Apocalypse never? The insurance markets’ response to climate change risks

For months now, everyone has been talking about climate change. Climate risks, climate events, climate modelling, climate exposures, new climate exclusions. Insurance companies and intermediaries have been talking up their climate change capabilities and parading their commitment to ‘Environmental, Social and Governance’ (ESG) criteria. Hardly a day passes without major market players announcing the appointment of yet another team of climate change specialists or new leadership focusing on their organization’s strategy for ESG.

The insurance markets’ response to ‘climate change’

Since 2017, the insurance industry’s movement to withdraw from the fossil fuel sector has gained momentum. Publicly available info indicates over 20 major insurance companies who have formally ended underwriting coal-related activities. In 2020, Australia’s Suncorp was the first insurance company to announce its intention to phase out underwriting for all oil and gas projects by 2040. France’s AXA and Italy’s Generali subsequently adopted similar commitments.

The exclusions are coming…

In late 2021, underwriters’ organizations, such as the Lloyd’s Market Association (LMA), commenced publication of model exclusion clauses to restrict insurance coverage of existing and new coal projects and associated exploration. Apparently aligning with Lloyd’s ESG commitments, LMA model clauses LMA5568 and LMA5569 apply to binding authorities, facilities and line slips to prevent Lloyd’s cover holders and leaders from participating in coverage for “thermal coal-fired plants, oil sands or new Artic energy exploration… whether on a construction or operational basis or any other basis.”

Initial attempts to implement a ‘total’ climate change exclusion have been troubling for clients and their brokers. An early milestone in November 2021 was LMA model exclusion LMA5570 which was very all embracing. It read:

“Notwithstanding any other provision in this Policy or any endorsement hereto, this Policy excludes any loss, liability, cost or expense arising out of any allegation or claim that the (Re)Insured caused or contributed to Climate Change or its consequences. For the purposes of this clause Climate Change means a change of climate which is attributed directly or indirectly to human activity.”

In their guidance notes, the LMA’s wordsmiths tell us that LMA5570’s definition of “Climate Change” has been taken from the UNFCCC (United Nations Framework Convention on Climate Change). On checking, UNFCCC Article 1 in fact defines "Climate change" as “a change of climate which is attributed directly or indirectly to human activity that alters the composition of the global atmosphere and which is in addition to natural climate variability observed over comparable time periods.” (emphasis added). The complete UNFCCC Article 1 definition is then much narrower than LMA’s. It also needs to be read in conjunction with several additional definitions, each carefully calibrated within the overall environmental and developmental context of the convention.

Another draft exclusionary endorsement released in 2021 adopts the environmentalist’s jargon of yesteryear, taking aim at “Greenhouse Gases”:

“… this Policy shall not apply to, and the Insurers shall have no liability hereunder (including, but not limited to, as respects any injury, damage, expense, cost, loss, demand, claim, or legal obligation) in respect of any actual or alleged Injury, Damage, Property Damage or Advertising Liability arising out of, resulting from, caused by, or otherwise related in whole or in part to: Greenhouse Gases in the earth’s atmosphere, including without limitation all effects of Greenhouse Gases in the earth’s atmosphere…”

The outright exclusion of insurers’ liability connected to “Greenhouse Gases” and their effects in the earth’s atmosphere in the endorsement is unpalatably wide-ranging.

A non-exhaustive snapshot of the culprits excluded under the endorsement include effects that are local, national, regional, continental or global regarding the level, temperature and other characteristics of oceans, seas, lakes, rivers and other watercourses. Every conceivable natural correlation is captured. Ice and snow, glaciers, snowpack, icebergs, tundra and permafrost. Tornados, hurricanes, winds, heat, cold, rain, drought, floods and all other climate and weather-related conditions.

Effects on humans and all living organisms of any taxonomic classification anywhere in the world are excluded, as well as those on private and public agencies, entities or divisions of every type at all levels, without geographical limitation. Note well that insurers’ liability is excluded whether the correlation is actual or alleged.

Interpreted literally, the exclusion should apparently justify non-payment of otherwise valid claims for losses that were clearly intended to be covered. That seems a troubling and unsatisfactory position for policyholders to face.

Addressing climate change risks

The markets’ response to climate change is understandable. In international circles, it has become almost untenable to not say you want to cut carbon emissions. Any self-respecting CEO will recognise that the board, shareholders, trading partners and stakeholders are all asking ‘what’s your climate change plan?’. There is a need to be seen to be doing something.

Regulators and underwriting associations also increasingly require insurers to show that they have a firm grip on their climate change related exposures. The threat of additional, possibly considerable, solvency capital requirements, for unquantified risks, doubtless concentrates the minds of CEOs and CFOs in the industry.

Historically, following major loss events, insurance markets often respond by inserting exclusionary or clarifying language into their policy wordings. This is nothing new. The insurance industry has seen this previously after big complex losses arising from cyber threat (e.g. NotPetya, WannaCry) and terrorism risks (Baltic Exchange bombing, 9/11). Underwriters’ associations, such as LMA, shoulder the burden of producing suitable wordings which strike a balance between providing sufficient cover and protecting the industry’s solvency. It’s a difficult job and we recognize the challenges of devising clauses that work for everyone.

