Rocks and Hard Places: Noteworthy Developments in Climate Change Regulation for US Insurers

Introduction

This update highlights some of the most noteworthy climate change-related federal and state regulatory, judicial and other developments of the past few months, and offers insights that may help guide insurers in their journeys toward more effective environmental, social and governance (ESG) and climate disclosures—whether they are traveling quickly or slowly.

These developments include, at the US federal level:

• The US Security and Exchange Commission’s (SEC) extended—but not yet finalized—climate change disclosure rulemaking, which is directly applicable only to registered companies (only a few more than 100 of which, including intermediaries, are insurance enterprises).
• The US Department of Labor’s November 2022 proposed rule, which is still in a 60-day comment period, enables fiduciaries to take into account the potential benefits of investing in companies that include ESG considerations in their planning and operations or, presumably, avoiding or minimizing investments in companies that do not.
• The Federal Insurance Office’s (FIO) delayed climate change report and proposed homeowners’ insurance data call. (Note that, as of this writing, the data call proposal is also still in a 60-day comment period.)
• The collective proposal by the General Services Administration, the US Department of Defense and the National Aeronautics and Space Administration (NASA) “…to amend the Federal Acquisition Regulation (FAR) to implement a requirement to ensure certain Federal contractors disclose their greenhouse gas emissions and climate-related financial risk and set science-based targets to reduce their greenhouse gas emissions.” This proposed regulatory change is also in a 60-day comment period that ends on January 14, 2023.
• The Board of Governors of the Federal Reserve System’s December 2, 2022, release of “Principles for Climate-Related Financial Risk Management for Large Financial Institutions,” which followed similar high-level guidance issued during the past year by the Office of the Comptroller and the Federal Deposit Insurance Corporation (FDIC) and is applicable to banks with more than $100 billion in assets. The Federal Reserve’s proposal will also be subject to a 60-day public comment period.

Developments at the state level include:

• California’s “Sustainable Insurance Roadmap” announced last month, near the close of Conference of the Parties of the UNFCCC (COP 27), by Insurance Commissioner Ricardo Lara. The roadmap includes “four interlocking goals of reducing emissions, accelerating community mitigation, keeping insurance affordable and available for vulnerable communities, and closing protection gaps between insured and uninsured losses.”
• The announcement by Illinois that it will become the 16th state to require domestic insurers to submit annual climate disclosure surveys using the Task Force on Climate-Related Disclosures (TCFD) template or the National Association of Insurance Commissioners’ (NAIC) revised climate disclosure survey form.
• The October 2022 serving, by Texas Attorney General Ken Paxton and Missouri Attorney General Eric Schmitt, of detailed civil investigative demands on six major banks that are members of the Net-Zero Banking Alliance.

Developments in federal and state courts include the following:

• In mid-October 2022, New Jersey joined more than 20 state and local governments that are suing, in state courts, five of the largest players in the oil and gas industry. The coalition of governments are hoping to force the companies to help pay to repair an environment damaged by decades of burning fossil fuels supplied by major oil companies. Some of the earliest-filed suits in this campaign are now in discovery following years of jurisdictional wrangling.
• A major point of contention in the lawsuits noted just above is whether they should be heard in federal court or in state courts. The oil and gas industry has argued for years that such lawsuits belong in federal court. A number of federal appellate courts have disagreed but the Supreme Court of the United States may yet decide the issue in an upcoming case from the US Court of Appeals for the Tenth Circuit ( of Cnty. Comm’rs of Boulder Cnty. v. Suncor Energy (U.S.) Inc.).
• The Kentucky Bankers Association sued state Attorney General Daniel Cameron, seeking to scupper his investigation into the alleged climate change-influenced lending practices of several large banks.
• In early October 2022, attorneys general from 21 states essentially threatened to sue the federal Commodities Futures Trading Commission (CFTC) if the CFTC moved forward to promulgate climate change disclosure regulations. The group lists three grounds for a potential lawsuit: The “major questions” doctrine, First Amendment concerns arising from alleged “compelled speech,” and that any agency action on climate change disclosure regulations would be arbitrary and capricious.

