Insurance companies are increasingly incorporating environmental, social and governance (ESG) factors into their underwriting processes when they examine risk. However, despite the increasing adoption of ESG-related factors by insurers, political polarization and divergent political stances on the utility of ESG have placed insurers in the crosshairs of certain regulators and legislatures.
The Net-Zero Insurance Alliance (NZIA), a UN-backed initiative founded in 2021 at the G20 climate summit in Italy to help the insurance industry transition to a low-carbon economy, has seen an exodus of nearly half its members following receipt of a letter, signed by 23 Republican Attorneys General, citing serious concerns about NZIA members being in violation of federal and state antitrust laws as a consequence of their climate-related commitments as members of the group.
While traditionally viewed as more likely to oppose business regulations than their counterparts in the Democratic Party, Republican-controlled state legislatures have increasingly pushed back on rules and regulations that require or advocate businesses to integrate ESG-related factors into their business, investment, and strategic decisions. Meanwhile, Democratic-majority state legislatures are moving in the opposite direction, increasingly passing laws mandating more ESG-related disclosures, such as the recently passed Illinois House Bill 2782, awaiting the Governor’s signature before it can be enacted into law. As a consequence of this red-and blue-state divide, optimized by these “pro-ESG” and “anti-ESG” laws at the state level, the regulatory landscape, particularly as it relates to insurers, has become increasingly difficult to navigate and risk-laden due to the various ways in which insurers incorporate ESG-related considerations into their underwriting processes.
Overview of SB 833
One recent example of such regulatory impact on the insurance industry is Texas’ Senate Bill 833 (SB 833), which seeks to address the challenges faced by the fossil fuel industry in procuring insurance coverage. As a response to a letter urging 30 insurance company CEOs to stop underwriting new fossil fuel projects and to divest from fossil fuel companies, SB 833 operates, in the legislature’s view, to combat the negative effects of such external pressure on the business decisions of insurance companies and emphasize “sound actuarial principles.”
SB 833 aims to achieve its purpose by prohibiting insurers operating in Texas from using an ESG “model, score, factor, or standard to charge a rate different than the rate charged to another business or risk in the same class for essentially the same hazard.” However, the Texas legislature also placed a broad exception, stating that an insurer “does not violate [the statute] if the insurer’s actions are based on an ordinary insurance business purpose, including the use of sound actuarial principles, or financial solvency considerations reasonably related to loss experience for the different types of risks and coverages made available by a particular insurer.”
For context, Texas law generally prohibits “excessive, inadequate, or unfairly discriminatory rates” for property-casualty insurance. SB 833 will take effect on September 1, 2023, and will apply to policies issued for delivery or renewed in the state of Texas after January 1, 2024, excluding fidelity, guaranty, and surety bonds and crop insurance policies.
While SB 833 does not include an express enforcement provision for insurers that fail to comply with the statutory requirements, the Texas Department of Insurance (TDI) would likely be able to enforce SB 833 through the general enforcement provisions in Texas Insurance Code Chapter 82. The TDI has shown a willingness to bring enforcement and disciplinary orders against insurers, as the TDI ranked among the highest states in terms of fines and penalties levied against insurers for both 2021 and 2020.
Depending upon the enforcement of SB 833, insurance underwriting could be impacted in a variety of ways. Critically, SB 833 fails to define “environmental, social and governance,” introducing considerable uncertainty as to whether current insurance practices would be in violation of the law. For example, the TDI could potentially take the position that an insurance company evaluating a policyholder’s relationship with stakeholders by considering the policyholder’s labor practices, diversity and inclusion policies, customer satisfaction, and community engagement efforts as a sign of good risk management and responsible corporate behavior would violate SB 833.
Moreover, as the physical impacts of climate change are expected to accelerate, it is also possible that an insurance company could face regulatory scrutiny as a consequence of considering the policyholder’s carbon footprint and its efforts to manage and mitigate environmental impacts to the extent that those factors are not directly related to the risks being underwritten. Further compounding this difficulty is the increasing pressure that insurance companies are facing to incorporate ESG-related factors into their policy decisions from both investors and stakeholders.
In effect, SB 833 requires insurers that use ESG-related factors in their underwriting process to be able to link such factors to an ordinary insurance purpose, such as the rate of claims by similarly situated policyholders or an actuarial forecast of losses for similarly situated policyholders. To the extent an insurer can demonstrate the former, it should be positioned to mitigate any potential impact of SB 833 on its operations. However, regardless of whether laws such as SB 833 actually require insurance companies to change their current underwriting practices, as a consequence of the existence of such laws and pressure from the anti-ESG movement more broadly, we may see insurance companies change or re-evaluate their utilization of ESG-related factors in their underwriting approach, particularly as it relates to certain industries such as the fossil fuel industry.
Proactive Steps Insurers Can Take to Mitigate the Impact of SB 833
Consequently, while in-house legal departments at insurance companies are well versed in state insurance laws and regulations, new legislation such as SB 833 will necessitate greater oversight by legal and compliance departments. While the extent to which regulators such as the TDI will leverage newly passed laws like SB 833 to bring enforcement actions remains to be seen, insurers should nonetheless be on notice and carefully scrutinize any underwriting guidelines or policy exclusions for certain industries in which they refuse to provide insurance to or adjust policyholders’ premiums for having or not having ESG-related programs.
As a first step, in-house legal and compliance departments should ensure that all of their underwriting team’s premium- and coverage-related decisions are substantiated using sound actuarial principles or are reasonably related to expected loss experience as the basis of their coverage or premium decision making. While it may be tempting to consider the external pressures, such as the reactions by stakeholders in underwriting a particular company in a particularly disfavored industry, insurers can protect themselves against liability by connecting any premium decision impacted by an ESG-related factor with an established evidentiary-based risk mitigation strategy.
For example, in the context of evaluating a policyholder’s climate governance practices for purposes of making a coverage or premium decision, in-house legal and compliance departments should work with their underwriting team to appropriately document the established correlation between strong climate governance profiles and reduced claims. Establishing a link between the relevant ESG-related consideration and financial loss via the increased likelihood of a potential claim is critical to rebutting any accusation that the insurance company is considering ESG-related factors above actuarial considerations or expected loss experience.
Legal and compliance departments play a critical role in analyzing enterprise risk management requirements and ensuring compliance with applicable laws. Accordingly, monitoring and ensuring that an insurer’s underwriting process is compliant with emerging state regulatory requirements should be a focus for in-house counsel and other legal professionals. Insurance companies that empower legal departments to play an active role in monitoring and then instituting compliance procedures will be in the best position to mitigate the risk of divergent state laws going forward.
Heather Palmer is a partner in the Houston office of Sidley Austin LLP. Andrew Holland is a partner in the New York office and Evan Grosch is an associate in the Houston office of the firm.
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