Insurance Law and Climate Change

Executive summary

Climate change is a pressing issue for the insurance industry. It presents physical risks, which are caused by the actual impacts of climate change, and transition risks, which arise from society’s response to climate change. Insurance is crucial to protecting individuals and organisations from risks in both categories, and can also contribute to reducing greenhouse gas emissions. Managing the climate crisis will require effective risk sharing systems,[1] and many insurers are at the forefront of understanding and addressing climate risk. While the insurance industry has been more proactive on climate change than some other industries, there are still significant risks that have not been mitigated and opportunities that are yet to be seized.

Climate change has multiple legal implications relevant to the insurance industry. Climate litigation against companies and individuals may prompt them to seek indemnity under their liability policies, and potentially give rise to disputes over coverage. Insurers are also increasingly subject to climate-related regulations. On the other hand, insurers can help drive the net zero transition by sending risk signals, writing insurance policies which encourage climate action and offering protection for activities that aim to mitigate climate change. Additionally, new insurance products can manage climate risks in innovative ways. Climate change will therefore be of growing relevance to insurance lawyers.

Key points in this section:

• Increasing liability risks associated with climate change may have significant implications for multiple types of insurance – causing a risk for insurers and policyholders that have not considered the impact of climate change.
• Climate change creates liability risks for insurers, and the Prudential Regulation Authority has set clear expectations that insurers should embed climate change risk into their decision making.  
• Insurers may write policies that incentivise policyholders to reduce activities that cause greenhouse gas emissions, for example in vehicle insurance. New assets and markets emerging from the net zero transition will also require insurance and may lead to novel disputes.
• Climate change also brings opportunities to the insurance industry. Some insurers are exploring new mechanisms such as parametric insurance to protect policyholders from the financial risks caused by climate change, but legal aspects of these products are still relatively untested. Alternative risk transfer products such as catastrophe bonds and weather derivatives are also becoming more prevalent as society faces climate impacts.

How climate-related legal risks are impacting insurers

Implications for liability insurance

Climate change can affect policyholders’ liabilities, and consequently insurers’ exposure to liability risks. Just as climate change creates and amplifies physical risks relevant to insurers, new legal risks are emerging. Actions that policyholders take now might lead to them incurring liabilities many years in the future, but claims may still be made under current insurance policies. Analogies have been drawn with the impact of asbestos-related claims once the link between asbestos and health impacts became clear – insurers cannot wait until climate litigation becomes a large threat if they wish to shield themselves from climate-related losses.

The insurance industry has identified three main classes of insurance that will face heightened liability risk – general and public liability insurance, directors’ and officers’ liability (D&O) insurance, and professional indemnity insurance.  Climate change may become increasingly relevant to general and public liability insurance as a growing number of claimants are seeking damages for harm caused by climate change, particularly in the USA. Defendants to date have largely been oil and gas majors, but other emitters may be targeted as this area develops. Tortious claims have seen mixed results abroad and have yet to be successful in the UK. Finding a duty of care and causation are two key hurdles for these claims. Still, as attribution science develops to give a firmer basis to causation and defendants’ contribution to harm related to climate change, this may become a more salient risk to insured parties. Forward-looking cases, often based on human rights, that aim to compel companies and governments to reduce their future emissions may not engage coverage under liability policies. In addition to cases based on a failure to mitigate climate change, future policyholders might face claims on the basis that they have failed to adequately adapt to climate impacts. There have been relatively few ‘failure to adapt’ cases to date, and most have been aimed at governments, but adaptation claims are likely to become increasingly important as this area of law develops. ‘Greenwashing’, where organisations make misleading claims about the environmental impact of their products or activities, could also create liability risks as demonstrated in ACCR v Santos, a case filed in Australia.[2] Policyholders who greenwash their products or services may face a variety of claims including failure to label products correctly or failure to disclose material risks to investors.[3]