For those who care about sound, balanced public policy with respect to insurers and climate change, the various financial risks it poses (and required financial disclosures of those risks) the past few months have been sobering. It seems that there is little common ground in the United States today. In the August 2022 update, we mentioned the widening “red” versus “blue” divide with respect to regulatory activity concerning climate change disclosure. The divide continues to widen, with—on the one hand—conservative critics on the right conflating climate change, ESG and “woke,” blue-state (read left wing) agendas that include “radical climate goals,” which these critics interpret as forming a “radical progressive worldview.” On the other hand, climate change activists continue to raise their voices (as will be described in more detail below).

Attorneys general in more than 20 red states have criticized (and continue to criticize) and investigate banks and fund managers that incorporate ESG factors into investment decisions or that curtail lending to enterprises perceived to be laggards in reducing greenhouse gas emissions. Announcing their disagreement, attorneys general in 17 states have pushed back on the Republican-led, red-state narrative in a strong letter supporting the SEC’s proposed climate change financial disclosure regulations.

Given these signals, we should expect state legislation in a number of red states during 2023 in an effort to put a stop to consideration of climate change or ESG factors by banks and fund managers. We also can expect legislation to “protect” state credit ratings from being affected by ESG or climate change considerations. Last week, for example, the new leaders of the Florida state legislature promised such an initiative in the coming year. Florida Speaker of the House Paul Renner promised legislation that would ensure that “fiscally irresponsible states like California [do not] receive a better credit rating than Florida simply because they embrace ESG’s political agenda.”

When the SEC finalizes and publishes its proposed climate change financial disclosure regulation, probably sometime early in 2023, it seems likely that multiple lawsuits will be filed to challenge the SEC’s statutory authority to mandate such disclosures. Some of these lawsuits are expected to assert that the agency’s decision to mandate such disclosures is a “major question” that requires “clear Congressional authorization” per the Supreme Court’s most recent decision on the major question doctrine in West Virginia et al. vs.Environmental Protection Agency, decided at the end of June 2022. If and when federal banking regulators seek to promulgate similar climate change financial disclosure requirements, we can presumably expect more such litigation. It remains unclear, however, whether the high-level climate change risk management “guidance” that federal bank regulators have already published or are in the process of finalizing are tantamount to agency regulations that can be challenged in court.

As noted above, climate change activists continue to criticize commercial entities perceived to be failing to quickly stop financing or insuring projects that are carbon intensive. Many such activists extol the climate change regulatory progress (real or imagined) made in non-US jurisdictions and congratulate financial sector regulators for progress with respect to climate change disclosure and related measures (which progress is often difficult to spot). Immediately following the conclusion of COP 27, the nonprofit organization Ceres sponsored a panel discussion featuring insurance regulators from various states—a panel discussion that was moved shortly before presentation from the aegis of the NAIC to that of the California Department of Insurance—essentially claiming and applauding climate change regulatory progress made by insurance regulators.

Despite these claims, and as we noted in our August 2022 update and would continue to note, it remains difficult to spot substantive progress by the NAIC. To be fair, earlier in 2022, the NAIC’s Executive Committee adopted a revised climate change disclosure template—but again, the full NAIC did not confirm that decision. There has been one additional state—Illinois—that has decided to require its domestic insurers to complete and file either the NAIC’s climate change disclosure or the TCFD template next year, which brings the count up to 16 states with similar requirements. Next week, during the NAIC’s final national meeting of 2022, the organization’s Climate & Resiliency Task Force will convene. We will be listening closely to what regulators have to report.

In a letter dated November 22, 2022, the NAIC itself criticized the FIO for failing to consult with state regulators before proposing to issue a data call to larger homeowner insurers in 10 catastrophe-exposed states. The data call would ask insurers to provide five years of policy counts, premiums and paid losses, along with insured property values, policy deductible amounts and replacement cost data.

Why the data call? In the words of the FIO:

The proposed data collection will assist FIO’s assessment of climate-related exposures and their effects on insurance availability for policyholders, including whether climate change may create the potential for any major disruptions of private insurance coverage in regions of the country particularly vulnerable to climate change impacts. FIO will also seek to assess any related effects on insurance affordability for policyholders.

State regulators questioned whether the data that the FIO seeks will in fact provide any real insight into climate change impacts on insurers (or policyholders). Initial industry reaction to the proposed data call can be characterized as tepid at best. In any event, the proposal is still in a 60-day public comment period, ending on or about December 21, 2022.

