Climate change challenges for insurers
The various manifestations of climate change are creating significant challenges for insurance sector both in the UK and internationally.
That is likely to remain so for the foreseeable future and the problem might continue to grow throughout this century. However, rather than adopt a defeated and fatalistic posture in response to this challenge, it is important to focus on the many good initiatives that are being undertaken within and beyond the insurance sector.
It is probably fair to say that fifteen years ago climate change was not an issue which was featuring on many corporate agendas. The world has moved on and is now part of the mainstream commercial discourse.
While perhaps not unanimous, there is now a very broad consensus on the relevant science and encouraging activity at an international level, by national and regional governments and by commercial entities, NGOs and individuals. There is an exciting momentum. The insurance sector is at the heart of that with great assistance from risk analysts, engineers and loss adjusters.
The Intergovernmental Panel on Climate Change published its Fifth Assessment Report in 2014, the culmination of several years’ work. Its key findings were:
- Warming of the climate system is unequivocal.
- Anthropogenic greenhouse gas emissions are extremely likely to have been the dominant cause of the observed global warming since the mid-20th century.
- Continued emissions of greenhouse gases will cause further warming and long-lasting changes in all components of the climate system.
- Limiting climate change would require substantial and sustained reductions in greenhouse gas emissions which, together with adaptation, can limit climate change risk.
At the Paris Climate Conference last year, governments committed themselves to introducing policies which will be aimed at limiting global temperature rises to no more than 2◦C above pre-industrial levels.
Liquidity and solvency
In September 2015, the UK’s Prudential Regulation Authority (PRA) published its report entitled “The impact of climate change on the UK insurance sector”. The PRA’s concern has been the impact that climate-related losses might have on insurers’ liquidity and solvency and the wider impacts that that might have on the UK economy. In its report, the PRA identified three key risk areas for the insurance sector:
- The physical risks arising from increasingly erratic and violent weather patterns.
- Insurers’ investments. In order to contain greenhouse gas emissions, many hydrocarbon assets may become obsolete and “stranded”, impacting on investment values. Assets may also be damaged by the physical effects of climate change.
- The risk of insurers having to indemnify policyholders for liabilities arising from climate change and envisages a future in which legal claims are brought against those corporations or industries which are thought to have exacerbated climate change. In fact, climate related cases are already being considered by the judicial authorities in numerous jurisdictions. Courts in the US considered a claim brought by Kivalina in Alaska, a town which has been badly affected by rising sea levels, against twenty two fossil fuel companies. In another case, the Dutch government was ordered to reduce greenhouse gas emissions by 25% by 2020. Prosecutors in the US are investigating major fossil fuel companies in relation to statements made about greenhouse gas emissions and climate change. In April 2016, the government of the Philippines launched a judicial enquiry into the alleged connection between greenhouse gas emissions and hurricane damage, and is expected to seek evidence from major fossil fuel companies.
We are already responding to liability exposures arising in more specific ways: responsibility for flooding, subsidence, fires. In the future, we might see claims against architects and engineers who might fail to design structures to reflect changes in the weather or energy generation or claims against directors, accountants or lawyers for failing to advise about the need for climate related disclosures to investors or regulators.
Very recently Standard & Poor’s have published a report which again highlights the considerable risks which climate change poses for insurers and other financial organisations.
One example of the many good projects within the sector is the excellent ClimateWise initiative which recognises the scale of the challenge and the need for insurers “to become more systemic in our thinking around climate risk, leveraging all of our resources in response and creating the types of partnerships that can lead to a meaningful and sustainable response to climate change.” ClimateWise has set principles against which its members’ contributions can be measured.
There is a concern that, if left to the free market, some properties and activities will be unable to obtain commercially viable insurance cover. An obvious example of this is homes in areas which are prone to flooding. Flood Re is a limited response to that problem. It is estimated that 350,000 homes will benefit from the scheme, but the scheme has a limited life span. It will cease after 25 years and it is envisaged that flood risks will revert to the free market. It is hoped that the limited availability of Flood Re will prompt new approaches to design and construction of dwellings and encourage better defences against flooding.
There is interesting talk of establishing an international court for the environment to resolve claims arising from climate change. The International Bar Association published a report in which they recommended the use of binding international arbitration with which to resolve such disputes. The Permanent Court of Arbitration has, since 2001, proved effective at resolving environmental disputes but has limited scope. Encouragement can be taken from the Paris agreement and it is in insurers’ interests to see it succeed. However, without a legally binding enforcement mechanism, its effects may be limited.
This article was first published by Insurance Day on 4 July 2016.