Climate change may also impact D&O insurance policies. Failure to take sufficient action in the face of the climate crisis is being recognised as a potential breach of fiduciary duties, in particular the duties under Sections 172 and 174 of the Companies Act 2006 to act in the best interests of the company and to exercise reasonable care, skill and diligence. Director and officers may be exposed to such derivative claims for many reasons, and greenwashing also represents a risk here, especially if the relevant misleading statements are in the company’s filings. As the link between fiduciary duties and climate change becomes stronger, insurers will need to consider how this might impact parties with D&O insurance. This could impact a wide range of insured parties – failure to take adequate climate action formed part of the basis in Ewan McGaughey v Universities Superannuation Scheme, a case brought against directors of the Universities Superannuation Scheme.[4]  It is also the basis for the main argument in ClientEarth’s derivative action against Shell’s directors.[5] Both cases were dismissed by the High Court, but legal risks might still compel insurers to restrict coverage under their D&O policies. Directors and companies, on the other hand, may be exposed to long tail claims as D&O policies often only cover claims made during the coverage period.

Professional indemnity insurance has also been identified as a source of liability risk for insurers. Professionals in industries like construction may face claims based on failing to properly account for climate-related weather risks, which could further increase insured losses. New types of projects, such as renewable energy developments, might also give rise to professional indemnity claims. There have already been disputes in other areas of law involving technical aspects of these projects, for example in MT Højgaard v E.On.[6]

Insurers’ exposure to liability risks

Recognising climate risks and the impact they may have on insurance policies, some insurers may change the scope and extent of their coverage to reduce their own exposure to these risks, or increase their premiums to adjust for the higher likelihood of losses.[7] Policyholders claiming under their policies for climate-related liability from their insurance coverage may face coverage disputes. In AES Corp. v Steadfast Insurance,[8] an American case, after a defendant resisted a climate-related nuisance claim its insurer successfully argued that they had no duty to defend the policyholder as causing harm by emitting greenhouse gases was intentional, rather than an ‘occurrence’ which is accidental. Ahola Petroleum Ltd. v. National Union Fire Insurance Co. of Pittsburgh is another US case that saw a fossil fuel company arguing against climate-related legal fees being excluded from coverage.

Legal issues directly impacting insurers

Recognising the multitude of climate risks that the insurance industry is facing, regulators have started to set guidelines for insurers to manage climate risk. The UK’s Prudential Regulation Authority (PRA) set out its expectations for UK insurers in its Supervisory Statement 3/19.[9] The PRA expects insurers to embed climate-related financial risks into their governance and risk-management frameworks, allocate responsibility for climate change to senior management functions, undertake long-term scenario analysis, and disclose emissions in line with the Task Force on Climate Related Financial Disclosures (TCFD). The PRA has since expressed that firms should be able to demonstrate that they have implemented these expectations, and expects that firms with larger, more complex businesses should have a more sophisticated understanding of climate risks. In the UK and some other countries insurers are expected to review their exposure to policyholders’ climate liability through scenarios developed by regulators.

Insurers face other direct legal risks through similar avenues to other organisations.  This includes direct regulation such as reporting and disclosure requirements as well as potential litigation against directors. Insurers will, like other organisations, need legal advice to understand these implications. As they are often large investors, insurers will also be affected by regulation intended to bring transparency and integrity to sustainable investment products, such as the UK’s Green Taxonomy.

Reinsurers will be exposed to the same risks as insurers and, given their role in managing risk from large claims and events, play a key role in understanding how climate change will impact the insurance industry. Public reinsurance schemes can also help to share climate risk. For example, Flood Re is a UK reinsurance scheme formed by a partnership of insurers and government that spreads insurers’ exposure to flood risk in home insurance policies. Flood Re is governed by The Flood Reinsurance (Scheme Funding and Administration) Regulations 2015, and all home insurers must pay into the scheme. As climate change continues to have systemic impacts on the industry, insurers’ obligations under the Flood Re regulations may change, and similar schemes could be established to manage other weather risks.

