Pacific Island Climate Change Insurance Facility

Legal assistance paper

All reasonable efforts have been made to ensure the accuracy of this information at the time the advice was produced. However, the materials have been prepared for informational purposes only and may have been superseded by more recent developments. They do not constitute formal legal advice or create a lawyer- client relationship. To the extent permitted any liability is excluded. Those consulting the database may wish to contact LRI for clarifications and an updated analysis.

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Date produced: 08/10/2018

The Pacific Island Climate Change Insurance Facility (PICCIF) is a proposed body aimed at the development of climate change risk-transfer products for Pacific Island nations.  One of the goals of PICCIF is to establish an arm, or tool, to monitor and ensure that the insurance and reinsurance industry is investing in climate-change-friendly portfolios[1]. In this context, what avenues (legal, technical or other etc.) might be put in place to exert pressure on the insurance industry to align its business with climate change objectives, including to ensure that major international insurance companies provide financial disclosure of their investments and direct their financial portfolios towards suitable investments?

Advice:

1. Background and scope of this note

Leading stakeholders have identified in clear and stark terms the impact that unchecked climate change will have on the very fundamentals of the insurance industry.[1]  There is also an acknowledgement by these bodies that such risk cannot be resolved in the traditional way by increasing premiums and exclusions – the uneasy and systemic way in which the insurance industry, via its asset management arm, contributes to the very risks it offers protection from must be addressed.

The intersection between how premia are earned (by purchasing risk from policyholders, through brokers) and then invested (into investments that potentially increase that policyholder’s risk) and the conflicts this creates has the potential for further exploration and strategic intervention. Similarly, there is a potential tension in respect of how insurers record and capitalise that risk purchase as required by directives such as the EU “Solvency II” directive.  Where the aim of Solvency II is to monitor the solvency of insurance companies and in doing so offer improved consumer protection and greater evaluation of insurers’ risk profiles, factors such as what climate model the insurance company has used to calculate its capital requirements (is it a 2, 4, 8 degree world?); how long into the future the model extends (and whether it is aligned to existing climate models); and how longer risks such as life insurance are calculated, are all relative to understanding whether the goal of Solvency II is being achieved.

This note sets out some of our thoughts on possible interventions in the context of the insurance industry.  There are, of course, a raft of avenues to promote these goals, such as lobbying and working with business, which we touch on at the end of this note.  There are also many frameworks in place which seek to promote the advancement of climate change policies, however, almost all of these are currently voluntary.  We consider these below, each of which already provides a solid framework and, if appropriate, could form the basis for any compulsory framework.  In addition, we consider practical ways which, within the existing legal and regulatory framework, steps could be taken to encourage the development of climate-conscious insurance.

We focus on the law as it applies to the UK insurance industry, given this is the jurisdiction in which we are qualified to practice, but also because the UK insurance industry is a world leader with many insurers, syndicates, Lloyds of London, and their regulatory bodies based in London. However, we anticipate that many of these concepts have broader application.

2. Key Stakeholders

We set out below a list of relevant stakeholders and the opportunities they present in respect of climate risk integration.  We focus on four key groups and the roles and opportunities within them:

·       Regulatory / governance bodies
·       “Supply” side – i.e. insurers and reinsurers, asset managers
·       “Demand” side – i.e. policy holders, insurance intermediaries
·       Other – media, existing groups, climate- change bodies etc.

Some routes, such as direct government intervention via regulatory change would obviously be more influential than others, but the ability to achieve this should be seen as a longer term goal, and initial strategies may be better focused on increasing engagement with insurers, insurance intermediaries and consumers of insurance products.We then discuss in the following part below potential avenues for approach and engagement with these groups.

  • Regulatory / governance

Prudential Regulatory Authority (PRA)
Supervises industry to achieve stability and resilience.  As the industry regulator it is best placed to implement regulatory changes in response to climate change by means of reporting and changes in investment and capital requirement holdings.  The PRA is the only UK financial regulator to have reported on climate change impacts to date[2].

Financial Conduct Authority (FCA)
The FCA oversees information made available when companies wish to sell shares through an IPO; and provision of information to the share market.   It also regulates insurance intermediary and insurer conduct towards policyholders: where policies may start to exclude climate risks, issues of fairness and fitness for purpose of products, and claims management procedures, could become relevant.

