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  • Writer's pictureVidal, Nieves & Bauzá LLC

ESG principles, climate-related risk and the insurance industry in Puerto Rico.

Updated: Sep 25, 2023

Environmental, Social and Governance principles (”ESG”) have been more than just a simple buzz phrase for business entities and their governing boards during recent times.

 

2023 Puerto Rico Financial Services Review by Pedro I. Vidal Cordero

Attorney Pedro I. Vidal Cordero is a Partner at the Vidal, Nieves & Bauzá law firm and he has significant experience in insurance regulatory, transactional and compliance matters.



As a result of the pressure exerted upon governments throughout the world to

address the impact of climate change, and its risks, rising activism by stakeholders, a growing call for greater transparency, and the adoption of clear business ethics on the part of companies offering goods and services everywhere, the need to pay attention and incorporate ESG principles in the conduct of business is here to stay.


In consequence, many businesses, including insurance companies, are focusing on the guiding principles behind ESG and taking concrete governance actions directed both, at voluntarily meeting their ESG goals, and objectives as a part of their overall strategy and values, as well as responding to the increasing number of laws and regulations which are being

adopted in this area.


For example, in August, 2022, the European Commission’s (EC) regulations requiring that European insurers and reinsurers incorporate sustainability risks as part of their governance polices took effect. The EC regulations in question, --Commission Delegated Regulations (EU) 2021/1256 and 2021/1257--, amend the EU’s Solvency II framework, and are consistent the

EU’s goal of prioritizing sustainability considerations within the financial systems generally. The

EC regulations require regulated entities in insurance to consider and account for sustainability

risk and factors across several key areas which potentially impact the operational results

of insurance companies.


THE REGULATIONS DEFINE “SUSTAINABILITY RISKS” AS ENVIRONMENTAL, SOCIAL AND GOVERNANCE EVENTS OR CONDITIONS THAT, IN IF OCCURRENCE, COULD CAUSE AND ACTUAL OR POTENTIAL IMPACT ON THE VALUE OF THE INVESTMENT OR ON THE VALUE OF THE LIABILITY.


The regulations add a new definition for “sustainability factors” which is centered of

environmental, social and employee matters, respect for human rights, anti-corruption and

anti-bribery matters. Some of the more salient changes introduced by the EC regulations include the need for insurers and reinsurers to specifically incorporate sustainability risks as a part of their general risk management policies’ framework. Therefore, insurer and reinsurer’s reserves and underwriting policies must now consider the risk of loss or of an adverse change in the value of their insurance obligations resulting from, among other risks, sustainability risks. They also include the need to consider sustainability risks as part of any actuarial opinion issued with respect to an insurer.


Further, the investment policies of insurers and reinsurers must now account for, evaluate and

manage sustainability risks identified in their respective investment portfolios. In addition, regulated insurers will also now need to take into account the so-called “sustainability preference” of their clients in respect to the products offered to such clients. Insurers and reinsurers will need to take into consideration environmental and climate risks as a part of the overall process through which investments are managed by such regulated entities, generally. In doing so, they are required to consider sustainability risks following the principle of the prudent person or investor.


In the United States, the Financial Stability Oversight Council (“FSOC”) was established in

2010 pursuant to the “Dodds-Frank Act” to monitor the safety and mitigate the risks to the

U.S. financial system, including climate-related financial risk. Its counterpart at the international

level is the Financial Stability Board (“FSB”), an international body established in 2009 whose

membership primarily consists of the G20 countries, including the United States, and is

responsible for promoting global financial stability and making recommendations to

strengthen the international financial system.


In 2015 the FSB established the Task Force on Climate-related Financial Disclosures (“TCFD”) in

order to develop voluntary recommendations for climate-related disclosures for businesses

that could assist different stakeholders, including governments, lenders, insurers and

investors, to improve their understanding and analysis of climate-related risks as part of the

efforts to transition towards a low-carbon economy. Two years later, the TCFD released final recommendations for climate-related financial disclosures.


The disclosures developed by the TCFD are centered on climate-related risks and opportunities

confronted by companies and other organizations, wherever they do business, in the following four core areas: governance, strategy, management of risks, and metrics and targets.

Through the recommended types of financial disclosures, 11 in total, the different stakeholders

are provided relevant information to understand how a disclosing company evaluates and manages its climate-related risks and opportunities.


In its 2021 Report on Climate-Related Financial Risk, the FSOC acknowledged the problems

resulting from the absence of common climate-related disclosure standards for compa

nies and financial entities among U.S. regulators. It similarly recognized that the TCFD disclosure

framework had gained widespread adoption internationally and was also the leading

structure followed by many companies in the United States. In an effort to address the lack of

common climate-related disclosures by U.S. companies, in its report the FSOC recommended

that its members consider enhancing public reporting requirements for climate-related risks

in a manner that builds on the four core elements of the TCFD.


The FSOC has ten voting members which include the heads of each of the main financial regulators in the U.S., and five non-voting members. One of the non-voting FSOC members is a state insurance commissioner who is elected by the Executive Committee of the National Association of Insurance Commissioners (“NAIC”). In response to the 2021 FSOC recommendation to financial services regulators to adopt the climate-related disclosures recommended by the TCFD in March, 2022, the NAIC Climate and Resiliency (EX)Task Force and its Climate Risk Disclosure Workstream revised the NAIC’s 2010 Climate Risk Disclosure Survey following the recommendations made by the FSOC to conform their climate-risk disclosures to those of the TCFD.


