The Effects of Climate Change on the Canadian Insurance Industry
Introduction
What is Climate Change?
Simply put, climate change is a long-term, human-caused shift in global weather patterns that lead to rising temperatures, increased frequency and severity of extreme weather events, and other related impacts, with significant implications for the environment, economy, and society.
Climate Risk and Insurance
As extreme weather events due to climate change become more common, property owners take on an ever increasing amount of risk, both in the short and long term. That being said, much of that risk can be mitigated with insurance (Canadian Lawyer, 2021). This article will analyze and attempt to predict climate related risks, and how they will affect property owners, D&O, as well as P&C insurance. Additionally, this article will attempt to provide recommendations for both insurers and homeowners on how to mitigate these risks.
Changes in Home Insurance
Over the next decade, the climate's changing conditions will present both opportunities and risks for insurance and property companies, affecting areas such as underwriting, claims, operations, investments, reputation, regulation, and more (cia-ica, 2019) Litigation related to climate change has also risen during this period. Legal actions taken against governments and major emitters create uncertainty and potential opportunities for insurers, lenders, and investors. (cia-ica, 2019).
"The average cost of home insurance has grown at more than three times the rate of inflation over the past decade as personal property damage claims have grown 42 percent nationwide over the same timeline" (newswire, 2021).
Impacts on P&C Insurance
Physical Risks
Examples include damage to buildings and infrastructure due to increased frequency of extreme weather
In response, P&C insurers will increase rates to account for increased risk P&C insurers may integrate climate modelling into rating engines.
For life re/insurers, physical risk exposure will be through underwriters.
Due to heightening climate risk, homeowners might want to search for policies with more extensive coverage. Water damage in particular has become particularly common (McMullin 2023). According to McMullin (2023), policies many homeowners should consider purchasing policies which cover sump pump failure, sewer backup damage and other water damage.
Transitional Risk
Possible risks associated with the transition towards a carbon-neutral economy
The shift towards a carbon-neutral economy is expected to affect general and life insurance, necessitating changes in policies and coverage.
Proactively addressing transitional risks is advised, as prompt decisions can mitigate the severity and frequency of physical risks.
Re/insurers have a crucial role as risk managers in comprehending climate change-related risks and informing stakeholders about its potential impact on their future.
The Canadian Mortgage and Housing Corporation (CMHC), along with other insurance-related institutions are pushing for "Climate Risk Disclosure." For homeowners living in areas prone to natural disasters such as wildfires, severe floods, hurricanes and other extreme weather events, rates could climb substantially (Gambrill, 2022).
Underwriters who do not already offer policies which cover damage from extreme weather events should do so as demand goes up this type of home insurance could prove particularly lucrative
Liability Risk
Examples of liability risk include legal action over losses from past GHG emissions, as well as changes in policy or public sentiment.
Liability risks increase the need for new D&O insurance policies to mitigate legal risks.
Any infrastructure not properly designed to handle extreme-weather events of increasing magnitude and frequency not only presents a physical risk, but also a liability risk (Koval, 2013). Engineering firms, construction companies, developers and more could be held liable for structural failures, especially if they are design related (Koval, 2013), and should take measures to ensure:
Structural integrity
Adequate insurance coverage
Compliance with current (and future) regulations, especially thosepertaining to extreme-weather event readiness.
Impacts on D&O Insurance
As climate change accelerates, and its become increasingly prevalent in the economy, D&O insurance providers will find themselves responsible for ensuring compliance with a growing set of legislation at both the federal and provincial levels. Examples include the Canadian Environmental Protection Act (Birchall et al., 2020). If a director or officer fails to meet this responsibility, they could be held legally responsible.
According to Gambrill (2023), climate NGOs around the world may begin launching corporate climate lawsuits in Canada following a precedent set in the UK. D&O Insurers stand as a principle target of these suits, creating potential liability risk.
Case Study: Baker et al. v. Director, Ministry of the Environment:
Canadian aerospace manufacturer, Northstar Aerospace Inc., ran operations leading to the contamination of their own manufacturing site, as well as surrounding residential areas with Trichloroethylene (Lee-Andersen, 2014).
Northstar's Liabilities
The Ontario Ministry of the Environment ordered Northstar remediate all environmental damage (Lee-Andersen, 2014). Although the company went bankrupt, the corporation was still liable for environmental damages. (Lee-Andersen, 2014). The case ended with a 4.75 million dollar settlement between the former directors and the Ministry of the Environment (Lee-Andersen, 2014).
