Coal, climate change and capital – Part I

23 September 2020
Knowledge Base

by Lieve Lowet

This blog is the first of a series of three articles written by me about coal, climate change and capital. The articles will be published on three consecutive days. 

When I googled “how relevant is coal for climate change”, the first answer which popped up was “coal is the single biggest contributor to anthropogenic climate change. The burning of coal is responsible for 46% of carbon dioxide emissions worldwide and accounts for 72% of total greenhouse gas (GHG) emissions from the electricity sector.” Phasing out coal from the electricity sector is the single most important step to get in line with the 1.5°C reduction target as laid down in Article 2 of the Paris Agreement. In that context, do insurers and reinsurers want to be part of the problem or part of the solution?

Insurers and climate-related risks

Climate-related risks, including coal and coal-related risks, impact insurers as asset owners, as asset managers and as underwriters. Whereas over the last years, attention, policy focus and (some) progress has been on the asset side (see for example EIOPA in its Financial Stability Report of July 2020, p. 100), this blog focuses on the liability side and the role of insurers and reinsurers in underwriting coal and coal-related risks. It does not describe what policymakers and the sector are undertaking on the asset side.

The three climate-related risks for insurers and reinsurers were described in 2015 by Mark Carney, at that moment governor of the Bank of England and chairman of the FSB, in his famous speech Breaking the tragedy of the horizon at Lloyd’s of London. These risks are, according to Carney, (1) physical risk, or the impacts today on insurance liabilities and the value of financial assets that arise from climate- and weather-related events, such as floods and storms that damage property or disrupt trade; (2) liability risks, or the impacts that could arise tomorrow if parties who have suffered loss or damage from the effects of climate change seek compensation from those they hold emitters – and, if they have liability cover, their insurers – the hardest; and (3) transition risks: the financial risks which could result from the process of adjustment towards a lower-carbon economy. Changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent. But regarding liability risk, will it really come decades in the future?

Enabling coal by underwriting

To understand the different coal policies of financial institutions, Reclaim Finance, a French non-governmental organisation and think tank, has launched in early September a Coal Policy Tool. Its main goal is to encourage high-quality coal policies, which is essential to reach the Paris Agreement goals. The tool rates the coal policies of about 500 financial institutions, situated in Europe and across the world. The tool includes banks, asset managers and 32 insurers and reinsurers as underwriters, 61 insurers and reinsurers as asset owners and more than 20 insurers and reinsurers as asset managers. It does not include captives. In insurance, the tool builds on earlier work such as the scorecard of Unfriend Coal which started its campaign 3 years ago.

According to Reclaim Finance, coal mines, coal-fired power plants and associated facilities (such as railways and coal ports) are capital intensive and face serious physical, technical, legal, political and management risks; as well as counterparty and credit risk. Insurers, and their reinsurer to whom part of those risks are transferred, thus play a critical role in new coal projects. But insurers’ property coverage for projects that are already built are also necessary, enabling the continued operation of existing coal projects.

In addition, insurers also provide several other types of coverage to coal companies and associated facilities, such as worker’s compensation or employer’s liability coverage, transport and transit (carrier) insurance, healthcare plans, etc. And Directors & Officers (D&O) cover protects the managers of these companies from claims related to decisions and actions they take. The Rio Tinto scandal, albeit iron ore and not coal, and destruction of an ancient Aboriginal site instead of the climate, may be a case in point. Shareholders and investors revolted in a landmark case of activism. Given the impact of coal on climate and on the insurer’s financial health, a coal policy should be a no brainer, shouldn’t it?

Focus on liability risk

In a recent speech, five years after Mark Carney’s famous speech, Anna Sweeney, Executive Director of the Insurance Supervision Division of The Bank of England warned commercial insurers again, to consider liability risk. These risks could arise for insurers from parties who have suffered losses from climate change, for example from companies misreading the transition risk, or who have suffered the consequences of physical risk, and then seek to recover those losses from others who they believe may have been responsible.”  Sweeney’s comments fit in with the main finding from a Moody’s Investor Service February 2020 report “We view [insurance companies’] retreat from coal as credit positive, as it protects them against potential climate change liability risk…”. EIOPA in its Opinion on Sustainability within Solvency II of September 2019 noted but decided not to include this liability risk. Could underwriting cover for coal mines, coal-fired power plants and associated facilities (such as railways and coal ports) be such an example?

If insurers and reinsurers do not have a sufficiently clear coal exit policy, how can they identify, monitor and manage that important climate-related liability risk? According to Anna Sweeney, Executive Director of the Insurance Supervision Division of The Bank of England in her 9 September speech “the developing of enhanced approaches to managing climate-related risks remains a novel process for many. There is still some way to go for a number of insurers in terms of embedding a climate risk management strategy which is underpinned by regular scenario modelling and accompanied by detailed climate disclosures of both sides of the balance sheet.” So, will insurers and reinsurers of coal mines, coal-fired power plants and associated facilities find themselves in the eye of the (liability) storm? And what can be learned from the pandemic risk surprise in certain business lines?

The author, Lieve Lowet is an EU Affairs consultant and lobbyist since 2003, focuses on European dossiers relevant for the insurance and pension sector. From 2003 to 2008, she was Secretary-General for the international mutual insurance association AISAM (now AMICE), which accounted for 15% of the European and 6% of the world insurance market. Prior, she worked for McKinsey as a European banking and insurance expert. 

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