The Pensions Regulator
Pension funds have long term large scale investments which are obviously susceptible to climate change risks.

The Financial Reporting Council (FRC)
A quasi-regulatory body (delegated authority by the Department for Business, Energy and Industrial Strategy) – oversees Corporate Governance, stewardship, and UK standards for actuarial work, among other things.

Lloyd’s of London
Key industry body and, because of the standing of the London market, has a global influence including in the EU and non-Lloyds insurers.

Other Government / ministerial
The costs of uninsured risks will ultimately fall back on the government and/or there will be a need for certain risks to be pooled/nationalised. Availability of insurance key to a growing and stable society thus interest in survival of industry. Also scope to consider in conjunction with other issues which will contribute to instability (food/water scarcity, migration, disaster prevention/mitigation).

  • Supply side entities

Association of British Insurers (ABI)
Insurance advocacy body (for Insurers). https://www.abi.org.uk/

Investment Association
Trade body representing UK investment managers and where the Investment Affairs team of the ABI now sits. Individual members of insurance investment management arms are also members.

Insurers / reinsurers:
Some insurance firms have been more active in terms of recognising and responding to climate change, especially via their investments arm, in particular AXA, Aviva and Legal & General,[3] each of which has moved away from coal and gas assets in favour of renewables and green companies. Insurers also need to identify new risks and offer innovative products in order to stay competitive/attract clients.  Underwriters and actuaries will be at the frontline of pricing of climate change and operation of exclusions, excess etc. From a claims management perspective, accurate reporting of claims and contribution of climate change so that future risks can be priced.

Asset managers
Key stakeholder to preventing (rather than responding via claims/policies) climate change, however, difficult to get access too. Manner in which investments can be made also complex due to requirement to have liquid funds to pay claims, and Solvency II. Vulnerable to transitional risks.

Shareholders
In the UK insurance market, the majority of insurers are private companies, but there are a handful which are publicly traded.

  • Demand side entities

Policyholders
Retail: consumers of insurance (property, life).

Business: in particular industries more acutely by climate change such as agriculture and forestry (especially in fire and hurricane/storm zones), businesses that have factories located in flood or fire prone areas, cargo/marine; pensions trustees with pension funds invested in such areas.

Individuals: Directors, officers.

Insurance Intermediaries (brokers)
Insurance Intermediaries, such as insurance and reinsurance brokers play a dual role both in presenting business to insurers (i.e. as the insurers’ “market”), and in advocating for their insured client’s needs when placing policies.  As such they may be well placed to encourage appropriate behaviour from insurers

AIRMIC
Association of risk and insurance managers (i.e. at insureds) – has a number of industry interest and focus groups https://www.airmic.com/special-interest-groups

BIBA
British Insurance Brokers’ Association https://www.biba.org.uk/

  • Other

Media / social interest / pressure groups
e.g. “Climate-Wise” – and insurance industry group focusing specifically on the role and opportunities of the insurance industry in climate change (in conjunction with the Cambridge Institute for Sustainability Leadership) and the potential to be a useful partner.

Existing groups/bodies and NGO or other international entities
The Task Force on Climate-related Financial Disclosures[4] (“TCFD”), which aims to develop recommendations for voluntary climate-related disclosures by financial industries including in insurance

Climate Disclosure Standards Board

The World Bank[5]

UN Economic and Social Commission for Asia and the Pacific (ESCAP)[6]

The Pacific Catastrophe Risk Insurance Company (PCRIC)

WWF

Carbon Tracker

3. Potential avenues for intervention

There may be a number of ways in which any task force or monitoring arm established by the PICCIF could monitor, and encourage, engagement by the above industry players in relation to climate-change-friendly investments.  These methods could include:

  • Engagement with Government and Regulators
  • Engagement with “demand side” consumers, businesses and brokers
  • Obtaining information in relation to insurance industry investment and engagement with Insurers which can then be used to support any action/pressure taken under 1. or 2. above
  • Encouraging Shareholder Action

Some routes, such as direct government intervention via regulatory change, would obviously have more impact than others, but the ability to achieve that should be seen as a longer-term goal, and initial strategies may be better focused on increasing initial engagement with insurers, insurance intermediaries and consumers of insurance products.
We emphasise that our thoughts below are only preliminary and we would welcome the opportunity to work further on this in relation to these and other possible initiatives.

