United States: Climate Change Insurance Alert – Are You Covered?

According to the Munich Climate Insurance Initiative, an international effort of Munich Re, the UN, World Bank and other experts,

Pakistan's current flooding is the worst recorded natural disaster in that country's history.  If, as many scientists and analysts think, these events are harbingers, now is the time to consider how insurance can protect companies against future climate-related disruption and risk.

Although no one has yet successfully sued a company for climate change damage allegedly caused by greenhouse gas ("GHG") emissions, lawsuits blaming industrial emitters for global warming, extreme weather events and other natural disasters are pending in Alaska, Washington, D.C., California and Louisiana.  Shareholder resolutions to force companies to limit their carbon emissions are becoming commonplace, and corporate executives and risk managers are becoming ever increasingly concerned about business risks related to climate change.  Our previous update, Part One:  Climate Change Risk Management, reviewed some of these risks.

Although climate change issues and claims are still relatively novel concepts, this update highlights the extent to which such risks may be covered under a corporate policyholder's insurance program.  In particular, we discuss the policies that most businesses already should have in their portfolios: comprehensive general liability, directors and officers liability,  and first-party property damage and business interruption policies..  Our discussion is, of course, necessarily general in approach. In every case, the specific language of each policy will ultimately determine whether coverage exists.  Accordingly, we recommend that risk managers, with the assistance of insurance counsel, carefully review their potential GHG exposures and assess the adequacy of their existing or proposed coverage programs.

These issues will affect Canadian policyholders as well as U.S. companies.  Although lawsuits aimed at local companies relating to GHG emissions are probably less likely in Canada, Canadian companies with U.S. shareholders or interests in the United States could be affected by U.S. GHG litigation.  In addition, because derivative shareholder litigation is easier to commence in Canada, and often easier to certify as a class action, Canadian directors and officers may be exposed to wide-ranging claims based on allegations of nondisclosure or mismanagement of their company's environmental activities. 

II.        Comprehensive General Liability ("CGL")

CGL insurance generally protects companies from claims that a policyholder's activities caused property damage or bodily injury to a third party.  If recent trends in climate change litigation continue, climate change damage lawsuits will become more common and may force policyholders to seek coverage under their CGL policies.  CGL insurers may, in turn, assert various defenses to coverage for climate change damage.  Some of the most common anticipated defenses are discussed below.

A.        An Insurerv May Attempt To Deny Coverage Under a "Pollution Exclusion."

Before 1973, CGL policies typically did not contain specific pollution exclusions.  Accordingly, pre-1973 policies may prove valuable, because Plaintiffs often allege that climate change damage was caused by emissions going back decades.  Therefore, insurance policies that were in force in the pre-pollution exclusion era may be triggered by lawsuits filed in the future and become valuable assets in protecting the corporate policyholder from both the costs of defending against such claims as well as from any damages that the policyholder may incur in connection with any settlement or judgment arising out of such claims.

After 1973, pollution exclusions became common.  Indeed, most current CGL insurance policies contain pollution exclusions that purport to bar coverage for bodily injury or property damage "arising out of the discharge, dispersal release or escape of smoke, vapors, soot, fumes, alkalins, toxic chemicals, liquids or gases, waste materials or irritants, contaminants or pollutants into the atmosphere."  This language is extremely broad and arguably could include almost any discharged substance, regardless of whether it comes within the scope of common notions of "pollutants.".  Accordingly, the debate between policyholders and their insurers probably will center on whether carbon dioxide and other GHG emissions  are "pollutants" within the meaning of a standard-form pollution exclusion.

Significantly, in 2007, the U.S. Supreme Court specifically included greenhouse gases as "pollutants" under the Clean Air Act. Massachusetts v EPA, 549 U.S. 248 (2007).  Thereafter, the Environmental Protection Agency ("EPA") issued a finding that GHGs threaten public health and welfare of current and future generations, 74 Fed. Reg. 66496, (December 15, 2009). Although such decisions are not dispositive when construing insurance policy language, insurers undoubtedly will latch onto both the US Supreme Court's and the EPA's determinations as a basis for applying their pollution exclusions to climate change-related claims and liabilities.