At that time in 2021 when the NAIC Climate Disclosure Survey was updated based on the TCFD framework, fifteen (15) U.S. jurisdictions had been receiving climate-related risk disclosures from their insurers. Companies responding to the NAIC survey were only those having

annual written premiums nationwide of $100 million or more. The NAIC initiative was adminis

tered through the California Department of Insurance. The deadline established by the NAIC for

responding to the climate-related risk survey was August 31st of each year. In light of the updated 2021 survey conforming to the TCFD framework, the NAIC provided insurers with several alternative dates for their year 2022 response. In the case of companies who had

never completed a TCFD-based survey voluntarily, the deadline was moved to November 30, 2022, and, for subsequent years, would revert to the August 31st deadline.


The latter notwithstanding, the NAIC also noted that companies who had never responded to a climate-related risk survey should be given until 2023 (August 31) to respond for the first time to

the survey. Companies were encouraged to provide their “best efforts” in replying to each survey question as honestly and completely as possible. All survey responses are considered public, and insurance companies were alerted by the NAIC that they should not include information they considered confidential in survey responses.


Puerto Rico has been a member in good-standing of the NAIC for years. Therefore, it participates in the U.S. state-based system for the regulation of the insurance business and its industry. In 2012 it became the first U.S. territory to become accredited under the NAIC’s Accreditation Program. It subsequently loss the accreditation in 2021 and, regained it back in December, 2022.


Puerto Rico had not required Puerto Rico’s domiciled insurers from completing and filing

the NAIC climate-related risk survey. However, shortly after the NAIC updated its climate-related risk disclosure survey (March, 2022), the Office of the Commissioner of Insurance in Puerto Rico issued a June 9, 2022 ruling letter addressed to insurers and health maintenance organizations domiciled in Puerto Rico with written premiums of $100 million or more to file the updated NAIC climate-related risk survey by November 30, 2022. The current year’s survey is due on August 31, 2023. Companies not meeting the $100 million written premium threshold have been encouraged to file the survey on a voluntary basis in order identify climate-related risks as a

special risk factor in their operations and to improve their best practices towards sustainability.


As indicated above, the TCFD survey, now also followed by the NAIC, focuses on the four core

areas of climate-related risk disclosures in an organization´s governance, strategy, risk

management and metrics and targets. Based on the TCFD´s implementation recommendations,

--which the NAIC recommends insurance companies follow in preparing and responding the

NAIC climate-related risk survey--, the TCFD provides guidance with respect to the responses

to the required disclosures in each of the four

core areas.


This guidance is provided for all industry sectors which provide disclosures under the survey, and also covers specific supplemental guidance directed at the four major industries in the financial sector, namely, banks, insurance companies, asset managers and asset owners

such as pension plans, endowments, foundations and others. The objective behind the disclosures by insurance companies is to allow key stakeholders to better understand how insurers are evaluating and managing climate-related risks in the underwriting and investments.


Therefore, governance disclosures are centered on how intensely an insurer´s board of directors

and its management focus on climate-related issues, and whether they incorporate climate-related risks issues in their decision-making policies in the organization. With respect to strategy disclosures, insurance companies should focus on the impacts of climate-related risks and opportunities of climate-related issues in the organization's short, medium and long-term strategy and on its assets and financial condition. Insurance companies should also consider including responses centered on how climate-risks impact client selection, product development and business activities by sector and geography. The area of risk management addresses the identification, assessment and management of climate-related risks within the insurance company, including their significance when compared to other risks in the organization´s

operations. Finally, with respect to metrics and targets insurers are asked to provide key metrics used to manage climate-related risks. Property Insurers, in turn, should disclose aggregated risk exposure to weather-related catastrophes, among other metrics and targets related to weather considerations, greenhouse gas emissions, water and energy usage, among others.


In conclusion, ESG principles, including climaterelated risk disclosures and others are here to stay. Insurance companies, whose core traditional business has been centered on quantifying and managing risks, generally, are particularly well-positioned to understand and respond to the underlying criteria behind ESG principles and the overall focus on values centered on sustainability. As the United Nations Environmental Program on Principles for Sustainable Insurance Initiative indicates, the insurance industry’s role in this area is centered on three main components.


THE ROLE OF A RISK MANAGER, OR BETTER UNDERSTANDING ENVIRONMENTAL AND SOCIAL RISKS today, and, as a result, in preventing and reducing losses now and in the immediate future.


THE ROLE OF ISSUING INSURANCE PRODUCTS IN THE MARKETPLACE THAT ARE RESPONSIVE TO THE RISK SUSTAINABILITY FRAMEWORK and its manifestation in the needs faced by actual and potential insureds and communities, in general.


THE ROLE FOR THE INSURANCE INDUSTRY IDENTIFIED UNDER THESE U.N. PRINCIPLES IS THAT OF INSURANCE COMPANIES AS THE INVESTORS AND MANAGERS OF SIGNIFICANT ASSETS WHICH INCREASINGLY WILL TAKE THE FORM OF SUSTAINABLE ASSETS, both in response to third- party pressures and to the risk management policies adopted internally by companies.


For more information about this article contact Pedro I. Vidal, Esq. at pvidal@vnblegal.com or visit www.vnblegal.com. Vidal, Nieves & Bauzá is located at Suite 110, T-Mobile Center.



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