  • Engagement with Regulators / Government

Relevantly, on 6 June 2018 the Environmental Audit Select Committee published a paper “Greening Finance: embedding sustainability in financial decision making” which (at section 4)[7] discusses the potential implementation of mandatory climate-related risk reporting.  As that paper notes, the UK financial regulatory framework is inadequate to monitor and manage climate-change risk, and identifies the PRA, FCA, FRC and the Pensions Regulator, among others, as bodies which will need to play a role.

The Select Committee’s report and recommendations noted that:

Of all the financial regulatory entities surveyed, the PRA was the most advanced in relation to its stance on climate change.
The FRC announced a review, in December 2017 of the Corporate Governance Code, including the issue of a draft revised code.
On 17 April 2018 the Government issued an independent review of the FRC, which is due for completion at the end of 2018.
The UK Government could help to encourage momentum on climate-related risk disclosures by making an announcement at the G20 Summit in November 2018 that it will implement mandatory climate-related financial disclosures by 2022.
The FRC Corporate Governance Code and UK Stewardship Code could be updated.
While the FCA has some power, as part of its IPO prospectus approval obligations, to challenge “risk factors” with that prospectus, the FCA listing rules could be updated to better reflect climate-related financial disclosure obligations.
Sustainability reporting legislation, similar to France’s Article 173[8], could ultimately be enacted.
The FCA is a member of the International Organisation of Securities Commissions (IOSC) – this could be an opportunity for it to push for co-ordinated regulation of climate-related financial disclosure internationally (e.g. based on the TCFD recommendations).
The Select Committee had recommended to the Secretary of State for Defra that it require certain regulators to participate in the third round of Adaptation Reporting under the Climate Change Act 2008[9] the third round of which is due to take place from 2018.

Arising out of the above, any monitoring task force established by the PICCIF could undertake a number of specific steps, such as:

– Monitoring the Government’s present review of FRC.

– Monitoring the outcome of the FRC’s review of the Corporate Governance Code.

– Monitoring whether or not Defra has required regulators to participate in the third round of Adaptation Reporting under the Climate Change Act 2008, and, if so, monitoring the production of those reports.

– Lending support to or liaising with other bodies which may be prepared to encourage the FCA to take steps such as (i) exercising, where appropriate, its current listing approval powers to challenge risk factors within a proposed prospectus; and (ii) taking a stance in relation to the IOSC.

– Engaging with the PRA to raise its awareness of PICCIF and other Pacific-Island insurance bodies.  As part of this, PICCIF may be able to promote initiatives or strategies complementary to Solvency II to, for example, incentivise insurers:

–        by exploring and challenging whether a sub-asset class with a low regulatory capital requirement could be introduced for “climate-friendly” projects.  While we doubt regulators would go so far as to encourage investments in companies who are acting environmentally responsibly due to the risk of price and, therefore, investment fluctuations there is benefit in lobbying the longer term for to see if economic stability can be married up with investments in climate friendly projects/companies.
–        by challenging modelling under incentives such Solvency II Insurers. Under Solvency II insurers must hold sufficient capital to meet 1 in 200 year events, however, as the climate is rapidly changing, what may have once been a 1 in 200 year event may no longer be (e.g. losses caused by Storm Sandy were made directly more likely as a result of increased water levels caused by climate change).  If there is a way to challenge any disparity between the modelling used to by insurers to calculate risk (say, for example, on a 1 degree world) and realistic climate change modelling (say, for example, on a 4 degree world) to show that the capital requirements held by insurance companies are insufficient to meet the changing risks associated with climate change, this could be a very powerful means to challenge whether the insurance industry, and its regulators, are taking the risks posed by climate change seriously and, therefore, whether the industry is sufficiently prepared.

