A new SEC regulation that requires public companies to disclose climate risks could create new business for insuring corporate directors and officers.
Under a final rule approved March 6 by the Securities and Exchange Commission, companies must report climate-related factors that materially affect their business strategy, operations and financial results.
In addition, large companies will have to report material greenhouse gas emissions that result from their operations – so-called Scope 1 – and from their energy sources – so-called Scope 2, according to the SEC.
The regulation aims to give investors “consistent, comparable and decision-useful information” related to climate risk, SEC Chair Gary Gensler said in a statement. The measure responds in part to the continuing interest in investing based on environmental, social and governance factors.
One of the required disclosures involves “any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks,” the SEC states.
That is where D&O insurance comes in.
“It creates a new category of risk,” said Howard Fischer (pictured top, left), a partner at Moses Singer. “You’ll probably see policies re-written to specifically take account of the new disclosures required under the rule and the liability for failure to make the disclosures.”
D&O insurance covers company officers and board members against personal losses related to lawsuits against a company and also pays for legal costs and judgments.
The SEC rule introduces “a new risk within an established product,” said Jon Perry (pictured top, center), an underwriter at Beazley. “Many reputable carriers are willing to take on that unknown risk.”
Indeed, the SEC rule could create new business for underwriters and brokers.
“If carriers wanted to explore this brave new world, it would be a great opportunity to provide coverage,” said Adrienne Kitchen (pictured top, right), a senior associate at Reed Smith.
The SEC rule could introduce new categories or new permutations within existing categories of environmental litigation. For instance, suits could focus on allegations that corporate leadership failed to mitigate climate risks, did not properly disclose how severe weather – such as floods somewhere along a supply chain – hurt financial results, or engaged in so-called “greenwashing” by failing to live up to climate promises.
One of the challenges insurers will face is determining how much climate-disclosure risk costs.
“Trying to figure out how to price policies is going to take some creativity,” said Fischer, a former SEC trial counsel.
The insurance industry also has to work through what exactly to cover when it comes to climate risk. For instance, many policies already include a pollution exclusion. Perhaps a climate-change exclusion will emerge as well, Kitchen said.
“As claims increase, and they undoubtedly will, the coverage fights also are going to increase,” Kitchen said.
The fact that the rule has been promulgated by the SEC, known as one of the toughest regulators in Washington, introduces another risk. The agency will examine public companies for adherence to the rule, which could result in legal costs if the agency finds compliance violations.
Many companies had been making climate disclosures voluntarily. Now, they’ll be compelled to do so, if the climate-related activities are material to a firm.
“Any new SEC rule raises our eyebrows,” Perry said. “Now there’s a rule potentially to break.”
Companies would have to make climate disclosures in SEC filings, such as registration statements and annual reports. In addition, disclosures about severe weather events will be required in audited financial statements.
The 886-page rule presents a heavy lift for insurance brokers trying to figure out how to help protect their customers.
“They want to make sure they fully know what the rules entail and how they affect their clients,” Perry said. “They’re very complicated rules to follow.”
Whether the SEC rule stands long enough for companies to have to comply is an open question.
The final regulation was promulgated two years after it was initially proposed. The measure drew strong resistance and was streamlined in response to the criticism. For instance, a requirement to report so-called Scope 3 emissions, or those related to the activities of a company’s suppliers, was deleted.
Despite the changes to the final rule, it is already being challenged in court by opponents.
