The rising tide of climate change liability

Although the current wave of tort liability litigation actions against carbon producers and emitters are a long way from trial, they are beginning to have an impact on claims for defence costs and on how insurers set their reserves for these exposures

Regulatory pressure has long been building on companies involved in activities that could be exacerbating global warming and its resultant weather-related natural catastrophes. However, a number of legal actions taking place across the globe are seeking to use the courts to establish direct liability on the part of oil companies for some of the damage that man-made global warming is causing.

As such, the insurance industry needs to be alive to the future risk of liability claims linked to climate change. What risks do insurers face as climate change goes from being a political and regulatory issue into a judicial one? And what are the opportunities they face to provide cover against this multi-faceted threat?

Some 194 states have committed to climate action under the 2015 Paris Agreement. Corporations are under mounting pressure to take steps of their own to address climate change. For example, shareholder activism is on the rise, with some major institutional investors joining the chorus – Shell's recent AGM is a case in point.

What about insurers? It is well documented that climate change is increasing the prevalence and severity of catastrophic weather losses. Independently of that, in the regulated sector, there is increasing pressure on companies to measure, report and mitigate the risks posed by both climate change itself and the transition to a low-carbon economy.

The Governor of the Bank of England, Mark Carney, has been particularly vocal in this regard, warning about the potential impact on the balance sheets of banks and insurers.

Major ratings agencies are now taking account of climate change in their assessments. And activists are pressing insurers to divest from coal and stop underwriting particularly "dirty" projects.

President Trump's administration has initiated the USA's withdrawal from the Paris Agreement and is rolling back environmental regulations. But this in turn is spurring counter-measures by states, cities, companies and activists.

Legacy liabilities

Another source of pressure on companies is litigation. There are hundreds of current climate-related cases around the world, with a disproportionate number being brought in the USA.

Perhaps the highest profile of these are claims that have recently been brought by municipalities in California, New York and elsewhere against oil majors, seeking damages for the steps they will have to take to make themselves resilient to climate change. They seek to link oil and gas production to global warming and the subsequent rise in sea levels, coastal erosion, flooding and extreme weather events.

Significantly, some of the actions allege these firms have ignored or hidden known links between fossil fuels and global warming for the past 40 years. The parties are engaged in procedural arguments about where they should be heard – in State or Federal Court.

While these cases are still a long way from trial, they may spur others into bringing similar tort liability claims against carbon producers and emitters. At the very least, the insurers concerned are likely to see an increase in claims for defence costs. They will also need to assess what reserves to set.

What are the plaintiffs' prospects of success in these cases? Historical asbestos and tobacco claims are a precedent of a kind, and there are some similarities in the way the case is being put against the defendant oil majors.

However, with fossil fuels, the causal chain between production and damage is much more extended. And the products are used by everyone, including the plaintiffs.

Directors and officers may face a different kind of exposure. They have a duty of care to assess the impact that climate change and transition risk (to more climate-friendly alternative production) will have on the company's business.

They must not mislead investors and customers about the environmental impact of the company and its products. Breach of these duties may well result in significant D&O liability claims, along the lines of those brought against executives in the German motor industry.

Possible areas of D&O litigation include failure to adapt to physical risks or to mitigate claims. In this scenario, claimants would seek to hold directors responsible for the losses incurred due to climate change – for example, the need to tank basements due to rising water levels.

Another possible area is failure to adapt to transition risks. The transition to a low-carbon economy could create risks for some industries. For example, if the market were to take the view that fossil fuel companies cannot exploit all their reserves, then their share prices could adjust sharply downwards.

The same could be true for motor manufacturers not transitioning swiftly enough to electric vehicle technology. In these scenarios, directors and trustees of institutional investors who hold on to these stocks could be exposed to lawsuits.

In addition to legal action from regulatory authorities, there could be shareholder claims for mismanagement or breaches of fiduciary duty regarding climate change risks, focusing, for example, on share price devaluation or financial losses linked to reputational damage.

Limiting exposure

Insurers have the opportunity to limit their exposure to these risks, as D&O policies are triggered by claims made against executives, rather than the activities that give rise to those claims. However, defending against potential class actions could prove very costly.

Climate change risk also offers innovative insurers an opportunity. In the first instance, insurers have the knowledge, incentive and opportunity to engage in the public debate on climate change and to help businesses make informed decisions about the risks their businesses face.

There are also opportunities in terms of product innovation. For example, parametric (or index) insurance linked to satellite data could make crop cover in developing markets a viable option and so offer vital protection to some of the world’s most vulnerable people. Since the middle of the past decade, climate scientists have been seeking to model the impact that climate change is having on the incidence and severity of natural catastrophes. This work is beginning to pay off and they can now assess with increasing confidence how much greenhouse gas emissions are contributing to the severity of, say, a windstorm.

This modelling might allow novel risk transfer products to be priced and sold. That said, it might also drive another wave of climate litigation.