Investor pressure to stimulate catastrophe re/insurance demand

Large corporations are under increasing pressure to disclose and ultimately financially protect themselves against weather, climate and natural disaster risks, the result of which will be a growing demand for insurance, reinsurance and risk transfer.

Artemis first wrote about the call to get corporations to take responsibility for their disaster and weather risks fives years ago. But in the last couple of years the pressure is mounting, with the United Nations and other global organisations now pushing for international accounting standards to include a level of disclosure.

The “1-in-100″ initiative, which looks to integrate climate and natural disaster risk into the financial system through a process of stress-testing and disclosure, is gaining support. It seeks to mandate that globally active corporations report their exposure to 1-in-100 year disaster losses and also their resilience efforts against weather and disaster risks on balance-sheets.

The idea is that by encouraging disclosure it will also encourage greater resilience. Corporations would look to become more physically and financially resilient to disaster and weather losses in order to improve their balance-sheets, which of course means greater use of insurance and risk transfer, resulting in greater need for reinsurance and risk transfer tools such as insurance-linked securities (ILS) and catastrophe bonds it is assumed.

The UN process is ongoing, with other organisations such as the World Bank heavily involved and engagement from across the financial, capital markets and business sector. The desire to get something in place to at the least encourage, if not mandate, disclosure of disaster and weather risks is high.

Interestingly, in some business sectors large shareholding investors are now pushing this same agenda as well, as they become increasingly aware of the threat that a changing climate and resulting heightened potential for disaster and weather impacts could have on their holdings.

Interestingly the sector that has most recently come under pressure is the U.S. oil industry. Key investors including some large private equity firms, alongside nonprofit groups such as Ceres and the Union of Concerned Scientists, have asked the five largest U.S. oil companies to disclose the risks their operations face from climate change impacts such as storm surge and rising sea levels.

The Guardian explains that oil companies, which may be among the most surprising to expect to change their ways due to climate change, have facilities and refineries which are greatly exposed to the impacts of storm surge, including that caused by hurricanes, as well as any rise in sea levels.

So the group of investors, that includes Calvert Investments, Pax World Management, Walden Asset Management, and the nonprofits such as Ceres, have sent letters to leading oil companies Valero, Exxon Mobil, Marathon Petroleum, Phillips 66 and Chevron asking them to disclose the risks their facilities face.

The letters discuss “the lack of public disclosure of physical risks due to climate change,” such as from sea level rise and storm surge or flooding.

The letters coincide with a Union of Concerned Scientists report, titled; Stormy Seas, Rising Risks: What Investors Should Know About Climate Change Impacts at Oil Refineries. The report states that oil company facilities and refineries are particularly exposed to growing climate impacts, with a particular exposure to rising sea levels and increasing storm intensity in the U.S.

The report notes that oil companies exposures are worth focusing on because:

• They are frequently built in low-lying areas, often near the coastline. 120 U.S. oil and gas facilities are situated within 10 feet of the local high tide line.
• They have long operating lives, and companies typically update or expand refineries in existing locations rather than building new ones.
• They do not have high profit margins, so any disruption in operations may have a material impact on cash flows for the company and ripple effects across the economy when the public pays at the pump.
• There is already a track record of disruptions to refinery operations due to climate-related events: recent storms such as Katrina, Rita and Sandy have caused significant refinery outages. Such events are likely to happen more often as climate impacts worsen.
• Communities adjacent to refineries are also vulnerable to climate impacts and have been disproportionately affected by spills, blasts, and other industrial accidents at these facilities.

Of course pushing an industry such as the oil or energy sector to take responsibility for its climate or disaster exposures is also a great place to start, given the industries link with climate factors such as warming.

The oil industry in the Gulf Coast region of the U.S. is particularly exposed to risks such as hurricane and storm surge. With low-lying refineries, storage tanks located close to shorelines, the potential for a major environmental disaster to occur after a natural catastrophe is clear. The impact to the oil companies and their shareholders is also clear, hence the push for disclosure being led by investors as well as science.

The report explains what can be expected due to the changing climate and that impacts may be interconnected:

• First, sea levels are rising. This is primarily due to the expansion of seawater as it warms and the melting of mountain glaciers and polar ice sheets. In the United States, sea levels are rising fastest along the East and Gulf Coasts, where many oil refineries are located.
• Climate change is also expected to increase the strength of coastal storms, so that when hurricanes form, they will fall into more intense categories.
• Both of these effects will amplify the impacts of storm surge—the rise of water above normal tide lines that accompanies severe storms such as hurricanes and nor’easters. As sea levels continue to rise, the flooding and destructive waves associated with storm surge will be more severe—and felt further inland.

