Insurers must consider the D&O implications of climate change

This article was originally published in Insurance Day on 25 August 2020.

Insurers must balance the income from insuring and investing in fossil fuel projects against the growing reputational and litigation risks.

Climate change is one of the most high-profile topics being tackled by the corporate world today. International agreements, such as the Paris Agreement and the UN Guiding Principles on Business and Human Rights, provide mechanisms for integrating environmental considerations into national economies.

Relevant for insurers are the UN Principles on Sustainable Insurance (PSI) launched in 2012. Allianz, Aviva, Axa, Munich Re, Sompo, Swiss Re, QBE, Willis Towers Watson and Zurich are among the 82 signatories to the document.

The four principles in the PSI provide a common aspiration and global framework for the insurance industry to manage environmental, social and governance (ESG) issues and to strengthen its contribution to building resilient, inclusive and sustainable communities and economies.

The first ESG guide for the global insurance industry, led by Allianz, was published in June 2020. The guide aims to raise awareness of the potential benefits of ESG integration into the insurance business model and the correlation between ESG factors and strong performance of companies.

Apart from having pledged to implement the PSI across their spheres of influence, what have insurers done in practice? There are different levels of commitment and a variety in responses.

Initiatives range from completely divesting from coal-related cover and investment or phasing out at a certain date to providing for low-carbon transition opportunities and investing in climate change research.

Insurers’ income from insuring carbon majors still represents a $6bn market. While Lloyd’s has implemented a coal exclusion policy with effect from April 2018, individual Lloyd’s syndicates remain free to continue to invest in and insure coal projects. Furthermore, only 2.5% of the Lloyd’s market has adopted the coal divestment policy.

Political activism is rife and as early as 2016, a coalition of top US state law enforcement officials vowed to hold fossil fuel companies accountable for their conduct in relation to climate change. Consequently, large oil and gas producers would appear to be a greater insurance risk.

Litigation risk

Increasing pressure in this area is likely to result in more investigations  and litigation relating to climate change. Such investigations  and litigation are likely to be extremely expensive, as extensive expert evidence on causation will be needed.

Carbon majors have begun dealing with more claims against them, in public nuisance and product liability, regarding their role in allegedly causing climate change and pollution. For example, Lliuya v RWE, the case by Peruvian farmer Saúl Luciano Lliuya against RWE, Germany’s largest electricity producer, for flood damage owing to climate change has been ongoing since 2015.

In addition, the damage caused to the environment and human health from oil spills such as the BP Gulf of Mexico spill and natural gas leaks such as the Aliso Canyon disaster in 2015 represent major risks for fossil fuel companies and their insurers in terms of quantum; not only related litigation for pollution liability but also the clean-up costs.

Tougher controls on carbon emissions by international, national and local governments will increasingly have an impact on oil, gas and coal assets, including regulatory efforts to deal with various health and safety issues and eventually the long-tail risk of decommissioning with potential for claims into the future – a prime example of the 'transition risks' of climate change.

These changed attitudes are demonstrated by local governments refusing planning permissions, such as the case of the Australian mining company Gloucester Resources (Gloucester  Resources  v Minister for planning (2019)) or the Heathrow airport extension (R(Friends of the Earth) v Secretary of state for transport and others (2020)).

Given the financial risk exposure – namely costly litigation,  investigations, regulatory intervention, clean-up costs in case of accidents, and long-tail risks after decommissioning – is insuring in this area still worth it?

Liability

Fossil fuel companies are still major assets in investment portfolios. Climate change risk management is a board-level governance issue and directors have to be actively involved in establishing and monitoring strategies to reduce wide-ranging climate-related carbon asset risks (such as those mentioned above), which are relevant for corporate risk or return.

The failure to consider or adapt to climate change-related risk factors could become the subject of shareholder actions against corporations and their directors for breaches of statutory or fiduciary duties or for loss of share value (particularly as fossil fuel assets become devalued), as seen in the investigation by the New York attorney-general to determine if Exxon deliberately misled shareholders about the financial risks of climate change to its business (People of the state of New York v ExxonMobil Corp (2018).

In a low-carbon future, insuring carbon majors may become more risky. Dialogue between insurers and fossil fuel companies should therefore focus on the extent to which they are adequately preparing for changing market dynamics and managing carbon asset risks. Emphasis should also be placed on their readiness to comply with international guidelines on environmental protection.

As a growing number of institutional investors become concerned about reputational risks associated with investing in fossil fuels and look to 'green' finance, and carbon asset risk factors become better understood, the monetary income from insuring and investing in these projects might soon be outweighed by reputational and monetary considerations.

Read other items in Professions and Financial Lines Brief - October 2020