Climate Disputes - Managing climate change risks – The role of insurance

Insurance is a familiar tool to help companies manage and transfer risk but, as climate change risks are evolving, so too is the sector's response

It is clear from our climate disputes series that the risks and reverberations of climate change are far-reaching, impacting as widely as shareholder claims, parent company and supply chain risk, disclosure investigations and greenwashing. Such impacts raise the inevitable question of how companies' trusted tools to address and mitigate risk can handle such a systemic global shift. In this article, we consider these risks and how an organisation's insurance programme and policies may respond, as well as how climate change is impacting the way insurers underwrite risks. We round off by exploring some practical points on claims handling.

Climate risks and relevant insurance products

Mapping an organisation’s risk profile and appetite and the relevance of insurance as mitigation is a complex exercise. Such analysis will frequently require input from operational managers, risk managers, insurance brokers and legal advisers, among others. But it is an important exercise, particularly when the risks are evolving.

Climate risks come in many guises and unexpected ways for businesses. As well as your own business, it is important to consider liabilities of any subsidiaries and others in your supply chain.

Existing BAU insurance policies should be considered through a climate lens to ensure they respond as necessary in the event of a claim. Depending on a business's exposure to certain risks, new insurance products may need to be considered.

So, what types of climate change risk should an organisation be considering?

Physical risks

Physical climate risks may be the most obvious. For businesses that own property or land, or rely on others who do, or who rely on the supply of physical resources, there is a potentially increased exposure to physical risks. This is due to the increased severity and frequency of extreme weather events caused by climate change. Such weather events, like flooding, hurricanes and wildfires, can cause enormous amounts of damage to property and resources.

• Property insurance is the most relevant product here. It is important to consider whether business interruption cover should also be included and whether there are any exclusions such as pollution which may be relevant.
• For sectors where profits are dependent on weather or the availability and use of natural resources or physical materials, parametric insurance may be valuable. Parametric, or index-linked, insurance is where a claim is paid based on a predetermined index, eg, Richter scale, area yield or rainfall amount. When relevant levels of that index are met, the insurance should pay out without the need for an actual loss. This can avoid the need for loss assessment, which can consume significant time and resource. Parametric insurance is increasingly used and, if effectively set up, could provide certainty for policyholders and organisations behind them like investors.

Climate liability risks

The climate disputes in this series fall under the umbrella of climate liability risk. These may be existing risks to businesses that need to be considered through a climate lens – for example, the potential increased liability for board members due to the recent rise in climate litigation. Even if allegations or claims turn out to be unsuccessful, the costs of defending or investigating can be significant and so relevant insurance should be in place.

• Directors and Officers insurance (or D&O) is potentially the key coverage here and at the centre of emerging climate risks, and ESG more widely. D&O typically responds to claims against directors or officers for actual or alleged acts or errors or omissions committed in their directorial or official capacity. Two key exposures potentially covered by D&O are: shareholder claims (against a company, if the relevant cover is purchased, and individual D&Os) and regulatory enforcement investigations/proceedings arising from matters such as alleged disclosure issues or the way a business is operated. A D&O policy may also typically cover costs incurred in responding to non-routine regulatory investigations into the company’s affairs or the conduct of directors or officers.
• Professional indemnity insurance (or PI) is typically relevant for claims against an insured party for breach of duty in its provision of professional services and costs incurred in responding to regulatory investigations. If climate-related claims allege such a breach, a PI policy may respond but much will hinge on how certain policy terms are defined, eg, 'professional services’ and 'professional loss'.

A feature of a liability policy is that if a third party brings a claim against an insured, the insured must be able to demonstrate to the insurer that it has a legal liability to that third party. That can be complex and difficult (involving issues of limitation and standing of the claimants), especially when publicly defending the claim.

• Product liability/public liability insurance might also be relevant depending on the nature of the business and the substance of allegations against it. For example, if products are said to be defective due to alleged contribution to climate change.

