Regulators Should Identify and Mitigate Climate Risks in the Insurance Industry

The insurance industry plays a critical role in both the financial system and the economy overall, with U.S. insurance companies writing approximately $1.5 trillion in premiums and holding trillions of dollars more in assets on their balance sheets.¹ By underwriting the risks of millions of individuals, businesses, and public entities, the insurance industry provides an essential service as a backstop after unfortunate events. At the same time, by investing the premiums they hold, insurance companies are major institutional investors and thus have significant influence in financial markets.

As is the case with many businesses, insurance companies face risks due to the worsening effects of global climate change. According to the International Association of Insurance Supervisors (IAIS), “[b]ecause of the dynamic, complex and global impacts of climate risk across the economy and society, it is likely that all insurance businesses will be directly or indirectly affected over the long-term—regardless of their size, business line, domicile or geographic reach.”²

The full severity and scope of the problem is difficult to determine at present, in part because currently available data on insurance companies’ exposure to climate risks are insufficient. The insurance industry may be prepared to deal with the effects of climate change; on the other hand, insurers may be at even more risk than other financial firms, and climate change may present new challenges and severity of losses that the industry has not previously seen. Recent instances of climate-related events causing insurance companies significant losses and leading to severe problems in insurance markets demonstrate that climate change is already having a negative effect that is unlikely to abate. This also portends that the price of inaction could be steepest for everyday individuals in the form of higher premiums and nonrenewed coverage.

U.S. insurance supervisors are increasingly taking these risks seriously: New York’s Department of Financial Services recently issued guidance³ to companies on disclosing climate-related risks; the Federal Insurance Office last year issued a request for information⁴ on climate risks and the insurance sector; and in April, the National Association of Insurance Commissioners (NAIC) updated its survey for disclosing climate risks to require more comprehensive data reporting.⁵ But despite the positive nature of these actions, regulators could do more to concretely address the problem.

This report identifies the types of risk posed by climate change to the insurance sector, characterizes the effect that those risks are having and are likely to continue having on insurance companies and those whom they insure, and makes a case for why government supervisors should do more to address these risks. It then suggests ways in which state regulators and the Federal Insurance Office can act to monitor and mitigate those risks, such as by issuing supervisory guidance to insurance companies on managing climate risks and by collecting and analyzing comprehensive data on the scope and severity of the effect that climate change has on insurance markets.

The insurance industry is a large and complex sector, with a variety of types of insurers (such as property and casualty, life, health, and others) and sizes.⁶ Insurance companies have substantial liabilities on their balance sheets stemming from payouts of insurance policies that they sell, such as a payment to a holder of property insurance if the individual sustains damage to their house. To pay for these liabilities, insurers invest much of the revenue they receive from premium payments in capital markets—typically more so in bonds than equities—making insurance companies some of the most significant institutional investors in the market.⁷ The risks taken on by insurance companies are substantial by nature, but in normal cases, they are mitigated by diversification—both in terms of underwriting and investing—and reinsurance,⁸ which is essentially insurance for insurance companies. These efforts, in theory, prevent any single company from taking on risk in a way that could threaten its financial solvency.

Because of their roles as both large institutional investors and underwriters of risks to financial firms, many insurance companies are major players in the financial services industry and are important to maintaining financial stability. The failure of American International Group Inc. (AIG) in 2008 was a significant event in the global financial crisis of 2007­–2009, requiring an immediate government bailout to prevent extraordinary damage to the economy.⁹ In fact, three of the largest insurance companies—AIG, Prudential, and MetLife—were designated by the Obama administration’s Financial Stability Oversight Council as systemically important financial institutions (SIFIs), subjecting them to heightened supervision by the Federal Reserve, until the Trump administration de-designated these firms as part of a wave of deregulatory actions toward the financial sector.¹⁰

Outside of potential SIFI designation, insurance companies are not regulated by the federal government and are instead overseen by state insurance departments. Per the laws of the various states, state insurance departments have several powers, including licensing, approval of insurance rates, examining firms’ business practices, collecting data, and writing rules and supervisory guidance.¹¹ In 2010, the Dodd-Frank Act created the Federal Insurance Office (FIO) within the U.S. Department of the Treasury.¹² This office does not have supervisory authority over insurance companies, but it is authorized to monitor all aspects of the industry and collect data from companies—by subpoena, if necessary.