How insurance law can help to address climate change

Green insurance policies

Insurers can encourage policyholders to reduce emissions and adapt to climate change. For example, property insurers can discount premiums for buildings that are energy-efficient or more resilient to weather risks. And motor insurers can incentivise driving less or switching to low emission vehicles. Policies could improve sustainability at the claims stage, for example by encouraging a ‘repair over replace’ philosophy[10] and use of “greener” alternatives when replacement is necessary. The Chancery Lane Project has produced model clauses for use in insurance contracts aimed at reducing emissions and mitigating climate risk.

Like other financial products, insurance policies that are advertised as being ‘green’ will be subject to increasing scrutiny, including by regulators. Potential regulations similar to those proposed in the UK’s Green Taxonomy could therefore impact insurers, who will rely on lawyers to understand the likely impact of this regulation.

Insurance for green industries

Another important function for the insurance industry is in insuring emerging technologies and activities that play a key role in reducing emissions or boosting climate adaptation. Insurance has already played a role in driving the net zero transition by, for example, helping to manage risks in renewable energy developments. Some firms have offered policies that specifically aim to make clean energy businesses more competitive. Insurers can also provide cover for work focused on decommissioning fossil fuel assets.

Insurance can help to protect natural areas that sequester carbon from the atmosphere. Property, agriculture, environmental liability, and engineering risk insurance may all help to preserve environments such as forests and mangroves that are significant carbon sinks. Nature-based carbon removal solutions are often sold as ‘carbon credits’ to buyers looking to offset their residual emissions. These solutions have many risks, but specific insurance products are being created that aim to protect buyers and sellers when these projects fail to deliver the expected carbon removals. This could also be extended to technological methods of carbon removal.

New insurance and alternative risk transfer products

New insurance products and alternative risk transfer mechanisms can help share risk from climate impacts across the economy.  Catastrophe bonds emerged in the 1990s as a way for insurers to manage risk from extreme weather events.[11] If a catastrophe occurs, issuers will retain some or all of the principal paid in by investors, whereas investors will receive a coupon if a catastrophe does not occur. This shields insurers from events which cause significant insured losses. A ‘catastrophe’ is defined by predetermined triggers which can be based on real or modelled financial loss from a weather event, loss suffered by the issuing insurer, or characteristics of the event itself. Catastrophe bonds are classified as ‘insurance linked securities’ under UK law and governed by The Risk Transformation Regulations 2017 and The Risk Transformation (Tax) Regulations 2017. Bonds can be issued through an insurance special purpose vehicle (ISPV), which must be approved in accordance with PRA[12] and Financial Conduct Authority rules.[13] Weather derivatives are another financial product which buyers, often organisations in sectors which face high risks from weather, can use to hedge against climate-related losses. Buyers pay a premium in return for receiving an agreed amount of money if certain weather conditions occur. Weather derivatives do not require the buyer to suffer a loss, and are therefore not generally characterised as insurance.

Parametric disaster insurance is another emerging type of insurance policy. As with weather derivatives and catastrophe bonds, parametric insurance policies pay out set amounts to policyholders if certain weather conditions occur. But unlike those instruments they require policyholders to have an insurable interest in the relevant weather risk. Parametric insurance has gained traction as a way of protecting vulnerable communities worldwide, for example through initiatives launched that focus on deploying this tool in small island developing states. There is also a growing market for these products in the UK, with both incumbents and start-ups offering parametric insurance for weather risks such as flooding. When reviewing the law surrounding insurable interest, the Law Commission suggested that parametric policies are best categorised as non-life indemnity insurance products.[14] There has been little case law in the UK or other common law countries that focuses on these products to date, but lawyers are likely to play a key role in creating an enabling environment for these solutions. 