Transition risks

Many transition risks may be relatively new, such as preparing for now mandatory climate reporting or the risk of ineffective carbon offsets. Due to the potential gaps in traditional cover, the insurance market is developing solutions by offering new products/services that seek to manage new transition risks and adapt existing insurance. For example, we have seen some existing products adapted to expressly provide cover for costs of climate-related investigations.

For the energy transition, insurance products can safeguard the commercial reliability of projects via:

• Energy efficiency insurance is specifically designed for investors in energy conservation or financing energy saving projects.
• Carbon offset insurance. One way for companies to try and reach carbon neutrality is to buy carbon offsets but the voluntary carbon market is unregulated. There is a risk that if the carbon offset scheme does not deliver the anticipated amount of sequestered carbon (for example, trees do not grow as expected, or the captured carbon is lost due to a forest fire) this could leave the offset buyer with risk and liability. This insurance product could cover that risk.
• There is also solar energy/wind product insurance for relevant projects: if there is a lack of wind or sun, then this product is intended to insure the shortfall.

Some of these products are relatively new and so it is not clear yet how they may respond in practice.

Reputational risks

All the risks mentioned above could cause damage to reputation. While there are some specific products available in the insurance market to mitigate this risk, a key part of managing reputational damage is to have the risk management processes and tools in place in the first place.

Relevance of climate change in securing insurance

Climate change (and ESG more widely) is increasingly important when it comes to obtaining insurance and the underwriting process. The insurance industry's response continues to evolve. There has been a reduction in risk appetite across insurers in relation to emissions-intensive businesses. Many European underwriters have committed to net-zero underwriting by 2050.

Even where climate change might not at first appear relevant to some insurance, at placement or renewal insurers may ask questions about climate credentials, policies and reporting. In addition, insureds must comply with the duty of fair presentation under the Insurance Act in the UK. This can affect the amount of cover available and the range of insurers available. Therefore, it is important that risk managers have that information available and have spoken to the relevant stakeholders.

Policyholders with better climate credentials may find they are in a stronger position when buying insurance. Insurers may offer lower premiums, additional capacity and other advantages if certain climate-related requirements are met or if an insured has good climate credentials. On the other hand, insurers may try to influence the conduct of policyholders whose credentials are not as favourable through climate-specific exclusions or higher premiums.

Climate risks and claims

Claims-handling practicalities

Insurance claims must be handled effectively by a policyholder to maximise recoveries for climate change-related risks. In the event of a claim, some key points for policyholders to bear in mind are:

• A notification of a claim (or, if necessary, a circumstance) must be made in strict compliance with the notification provisions in the insurance policy – especially as to timing. In the context of climate risk, whereas previous climate-related allegations may not have been considered meritorious enough to warrant notification to insurers, given that recently regulators and courts are taking such allegations or claims seriously, the decision as to whether a potential claim warrants notification should not be taken lightly.
• It is common in liability policies for there to be aggregation wording. This will provide for two or more separate claims or other insured events to be treated as one claim when they have a unifying common factor. Without aggregation wording, each claim will generally trigger separate application of a deductible/excess and limit/sub-limit of liability. In the context of climate change, it is possible that there might be multiple claims with a unifying common factor – eg, multiple claims by local residents in relation to environmental issues. How these claims may aggregate should be considered early as it may affect the amount of cover available.
• Settlement – Depending on the policy wording, it is likely that insurers' consent will need to be sought to settle underlying claims. The decision whether to settle may be more challenging in the context of climate change given recent increases in related litigation and the risk of opening the floodgates.

Sustainable choices in the claims process

There is encouragement from the insurance industry for policyholders and insurers to agree sustainable choices in the claims process. For example, repairing property that has suffered damage instead of complete replacement and using sustainable or re-claimed materials to do so. It is likely that this would need to be agreed as part of negotiations of the policy wording at placement or renewal.

Conclusion

As organisations assess their exposure to climate risks and consider updated risk management strategies, considering appropriate insurance should be front and centre. Adequate thought should be given at placement stage and in the event of any climate risk materialising that could rise to an insurance claim.