Defining climate risks

Like most financial firms, insurance companies likely face two major forms of climate-related risks: physical risk due to financial losses from damage caused by tangible changes in weather or climate patterns (such as sea level rise or increased incidence of natural disasters) and transition risk due to losses in asset values as government policies and private actions shift toward a low-carbon economy.¹³ But insurance companies may also face a unique exposure to liability risk resulting from increasingly common litigation over climate mitigation and adaptation efforts. These risks can potentially manifest on both sides of insurance companies’ balance sheets—through reduction in the value of their investments and increased liability for claims.

In terms of physical risks, insurance companies could face higher losses due to increased physical damage resulting from climate-related events, resulting in more claims payouts than in previous years. This is particularly concerning if events become more frequent, widespread, and disastrous than before, making existing catastrophe models and rate-setting practices less effective.¹⁴ For example, rising sea levels and more frequent wildfires could lead to significantly greater instances of property insurance claims, forcing insurance companies to pay out more than they expected when they created the policies.¹⁵ In the first half of 2021, natural disasters led to $42 billion in insured losses in the United States—a high for the decade—and Hurricane Ida that September may have caused that much damage alone.¹⁶ Meanwhile, physical risks could also affect insurance companies’ investments, since physical climate events could cause losses to the value of financial assets (for example, property damage resulting from rising sea levels could significantly decrease the value of mortgage bonds that include coastal properties).¹⁷ And while insurance companies frequently deal with the fallout of natural disasters, climate change could accelerate physical disasters and the occurrence of previously uncorrelated events, which could lead to more significant losses than insurance companies typically face, especially since increasingly widespread disasters could reduce the protection afforded by diversification across geographic locations.

In terms of transition risks, insurance companies could face losses if changing consumer preferences, market forces, business practices, or public policies lead to declining market demand for carbon-intensive industries. On the underwriting side, insurance companies could face losses due to a decline in revenue from premiums paid by carbon-reliant businesses if fossil fuel companies see major declines in business or fail.¹⁸ Yet even more importantly, transition risks could be significant for the investments side of insurers’ balance sheets. According to one estimate, U.S. insurance companies have $582 billion invested in fossil fuels,¹⁹ and in New York state, for example, 11 percent of insurers’ investments in equities and fixed income are in carbon-intensive sectors.²⁰ Meanwhile, a recent poll found that more than half of institutional investors believe that climate risks are currently not adequately priced into public equities and bonds.²¹ If a global transition away from fossil fuels occurs, investments in fossil fuel companies or other carbon-dependent sectors could face major losses, directly affecting the value of insurance companies’ investment portfolios.²²

Physical and transition risks also pose threats to other financial institutions such as banks for reasons similar to those described above.²³ But one form of risk that could be uniquely problematic for the insurance industry is liability risk. In recent years, private citizens, activists, and governments have brought lawsuits²⁴ against businesses, alleging inaction or negligence, in efforts to mitigate or adapt to climate change. While this type of litigation is novel and has been largely unsuccessful to date, as lawsuits become more frequent,²⁵ businesses could eventually begin to lose cases or settle, requiring potentially large payouts or damages.²⁶ The problem for the insurance industry is that many businesses hold liability insurance policies both for the businesses themselves as well as for senior officers and managers—meaning that insurance companies could be on the hook for payouts resulting from successful lawsuits or settlements. At present, the scope of potential liability risks for insurance companies remains difficult to estimate until courts handle more litigation of this nature.

