UN report puts climate change at heart of insurance risk assessment

Out-Law News | 02 Feb 2021 | 1:46 pm | 2 min. read

A report produced by the United Nations (UN) in collaboration with 22 major insurance firms has suggested that the insurance industry needs to adopt an integrated approach in order to manage future climate change risk.

The final report of the UN’s Environment Programme’s Principles for Sustainable Insurance Initiative (107 page / 1.6MB PDF), which aims to pilot recommendations from the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TFCD), assessed climate-related physical, transition and litigation risks in an integrated manner with a focus on scenario analysis.

The report found that the level of analytical sophistication varied considerably across climate risk categories, insurance lines and economic sectors. It argued that climate change presents not only downside risks but upside opportunities to develop new insurance products and expand existing ones with a changing risk landscape.

The report said it was making a “ground-breaking, yet still preliminary” effort to develop a methodology to assess climate-change related litigation risk, encompassing potential costs, fines and penalties, prosecutions of executives, impacts on valuation and credit ratings, policyholder claims and exclusions between the insured and insurer.

The UN said previous discussions on how the insurance industry should approach climate change related risks had either dealt with physical, transition and litigation risk as three separate categories or had disregarded climate change litigation as a category altogether.

The UN said climate related litigation could take place locally, nationally, internationally and on a global scale, and may present a material risk to insurance industry participants, although the report could not identify any instances of claims paid out to date on climate change litigation. It said climate-related litigation risks were tightly interconnected with physical and transition risks, and should be assessed accordingly.

Insurance law expert Charlotte McIntyre of Pinsent Masons, the law firm behind Out-Law, said the discussion of litigation risk was notable.

“The most striking aspect of the report is the introduction of litigation risk – which it extends to include climate-related corporate governance litigation – as an equal factor to physical and transition risks when calculating climate-related insurance risks, arguing strongly for an integrated approach and a novel recognition of the risks presented by climate change related litigation,” McIntyre said.

“If this approach is adopted by the industry to a significant extent, it could incentivise corporates and organisations, particularly if applied to risk rating directors’ and officers’ insurance and similar policies, to place climate change at the heart of corporate governance policies. Such an approach by the insurance industry may help accelerate the transition to net-zero emissions economies,” McIntyre said.

The UN proposed a model for physical risk analysis in relation to indemnity insurance relating primarily to the risk of hazard – the frequency of loss, geographical areas exposed, and the severity of damage caused by climate change. The report said physical risk should be factored into insurance financial modelling and key performance indicators would help insurers determine their response to the shifting demands for insurance products, to evaluate insurability of risks and refine their risk appetite.

Meanwhile the UN’s proposed model for transition risk modelling could provide a framework to assess transition risks in underwriting and assist in meeting the requirements of the TCFD-aligned climate scenario analysis for insurance portfolios.

The report said transition risks were mainly driven by regional business dynamics in the policyholder’s economic sector, and suggested that climate transition drives volume impacts such as the demand for certain insurance lines through market, technological and regulatory changes.

It added that the vulnerability of insured assets may be due to both transition risks and physical climate related risks, and that assessment of climate change related transition risks would be of most use when integrated into macro-economic trends and combined with the impact of physical risks.