As climate change continues to accelerate, lawyers at Willms and Shier, one of Canada’s leading environmental law firms, predict that the Canadian insurance industry will experience a wave of climate change-related D&O liability (Birchall et al., 2020). Environmental responsibilities currently being tested in court include the failure to: limit GHG emissions, adapt to physical changes caused by climate change, adapt investment strategies, disclose climate related risks, and failure to comply with regulations.
Municipal Government Involvement in Climate Litigation
The Vancouver City Council and other large Canadian municipal governments such as the Toronto City Council and Victoria City Council have recently allocated part of their municipal budgets towards supporting class action lawsuits against fossil fuel companies such as BP, Chevon, Exxon Mobil, Saudi Aramco and more (Gill,2022).
So far, it is unclear what sort of liabilities oil and gas giants, as well as other corporations which may come under-fire, will have to face. Although government backed lawsuits represent a legal risk for many large emitters, it is unlikely for legal risks related to greenhouse gas emissions to become a serious legal risk for some time. For the foreseeable future, government-backed class action suits do not present any serious risks for insurance brokerages in BC.
These efforts are led by activist groups such as West Coast Environmental Law and the Georgia Straight Alliance (Dickon, 2022). The Union of BC Municipalities (UBCM) is an important organization which has been called on by the Victoria City Council to support class action suits; but has stated that litigating oil and gas companies is counter productive towards the goal of a zero-carbon economy (Gill, 2022)
What does this mean for brokers?
It would be prudent for brokers to analyse whether their client’s company will have exposure to climate change (Trisura, 2020). For example, if the company operates in a coastal region, how will the company be affected by a one-foot rise in sea level?
If there is a risk of exposure, the next step is to investigate if these exposures are adequately disclosed in public filing documents (Trisura, 2020). If not, brokers can seize the opportunity to provide risk management advice (Trisura, 2020).
It may be time for businesses and brokers to revisit their current levels of D&O insurance as well as environmental liability insurance, with special attention paid to the size of the limit and the terms and conditions of policies, to ensure that they will be prepared in the face of a rapidly changing environmental and political climate brought about by global warming (CFC Underwriting, 2020).
Additionally, increased climate risk may provide brokers with a significant opportunity. As climate risk increases, the number of homeowners, small businesses, property developers, etc. which will find themselves in need of insurance to cover the ever-increasing costs of property damage caused by extreme weather events will only increase.
Brokerages serving (or looking to serve) customers in areas which have high climate-change related risks should provide a plethora of policies addressing climate change related risks.
Increased climate-risk related sales could present a major opportunity for many brokerages to greatly increase sales and better serve clients in need of coverage.
With new tools being made available by organisations such as the Canadians Mortgage and Housing Corporation to assess climate risk (Gambrill 2022), both current and potential homeowners, as well as brokerages, can expect to better understand the actual risk at given locations to infrastructure from extreme weather events, and have better access to fairly priced insurance to cover physical risks.
Recommendations
According to Mckinsey (2020), the insurance industry can create economic security by offering reliable protection. With this in mind, here are some recommendations which may be helpful for brokers risk modelling to inform underwriting decisions.
First, insurance brokerages can use advanced analytics to project how various acute and chronic hazards are likely to affect them over time. Brokers should combine detailed climate data, with an analysis of the macroeconomic implications of climate change to inform pricing and portfolio adjustments.
Second, brokers should advise clients to mitigate and prevent physical climate risks. This commitment requires shifting business models away from transactional risk transfers and indemnity payments towards incentive based systems, such as exploiting rebates, using resilient construction materials and toward direct partnerships with clients.
Third, organizational boards should be made aware of various climate risks. By establishing a clear governance structure to evaluate the impacts of climate-related risks, brokers can imbed ongoing climate risk assessments and mitigation efforts across the organization.
Fourth, brokers can address underwriting and operational risks through both individual initiative and industry collaboration. Brokers should continue the development of risk reduction best practices such as loss data and models that inform industry management of flood, wildfire and climate-related risks.
Fifth, brokers could work with public sector to improve building standards and policies. By proactively sharing information with companies, customers and the government, brokers and insurers can actively mitigate some of the physical risks related to climate change.
It is recommended that brokers reevaluate their investment allocation strategies as the economy transitions toward long-term decarbonisation, which may cause rapid asset repricing and portfolio volatility. This would particularly apply to carbon-intensive investments.