Shareholder resolutions are seen as an effective way to push companies to become better protected and even to push them to be more climate friendly as well. Addressing the risks posed by weather, climate and natural catastrophes is a key aim for large investors around the world now, with an increasing expectation that the impacts of these events may be increasingly financially damaging.

The report states that stakeholders should respond in the following ways to serious climate risks:

• Companies should be more transparent about their risks from—and contributions to—climate change.
• The SEC should push companies to follow its guidelines for disclosing climate risks, educate them about how to comply, and go beyond guidance to issue a rule requiring companies to report on climate risks annually.
• Investors who have previously pressed companies to consider climate risks should continue to do so; investors new to these issues should focus on the financial effects of climate change and press companies and the SEC to improve their responses.
• Refineries should conduct facility-specific risk assessments; adapt their facilities to withstand climate impacts; reduce the global warming emissions of their operations; use safer inputs and processes whenever possible; be prepared to respond adequately to disasters when they occur; and be transparent about chemicals and processes used, safety records, and preventive measures.
• States should enact laws to enhance safety, transparency, and preparedness for climate impacts at refineries.
• The public should demand that companies not only consider physical climate risks, but also take appropriate steps to protect surrounding communities.

Now, the oil and energy industry is notorious for not using a great deal of insurance to cover its exposures. Case in point the Deepwater Horizon disaster, which cost tens of billions of dollars, but which only had an insurance industry impact of around $1.5 billion to $2 billion, far below the economic cost and payouts made by oil and energy companies and contractors.

BP alone paid $14 billion for response and clean-up, $13 billion for claims and settlements, as well as additional for assessments etc. BP has a captive insurer, Jupiter, which is not reinsured and was effectively drained of capital to pay for the disaster, which is what it’s there for but for shareholders it might have been preferable if the oil company had some reinsurance to recoup losses from.

Deepwater Horizon is an extreme example, but the energy industry does use a lot of captive retention which is not reinsured in the private market at all. The push to make oil companies disclose their weather, climate and disaster risks could result in a greater willingness to spend money on insurance, resulting in greater use of reinsurance and more opportunity for insurance-linked securities (ILS) and catastrophe bonds.

But this story is much bigger than just the oil industry. Global corporations, particularly those with large and interconnected supply chains, carry huge exposures to catastrophe and weather risks. Consider the clothing manufacturers in Indonesia which do not carry much insurance cover for earthquake and volcanic risks, companies like car manufacturers and technology firms that were so affected by the Thai floods and Japanese tsunami. All of these companies could be reporting their disaster and weather exposures on their balance-sheets, in order to encourage resilience.

As we’ve said before, the ILS market actually stands very well positioned to provide risk capital when it is required for these risks. Instruments using parametric triggers also seem very appropriate for covering risks in many disaster exposed regions for 1-in-100 year type exposures.

Could the push for disaster and weather risk disclosure result in greater uptake of catastrophe bonds, and similar instruments, by global corporations? It seems possible. The key is to be involved in this process and to have the industries voice heard.

It will be fascinating to see what agreements can be made at the upcoming United Nations World Conference on Disaster Risks Reduction held in Sendai, Japan in a few weeks time. The push for disclosure of disaster, climate and weather risks will continue there and broker Willis Group believes that this key meeting will “expand and deepen the role of the private sector and the insurance industry in ensuring the resilience of populations and assets to natural disasters.”

These efforts are about much more than growing insurance penetration and ultimately premiums for the insurance, reinsurance and ILS market. They are about increasing the world’s resilience while making corporations take responsibility for their exposures. However a side effect is likely to be growing catastrophe risk transfer demand, which the reinsurance, ILS and capital markets will be eager to support.

One things for certain, even the largest corporations will have to take note as their largest shareholders become increasingly vocal about the need to take responsibility for disaster exposures and resilience.

Further reading:

– Re/insurance and ILS have important role in climate change battle.

– Loss & damage wording survives climate talks, remains on UN agenda.

– Push for natural disaster stress-tests and disclosure of risks gains pace.

– Companies called on to disclose natural disaster risks.