Insurance 2020: Climate change

27/02/2020

Across all sectors

Laws and policies either have been or are being devised across all sectors to wean economies off CO2 emissions. Moreover, the pace of such law and policy is accelerating. This article allows us only to cite a few examples (and because so much law and policy exists in the energy sector we will not refer to this here):

  • Net Zero: In June 2019 the UK Government committed the UK to net zero by 2050. Other countries are following. The EU is currently debating legal instruments to bring such commitment into law across the EU.
  • Transport: The traditional internal combustion engine in road transport is in terminal decline. EU policy is that such engines will count for no more than 50% of vehicles in large populated areas by 2030 and 0% by 2050. Already some cities have gone further. Amsterdam’s target is 0% by 2030 and London has introduced emissions charging schemes. Emissions controls from air and maritime transport is much further behind in terms of law and policy but is on the agenda.
  • Finance: the EU has major policies in place relating to sustainable finance and has developed a “taxonomy” to define what is green finance. The objective is to stimulate investment in clean or green projects, products etc. Of course, implicitly the real outcome may be, or become, the defining of “brown” investment, making such investment less attractive. If there is a substantial market move away from such brown investment, a question may arise whether this might result in significant revaluation of an insurer’s current investment portfolio.
  • Pensions: in October 2019 climate change became an express consideration in terms of statements of investment principles in pensions regulation.
  • Real estate: there is plenty of law and policy developing in terms of increasing the energy performance of buildings, which account for approximately 40% of end use energy in the EU. In the UK the Minimum Energy Efficiency Standard prohibits (subject to some exemptions) new lets of buildings with energy performance certificates below “E”. It was always anticipated that this would be a first step and the UK government is already consulting on increasing the standard to “B” or “C”.
  • Products: regulation has been required to force into the design of products consideration of energy use by products (e.g. Eco-design of Energy Related Products Directive).
  • Reporting energy: more law and policy is being developed requiring large corporates to monitor and report on energy consumption (e.g. Energy Efficiency Directive) which of course feeds into designing other law and policy.
  • Reporting Corporate: The directors’ duties under Section 172 of the Companies Act 2006 (which include environment and long term risks), along with the Strategic Report and Directors Report, are now beginning to be examined more carefully by activists, and potential investors, in terms of climate change risk.

The financial services regulators’ perspective

For financial institutions, general law and policy is being supplemented by PRA and FCA. It is clear that climate change is high on the FS regulatory agenda. It is having a significant and wide-ranging impact on the UK economy and on financial services markets. In July 2019, the Financial Conduct Authority, Prudential Regulation Authority, Financial Reporting Council and The Pensions Regulator issued a joint statement welcoming the Government’s Green Finance Strategy and set out their commitment to working collaboratively to address the risks of climate change.

The Prudential Regulation Authority (PRA) has published policy and supervisory statements relating to climate change in which it was unequivocal about the risks posed by climate change. Those risks may be physical (e.g. more extreme weather events) or transitional (arising from the transition to a low-carbon economy), both of which can also give rise to new or increased liability risks. All of those risks are difficult to assess and quantify.

In the PRA’s view, few insurers are taking a strategic approach that considers how actions today affect future financial risks. The PRA’s messages are clear. It expects a firm’s board to understand, assess, address and oversee the financial risks from climate change within the firm’s overall business strategy and risk appetite and to ensure that adequate resources are devoted to managing the financial risks from climate change. Responsibility for identifying and managing financial risks from climate change should be allocated to the relevant existing senior management function(s). It is less clear how the industry will respond. There is no consensus yet as to how insurers should assess and address the financial risks in a way which meets PRA’s expectations. Each firm will need to reach its own conclusions in a world of rapidly changing expectations. This will be a big challenge for the industry in 2020 as (currently fragmented) policy continues to develop.

The FCA and PRA’s Climate Financial Risk Forum met three times in 2019. The Forum’s working groups have been putting together draft practical guidance and recommendations in key areas such as disclosures, risk management, scenario analysis and innovation. The Forum plans to publish the draft guidance and recommendations for wider industry input in early 2020 and has now agreed to undertake a second year of work.

In addition, the Bank of England’s 2021 biennial exploratory scenario (BES) will explore the financial risks posed by climate change. The BES is part of the Bank’s stress testing frameworks used to explore less well-understood risks that are not nearly linked to the financial cycle. The objective of the 2021 BES is to test the resilience of the current business models of the largest banks, insurers and the financial system to the physical and transition risks from climate change. The BES should launch in the second half of 2020 with the results being published in 2021.

On a narrower issue, in October 2019, the FCA published a feedback statement setting out its proposals to improve climate change disclosures by issuers and information to consumers on green financial products and services. The Statement identifies a number of priorities, which will provide a foundation for the FCA’s future work on climate change and green finance.

Sitting alongside law and policy is an active market in climate change litigation. This litigation is sun rise but appears to be increasing in terms of numbers and breadth. This litigation has had many failures (for instance, in January 2020, the “Kids case” in the US, Juliana v US, failed in the Court of Appeals Ninth Circuit) but also some material successes (for example Urgenda’s defeat of the Dutch Government in the Netherland’s courts, including the Supreme Court in December 2019, and the Court of Appeal’s ruling in England on Heathrow Airport this month). All in all, for the insurance sector, the economic changes that are coming into play will be of considerable interest from many perspectives.