20 November 2008

Will climate change alter liability risks?

On one issue the experts are in agreement: Anthropogenic climate change will have an impact on the environment, society, and the economy. A subject that has not yet received much attention, however, is: How will climate change alter the field of liability insurance? On October 14, 2008, Munich Re sponsored an all-day discussion of this evolving issue in its U.S. headquarters in Princeton. The Munich Re Climate Change and Liability Workshop provided scientists, brokers, consultants, and insurance and legal experts with a platform to discuss current and prospective court practice in the context of climate change and liability issues.

In the United States, we are already witnessing an increased number of lawsuits against energy companies, car manufacturers, public entities, and others. Some seek economic damages, while others a change in government policy, greater corporate accountability, or more responsible individual consumer behavior. Not surprisingly – as awareness of climate change continues to grow – so does the interest in such lawsuits. As a result, lawsuits targeting official bodies as well as corporations in the private sector are expected to increase. Whether these lawsuits will succeed, however, is uncertain.

What is the current status on the topic of climate change and liability? Who are the potential plaintiffs and who are the potential defendants? What legal parameters are already in place? To what extent should, and how can, the insurance industry respond? How can the emerging risks be managed? How can you pinpoint cause and effect? Who ultimately must take the blame for losses attributable to climate change? And what constitutes what is or is not attributable to climate? These are some of the many complex questions that scientists, brokers, consultants, and insurance and legal experts explored during the workshop.

The current situation from a reinsurer's point of view

"The key question in connection with liability for the consequences of climate change is: Who caused what damage to whom?," said Prof. Dr. Ina Ebert, Munich Re's expert for core issues of liability law. However, the answer to this question is – for the moment at least – anything but clear. Owing to the complexity of cause and effect, it has up to now been impossible to attribute specific climate change losses to one particular polluter. Another question that needs to be addressed is how to resolve discrepancies between federal law or decisions by federal authorities and the liability laws of individual states. And what happens if an illicit activity is stopped: What about all the activity that preceded it? Where do you draw the line? The main point, however, is whether these are issues that should be resolved by way of liability law at all. Or do they not rather require solutions in the form of legislation and international agreements.

At this time, Munich Re divides the question into two distinct categories:

• Direct liability – losses directly caused by CO₂ emissions and/or other greenhouse gases
• Indirect liability – losses indirectly related to climate change

At the moment, politicians, regulation, and the courts have to tackle questions surrounding direct liability. At this time, it is not an issue that can be nor should be handled by insurers. Munich Re’s position is that until legislation evolves that can actually hold defendants accountable for direct liability in connection with climate change, this will remain the case – now and in the foreseeable future.

Kevin Haroff, a partner in the international law firm of Sonnenschein, Nath & Rosenthal LLP, noted that current U.S. laws, such as the Federal Clean Air Act (CAA) and the National Environmental Policy Act (NEPA), are not well-suited to addressing the unique challenges presented by global warming and related phenomena. The state of California is assuming a pioneering role in the United States in terms of climate protection, with its adoption of wide-ranging climate change legislation and the introduction of environmental impact analysis requirements for development projects. But California and other states, as well as the federal government, have a huge challenge in creating laws that actually take action against those responsible for causing losses resulting from climate change. Until the legal environment evolves, it is unlikely that insurers can develop or adapt products to accommodate climate change.

As for indirect liability, climate change is a subject that is relevant to both professional indemnity and directors and officers insurance. Currently, insurance coverage is available because such losses are not based on climate change itself but on the fact that the subject has not been given proper consideration in the activities of the professionals concerned.

We strongly believe that indirect liability resulting from climate change will grow in importance to the insurance industry, as evidenced by the following:
Stricter regulation leading to stricter liability/standards of care,
growing public awareness due to intensive media coverage,
scientific consensus about the anthropogenic causes of climate change.

It is to be expected that insurance products for "new" liability risks will emerge in the future. They could cover the following risks:

• Failure to warn/report/inform
• Conspiracy
• Wrong reaction to emergency situations
• Improper claims handling

Furthermore, the question of whether claims for coverage could emerge through general liability or product liability insurance may continue to evolve and may become more frequent. Such covers are intended to extend only to emissions caused by fortuitous events and not to emissions caused in the normal course of operations or due to wilful action. Finally, what is considered "normal" will have to be defined more exactly both in the courts and in corporations’ code of conduct regarding energy and environmental practices.

How can companies mitigate future liability, above and beyond what an insurer can provide in coverage?

Many of the participants agreed that at this stage in the evolution of climate liability issues insurers are not faced with the immediate challenge of covering direct risk associated with climate change. Individual companies must seek ways to avoid future potential liability.

