Is your enterprise risk management framework climate-ready?

An insurer’s board is the beginning and end of the climate risk oversight operation and is an essential piece of developing a climate risk framework, climate expertise, and continuous oversight. To start with, boards should establish a robust plan that highlights key timelines, internal and external stakeholders, and interdependencies. Details on the company’s implementation plans and pathway to meeting the expectations relating to organizational structure were to be in place as of August 15, 2022. Board governance includes the following points:

• The guidance envisions a board deeply involved with climate risk considerations, one that is actively engaged and ready to tap into and communicate risks at any time, more so if climate risk is considered a material risk to the insurer’s position or is expected to be so in the future.
• This board must designate a member or committee to be responsible for overseeing climate risks to ensure that the board can understand and actively manage the ongoing threat and impact of climate risk for the long term, not just for a three- to five-year time horizon.
• Insurers should not limit climate expertise to one individual at the executive and board level. NYDFS recognizes that climate change could affect operations and businesses across the company, and this reality demands multiple senior management individuals who develop or have expertise in responding to climate risk.

NYDFS also expects each insurer to designate one or more members of its senior management to manage climate risks. As an alternative, NYDFS suggests a cross-functional committee of senior management.

NYDFS advises companies to proactively manage climate risk through existing enterprise risk management (ERM) functions. So that climate risk doesn’t become a superficial exercise, the goal should be to embed climate risk metrics in the overall risk appetite framework and to be used to inform decision-making.

NYDFS also expects insurers to undertake robust examination of a “full range of potential future outcomes and consider forward-looking data” in their risk analysis. Risk functions will need to become fluent in the climate risk activities for adjusting to analysis results and material risk changes over time. Such an expansive approach can stave off or reduce the potential for higher losses stemming from underestimation of future extreme weather events, or from failing to understand the connections between transition and physical climate risks.

The NYDFS guidance, like similar documents from other bodies, sees a quantitative scenario analysis function as an ideal way for insurers to understand and plan for climate risk. Insurers’ risk functions should start to think about what this would look like, even if in a highly preliminary state, as eventual maturation into a quantitative and repeatable scenario analysis process is the goal. Early iterations of climate risk scenario analysis are expected to be qualitative in nature.

Whether qualitative or quantitative, the NYDFS says an insurer should be able to understand and address material climate risks.

The transformations mentioned previously will need to be reflected in reporting documents, including own risk and solvency assessment (ORSA) filings with state regulators. Insurance companies should work toward being able to describe how climate risks are identified, categorized, managed, and monitored in disclosures, including details on assessment tools and methods used. To meet the emerging expectations, insurers should establish a dynamic and well-rooted reporting plan that highlights key timelines, internal and external stakeholders, and interdependencies.

Keeping with the trend, an insurer’s analysis of climate risks and assessment of their materiality for its business should shift from a qualitative approach to an approach that is both qualitative and quantitative over time, which will become necessary for risks that are quantifiable and as more data becomes available through modeling, research, and statistical resources.

Climate risk is present in many business activities, product development not the least among them. Deloitte’s SC&E risk framework emphasizes product risk because 1) products are the economic motor of an organization, and 2) the climate risk inherent in insurance products is a new and important frontier for much of the industry. It will be important for organizations such as life insurers, health insurers, and reinsurers to understand, as quantitatively as possible, how climate risk can impact the profitability and effectiveness of products.

Climate’s impact on products may present an opportunity for insurers to capitalize on new markets, customers, and technologies that need risk transfer products. Specializing early will facilitate a competitive edge in an environment of economic transition to a low-carbon economy.

For many insurance companies, the technological aspect of measuring and tracking various climate metrics—and socializing them in a way that impacts decision-making—is perhaps the area in need of the most improvement. The field is relatively new and rapidly evolving, with few leading practices or universal standards to use as guideposts.

Yet as stated before, uncertainty does not justify inaction. Insurers should be building internal expertise on relevant climate data sources and systems, as well as identifying process owners. From there, the organization’s climate subject-matter experts should work to identify information technology (IT) system assumptions and limitations that affect measurement, tracking, and reporting of key metrics.

As an end state, the goal should be a battery of flexible climate systems that can adapt to changing standards of technology and data, as well as defined internal process and general IT controls that help mitigate climate-related risks.

Many insurers will need to transform at least some of their internal operations to meet the expectations touched on previously, which will transition over time from suggested actions to required ones. The seven-part SC&E risk framework provides a helpful first view, by organizing guidance from a regulator such as the NYDFS into operational components familiar to most corporate environments.

From there, an insurer will likely need to plan on internal transformation and realignment to content with climate challenges. Deloitte’s sustainability and climate journey for insurers map is a more detailed view of the steps needed to become an insurance company of the future.