In addition to these main categories of risk, insurance companies could face secondary—though still potentially serious—climate-related risks. Companies may face operational risk, in which physical climate events negatively affect an insurance company’s ability to carry out basic functions due to damage to physical property, energy disruptions, malfunctioning information technology (IT) systems, and the like. Insurance companies, like other financial institutions, may also face reputational risk, in which changing public attitudes about underwriting and investing in fossil fuel companies lead to increasingly negative publicity for firms.²⁷

Currently, the extent of insurance companies’ exposure to these risks is hard to quantify. This is in part because many U.S. insurance companies are not required to publicly disclose information about climate-related risks. For example, only 15 states require companies to complete the NAIC Insurer Climate Risk Disclosure Survey, which just recently has been updated to provide for a more comprehensive range of disclosures in line with the international Task Force on Climate-Related Financial Disclosures (TCFD).²⁸ And currently available information shows that companies may have more work to do to mitigate risks: A 2020 NAIC study based on disclosures from roughly 70 percent of the U.S. insurance sector (in terms of premiums written) found that only a few firms had changed their investment strategies to account for potential climate risks to their asset portfolios.²⁹

Climate-related events are already affecting insurance markets

Even though the full scope of the risks above remains uncertain, events in recent years demonstrate the types of problems that may be in store for the insurance industry in the short and long term. One notable example occurred recently in California, where wildfires have been intensifying and causing significant damage in just the past few years. After a series of destructive wildfires in 2017 and 2018, insurers in California had to pay out $29 billion in claims while collecting $15.6 billion in premiums, with Allstate alone losing more than half a billion dollars.³⁰ In fact, eight of the nine most costly wildfires in U.S. history (in terms of insured losses) have occurred just since 2017.³¹ Similarly, flooding, which climate change will likely continue to worsen due to rising sea levels and severe weather events, is causing more losses and rising prices in the insurance market around the country. Flooding has caused $155 billion worth of damage in the United States in the past decade, and more than 4 million properties are presently at substantial risk for flooding.³² According to one estimate, rising sea levels due to climate change could cause more than $14 trillion in global damage by 2100.³³

The vast majority of flood insurance in the United States is provided by the federal government’s National Flood Insurance Program (NFIP). Increasing instances of flooding due to natural disasters in recent years has caused the NFIP to incur significant debt,³⁴ putting at risk a program that is essential for providing coverage to high-risk areas. Recent research has found that current NFIP insurance premiums are, by a factor of 4.5, too low to cover the existing risks of damages,³⁵ and premiums may start to increase as flooding continues to worsen.³⁶ In a positive step forward, the NFIP, which had not substantially changed its rate-setting policies since the 1970s, recently implemented a new risk-rating system that will take climate change into account when setting premiums.³⁷ But the fact that incorporating climate change into rate setting will likely result in premium changes and changes in home values for many property owners³⁸ is indicative of the climate-related risks to other types of property insurance markets.

For nonflood insurance markets that rely on private insurers, property damage caused by climate-related events has not only generated losses for insurance companies themselves but also led to higher costs for consumers due to elevated premiums—or worse, nonrenewal of coverage. In some cases, insurance companies have taken actions to reduce risks to their own solvency but in doing so caused harm to individuals who rely on the insurance policies they provide. For example, in California, the 2017–2018 wildfires caused significant turbulence in the state’s insurance market, with nonrenewals of residential insurance policies jumping by 31 percent to 235,250 in 2019 alone,³⁹ and other customers being forced to pay hundreds of dollars more in premiums.⁴⁰

Worse yet, a significant consequence of insurance market turmoil due to increased instances of natural disasters is that insurance companies may be engaging in “bluelining”—a process by which financial institutions decrease or deny services to neighborhoods most at risk of climate-related disasters.⁴¹ Widespread instances of insurance companies pulling out from coverage altogether in California following the 2017–2018 fires grew so problematic that the state insurance department issued a moratorium to temporarily halt the practice.⁴² A similar dynamic is occurring in flood insurance markets, as the increasing threat of floods in high-risk areas has led to significant premium increases in neighborhoods such as Canarsie in New York City, prompting fears of a looming foreclosure crisis.⁴³ And in Louisiana, heavy losses resulting from claims due to a series of hurricanes may be prompting property insurance companies to withdraw from the state.⁴⁴ In fact, extensive damage from Hurricane Ida in 2021 caused the failure of two regional property insurers.⁴⁵ Notably, all of these effects compound the devastating financial harm that occurs to people who lose their homes—one of their main sources of economic security—due to natural disasters. With research suggesting that insurance companies will likely face additional losses due to climate change in the future,⁴⁶ negative consequences for consumers are also likely to continue—particularly low-income individuals and people of color, who are more likely to live in neighborhoods that face higher environmental risks.⁴⁷