More generally, pressure could be exerted on the Government by way of contact with the following bodies and departments to make them aware of the PICCIF and its remit:

– the Department for the Environment, Food and Rural Affairs (Defra),

– the Department for Business, Energy and Industrial Strategy

– The Committee on climate Change: this is an independent committee established to provide advice to Government on preparing for climate change: https://www.theccc.org.uk/

  •  “Demand side” Engagement

Recent polls show that the British Public supports holding fossil fuel companies and the Government to account for climate change[10]. Against that background, the PICCIF taskforce could consider lobbying or engagement steps with consumers, businesses and insurance brokers, such as the following:

– Attend at or present to AIRMIC and BIBA or other industry group events to discuss climate change impacts in relation to insurance, and to promote and discuss how insured businesses and brokers can encourage change within the insurance market.  From a demand perspective, if large brokers and large businesses with multiple insurance needs show an interest in, and support for, obtaining insurance products and services from insurers who adopt climate-change friendly goals and investments, then this is obviously an incentive for such insurers to adopt such behaviours.

– Collate information (e.g. by way of surveys) in relation to issues such as individual, business and broker view of (anonymized) insurer behaviour in relation to climate change.  This could include, for instance, on issues such as: which insurers are tending to support or discourage climate-change-friendly actions e.g. are insurers including exclusion clauses relating to climate change in policies? Are insurers declining cover due to extreme climate-change events?  What information do insurers provide to prospective policyholders in relation to their climate change policies?  Such information then be used to support publications or studies in relation to market behaviour and the identification of systemic issues that could in turn support steps such as:

    • Further engagement with regulatory bodies (as above).
    • Identification of areas where policies may have been “mis-sold” as they are not fit for purpose in relation to climate change issues, or if insufficient information has been provided to allow purchasers of insurance to consider such risks.
    • Identifying whether consumer protection legislation (such as The Consumer Protection from Unfair Trading Regulations 2008) can assist.  Section 6 of this Act provides that a commercial practice is misleading if it omits or hides material information and as a result causes or is likely to cause the average consumer to enter a transaction it would not normally have undertaken otherwise: – e.g. consumer users of insurance products, if paying increased premia because they now live in flood-prone area, may be less likely to purchase insurance from a provider which invests in industries with practices known to contribute to climate change.
    • In this context, the support or monitor public challenges by businesses or individuals against institutions in respect of investments in climate change (whether in the context of insurance or otherwise, on the basis that all challenges ultimately support increasing transparency in the financial services industry).  For instance, a pension fund member in Australia has taken his fund to Court over a lack of information about what the scheme knows about the impact of climate change on its investments.[11]

– Engage with, monitor or lobby companies of a type in which insurance asset managers might invest, in relation to those companies’ disclosure regarding climate change.  At present, companies must only disclose how climate change affects their business.  However, for instance, directors of fossil fuel companies may be placed under increasing pressure to consider climate change risk in the context of business decisions.   For instance, the Philippines Commission on Human Rights is currently hearing evidence in relation to the human rights impacts of climate change in the Philippines, and it may link that to actions of various fossil fuel companies.  The PICCIF task force could monitor this and similar steps taken at an international level, which may open up additional avenues to place pressure on such entities in relation to their climate-change practices in future.

  • Obtaining information in relation to insurance industry investment / Insurer engagement

Another ongoing step could be to attempt to identify how insurance companies are using premia to invest. Insurance companies are notoriously secretive and it will be a challenge to obtain this information.  However, a possible avenue could include engaging with the Task Force on Climate Disclosures / Climate Change Disclosures Board to make them aware of PICCIF and its role, and through those entities obtain information provided by companies who are voluntarily participating in the reporting framework scheme(s).

More generally, the PICCIF task force could meet informally with private insurance industry bodies to take steps such as:

– Encouraging discussion on climate change and investments, particularly in the Pacific-Island context: in this regard, it might be useful to identify private insurers who have a specific presence both in operating directly in pacific island nations, but also those who operate in larger Pacific countries such as Australia and New Zealand.

– Engaging on developing products that encourage/reward green industries and insurance/investment products and give consumers more choice in this regard.

PICCIF may also have scope to support or arrange events or conferences which bring together senior personnel at private insurers with NGOs or other public-sector bodies involved in climate change.  Through this sort of contact information may be able to be obtained, on a more informal basis, as to insurers’ intentions in relation to investment, and would also be an opportunity change insurer perceptions.

