Coming to terms with climate change risk in casualty insurance

These days, the (re)insurance industry tends to associate climate change with large property catastrophe (cat) losses arising out of extreme weather-related events, or with political and societal pressure the industry is facing when it comes to insuring certain industry sectors like thermal coal. Casualty underwriters are necessarily concerned with the latter, as their top lines will be affected by corporate decisions to exit certain problematic industry sectors.

However, casualty underwriters are likely thinking less about the potential bottom-line impacts of climate change on their loss ratios, preferring instead to leave those concerns to their property colleagues who are modeling rising sea levels to assess potential future risks to their portfolios. But to think of climate change as a property problem is risky for casualty insurers, who should be concerned about the effects of climate change on their combined ratios. Indeed, climate change has the potential to impact casualty insurers both directly and indirectly—and the industry must prepare and develop modeling tools to mitigate the very real potential for casualty systemic and clash events arising out of climate change.

Direct exposures to climate change for casualty insurers

Direct exposures to climate change for casualty insurers can be quite simply described as third-party claims alleging that an insured’s actions contributed to climate change, which led to weather-related events or rising sea levels that resulted in third-party property damage or bodily injury covered under the insured’s commercial general liability (CGL) policy. Currently, there are dozens of such lawsuits pending across the United States against more than 15 large oil and gas companies. In those lawsuits, states, cities and municipalities are suing the oil and gas defendants alleging that their operations dating back to the 1950s contributed to climate change and its environmental effects—including global warming and sea level rise—and that this resulted in injury or damage, including property damage to state coastal areas. The litigation resembles the opioid litigation in which cities and municipalities sued pharmaceutical companies to recoup the billions of dollars in costs spent on drug rehabilitation services, among other things.

The climate change litigation has been pending for four years while the parties engage in a drawn-out battle over whether the cases belong in state or federal courts. There have been no substantive rulings to date, and there are many outstanding questions that make it difficult to assess whether these lawsuits will be successful and result in significant, covered damages. One of the biggest questions is whether the plaintiffs will be able to prove causation, which is a necessary element of a negligence claim. Specifically, plaintiffs will have to prove through expert evidence that the defendants’ activities caused climate change (which in itself implicates the politicized question of whether climate change is real) and that this climate change in turn caused the specific property damage being alleged (e.g., coastal erosion in California). If the plaintiffs can get over that evidentiary hurdle and the judges allow the cases to go to juries, the question then will be how juries will evaluate damages and apportion them among the defendants who undeniably are not the only contributors to greenhouse gases on the planet.

In light of the current state of the US tort system, it is not unreasonable to postulate that despite the hurdles, at least some cases will succeed and that juries in certain jurisdictions will award significant sums in order to send a message to the oil and gas industry. Indeed, in the past few years, juries have awarded billion-dollar verdicts in pesticide and talcum powder cases despite dubious scientific evidence linking such substances to bodily injury. If a large verdict is rendered in the climate change litigation, or if the defendants are unsuccessful in summary judgment and opt to settle the claims for significant sums, then there may be a domino effect in which additional litigation is brought against other entities who also allegedly contributed to climate change. One could imagine, for example, lawsuits against utility companies, automobile manufacturers, airlines, railroads, farmers, construction material companies, and so on. Indeed, the list is endless as so many activities in the modern-day economy can be said to contribute to climate change. Moreover, even though many companies are taking proactive steps towards reducing their carbon footprint, civil litigation tends to focus on past harms—and juries rarely give defendants credit for their promises of a better tomorrow.

Indirect exposures to climate change for casualty insurers

The direct exposures described above—while difficult to quantify in terms of likely monetary impact—are nonetheless intuitive from the point of view of understanding how they implicate CGL coverage. But climate change creates other, indirect exposures that pose systemic risks perhaps not contemplated by many casualty insurers. Specifically, these indirect exposures are liability claims arising out of the same extreme weather-related events that property underwriters have been focused on for years.