Why regulators must address insurance companies’ climate risks

Climate risks posed to the insurance industry are a public policy concern because both the soundness of the insurance industry as well as the health of insurance markets directly affect the well-being of everyday individuals who rely on insurance to maintain their financial security. While many insurance companies have experience in handling risks of severe weather events, climate change poses risks that are novel and dangerous enough that existing expertise, models, and strategies may be insufficient.⁴⁸ Therefore, government supervisors have an important role to play in helping firms mitigate those risks.

Based on the current and potential effects of climate change on the insurance industry, there are two overarching reasons why government supervisors must address climate risks:

1. Climate change could threaten the financial health of insurance companies.
2. Climate change could cause disruptions in insurance markets, particularly in terms of the affordability and availability of coverage.

First, the physical, transition, and liability risks stemming from climate change could pose a threat to the financial health of insurance companies. These risks could affect both sides of insurance companies’ balance sheets, potentially simultaneously, especially as changing conditions deviate from models based on historical datasets in unpredictable and nonlinear ways.⁴⁹ Increasingly costly physical damage due to natural disasters could result in higher-than-expected claims payouts, and both the effects of major climate events and a potential transition away from fossil fuels could lead to losses in the value of insurers’ asset portfolios.⁵⁰ In addition to posing harm to the customers who purchase their policies, insurance companies’ financial problems could have spillover effects to other parts of the financial system through loan performance, investment returns, and changes to credit risk profiles.⁵¹ Solvency problems for insurance firms could not only affect the customers those firms insure but also the safety and soundness of the broader financial system, which relies on the dependability of the insurance sector.⁵²

The prudential risks climate change poses to insurance companies should be of prime concern to insurance supervisors, who have a responsibility to monitor the financial health of the firms they regulate.⁵³ The rationale for this is the same for why governments regulate and supervise the banking industry: There is a public interest in preventing the harm to customers that inevitably occurs when large financial firms fail. If an insurance company becomes unable to fulfill its obligations to customers—for example, in the aftermath of a costlier-than-anticipated natural disaster or series of disasters—the greatest harm will be felt by individuals and businesses who rely on their policies being fulfilled to avoid financial ruin. As noted in a report by the IAIS, “Supervisors have varying levels of familiarity with the current and potential future impacts of climate change. While climate change may not appear immediately relevant to the supervision of insurers in certain jurisdictions, the wide range of potential impacts on the economy, high degree of uncertainty associated with impact scale and time horizons, and the potentially systemic and transformative nature of such factors across the industry, compels a strategic response.”⁵⁴

Action is required by regulators because individual companies cannot necessarily be counted on to act voluntarily: A 2019 global survey of insurance companies found that 72 percent of insurers expect that climate change will affect their business, but 80 percent had not taken any steps to implement TCFD climate risk mitigation recommendations.⁵⁵ This disconnect indicates that supervisors have an important role to play in monitoring financial risks to firms resulting from climate change and recommending ways to mitigate those risks. At the very least, supervisors need to understand the full scope of these risks so they can best determine how to formulate a response, whether in the form of new regulations or supervisory guidance.

Second, the evidence of insurance market turmoil, discussed in the previous section of this report, demonstrates that risk aversion on the part of insurance companies resulting from climate-related events could negatively affect insurance markets, specifically in terms of access and affordability of coverage to consumers. Importantly, practices such as bluelining can have disproportionately negative effects for low-income communities and communities of color, which are more likely to be located in areas at higher risk of natural disasters and have fewer means to withstand rising premiums or the consequences of withdrawn insurance coverage.⁵⁶

Crises in insurance markets such as the one that occurred in the aftermath of the California wildfires are likely to continue—and possibly worsen—due to climate change, and it is clearly within the remit of regulators to study this problem and find possible policy solutions. State insurance departments’ responsibilities include maintaining fair prices, preventing unfair industry practices, and promoting availability of coverage⁵⁷—and actions by insurers such as nonrenewals and bluelining could threaten those objectives. If insurers continue to engage in these practices in response to climate-related events, the responsibility will increasingly fall on regulators to prevent severe harm to affected households and communities.