International climate law and insurance

Developments in international climate agreements are relevant to the insurance industry. Article 8 of the Paris Agreement deals with ‘loss and damage’ from climate change,[15] an issue of particular importance to many developing countries which are highly vulnerable to climate impacts. The Agreement mentions insurance as one of the key areas in which there must be international cooperation to mitigate and address loss and damage. There is significant work to be done to properly implement this provision, so insurers may play an increasingly important role in guiding and operationalising climate agreements through public/private partnerships such as the InsuResilience Global Partnership. Insurers’ role as investors is relevant to climate finance, which must also be scaled up rapidly to meet international climate targets. International networks such as the UN-convened Net Zero Insurance Alliance can help to promote change in the industry, however fears of breaching competition law have led to some withdrawals from the Alliance.

[1] Ana Gonzalez Pelaez, ‘Risk Sharing in the Climate Emergency’ (Cambridge Institute for Sustainability Leadership 2021) <www.cisl.cam.ac.uk/resources/publications/risk-sharing-climate-emergency> accessed 22 June 2022.

[2] Australasian Centre for Corporate Responsibility v Santos Limited (ACN 007 550 923)

[3] Lisa Benjamin, Akriti Bhargava, Benjamin Frantin, Karla Martinez Toral, Joana Setzer and Aradhna Tandon, ‘CSSN Research Report 2022-1: Climate-Washing Litigation: Legal Liability for Misleading Climate Communications’ (Climate Social Science Network, 2022)

[4] Ewan McGaughey et al v Universities Superannuation Scheme Limited [2022] EWHC 1233 (Ch)

[5] ClientEarth, ‘ClientEarth starts legal action against Shell’s Board over mismanagement of climate risk’ (ClientEarth, 15 March 2022) < https://www.clientearth.org/latest/press-office/press/clientearth-starts-legal-action-against-shell-s-board-over-mismanagement-of-climate-risk/> accessed 20 June 2022.

[6] MT Højgaard A/S v E.On Climate & Renewables UK Robin Rigg East Limited and another [2017] UKSC 59, [2017] All ER (D) 19 (Aug).

[7] Marcel Fontaine, ‘Climate Change and Insurance Law: General Report submitted to the AIDA World Congress’ (Association Internationale de Droit des Assurances 2010). 29-31.

[8] The AES Corporation v. Steadfast Insurance Company 283 Va. 609 (Va. 2012) 725 S.E.2d 532.

[9] Prudential Regulation Authority, ‘Supervisory Statement SS3/19: Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change’ (Bank of England, 2019).

[10] Neal Baumann et al, ‘Climate Product Innovation within the Insurance Sector’ (ClimateWise, 2021). <https://www.cisl.cam.ac.uk/climate-product-innovation-within-insurance-sector> accessed 20 June 2022.

[11] Rosalind Mann and Katie Green, ‘Spotlight on Catastrophe Bonds’ (Schroders, 2013) <https://prod.schroders.com/en/sysglobalassets/digital/insights/pdfs/cat-bonds-october-2013-final.pdf> accessed on 21 June 2022.

[12] Prudential Regulation Authority, ‘Supervisory Statement 8/17 – Authorisation and supervision of insurance special purpose vehicles’ (Bank of England, 2017).

[13] Financial Conduct Authority, ‘Policy Statement PS17/24 – Handbook changes to reflect the new regulatory framework for Insurance-Linked Securities’ (Financial Conduct Authority, 2017).

[14] Law Commission and Scottish law Commission, ‘Insurable Interest and Parametric Policies’ (2016) <https://s3-eu-west-2.amazonaws.com/lawcom-prod-storage-11jsxou24uy7q/uploads/2016/04/parametric_policies_stakeholder_note.pdf> accessed 21 June 2022.

[15] United Nations / Framework Convention on Climate Change (2015) Adoption of the Paris Agreement, 21st Conference of the Parties, Paris: United Nations. Article 8.