Underwriters need to protect their companies’ capital. Most insurers’ pricing models and loss estimates do not account for unbudgeted catastrophes. The insurance industry cannot step up to cover losses if they are so large or widespread that no private or public company could have the means to insure them. The industry simply does not have enough money for risks such a war or state sponsored hostilities. There is though a need for the industry to show it has accurately assessed its potential climate change exposure with sound analysis of reliable data and predictive modelling.

Keeping your cool in the climate change debate

Climate alarmism makes good headlines and has impressive topicality. Almost every newspaper and industry magazine op-ed tell their readership that the planet cannot afford any fossil fuel expansion if it is to meet a 1.5°C UN target. Political leaders and governments pillory global insurance markets for continuing to support new oil and gas production and ask for net zero commitments in their underwriting portfolios to avert a ‘climate crisis’.

“The scientists told us three years ago that we had 12 years to avert the worst consequences of climate crisis. We're now three years gone. So we have nine years left.”

– President Biden's Special Presidential Envoy for climate, John Kerry (Feb 2021)

The premise is that there exists a clearly defined irrefutable scientific consensus regarding how bad the problem is and to the amount of time left to fix it. Insurance companies are told they need to ‘follow the science’ and stop insuring all new coal, oil and gas projects if they want to regain their credibility as climate leaders.

The problem is that the available data doesn’t support those conclusions. It’s an incredible misrepresentation of what the UN has actually said. To recap, a little before 2018, the UN was asked to produce a report that would explain how to keep within a 1.5°C temperature rise for all time. For context, there has already been approximately a 1°C rise in the earth’s global temperature to date since the industrial revolution. Much of that is manmade. So there is a very, very small margin to play with.

What the UN report said was that keeping within the 1.5°C target would require immense effort. It would be almost impossible. And an enormous amount would need to be done by 2030. That’s how a 9 year time schedule (and the original 12 year time schedule) gets misrepresented. The UN did not say we have 12 years until we all die in a giant ball of fire.

The gold standard of climate science — which is the UN’s IPCC — say in their 2014 report, that the total cost of global warming by the 2070s (so half a century from now), is the equivalent of most of us losing somewhere between 0.2-2% of our total income.

Remember that by then the UN also estimate that most of us will be around 360% as rich in terms of a medium impact as we are today. So in 50 years from now, instead of being 360% richer than we are today, we will only be 358% richer!

Human induced climate change is a problem. It’s also something we should fix. But a sense of proportion is vital. It is by no means obvious that global and international actors know how to effectively address climate change or what measures should be taken. When coupled with an alarmism that is characterized as a global planetary crisis, climate change becomes a justification for virtually any political or commercial action.

Adaption and innovation

“The last 30 years of climate policy have delivered high costs and rising emissions. The only reliable ways of cutting emissions have been recessions and the COVID-19 lockdowns, both of which are unpalatable. We need innovation.”

– Bjorn Lomborg.

A 1.5°C target is fantastically expensive and will not achieve anything close to a comparable benefit. Spending trillions on unsustainable forms of ‘clean’ or ‘green’ energy that cannot function without considerable public subsidies is a futile Western approach. Yet politicians doggedly unite around climate policies that will dramatically cut economic growth. Moreover, such policies have negligible impact. On the current promises, the Paris climate agreement will not do very much. It will move the needle about 1% of the way to the 1.5°C UN target. On that projection, it should reduce temperatures in 2100 by about 0.1°C.

Naively asking people ‘Could you do with less? Could you turn off your lights? Could you use less heating? Could you drive less? Could you fly less often?’ is an unappealing strategy. But it seems to have been taken up as the default setting for insurance companies on the issue of climate change by restricting available capacity and insuring fewer projects, leaving parts of the fossil fuel sector near uninsurable.

As seen with communicable disease exclusions adopted by insurance markets from early 2020, when considering exclusionary language, there is a high degree of group think. Experience shows that LMA model exclusions are typically perceived by insurers as the required standard and market wide use of the same restrictions quickly becomes entrenched, with no realistic chance of negotiated variations.

Phasing out underwriting capacity for fossil fuels and unilaterally imposing overreaching exclusionary language increasingly stymies project financing for new projects and makes it more difficult and expensive for existing policyholders to operate. On an objective assessment, such actions will also make no difference to global temperatures. And of course that's a problem with much climate policy. It's not so much about how much good it does. It's about how much good it makes us feel. The intention is good, but it’s largely a symbolic act.

Where do we go from here?

It would be more sensible and impactful for markets to instead focus on investment in innovation and adapting to changes in climate that finds a way to continue to produce more while emitting less.

As to policy coverage, innovating around sufficiently clear operative policy language to give insurers the protection they say they need while preserving underlying cover seems worthwhile. If express exclusions are vital, developing scenario-based thresholds beyond which a specified loss is uninsurable could be considered.

The trouble is that total exclusions and withdrawing from existing business classes is a quick fix and represents certainty. Negotiating effective and clear policy wordings takes time and requires compromise with clients and intermediaries. It is hoped that developed insurance markets – such as Lloyd’s – will step up to meet the challenges, proving their reputation for innovation and creative solutions for tricky risks. In the current climate though, it remains to be seen whether they will do so.

Grant Pilkington

[original article March 2022]