However, the dual problem of prudential risks to firms and negative shocks to insurance availability and prices could pose a difficult tradeoff, since a particular insurance company may be acting in what it perceives to be its own best financial interest by completely withdrawing coverage from a high-risk market. Consequently, it is important that supervisors do not inadvertently encourage such behavior when helping firms mitigate their climate-related risks, and supervisors should proactively seek to avoid situations in which they are forced to issue moratoria to prevent insurance companies from pulling out of coverage in their states. Supervisors should therefore act now to mitigate risks faced by insurance companies before climate change gets substantially worse and poses problems that would have negative spillover effects to consumers and the financial system.

Unlike other financial firms such as banks, insurance companies in the United States are solely regulated at the state level unless designated as SIFIs. Each state government’s executive branch has an insurance department run by a commissioner or director, most of whom are appointed by the governor but in some cases are themselves elected officials. State insurance laws are fairly consistent across the country, with each insurance regulator having powers such as approving rates, licensing companies and agents, conducting supervision of firms, and regulating the handling of claims. Insurance departments are empowered to enforce state insurance laws and issue regulations and guidance to the firms they supervise.⁵⁸

Yet insurance regulators have done relatively little so far to address the issue of climate-related risks. Only 15 states currently require companies to fill out the NAIC’s Insurer Climate Risk Disclosure survey, and only in New York have regulators taken the important step of issuing final supervisory guidance on how insurance companies can mitigate climate-related risks.⁵⁹ In welcome news, the NAIC in April approved a major change to its climate risk survey by aligning it with the Financial Stability Board’s TCFD standard.⁶⁰ The survey previously was flawed because it only asked qualitative questions and yielded minimal information,⁶¹ but the new survey now includes detailed sections on governance, risk management, investments, and Scope 1 and 2 greenhouse gas emissions.⁶² The survey’s improvement is a positive step forward, but requiring participation in this survey is just one of many steps that state regulators can take to address climate risks.

This section describes actions state insurance departments can take to proactively address climate risks facing the insurance companies they regulate as well as to mitigate negative consequences to the insurance market as a whole.

Issue supervisory guidance instructing companies to manage climate risks

One of the most important actions that financial regulators at any level can take is issuing supervisory guidance, which sets the regulator’s expectations of how insurance companies should act and comply with the law. Although guidance documents are typically nonbinding and do not carry the full force of law, they are nonetheless a commonly used and effective tool regulators employ to ensure the safety and soundness of the firms they supervise.⁶³ In fact, federal banking regulators are increasingly using guidance to set expectations for managing climate-related risk; notably, both the Office of the Comptroller of the Currency⁶⁴ and the Federal Deposit Insurance Corporation⁶⁵ have in recent months issued proposed guidance that sets principles for banks to manage climate risks.

In November 2021, the New York Department of Financial Services issued guidance on how insurers in the state should manage climate-related risks.⁶⁶ The first of its kind in the United States, the document is modeled on guidance and publications issued by international organizations such as the IAIS as well as the TCFD’s recommended framework for climate disclosures.⁶⁷ This framework involves a more thorough disclosure regime than U.S. insurance companies typically engage in at present. Other states should follow New York’s lead by issuing similar guidance, including the following key features:

• Integrate climate risks into companies’ governance structures, such as by designating specific individuals on the board of directors and senior management teams to oversee climate risk management.
• Consider current and forward-looking climate-related factors in business decisions.
• Integrate climate risk into companies’ risk management procedures, including existing tools such as the Own Risk and Solvency Assessment. Procedures should include identifying climate risks, considering risk appetites, and developing a plan for managing those risks.
• Engage in scenario analyses to test companies’ resiliency to a variety of climate change scenarios. Scenario analyses should investigate the effect of climate risks on companies over multiple time horizons, including short term (less than five years) and long term (more than 10 years).
• Enhance existing disclosures by incorporating climate risks into public filings.