"If you are not at the table, you are on the menu" explained Thaddeus Huetteman, consultant at PEAR (Power & Energy Analytic Resources) in Georgia, as he described the dilemma facing companies trying to decide whether or not to weigh in on Congressional deliberations over climate change legislation. "See yourself as part of the solution rather than as part of the problem." Companies that are particularly in the focus of climate change activism and the target of legal action – like oil and power-generating companies – have a vested interest in being part of the solution. But they know that even firms with a good corporate social responsibility are not immune to future liability risks.

Sustainability management is a matter of course at most companies nowadays. A commitment to sustainability on the part of company management is increasingly being called for by investors as well. Large institutional investors have become increasingly demanding while evaluating a company and have expanded their terms of reference to consider CEO leadership, sustainability reports, emission balance sheets, and strategic planning in their evaluations. Besides the reputational and financial risks that companies with poor sustainability practices have to contend with, we may now see the emergence of liability risks associated with climate change.

Improving climate modeling will be essential in pinpointing climate liability

Advancements in the science of climate modeling might make it easier in the future to attribute climate-related damage to a particular perpetrator. Indeed, skillful prediction of natural variability on decadal time scales would increase confidence in the attribution of observed changes to specific causes.

Thomas L. Delworth, Head of the Geophysical Fluid Dynamics Laboratory in Princeton, New Jersey, pointed out how increasing climate model fidelity, particularly on smaller spatial scales, is paramount. Computers and model resolution, an improved understanding of physical processes (clouds, effects of aerosols, atmospheric chemistry, etc.), and inclusion of complete carbon and methane cycles in models will become essential. Today, the presence of large natural variability can make the attribution of observed change to human activity difficult. Thus, the key focus of future research is to improve our understanding of mechanisms of natural climate variability and to attempt to predict such variability and to distinguish more accurately between anthropogenic and natural forcings.

Climate liability risks – Opportunities for the insurance industry

It is rather unlikely that we will see an emergence of pure climate liability covers in the near future, but contract language is beginning to explicitly reference climate change. Admittedly, there is now convincing scientific evidence that human activity is contributing to the global increase in air and sea surface temperatures, the melting of glaciers and ice shelves, increases in sea level, and impacts on ecosystems. However, in terms of the secondary effects, like the change in the frequency and intensity of weather-related catastrophes, the evidence is in the near term unlikely to be sufficient to allow the allocation of specific losses to specific polluters as a basis for court decisions in favour of plaintiffs.

"The insurance industry has built up a wealth of knowledge and expertise on the subject of climate risks," said Evan Mills from the Lawrence Berkeley National Laboratory, California. "New products and services are being offered with a view to proactively managing climate liability risks related to current and future loss events and to addressing future climate liability issues in a clear-cut manner."

According to a study by Ernst & Young (Strategic Business Risk – Insurance, 2008) climate change is the No. 1 insurance risk. Besides involving risks, it will also lead to opportunities. The Global insurance broker Willis has set up a climate change task force with the mandate of monitoring developments supplying information to clients and tracking market solutions. Nevertheless, insurance products will not be the only response to the problems of climate change liability – because although the potential loss amounts may increase dramatically, the volume of cover available will remain limited.

Emerging legislation and the growth of new innovative low carbon technology will provide significant opportunities for the insurance industry to support, in a positive and significant way, the solutions to climate change as they evolve over time.

Core messages

During the workshop, the participants drafted a number of Core messages on the current status and future development of climate change and liability issues.

• Liability issues associated with climate change are increasingly the subject of litigation. They confront governments, the legal system, industries, and the insurance sector with new risks. Insured defense costs can be significant irrespective of litigation outcomes.
• Successful climate change liability litigation is rather unlikely in the near future. While there is overwhelming scientific evidence that human activity has contributed to globally rising air and sea surface temperatures and melting glaciers/ice shelves, for secondary anthropogenic effects (e.g., windstorms, floods, droughts) the body of evidence today is not sufficient ground for litigation. Scientists and legislators still have a lot to do as far as the liability issues are concerned.
• In the foreseeable future, successful lawsuits may be those founded on single cases indirectly related to climate change (D&O, PI, shareholders, etc.).
• Climate liability risk can be managed by incorporating appropriate language that limits liability under the policy. New liabilities might emerge with the advent of renewable technologies and other strategies for reducing emissions such as carbon capture and storage and a resurgence of nuclear power. Liability issues therefore call for new approaches in legislation with a view to transforming the traditional principles of liability law, especially in the causation context.
• As public awareness of climate change and demand for stricter environmental policies increases, so too will the number of lawsuits being filed – primarily against supervisory and regulatory bodies. Lawsuits for damages against private entities have already occurred – but none have succeeded (as of October 2008).
• Reducing one’s own carbon impact and implementing sustainable business processes are the best measures to reduce one’s vulnerability to climate liability issues.
• Insurance coverage for climate change risk is a nascent field. Some insurers have already built up second-to-none expertise in climate-related risks and are beginning to develop products and services to help manage climate risk related to current/expected future loss and to mitigate future potential climate liability issues. For example, Munich Re is a leader in using insurance to accelerate the development of renewable technologies.

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