To this end, in recent years there has been a growing amount of civil litigation arising out of weather-related events that has triggered CGL coverage. For example, after Hurricane Harvey, lawsuits were filed against oil and gas operators in Houston for property damage that occurred in conjunction with petrochemical spills during the storm. Likewise, a hospital in Louisiana was the subject of a class action and wrongful death lawsuits after Hurricane Katrina when generators failed and there was no evacuation plan in place during the storm. More recently, the Texas winter storms of 2021 resulted in a slew of wrongful death lawsuits against various utilities in the region, creating a potential clash event for CGL insurers who provided coverage to multiple insureds in this sector.

We anticipate this trend will continue and grow over time. Indeed, if climate change leads to more extreme weather-related events, there will be a knock-on effect for liability insurers as plaintiffs and subrogating homeowners’ insurers seek deep pockets to make them whole after a loss. The industry has seen this most acutely in California, where in the last ten years every wildfire has resulted in civil lawsuits against utility companies and their contractors. The practice has become so prevalent, and the dollar figures for such claims so enormous, that such companies in California are all but uninsurable from a CGL perspective, absent wildfire exclusions.

Insurers should also be concerned about how this developing trend might impact the construction industry, since many casualty insurers have expanded into this industry class in recent years. Here too we are starting to see an uptick in construction defect claims associated with extreme weather-related events like hurricanes. For example, one recent claim alleged that after a hurricane, water damage to the interior of a building was due to faulty installation of windows and not to the 130 mph winds that ravaged the building. While such claims may not seem meritorious, they are very difficult and expensive to defend against on account of challenges in proving (or disproving) causation. Compounding this problem is that there are long products-completed operations periods on construction project policies (typically ten years from project completion, depending on the particular state statute of repose). Therefore, if a CGL policy covers a project from 2010 to 2012 and there is a ten-year completed operations period after project completion, then a hurricane causing damage in 2018 could conceivably give rise to construction defect claims in that year relating back to the 2010-12 policy. Therefore, insurers need to think about the long-term projections for changes in weather conditions and topographies in areas most impacted by climate change in order to really gauge the exposure on their construction portfolios. If climate change causes more frequent or severe weather-related events, we can expect to see more claims of this nature in the future and need to consider the potential for those future claims on the policies we are issuing today.

Evolution of casualty modeling in light of direct and indirect climate change risks

Climate change presents systemic risk for casualty insurers and undoubtedly has the potential to lead to clash events within casualty portfolios. Casualty modeling tools are relatively new, but there is a lot of work being done to develop them into robust and reliable analytical tools, much as the property industry did in earnest 30 years ago. Indeed, several casualty cat modeling firms have gained traction in recent years in developing models for systemic risk events associated with mass torts such as opioids or glyphosate. Such tools have promise in relation to modeling direct exposures such as the direct climate change risk described above, but their accuracy and utility is somewhat undermined by the poor quality of data being captured by insurers. Specifically, these modeling tools rely on insurers’ casualty portfolios having industry code classifications assigned for each risk (e.g., North American Industry Classification System [NAICS] codes). Unfortunately, insurers have not consistently adopted NAICS as an industry classification standard; and even fewer have incorporated that data point into their underwriting systems.

When it comes to indirect risks presented by climate change, the casualty industry should work on adapting property modeling tools that rely on geographic data rather than industry classifications. In order to do this, casualty underwriters must capture accurate data on physical risk location as a matter of course during the underwriting process in addition to the other information they typically collect to assess liability exposure. Property geocoding programs could map insured locations to show areas of geographic concentration and modeled storm propensity, and then other assumptions could be factored into the analysis—such as legal jurisdiction or litigation rates—in order to account for the variables unique to liability exposures.

Where do we go from here?

Climate change is no longer a topic reserved for property cat underwriters. The risks to casualty portfolios are very real and will increase over time as the effects of climate change intensify and the US tort system continues to be used as a mechanism to hold companies accountable for societal ills and natural events. Casualty insurers will be directly affected through third-party claims alleging that insureds contributed to climate change as well as indirectly affected through third-party claims arising out of property damage or bodily injury caused by extreme weather-related events. Now is the time for the industry to wake up and start creating tools to prepare for potential systemic and clash events associated with climate change so that we will be prepared to face these risks head on.