Meanwhile, insurers, banks and fund managers are all occupying climate change and ESG hot seats of varying temperatures. Some banks and fund managers have already had to handle investigative demands from state attorneys general. Large banks will be required to address the high-level climate change risk management guidelines that have been proposed most recently by the Federal Reserve, the FDIC and the Office of the Comptroller of the Currency (OCC). State insurance regulators in 16 states will continue to require domestic insurers to file climate risk financial disclosures. Insurance groups headquartered in the European Union, United Kingdom, Bermuda and elsewhere will have embarked on their climate change risk management journeys well before now. For US insurers still on their climate change risk management journeys, however, we offer a few points to keep in mind.

First, and obviously, the climate change regulatory environment is not static, nor is it affected solely by the activities of state insurance regulators. Keep an eye on federal activity via the FIO—with little doubt, certain homeowners’ insurers may well have to deal with an FIO data call next year. Increases in climate change-related litigation—whether challenging federal agency regulations and guidance, implementing and resisting state AG investigations, or involving suits against oil and gas majors—seems inevitable in 2023.

Second, state legislative activity concerning climate change risk management in 2023 needs to be monitored. Will such activity affect banks and fund managers only, or will legislators include insurers in whatever measures are proposed and adopted?

Third, insurance regulatory activity by the NAIC during 2023 seems likely to be limited. It will continue to be difficult for the institution to speak with one voice as to a variety of regulatory considerations, given the red versus blue political tensions. However, activity with respect to increasing awareness and better modeling of physical risks posed by increasingly intense weather events may be an area that even regulators from catastrophe-exposed red states—such as Florida and Texas—and industry can work on together.

Fourth, climate change financial risk disclosures will continue to be required for many insurers domiciled in the 16 states that have adopted such requirements. Whether additional states will follow suit remains uncertain. More comprehensive climate change regulatory activity will probably be limited to states, including New York and Connecticut, that have developed or will develop more detailed regulatory frameworks, including expectations with respect to governance and climate change modules within periodic financial examinations.

Fifth, beware of states such as California that historically have viewed insurers as key players on the investment side of climate change regulatory policy. Compared to the largest fund managers and the funds management industry in the aggregate, insurers have some ability to finance the damage repair from weather events but possess only limited resources to invest in adaptation efforts (whether in infrastructure upgrades or in decarbonizing agriculture, homes and commercial properties and transportation) that will cost many trillions of dollars in the United States alone over the next several decades. Insurers cannot close protection gaps for various perils that have persisted throughout the country, at least not absent state (or federal) efforts to require insurers to provide coverage at artificially low rates. Even if regulators somehow managed to succeed in forcing insurers to provide coverage at artificially low rates (e.g., by allowing premium tax offsets), one can question whether US consumers—most of whom are living paycheck to paycheck as it is—would be able to afford to purchase the protection.

Sixth, insurers should continue to carefully review public statements about commitments to reduce greenhouse gas emissions, announcements about how “green” their investment portfolios are or will become, or public statements concerning risk appetites for insuring companies or projects involving extraction, processing, shipment or storage of coal, oil and gas. Such analyses should bear in mind policy backtracking by many governments in the United States and elsewhere with respect to continuing use of fossil fuels. Discretion may be the better part of valor until there is more general agreement as to which metrics should be utilized to analyze investment portfolios. All parties should recognize the impacts that geopolitical events such as the Russian-Ukraine conflict will have on fossil fuel demand and the knock-on effects on reducing greenhouse gas emissions. We have decades to go before we exist in a world powered by non-polluting energy sources.

Now that COP 27 and the midterm elections have concluded (including the runoff in the US senator race in Georgia), we have two fewer variables to consider. But there are still many uncertainties with respect to climate change regulatory efforts, not the least of which, at least for climate financial risk disclosure purposes, have to do with data and metrics. Even the recent TCFD report on progress to date, admits that there are issues:

For instance, there still is no consensus concerning the standards and metrics companies should use for measuring Scope 1, 2 or 3 greenhouse gas emissions; multi-national companies confront different materiality standards in the U.S. and Europe, with the latter having adopted the concept of “double materiality” whereby an issuer’s external impact is deemed material even if not impactful on the issuer itself; it is often difficult to obtain information necessary to make accurate disclosure, especially if the information has to come from third parties; and more generally climate change is a dynamic situation and companies risk having to deviate from prior good faith disclosure of plans or correct past disclosure of historical information such as GhG emissions in light of real-time developments or improvements in GhG measurement.

In other words, to be continued…