Janis Sarra, professor of law, University of British Columbia and principal co-investigator, Canada Climate Law Initiative
Climate change has become a prudential risk for Canadian insurance companies, requiring their attention as a fundamental business issue. Insurers are somewhat unique in that they have to manage climate-related risks on both sides of the balance sheet. On the asset side, insurers are significant investors and there are numerous risks to their portfolios as countries transition to net-zero carbon emissions. On the liabilities side, more frequent and severe wildfires, flooding, heatwaves and other acute and chronic events are increasing claims volumes while the probabilities of occurrence and severity of effects are becoming harder to price.
The insurance sector is important to effective management of climate-related financial risks because it provides the financial safety net for many Canadians suffering losses associated with climate effects. Severe weather damage in Canada caused $2.4-billion in insured losses in 2020, according to the Insurance Bureau of Canada. Uninsured losses are estimated to have been three times that amount.
Assessing, managing and underwriting risk is at the heart of the insurance business. As risk underwriters, insurers offer protection to people, businesses and governments by pricing, assuming, carrying and transferring risks to the insurer in return for a premium from policy holders.
To guarantee that policy-holder losses will be indemnified, insurers rely on pooling of risks, reinsurance and securitization to hedge their own risks. Yet climate-related weather events are growing in severity and frequency; in Australia and elsewhere, many businesses and homeowners are finding they can no longer get insurance if they are located in high-risk areas. Given the well-documented evidence of accelerating climate change in Canada, we cannot afford to have insurance become unaffordable, or even worse, have our assets become uninsurable.
Directors of insurance companies should ensure that the firm is assessing and managing climate-related risks across all product lines, services and operations. Under financial services legislation, directors’ duties are a prudential duty – directors have an obligation to ensure the company is managed wisely so there is sufficient capital that the promises to insurance policy holders and to annuities beneficiaries can be met.
Prudential supervisors have recognized climate change is a risk to the safety and soundness of Canada’s financial system and are heightening oversight of the board’s actions in this regard. The Bank of Canada says climate change “looms as a potentially large structural change affecting the economy and the financial system.” Insurers will have to build the actuarial and risk assessment models even as they are trying to manage the risks.
While Canada’s insurers have commenced climate-related risk management, and some are undertaking strategic planning to capture the upside potential of climate-related opportunities, most insurers do not yet have the data or modelling to understand the long-term effects of climate change. Many Canadian insurers have not yet embedded climate-related risks into their financial statements or business plans.
While Canadian securities regulators have not yet started to enforce breaches of securities law disclosure requirements in respect of climate change, they have cautioned that material risks must be disclosed. The announcement earlier this month by the U.S. securities and Exchange Commission that it will begin monitoring and enforcing material gaps and misstatements in issuers’ disclosure of climate risks is significant, and Canadian securities regulators are likely to follow suit.
Canadian insurers are at different stages of addressing climate-related risks. Key to fulfilling their duties, directors should ensure the board has in place effective governance mechanisms to oversee and manage climate-related risks and opportunities. Oversight of climate risk is both an immediate and longer-term obligation, and actions taken now could significantly mitigate adverse effects later.
The Canada Climate Law Initiative has issued a guide titled “Life, Health, Property, Casualty: Canadian Insurance Company Directors and Effective Climate Governance.” The guide discusses what directors in the Canadian insurance sector should be considering as they engage with climate-related risks and opportunities and develop strategic plans to address climate change. It offers an overview of the risks that insurers face on both the liability and asset sides of the balance sheet. It sets out the legal duties of directors of insurers and offers insights into best practices, including how directors of insurance companies can begin to implement effective governance, strategies, risk management and targets and metrics aligned with the Task Force on Climate-related Financial Disclosures (TCFD) framework.
The boards of insurers should develop an action plan to decarbonize, setting clear goals that can be immediately acted on and that will have measurable results over the next five years. We need insurers to remain viable, as their services underwrite policy holders’ risks across all aspects of the Canadian economy.