In the early 1990s, the insolvencies of three major life insurers – Executive Life, Mutual Benefit and Confederation Life – rocked the industry and threatened to bring about the end of the state-based system of insurance regulation the United States has employed since roughly the Civil War.
The failures were attributed largely to the companies’ excessively risky investment strategies. A consensus was building within Congress that states simply were no longer up to the task of appropriately monitoring insurer solvency, given the complexities of the modern financial system. Legislation to create a federal system of regulation was prepared by the House Commerce Committee chairman and was widely expected to sail through to enactment. But then the Contract with America election of 1994 changed the balance of power in ways that few foresaw and the threat passed for another decade or two.
To their credit, the states did not sit by idly after catching that lucky break; they responded forcefully to what they rightfully deemed an existential threat. Led by the National Association of Insurance Commissioners, states across the country rapidly adopted modern risk-based capital standards that have proven a model the world over. This model certainly has been tested – first, by the failure of the Reliance Group of property-casualty insurers in the early 2000s and later by the catastrophic failure of American International Group – but, by and large, it’s held up pretty well.
Alas, giving regulators – some of them elected politicians and all of them prone to some degree of political influence – outsized power to decide what sorts of investment instruments insurers may buy has always carried the risk of abuse. Billions of policyholders’ premium dollars flow through insurance companies every year. Small tweaks to the investment rules could have the effect of directing those dollars toward the politically favored or away from the politically disfavored. To wield this enormous power responsibly requires that a regulator be painstakingly committed to policyholder protection, to ensuring that their premiums are held in investments that are reasonably safe and appropriately matched to the nature and duration of the risk transferred.
With his decision today to ask that insurers “divest from their investments in thermal coal,” California Insurance Commissioner Dave Jones has laid bare for the world to see that he is not that sort of responsible regulator.
Insurers’ investments in carbon-intensive industries is a long-standing bugaboo for Jones. Since taking office in 2011, he has been vocal in his efforts to get the NAIC to amend its Climate Risk Disclosure Survey (first adopted in March 2009) by making it binding on a far greater number of companies and by including reams of questions that would appear to have little direct connection to the ostensible goal of cataloguing “climate change-related risk.” In one notable example, a proposed survey question solicited discussion of the steps “the company has taken to engage key constituencies on the topic of climate change,” implying insurers actually have a duty to lobby lawmakers on environmental issues.
Jones and his allies – including Washington Insurance Commissioner Mike Kreidler, the then-chair of the NAIC’s Climate Change and Global Warming Working Group – failed in their attempt to push the revised survey through the body, but instead applied it domestically to any companies that did any business in their respective states. As those edicts have evolved, it’s become clearer that the goal all along was never actually to assess the ways in which climate-change risks could affect an insurance enterprise, but rather to force through a politically motivated divestment campaign, away from fossil-fuel interests and toward “green” technologies.
With this most recent edict, Jones has removed all doubt about his motivations, though he continues to hang his argument on this very thin reed – that coal companies universally represent bad risks.
My decision to ask insurance companies to divest from thermal coal and to require insurance companies to disclose investments in the carbon economy arises from my statutory responsibility to make sure that insurance companies address potential financial risks in the reserves they hold to pay future claims.
As utilities decrease their use of coal and other carbon fuel sources, as states like California limit the ability of the private sector to use coal and other carbon fuels for power generation and require their pension funds to divest from coal, as states like California and the United States impose more stringent air quality requirements which limit the ability to burn coal and other carbon fuels, and as nations across the world begin to implement the commitments they made to reduce their use of carbon at the recent United Nations COP21 Climate Summit in Paris, investments in coal and the carbon economy run the risk of becoming a stranded asset of diminishing value.
While it is certainly true that future changes in regulation or market conditions could very well affect the value of capital investments made by, in this case, the fossil-fuel industry, such risks are pretty broadly known and were not uniquely discovered by Commissioner Jones on his recent holiday to Paris. The market, thus, has already priced them in to the equity valuations of coal, oil and gas company stocks. If there’s been a change in the risk premia, then it’s one that insurers holding those stocks already would have suffered through lower stock prices. Unless, that is, they bought after the stock decline, in which case, they might well be holding on to a bargain. In either case, it’s hard to see what in the world has changed that requires divestment now.
And, of course, to the extent such concerns are relevant, it’s largely to equity investments. Insurers’ investments in the energy sector overwhelmingly take the form of fixed-income securities – aka, bonds. That Coal Company X might in the future begin to face greater regulatory pressure does not necessarily mean it is a bad risk to repay its debts today. If it were, then that, too, would be reflected in the price of its bonds and in the coupon any new issuances would be required to pay. If it were really the case that a company’s creditworthiness changed drastically overnight (for instance, if its rating was downgraded to junk), then dumping those bonds as part of the mass panic actually would usually be a bad move, relative to just holding them until maturity.
But what ultimately reveals Jones’ faux invocation of solvency concerns as jiggery pokery is just how utterly arbitrary it is. One can’t help but notice that he obviously is not calling for divestment from the alternative-energy sector. Yet alternative energy is one of the riskiest investment markets around. So much so that the industry site Greentech Media publishes an annual list of solar company failures, and has noted that “[k]eeping track of failing solar companies in 2011 and 2012 bordered on full-time work.” Alternative energy is subject to the whims of political actors, just as coal, oil and gas are. Should Congress repeal the Production Tax Credit or amend Renewable Portfolio Standards, the impact on alternative-energy investments could be enormous. To the extent that Jones intends “to make sure that insurance companies address potential financial risks in the reserves they hold to pay future claims,” then holding wind and solar investments should be very high on his list.
This is not a question of the science of climate change. Nearly all actors in the insurance industry, and particularly those who write property insurance and reinsurance, accept that climate change is a real threat that requires a policy response. Commissioner Jones no doubt has aims for higher office when his term is up. If he wishes to tackle such concerns as a governor or member of Congress and to offer plans to reduce carbon emissions in an effective and efficient way, more power to him.
But for the time being, his job is to regulate the business of insurance in the State of California. His most important duty in that role is to ensure the companies he regulates can make good on the promises they have made to policyholders. It may very well be that a ten-year Peabody Energy Corp. bond, purchased at a given price and paying a given interest rate, is not an appropriate investment match for a ten-year term life policy. But such decisions can only responsibly be made through thoughtful and deliberate evaluation of the actual nature of the investment and the actual nature of the risk. Suggesting otherwise is nonsense on stilts.
It’s appropriate for insurance regulators to monitor the investments of the companies they regulate, particularly those domiciled within state borders. If Jones requires some assistance in that task, the NAIC’s Capital Markets & Investment Analysis Office is available to help and has whole teams devoted to credit-quality assessment and securities analysis. That he apparently thinks that such analysis can be boiled down to blanket declarations that entire sectors of the economy are off limits suggests either that he has alarmingly little facility with one of the most important duties of his office, or that his arguments that this is anything but a blatantly political decree amount to twaddle in all its infinite splendor.