Notwithstanding the Supreme Court's and the EPA's pronouncements, most states distinguish "traditional industrial pollution" from other releases.  "Natural" substances such as carbon dioxide, which is produced by all animal metabolisms, may not be treated as "traditional industrial pollution" within the meaning of such typical pollution exclusions.  However, it is too early to know whether courts will define GHG emissions as falling within the scope of a standard-form pollution exclusion.

B.        Insurers May Deny Coverage Under an "Intentional Acts Exclusion."

CGL insurance policies generally provide coverage for property damage or bodily injury resulting from a policyholder's negligence, reckless behavior or from an "accident."  In other words, most CGL policies exclude property damage or bodily injury that the policyholder intentionally caused.

In the context of GHG emissions, while emitters typically knew they were releasing carbon dioxide and other gases, they did not know -- and may deny to this day -- that such gases had any damaging properties.  Simply put, while the releases, themselves, were neither negligent nor accidental, any damage purportedly arising from such emissions not only was not intended, it probably was not even foreseen.

This significant distinction may not deter insurers from attempting to avoid coverage for climate change claims on the premise that emissions, themselves, were intentional acts.  Fortunately, insurers have the burden of proof on any exclusion and may find it difficult to prove that policyholders intentionally caused any extreme weather events or, more importantly, any resulting property damage or bodily injury. 

III.         Directors & Officers Liability Insurance ("D&O")

In addition to lawsuits alleging climate change-related property damage on bodily injury, there is also the prospect of securities-related lawsuits.  For example, by requiring disclosure requirements that relate to climate change, the SEC has created a scenario where a corporation could be held liable for failing to make adequate disclosures.  Accordingly, securities class action lawsuits could be filed against public companies on the basis of an alleged connection between a drop in share price and a climate change event.   

Companies that face securities lawsuits or regulatory action based on such SEC mandates, should look to their Directors and Officers ("D&O") liability insurance.  Such insurance provides coverage for a "Loss" that directors and officers become obligated to pay for "wrongful acts" – such as an inadequate climate change disclosure – and also provides coverage to the company itself for securities claims. 

However, like CGL policies, D&O policies typically exclude pollution-based claims and claims of bodily injury or property damage alleged in shareholder derivative or regulatory lawsuits.  Analysis of whether a D&O pollution exclusion policy bars coverage for a given claim will be somewhat similar to the analysis under a CGL policy.  The principal inquiry probably will be whether GHG emissions constitute "pollutants" within the meaning of the policy's pollution exclusion.  To exclude climate change claims under a D&O policy pollution exclusion, an insurer should have to show that the allegedly wrongful business act—here, inadequate disclosure, not GHG emissions—caused the damage that is the subject of the claim. 

The extent to which courts will enforce pollution exclusions under D&O policies varies by jurisdiction.  Some state courts apply a broad "but for" standard—which could link many GHG-related liabilities to a variety of business acts—while other state courts apply a more stringent standard—which could require the insurer to prove that a given GHG-related liability unquestionably arose from the alleged wrongful act.  In a shareholder lawsuit alleging that a company misrepresented its exposure to GHG emission claims, application of a D&O insurer's pollution exclusion would have to depend on whether liability resulted from the pollution itself or was actually linked to the directors' and officers' incomplete or misleading statements in the company's disclosures.

IV.       First-Party Property Damage and Business Interruption Insurance ("PD&BI")

First-party property damage and business interruption insurance typically protects a policyholder against risks to its property or operations.  In general terms, first-party policies cover a policyholder for the value of its physical property if it is damaged or destroyed as a result of a covered risk or peril.  Some first-party policies are "all risk" policies, meaning that they cover all causes of the loss, other than causes expressly excluded.  Other first-party policies provide coverage only for "named perils," which means the specific cause of the loss must be expressly included in the policy.  Perils typically include fires, explosions, winds, lightning and, often hurricanes or "named windstorms."

