UK: Natural Catastrophes On The Increase - Impact On Insurers And Reinsurers

In this article we identify some of the perhaps less obvious areas of exposure which have the potential to cause huge financial loss to the insurance industry, and, perhaps, the reinsurance industry if the predicted rise in frequency and severity of natural catastrophes does happen.

Not surprisingly, in light of the potential magnitude of losses from a natural catastrophe, claims which seek to pin responsibility on corporate entities (said to be emitting the substances causing global warming) are starting to surface.

In the US, for example, Comer et al v Murphy Oil USA et al is a claim, filed by homeowners in Mississippi, which targets oil, chemical and utility companies doing business in the State of Mississippi in relation to their environmental emissions. The lawsuit specifically claims that the greenhouse gases emitted by the defendant companies contributed to global warming and that this intensified the effects of Hurricane Katrina. The plaintiffs' claim includes, amongst other things, loss of property, business and income.

Interestingly, growing litigation of this nature is not just a phenomenon coming out of litigious jurisdictions such as the US. Other parts of the world are also seeing a rise in liability claims linked to climate change. In June this year, directors of 20 companies in New Zealand which were considered to be heavy emitters of greenhouse gases or which had a significant proportion of their capital tied up in greenhouse gas emitting activities were served with notices from Greenpeace warning them of their potential liability for their contribution to the damage and cost of climate change. Serving notices on these companies and their directors means that they are now fully aware of the climate change risks which their companies face, and if they fail to act upon them, the companies (and, as we explain later, the directors) could find themselves exposed to enormous climate change related claims in the future.

Another example is Nigeria, where communities across the Niger Delta filed a case in June 2005 in the Federal Court of Nigeria against the government and a host of multinational oil companies, including Shell and ExxonMobil in relation to the flaring of gas in the region for over 40 years. Nigeria is the world's biggest gas flarer, a practice which results in huge greenhouse gas emissions. The plaintiffs argue that gas flaring is a gross violation of their fundamental right to life, which includes a healthy environment.

While these types of claim will face a number of legal hurdles, it is clear that if they are successful they would create tangible corporate liability for global warming. If class actions of this nature develop it would be similar to the early worldwide use of asbestos, or tobacco at a time when there was no perceived danger in their use. It is only some time later that the consequences emerged at staggering financial cost to the (re)insurance industry.

Directors and officers will now have to bear in mind that if they do not act appropriately in relation to identifying and dealing with the risks of climate change they could be running the risk of leaving a corporation vulnerable to a climate change liability claim. This is made more of an issue by the fact that the more information and publicity there is surrounding climate change, the greater the potential that a refusal to examine these risks could lead to a breach of the directors' fiduciary duties. The example above of Greenpeace issuing notices on the directors of 20 companies in New Zealand is a very good illustration of how climate change risks are being brought to the attention of directors or companies which will prevent them from claiming ignorance should climate change have a detrimental effect on their corporations.

If a company were to suffer financially due to climate change exposures, or if it fails to disclose climate change risks to its investors, it can expect to face large shareholder lawsuits for any losses suffered. Investors being kept in the dark about more traditional risks facing a company, and subsequently bringing large shareholder claims for financial loss suffered, have been occurring for years, particularly in the US.

These types of claim, if reaching the magnitude of the tobacco or asbestos claims, can easily be seen as a threat to the reinsurance industry where they are likely ultimately to accumulate. However, a recent case provides an interesting example of where the chain of insurance and reinsurance broke down in the context of an environmental claim from another jurisdiction and a significant gap in cover resulted for the insurer.

In Wasa v Lexington (2007), the underlying policy holder was Aluminium Company of America (Alcoa) which, in the early 1990s, was ordered to clean up pollution and contamination at various manufacturing sites in the United States which had occurred between 1943 and at least 1980. For a three year period (July 1977 to July 1980), Lexington insured Alcoa for these types of loss. For the same three year period, Wasa reinsured Lexington's insurance of Alcoa. The reinsurance included a "follow the settlements" clause.

As a result of litigation in the United States between Lexington and Alcoa (and a settlement following that litigation), Lexington was required to indemnify Alcoa for the clean up costs for contamination which had occurred over that 40 or so year period and not just for the contamination which occurred between 1977 and 1980.

Lexington sought indemnity from Wasa for the total clean up costs, and relied on the follow the settlements clause. Wasa refused to meet these costs saying that it was only liable for the losses sustained in 1977 to 1980. The English Commercial Court judge accepted Wasa's arguments and concluded that, although a US court had determined that the insurance policy covered the full 40 years worth of losses (and even though the consequent settlement between Alcoa and Lexington was honest and businesslike), as a matter of English law the reinsurance policy loss did not provide cover outside the three year period and the reinsurers were only liable for losses which fell within those three years (applying the second limb of the two stage test established in ICA v Scor (1985)). Accordingly, the insurer was left with a significant gap in its coverage.

Perhaps ominously for the insurance industry, this case (in its basic terms) involved the liability of an insurer in the US to indemnify its insured for the costs of cleaning up many years of environmental damage irrespective of having insured that entity for only three years. Whilst in Wasa the clause setting out the period of cover was important enough to supplant the 'back to back' nature of reinsurance, it may be the start of things to come that insurers are found liable for claims connected with environmental damage (particularly global warming) which they will in turn seek to pass on to reinsurers. The result for other reinsurers in a similar position may be less successful than it was for Wasa where the case turns on an issue which is less clear cut than the period of cover. The decision in Wasa is expected to be appealed in early 2008.

In the immediate future, insurers will no doubt see an increased incidence of claims based on the damage sustained from global warming. Time will tell whether that translates into a commensurate increase in claims made to (and met by) reinsurers and whether the industry is able to withstand the impact of potentially significant and numerous claims.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.