Setting guidelines such as these, even if nonbinding, is a crucial first step for supervisors to provide consistent expectations for insurance companies, and insurance departments in all states should issue guidance using New York’s as a model. Such guidance is especially important because many insurers are private companies and would not be subject to the Security and Exchange Commission’s recently proposed climate disclosure rule that would require publicly traded companies to include information about climate risks in registration statements and periodic reports.⁶⁸

Collect and analyze data from companies about the extent of their exposure to climate risks

State insurance departments collect information from the companies they regulate, including data about assets and liabilities, policies, and premium setting. In order to get a better sense of the problems climate change may pose to companies in their states, supervisors should also collect data from insurance companies about climate risks to their businesses. At a minimum, every state insurance regulator should require its companies to participate in the upgraded NAIC Insurer Climate Risk Disclosure survey. However, they should also consider requiring companies to disclose important information not included in the revamped version of the survey, particularly since the survey only requires companies to report information that they deem “material.” For example, the survey does not require insurers to report their Scope 3 greenhouse gas emissions—the emissions associated with the individuals and companies they insure—nor does it require information about a company’s plans to respond to the impact of climate risks in underserved communities.⁶⁹ Gathering such information in addition to the materials reported through the NAIC survey would give state regulators a more comprehensive picture of the risks posed to companies by climate change as well as the potential effects on insurance markets in their states.

Insurance departments should then use the data collected to conduct scenario analyses of climate risks at a statewide level and report on the results, which California⁷⁰ and Vermont⁷¹ have recently done. This research can provide valuable information to both regulators and companies and help determine whether and what further action may be needed to mitigate risks. Insurance departments could also use data collected about climate risks to develop and publish statewide risk management plans, such as a 2018 report by the California Climate Insurance Working Group,⁷² recommending ways state governments can proactively work to reduce climate-related risks to property. Such actions could include incentives for sustainable home retrofits and resilient building standards or approval of lower premiums when policyholders adopt building standards that reduce the likelihood for a policy payout.⁷³ For example, Louisiana passed a law last year allowing for insurance rate discounts for residential and commercial buildings built or retrofitted to mitigate the potential for damage from windstorm events.⁷⁴

Use existing tools such as risk-based capital requirements to account for companies’ existing climate risks

One of the supervisory tools available to insurance regulators is risk-based capital requirements, which can compel a company to fund risky liabilities through shareholder capital to protect the public against potential losses (i.e., to protect against “heads-I-win, tails-the-public-loses” investments).⁷⁵ Currently, regulators do not directly incorporate climate risks into their consideration of risk-based capital requirements.⁷⁶ Given that climate risks could pose a threat to the financial health of insurance companies, regulators should consider whether including these risks in their risk-based capital regimes would be an effective tool to protect companies against the potential for financial losses due to assets or underwriting policies being negatively affected by climate change.

Develop strategies to prevent insurance market problems resulting from climate-related events before they become worse

In addition to helping companies mitigate their own risks, insurance supervisors are also responsible for maintaining affordable prices and access to insurance markets. Turmoil in insurance markets due to wildfires, floods, and other natural disasters is likely to continue as climate change worsens, and insurance departments must begin to consider strategies to deter practices such as bluelining and prevent sudden premium increases.

To start, insurance supervisors should collect and analyze data about the risks that climate change poses to insurance markets in their states, such as whether particular geographic locations are most at risk of insurance coverage being withdrawn. Supervisors should not be forced to issue a moratorium to prevent insurers from pulling out coverage because doing so means the problem has already grown severely out of hand, so supervisors should consider strategies that would disincentivize companies from withdrawing coverage in the first place. These include mitigation grant and insurance discount programs or public reinsurance funds, which would help insurance companies unload some of their catastrophe-related risks at a cheaper price than the private reinsurance market would offer.⁷⁷ Also, states that do not currently do so should create Fair Access to Insurance Requirements plans, a type of public insurance fund subsidized by taxpayers and private insurance companies that allows homeowners living in areas of high risk of property damage to purchase coverage if they cannot obtain a plan from a private insurer.⁷⁸ To the extent possible, states could also incentivize homebuyers to live in areas at lower risk of climate-related disasters by subsidizing housing in those areas.