Business interruption coverage indemnifies policyholders for income lost when damage to covered property disrupts the policyholders' business operations.  Typically, recovery is limited to income lost during repair or replacement of the damaged property.  In addition to damage to property and interruption of business operations, typical first-party policies include coverage for the:

• Costs incurred to avoid or minimize a loss;
   
• "Extra expense" costs beyond normal overhead costs, incurred as a result of hurricane or other peril, including debris removal; and
  
  
• Revenue lost because:
   
  • customers could not take delivery of product or services;
     
  • the business lost access to utilities or supplies;
    
    
  • access to the business premises was impaired or restricted; 
    
    
  • a civil authority's order (e.g., an evacuation order or curfew)

After Hurricane Katrina, disputes often arose between policyholders and their insurers because policies typically provided coverage for "hurricanes", but excluded coverage for floods, (storm surge floods caused most of the damage).  Although a policy which fully covered hurricanes, but excluded coverage for the inevitable storm surge floods, seemed internally inconsistent, many courts enforced the flood exclusions in first-party policies.  As climate change and extreme weather event exposure becomes an increasing business risk, policyholders should clarify the extent to which their first-party policies provide coverage for all of the perils associated with severe weather events, such as a hurricane.

V.        Canadian Policies

Broadly speaking, similar considerations will apply to the interpretation of Canadian insurance policies, and similar strategies should be expected from Canadian insurers and policyholders.  Canadian jurisprudence on pollution exclusions is relatively modest but generally supports the narrow interpretation of clauses.  In some respects, the current insurance market in Canada may provide generally broader coverage, including coverage for defense costs or even indemnity against pollution claims, along with coverage for shareholder claims arising from pollution issues.  Generally, the law concerning insurance coverage is common across Canada, apart from the Province of Québec, thus, avoiding the wide variation from state to state in the United States.

The involvement of Canadian companies in U.S. environmental litigation has already given rise to substantial litigation concerning whether Canadian courts should exercise jurisdiction over insurance coverage claims arising from U.S. environmental litigation, and whether the courts should apply Canadian or U.S. coverage law. In Teck Cominco Metals Ltd. v. Lloyd's Underwriters, 2009 SCC 11, [2009] 1 S.C.R. 32, the Supreme Court of Canada declined to stay litigation in British Columbia concerning insurance coverage for underlying environmental litigation in the State of Washington concerning contamination of Lake Roosevelt, even though there was parallel coverage in a U.S. district court.  In another Canadian case, a British Columbia trial court recently took jurisdiction in a case involving  D&O liability coverage for directors of a Canadian subsidiary under D&O policies issued by U.S. insurers to a parent corporation located in Oregon: In re Pope & Talbot Ltd., 2009 BCSC 1552.  These cases indicate that the choice of forum or governing law between a Canadian and a U.S. jurisdiction may make a considerable difference as to the result.

VI.       Emerging Insurance Products

In addition to the traditional insurance products discussed above, corporate risk managers should carefully review their company's coverage profile as it pertains to climate change exposure and consider the following emerging insurance products:

• Liability insurance clauses that confirm that GHG emissions are not subject to the pollution exclusion;
  
  
• Insurance that expressly covers the costs of GHG measurement and verification (carbon footprinting), and the obligation to purchase carbon credits; 
  
  
• Property coverage enhancements for energy efficiency or "betterment" repairs; and
  
  
• Specialty coverage for investments in "offsets" or other carbon credits.

VII.     Conclusion

We continue to wait for a definitive decision on whether GHG emitting businesses will face liability for climate change damage or some of the other risks discussed above.  However, in the past five years, a broader consensus has arisen that climate change risk exposure for the corporate sector is real and increasing, even if it limited to damages that affect business property and operations as a result of extreme weather events.  Until the extent of this risk can be determined with confidence, risk managers should review their existing and proposed insurance policies and prepare to clarify or modify their coverage profiles to protect against potential climate change risk to their firms and their operations.

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.