May 7, 2020 by Dr. Janis Sarra, Professor of Law, University of British Columbia
As the insurance sector adjusts to respond to challenges related to the novel coronavirus, flood season in Canada is beginning.
Today, residents in Fort McMurray, Alta., are returning to clean up their flooded homes and businesses on the anniversary of a wildfire four years ago that caused almost $3.8 billion in insured damage to the town (the 2016 Fort McMurray wildfire remains Canada’s largest insured catastrophe event).
Climate change is not going to pause while the world is trying to control the pandemic.
Accounting firm PwC observes that climate change is the biggest long-term risk for insurers. Human activities are causing the rise of global temperatures, resulting in increasing frequency and severity of acute events such as wildfires and flooding. COVID-19 is an unexpected catastrophic event, climate change is an expected one. As the chief underwriting officer of Swiss Re said last week, “COVID-19 is an existential threat… but so is the climate crisis.” Preparedness is key for insurers.
From 2010 to 2019, insurance payouts in Canada for catastrophic losses from natural disasters exceeded $1 billion per year. Globally, insurance payouts typically cover approximately one-third of economic losses, with many businesses facing a widening protection gap. Insurance Bureau of Canada (IBC) reports that water damage claims are now the most frequent claim in Canada. Insurers have been offering overland flood insurance products to homeowners since 2015, two years after a flood event in Calgary caused almost $2 billion in insured damage, the third-highest insured damage loss in Canadian history.
The International Association of Insurance Supervisors reports that climate-related extreme weather events are resulting in unforeseen large payouts and shocks to the sector. Physical risks due to climate can change in non-linear ways, so annual contract repricing may not be effective. There is growing uncertainty in pricing, including risk-based pricing beyond elasticity and customers’ willingness to pay. As the severity and frequency of events increases, the cost of reinsurance coverage may become prohibitive. Chronic events, such as rising temperatures and heavier precipitation, are being magnified by the continued expansion of cities into existing floodplains. At the municipal level alone, avoiding the worst impacts of climate change will cost Canada an estimated $5.3 billion per year, equivalent to 0.26% of GDP.
Canada’s regulatory authority, the Office of the Superintendent of Financial Institutions (OSFI), reports that climate-related losses are now a key solvency risk to insurance companies. While most insurers have geographically diversified portfolios and adequate reinsurance to cover losses, that cushion is likely to change. OSFI has instructed all insurance companies to quantify their exposure to carbon-based asset repricing and to develop strategic approaches for making the transition to fewer carbon-linked assets as a key aspect of their management of solvency risk. In the longer term, OSFI expects companies to include stress analyses and their responses in their own risk and solvency assessments. Companies like Desjardins are already using climate-change scenarios in their annual dynamic capital-adequacy testing.
The news is not all negative. Insurance companies, as investors, have huge upside potential earnings, particularly in investing in green adaption and mitigation technologies. IBC observes that investments in resilient infrastructure have a return on investment of $6 in future averted losses for every $1 spent proactively. Sixteen large insurance companies globally have partnered to develop a new generation of risk assessment and analytical tools, including forward-looking climate scenarios, aimed at helping the insurance industry better understand the impacts of climate change on their business. Reinsurers are developing more accurate flood modelling and adjusting their pricing of catastrophe risks accordingly. ClimateWise, a network of 27 leading insurers, reinsurers and brokers is committed to reducing the impact of climate change on the insurance industry.
The key to managing these risks is effective climate governance. Directors and officers have a fiduciary obligation to act in the best interests of the insurance company. These duties are set out in the legislation under which insurers are registered, such as the Insurance Companies Act, as well as the common law. Directors and company managers have a duty to exercise care, diligence and skill in their management and oversight of the company, including managing climate change risk.
Outside Canada, more than 2,000 lawsuits are now underway — including claims for damages, and claims that directors and officers violated corporate and securities law by failing to address or disclose climate-related financial risk. When these lawsuits appear in Canada, directors and officers that have been duly diligent and acted reasonably are likely protected from liability. Inaction likely means they are not.
Where companies offer directors’ and officers’ (D&O) liability insurance, it is important that the premiums reflect the risk of insured directors and officers who do not address the climate risks in their sector; adequate pricing helps insurers to prevent unplanned losses.
Making companies climate-competent
Directors and officers need the information and skills necessary to identify material climate-related risks and opportunities to their business. They need to adopt appropriate strategies to manage risks and have mechanisms in place to respond rapidly to changes in the company’s risk profile, including monitoring the actions of individuals charged with managing the risks. Increasingly, tools are available to assist. Globally, many insurance companies are adopting the disclosure and governance framework proposed by the Task Force on Climate-related Financial Disclosures (TCFD), which offers insurance sector-specific suggestions on how to identify and assess climate-related risks arising from the increased frequency and intensity of acute events on insurance and reinsurance portfolios. It offers support for the development of a going-forward business strategy.
Advising on Climate Governance
Directors can get advice on how to get started. The Canadian Climate Governance Experts, an initiative of the University of British Columbia and York University, involves 55 highly regarded lawyers, accountants and capital markets experts who are donating their time over the next year to meet with company boards to share expertise on effective climate governance.
Featured image by iStock/hocus-focus
Other images by iStock/keeperofthezoo; iStock/Ian Dyball; and iStock/RomoloTavani