect the frequency and severity of claims. That has meant, in general, a focus on property/casualty insurers. This report, however, looks at the potential risks to all types of New York domestic insurers – life, health and property/casualty – and focuses instead on the impact to the asset side.
By looking at public information in the insurers’ financial statements, the report concludes that “insurers’ assets [are] meaningfully exposed to transition risks.”
The exercise detailed in the report follows several new developments in the financial markets and in the federal government concerning the impact that climate change is expected to have on financial institutions. For instance, the report highlights recent corporate pledges to be net zero by the end of the century, noting that “asset owners, asset managers, and banks have made similar pledges.” In particular, the members of the Net Zero Asset Owners Alliance have “committed to transition their investment portfolios to net zero by 2050.”
The report appears in the wake of NYDFS’s other recent climate-related activities. Perhaps most notably, just a few months earlier, NYDFS proposed “Guidance for New York Domestic Insurers on Managing the Financial Risks from Climate Change,” which speaks directly to NYDFS’s efforts to address the impact of climate change on insurers and its expectations of those insurers.
Specifically, NYDFS and 2DII analyzed the investment portfolios of New York domestic insurers as reported as of 2019 in Schedule D of their financial statements. NYDFS and 2DII ran this data through the Paris Agreement Capital Transition Assessment, which “assesses the alignment between the investors’ and banks’ portfolios with different climate scenarios, ranging from business-as-usual to alignment with the Paris Agreement.” The exercise allowed NYDFS and 2DII to evaluate the extent to which New York domiciled insurers are actively planning for the transition to a lower carbon environment in the years to come. Additionally, although the report and its conclusions address the New York insurance industry as a whole, 2DII provided insurers with individualized results of the analysis. Finally, the report offered a list of suggestions for mitigating the risks the analysis uncovers.
Insurers must be more cognizant of the risks of climate change
The report’s findings make clear that New York insurers must be more cognizant of the risks climate change poses to their business. In summary, the report finds:
- “New York domestic insurers’ investments in 2019 had meaningful exposure to carbon intensive sectors.” Approximately 11 percent of insurers’ assets were in carbon intensive sectors, with life companies’ having approximately 20 percent of their bond portfolios in such sectors. The report found one property/casualty insurer that had “all its equity investments in the fossil fuel sector.”
- “The five-year forward-looking capital plans of most insurers’ investee companies in these sectors were not Paris-aligned, except for natural gas production, natural gas -fired power generation, and electric vehicle production.” More specifically, insurers were overly invested in coal and oil-fired generation and underinvested in renewable sources.
- “In many cases, insurers’ portfolios were less Paris-aligned than market benchmarks.”
Five categories of mitigation strategies
The report highlights five categories of mitigation strategies for insurers to address deficiencies: Divestment; Investment; Exclusion; Engagement; and Setting Climate-Related Conditions. The first three categories are largely self-explanatory. The other two are less so, and further regulatory activity by NYDFS is possible in these areas.
Under “engagement,” the report suggests that insurers can use their “power as investors” to influence corporate behavior on climate issues. The report indicates that, as equity investors, insurers could directly communicate with company board members or management or make themselves heard via proxy voting or “co-filing shareholders proposals.” As debt investors, insurers may use the leverage afforded by borrowers’ needs to refinance outstanding debt. Similarly, the report suggests that insurers require that investees abide by certain climate-related criteria as a condition of investment.
NYDFS suggests that insurers take a position
In essence, NYDFS is suggesting that insurers, many of which have publicly traded corporate parent entities, take positions vis-à-vis the entities in which they invest. Insurance laws, NYDFS, and its sister regulators have long prescribed the qualitative and quantitative aspects of insurance company investments and, thus, future regulatory action requiring divestment, investment or exclusion seems in line with well-established practices. It would be a significant development indeed if NYDFS, or any insurance regulator, were to propose amending the investment laws or regulations, or impose some sort of disclosure requirement, affirmatively enjoining how insurers act as investors.
These suggestions appear tempered by the paramount need to protect insurer solvency. For that reason, the report states that whatever course an insurer takes, it “should consider financial returns and asset-liability matching, among other factors.”
Learn more about the implications of this development, and the overall actions of the NYDFS around climate change, by contacting any of the authors or your usual DLA Piper relationship attorney.