Study the feasibility of innovative products such as parametric or community-based insurance

Beyond changing incentives for private companies, insurance departments seeking to mitigate risks to insurance markets should study the feasibility of their states implementing unique insurance products that mutualize risks differently than traditional insurance. One such product is parametric insurance, which, unlike traditional insurance products that pay out policies as determined by an assessment of damages, is structured so pre-determined payouts are made if a given event occurs.⁷⁹ In other words, parametric policies insure against the probability of an event occurring rather than reimbursing for the actual damages incurred. The advantage of such policies is that on-site assessments of damages are unnecessary, meaning that insurers can charge lower premiums, and those in need of payouts can receive the money much faster. During the past two decades, many countries around the world have developed parametric plans to insure against extreme weather and natural disaster events.⁸⁰

Another type of product, although currently in the form of an academic proposal, is community-based catastrophe insurance. An example of this system could involve having a public entity such as a local government or a community group arrange or purchase insurance on behalf of individuals in a given community or supplement existing private insurance. Community-based insurance could provide a needed, affordable backstop, particularly for low-income communities located in areas at higher risk of natural disasters.⁸¹ Insurance departments should study whether implementing some form of community-based insurance would be beneficial for their states.

Although state insurance departments are responsible for directly regulating the insurance industry, the FIO can play a constructive and important role in addressing risks stemming from climate change. Created by Title V of the Dodd-Frank Act of 2010, the FIO, which is housed within the Treasury Department, is authorized to monitor “all aspects of the insurance sector, including identifying issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance sector or the U.S. financial system,” as well as to monitor “the availability and affordability of insurance products for traditionally underserved communities and consumers, minorities, and low- and moderate-income persons.”⁸²

Examining the effects of climate-related risks is squarely within the FIO’s remit, and it has an opportunity to go beyond the limited engagement it has done so far on this issue to take a leadership role. Although the FIO does not have direct supervisory powers over insurance companies, it can use its expertise and stature as the only federal government entity focused specifically on the insurance industry to play a key role in both analyzing climate risks and coordinating a nationwide strategy to mitigate those risks.

The FIO issued a request for information⁸³ in August 2021 asking stakeholders to weigh in on what the FIO can do to address climate risks and how it can go about doing so. The FIO should act on the information provided in response to this request to begin taking concrete steps forward—detailed below—on facilitating the mitigation of climate risks in the insurance industry.

Collect comprehensive, nationwide data on climate-related risks to the insurance industry

Dodd-Frank explicitly grants the FIO the power to collect data and information from insurance companies, including by subpoena if necessary, and to analyze and disseminate data and issue reports.⁸⁴ The FIO should use this authority to issue a data call from large insurance companies around the country, with information including both qualitative and quantitative data on companies’ exposure and strategies relating to physical and transition risks. The data should also specifically include information relating to companies’ coverage and pricing policies. Nationwide data about insurance companies’ climate risks are currently incomplete because, as discussed previously, not all states require disclosures of such information and, to this point, the NAIC’s climate risk survey has yielded minimal information from the companies that have completed it. Gathering high-quality nationwide data on climate risks would be a critical first step for the FIO to put together a comprehensive picture of how climate change is affecting and will continue to affect the entire U.S. insurance sector. Such data will help the FIO to better fulfill its mission to monitor all aspects of the insurance industry—particularly whether climate risks could affect access to affordable insurance among traditionally underserved communities and consumers.⁸⁵

Use the data collected to conduct and publish research examining present and future risks to the insurance sector

Using the data it collects, the FIO should, in collaboration with the Treasury Department’s Office of Financial Research, produce comprehensive research on climate risks to the insurance industry nationwide. This research should include the following:

• Identify the current severity of climate risks posed to the insurance industry, particularly to what extent extreme weather and natural disasters could lead to significant losses for insurance companies.
• Conduct scenario analyses of large insurance companies, evaluating the resiliency of companies’ balance sheets to a range of potential climate scenarios in the short and long term.
• Examine which geographic regions or sectors of the insurance industry may be most vulnerable to climate-related risks in the short and long term.
• Investigate the prevalence of practices such as bluelining and the extent to which climate risks could have a disproportionate effect on low-income communities and communities of color due to premium increases and nonrenewal of coverage.