Work with insurers to develop products that encourage/reward green industries and insurance/investment products and give consumers more choice in this regard.

  • Shareholder action under Companies Act

The efficacy of this approach would depend upon obtaining access to shareholders[12] of insurance companies (or companies in which insurance companies invest).  This is likely to have significant practical challenges, especially as the majority of insurers are privately held entities.  In addition, direct legal action is a costly step and may not be the most preferable approach when other more constructive avenues may exist. As such, we only comment briefly on possible potential shareholder action below.

UK-incorporated insurance companies (and also other companies in which insurance companies invest) owe a duty to shareholders to promote the success of the company under Section 172 of the Companies Act. This includes having regard to:

– the likely consequences of any decision in the long term,

– the interests of the company’s employees,

– the need to foster the company’s business relationships with suppliers, customers and others,

– the impact of the company’s operations on the community and the environment, and

– the desirability of the company maintaining a reputation for high standards of business conduct.

Shareholders can also bring claims for false or misleading statements under Section 463 of the Companies Act 2006, or under Section 90A of the Financial Services and Markets Act 2000 in relation to statements to shareholders or policyholders as to risk, and whether it is made clear that the company is in fact increasing that risk.

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[1] See, for example, the comprehensive report by the Prudential Regulation Authority, “The Impact of climate change on the UK insurance sector: A climate change adaptation report by the PRA” published in September 2015; and the more recent report by The Geneva Association, “Climate Change and the Insurance Industry: Taking Action as Risk Managers and Investors” (January 2018).
[2] See footnote 2 above
[3] http://aodproject.net/insurance/
[4] https://www.fsb-tcfd.org/
[5] The World Bank has already worked on an number of initiatives and investments in the region in this context http://www.worldbank.org/content/dam/Worldbank/document/EAP/Pacific%20Islands/climate-change-pacific.pdf
[6] E.g. in April 2018 ESCAP organised a New York-based event which hosted both pacific nation officials and private insurer to discuss climate change challenges
[7] https://publications.parliament.uk/pa/cm201719/cmselect/cmenvaud/1063/106307.htm
[8] Article 173-IV of France’s law on Energy Transition for Green Growth, implemented in January 2016, which provides for mandatory climate-change related reporting by institutional investors (including asset managers, insurance companies and pension funds.   Investors must report on how they integrate environmental, social and governance factors into their investment policies; and on how climate change considerations are incorporated.   Larger investors (total group balance sheet over Euro 500m) must also disclose how they address climate-related risks, and their contribution to international efforts to “cap” climate change.  The implementation of the law is due for a review at the end of 2018.    A useful handbook for investors in relation to the law was published by the French Forum pour L’Investissement Responsable in October 2016  https://www.frenchsif.org/isr-esg/wp-content/uploads/Understanding_article173-French_SIF_Handbook.pdf and Ernst & Young produced an analysis of how investors have met their obligations under Article 173 in December 2017: https://www.ey.com/Publication/vwLUAssets/ey-how-have-investors-met-their-esg-and-climate-reporting-requirements-under-article-173-vi/$FILE/ey-how-have-investors-met-their-esg-and-climate-reporting-requirements-under-article-173-vi.pdf
[9] This Act allows the Secretary of State for Defra to direct bodies with a public function to prepare a report containing an assessment of the current and predicted impact of climate change in relation to that organisations’ functions; and a statement of their proposals and policies for adapting to climate change, among other things.  The Environment Audit select committee recommended to Defra that the FCA, FRC and Pensions Regulator be required to produce reports in this round of reporting.
[10] You gov Poll 20 August 2018
[11] https://www.clientearth.org/twenty-three-year-old-takes-his-pension-fund-to-court-over-climate-change/.
[12]We note that insurance entities may be structured in other ways (e.g. mutual society) or a Lloyds’ syndicate, but we have not considered such structures for the purpose of this note.

[1] Pacific Islands Forum Secretariat – 2018 Forum Economic Ministers’ Meeting: Pacific Islands Climate Change Insurance Facility – 25 – 27 April 2018: https://www.forumsec.org/22018-femm-pacific-islands-climate-change-insurance-facility/