Will Insurers be Burned by the Climate Change Phenomenon?
Global warming is just beginning to be recognised by many insurers as a significant risk factor for past, current and future insurance policies.
According to Guy Scott, CEO of Aon Risk Services for South Africa, a leading provider of risk management services, insurance and reinsurance brokerage, human capital and management consulting, and specialty insurance broking, there are numerous risks associated with climate change that may cost billions of Rands to mitigate and reverse, such as risks to life and property. These risks affect insurance companies providing life and health insurance, as well as protection against natural disasters related to climate change, including forest fires, hurricanes, tornados, floods and storm surges.
Of concern, findings show that risks of loss emanating from higher temperatures, more severe windstorms, floods, storm surges and other climate change phenomenon are significant and are predicted to be more severe in the future. “While sophisticated research and modelling capabilities have provided insurers with the tools necessary to predict losses, these tools are however not widely or consistently employed by the insurance industry,” says Scott.
Insurance companies and risk managers are uniquely positioned to be agents of change in providing leadership – not only in the area of insuring risks associated with global warming – but in leading the industry and the general public to embrace the principles of sustainable development.
Scott says that to date, the steps that insurers have taken as a result of substantial increases in insured and uninsured losses have been modest relative to the increasing risks. “This may not be the case when the full impact of climate change is better understood,” he warns.
In addition to the direct liability of corporations for the damage caused by global warming, there is a risk of liability for corporate executives who do not recognise the importance of environmental issues and fail to make decisions to implement sustainability measures that could reduce GHG emissions, reduce the consumption of non-renewable resources, cut energy use, and set goals for ecological neutrality. “With third-party evaluations of performance available, stakeholders can point to ‘objective’ reviews of a corporation’s sustainability efforts,” says Scott.
Global warming is a key environmental factor that could cost corporations and countries billions – and the financial and social consequences of global warming are expected to be unevenly distributed with the heaviest burdens falling upon the poorest nations. Scott says that in order to avoid disaster it is recommended that industrialised nations invest up to 1% of their GNP in technologies that would reduce global emissions of CO2. “If this investment is not made, the future costs could reduce global wealth in the aggregate by as much as 20%,” he explains.
Commenting on the Insurance Industry’s reaction to global warming Scott says insurers have always reacted to higher loss ratios by raising the rates charged for coverage’s where the losses are increasing. In some cases, the correction dictated by the loss ratio involves more than just an increase in the rates. Other reactions can be to limit the coverage that is offered to the insureds in classes that are losing money, to reduce the number of policies issued in geographic regions or to groups of insureds (classes) where losses are most severe, and as an ultimate measure, to withdraw from the market completely.
Over recent years the insurance industry has become increasingly skilled in the use of probabilistic catastrophic risk modelling as a tool to predict future losses. This type of modelling has become an integrated risk management tool that has helped insurers digest catastrophic losses.
Insurers have used the results of research and modelling to modify the way they do business in several areas. “With a better ability to predict large losses, insurers have limited their exposure to weather-related losses by making changes in the policies they write and in restricting the number of policies issued to insureds in high-risk areas. They have also increased the use of re-insurance to reduce their net losses in the years when claims have run higher than expected,” says Scott.
Scott says current insurance policies are silent with respect to insuring claims arising out of climate change risks. To the extent that climate changes manifest themselves in natural disasters such as hurricanes, floods and forest fires, existing “All-risk” physical damage policies typically provide coverage for losses arising from such events. While some of these perils may be subject to coverage limitations and/or significant deductibles, losses are generally insured, especially those that could be catastrophic to homeowners and businesses.
The status of general liability claims is less certain. General and excess liability insurance policies written include pollution exclusions that may be interpreted as applying to claims alleging liability of the insured for damage caused by climate change. Scott explains that if coverage depends on whether CO2 is a “pollutant” , a number of successful global court rulings may weigh in favour of applying the exclusion.
Pollution exclusions similar to those in general liability policies are also found in Directors & Officers (D&O) Liability forms, raising questions with respect to the coverage provided for global warming cases in current D&O policies. Unlike general liability policies, D&O coverage is only available on claims-made forms, making coverage from earlier periods inapplicable to claims from current events. Scott advises that corporate executives should not rely on this coverage to provide complete protection against claims arising out of climate change issues.
Environmental Liability insurance is written on forms that provide coverage for claims arising out of pollution conditions. However, environmental liability policies were obviously not written with claims arising out of climate change in mind and do not include affirmative coverage language for such claims.
In conclusion, Scott says that global warming is just beginning to be recognised by many insurers as a significant risk factor for past, current and future insurance policies. “Keeping climate change risks insurable is complex and will depend not only on the continued participation of private insurers but also on legislative, regulatory and political action to keep risks at levels that remain insurable.”
“Insurance companies and risk managers can be agents for change in providing leadership in the area of insuring risks associated with global warming, and in leading industry and the general public to embrace the principles of sustainable development,” concludes Scott.