Research of these topics by the FIO would be extremely helpful in identifying the magnitude and nature of the risks facing the insurance industry and would be an invaluable guide to state regulators seeking to incorporate climate risks into their supervisory frameworks.

Advise state regulators on how to incorporate climate risks into their supervisory practices

The FIO should conduct a thorough review of the regulatory practices of all state insurance departments and make specific recommendations for policy actions that states should take to integrate climate risks into their supervision and regulation of insurance companies. Even though the FIO cannot set local policies, it can use its stature stemming from its expertise in insurance matters and the quality of the data it can collect from a nationwide data call to influence local policymakers.⁸⁶

Specifically, the FIO should work with state insurance departments to help each state develop and publish supervisory guidance similar to New York’s so that insurance companies across the country receive consistent expectations from their primary regulators on mitigating climate risks. This should include encouraging every state that does not already do so to require their companies to participate in the NAIC’s climate risk disclosure survey. Importantly, the FIO should also recommend ways for state regulators to proactively address problems such as premium hikes and nonrenewals due to natural disasters and extreme weather—particularly with an eye to practices such as bluelining and the availability and affordability of coverage in low-income communities.

Work with the FSOC to incorporate climate risk factors into the SIFI designation process for nonbanks

The director of the FIO serves as a nonvoting member of the Financial Stability Oversight Council (FSOC), a committee consisting of the heads of the U.S. financial regulatory agencies that is charged with identifying and responding to risks related to the stability of the financial system.⁸⁷ One of the FSOC’s most important statutory authorities is the power to designate nonbank financial institutions as systemically important financial institutions. SIFI designation subjects a firm, regardless of its form, to consolidated supervision by the Federal Reserve and enhanced prudential standards,⁸⁸ with the assumption that failure of or significant problems with a SIFI would likely have severe negative consequences for the rest of the financial sector.

Of the four nonbank firms that have received SIFI designations, three (AIG, Prudential, and MetLife) are insurance companies.⁸⁹ However, the Trump administration FSOC de-designated AIG and Prudential and dropped a court fight against MetLife, with the result being that no nonbank firms are currently designated despite the potential systemic risks that these firms pose.⁹⁰

The FIO should use its position on the FSOC to advocate for climate-related risks being incorporated into the SIFI designation process—particularly for insurance companies—and work toward revising the Trump administration’s 2019 FSOC guidance that made the designation process substantially more difficult in violation of the original intention of the Dodd-Frank Act.⁹¹

 Coordinate federal policy on international insurance matters to advocate for effective climate risk policies

The FIO is authorized by Dodd-Frank to coordinate federal policy on international insurance matters and serve as the U.S. representative in the IAIS.⁹² The FIO should use this power to advocate for sound climate risk policies on the international stage, such as by supporting the development of international supervisory frameworks that account for physical, transition, and liability risks stemming from climate change.⁹³

Climate change is increasingly posing risks to the financial system, and regulators around the world are starting to take actions to mitigate those risks. Physical, transition, and liability risks could have a material impact on the insurance sector in both the near and long term—and the effects of physical risks are likely already being felt in fire and flood insurance markets. It may be the case that these risks can be managed by straightforward actions on the part of the industry—or, it may be that the risks are significant and bolder actions are necessary. But the public cannot know for sure until regulators take the initial steps of issuing supervisory guidance to insurance companies and collecting and analyzing comprehensive data on climate risks.

Critically, state insurance regulators and the FIO must act now to develop strategies to mitigate scenarios in which climate change causes direct financial harm to consumers because of disruptions to the insurance market. If catastrophic events—such as the California wildfires and their fallout—persist or worsen, regulators must be equipped with tools to make sure both that climate change does not threaten the financial health of the industry and broader financial system and that disruptions in insurance markets do not harm the most at-risk consumers.