Republished with the kind permission of Insurance Day. While climate risk threatens to increase over the coming decades, it is also leading to innovation in environmental liability insurance writes Suki Basi in Insurance Day. (To read a PDF copy of the article, please scroll down to the end of the article)

Climate risk has risen significantly in the public consciousness in a way that has not been seen for over a decade. This rise has been driven, in part, by a combination of a greater frequency of natural catastrophic events such as the Californian Wildfires and global climate activism.

Therefore, it is no surprise that climate risk is rising up the agenda in corporate boardrooms in a way that was incomprehensible three years ago. For example, in a 2017 survey for Goldman Sachs Asset Management (GSAM), 68% of respondents did not believe that sustainability factors should be taken into account or were not applicable when making investment decisions.

By 2020, this figure had fallen to 21%. Likewise, in 2020, climate risk was identified as playing a significant role in the investment process for more than 73% of cases in the EMEA region. Similarly, vast numbers of respondents were open to using climate stress testing and scenario analysis to measure their portfolio’s exposure to climate risks.

While this shift in corporate behaviour is welcome, there is a wider question at play: are corporates and their (re)insurers mitigating and managing their exposures from climate risk?

The answer is yes and no. Yet, before we examine the current mitigation techniques, it is worth looking at why corporate behaviour and attitudes towards climate risk is changing.

Many proponents of greater climate activism point out that many large corporations need to encourage a better balance between both the consumption and production of many consumer goods. At current levels, there is a cost to the planet.

This viewpoint was reflected by a recent study by Changing Markets Foundation, which analysed all the global companies, which disclose the amount of plastic produced from their products. Coca-Cola was named the worst offender, followed by Pepsi, Co, Danone, Nestle, Procter & Gamble, Unilever, Colgate/Palmolive, and Mars.

However, when Russell analysis combined the results of this study with corporate revenue levels, the results were even starker. This new analysis showed that for every dollar that it earns on its products, Coca Cola produces more than 77g of plastic waste to the planet. Pepsi Co was the second highest polluter with 34g of waste, followed by Danone with 28g of waste produced. Of those same companies in Changing Markets study, Mars was bottom with 5g.

While many of the companies identified in the study have publicly announced that they are changing their methods to become more environmentally friendly, from a liability front this raises the possibility of greater regulatory prosecutions and oversight. This was identified by Allianz Global Client Specialty as being a key liability trend for 2020 in a recent white paper.

Awareness

The paper argues that a greater public awareness of environmental matters means that businesses are judged at a higher standard than they are normally used to. Consequently, a failure to meet that standard will result in higher fines and legal action.

However, in the UK, the Environment Agency is adopting a different approach, with a rise in “enforcement undertakings.” This works as an alternative to prosecution following an environmental offense and usually takes the form of the offender paying for damages and donations to third party organisations and charities. An approach that has been used in the water industry, with UK water companies paying £3.52m in enforcement undertakings between October 2018 and May 2019.

Yet, from an insurance perspective, a rise in “enforcement undertakings” is a cause for concern according to Chris Strong, Head of Environment Impairment Liability for AGCS. While clean-up costs and natural resource damages are covered, financial contributions to charities and environmental management improvements fall into a “grey area”. Therefore, many companies could be in a situation of accepting an “enforcement undertaking” and finding out later on that it is not covered by their environmental liability insurance.

Yet for many figures in the industry, this lack of “explicit coverage” is not just limited to environmental liability insurance but applies to all liability insurance.

Policy Exclusions

According to Bob Reville, CEO of Praedicat, an emerging risk specialist, “Liability insurance is written to cover all perils, but all policies have exclusions. As an industry, we are quick to exclude perils that are difficult to underwrite”.

In Reville’s view, the industry needs to start pricing and covering named perils rather than to take an “all perils with exclusions” approach.

While climate risk continues to grow more potent over the coming decades, this will inevitably lead to continuing innovation in environmental liability insurance.

Berkshire Hathaway Specialty Insurance is leading the way in this regard. Berkshire has introduced Environmental Liability Insurance in France, which pairs coverage for multiple environmental risks with the needed technical and legal support to help insureds mitigate environmental incidents and claims. The policy aims to provide coverage for an insured’s operating sites along with off-site services such as transport operations. In addition, the coverage protects the insured from third-party claims arising from gradual damage and mitigation costs too.

For the casual observer, it would seem that the industry is not doing enough to manage their climate risk exposure but to the more seasoned observer, the reality is more complex. Currently, the industry is at the stage of acknowledgement; many leading insurers identify climate as a significant issue. For example, many leading (re)insurers have pulled out from insuring fossil fuels because of the significant environmental damage. That is a positive step. Now comes the hard part, to move from acknowledgement to implementation.

Only by taking a holistic view of risk, working with corporates, deepening and expanding their data sets, can (re)insurers develop the necessary innovation to provide new products to help their clients understand and mitigate their environmental exposures.

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