Climate change. It’s an issue that tends to polarise. But new legal opinion has put the topic square on directors’ agendas, whether they are believers or deniers.
In fact, after the memorandum of opinion by respected SC Noel Hutley and Sebastian Hartford- Davis “Climate change and directors’ duties”, it would almost be foolish for directors to be deniers.
The opinion says quite unequivocally: “It is conceivable that directors who fail to consider ‘climate change risks’ now could be found liable for breaching their duty of care and diligence in the future.” That’s the duty given legislative force by the Corporations Act 2001 under section 180(2) they are talking about.
“It is clear that climate change should, and must be, at the forefront of the mind of directors and leaders in general,” Ralph Ronnenberg, Munich Re Australia CEO, told Insurance Adviser.
“The legal advice introduces the concept of a risk in respect of climate change being ‘foreseeable’ – that is, not ‘far-fetched or fanciful’. We can see that foreseeability is different from probability in that while a risk is unlikely to occur it can nevertheless be foreseeable.
“This is a convincing issue in itself that directors must be proactive in their approach to climate change and must look to adapt or mitigate certain effects of climate change in their organisation.”
From an insurance perspective, looking at reinsurance data, it is clear that the incidence of major weather events are increasing and the cost of these events are rising too.
For example, Lloyd’s representative in Australia Chris MacKinnon points to Superstorm Sandy in the US, where it was found that the 20cm rise in the sea level at the tip of Manhattan since the 1950s increased storm losses in New York alone by 30 per cent. He adds the cost of weather-related events have increased dramatically – from an annual average loss of around US$10 billion in the 1980s to around US$50 billion over the last decade.
“So, for directors to stick their heads in the sand and say ‘I’m not worried about climate change’, it is not realistic. This is going to have to become part of their fiduciary duty. It is no different from the other emerging risks that are coming along now,” MacKinnon says.
Indeed, NIBA CEO Dallas Booth agrees: “What this advice does is really draw attention to the much higher risk of loss… It doesn’t really matter whether you put it down to climate change or something else, whether you agree with the science or not, whether you are a denier of man-made climate change or not, the reality is that the risk of loss is real and is increasing.”
And it’s not a scare campaign. “It is very valid legal advice from a highly respected senior counsel. Nobody has challenged the opinion as being flawed. It’s there and is a good reminder to people,” he warns.
There are two aspects to the advice. First, is the duty of care and diligence, which “obliges a director to obtain knowledge sufficiently to place themselves in a position to guide and monitor the management of the company”. This includes climate-related risks, how they might materialise, how they will impact the business and what can be done to meet that risk.
Directors need to look beyond the direct impact on physical assets from climate, such as storms or cyclones, Booth points out. The aspect of this is its impact on business operations and business continuity. “Even if your physical property is not subject to weather, will a major weather event affect your business operations? Because even if you are not directly affected, you could well be indirectly affected downstream by climate events.”
A case in point were the Northern Thailand floods over four or five years ago. MacKinnon says US car production ceased for two or three weeks because they couldn’t get component parts. “As a director of those car manufacturers, I’d be asking ‘where do we get our parts from?, is it exposed to any significant weather related activity?’,” he says.
“The international connectivity of the world is now becoming so significant that you can’t just keep ignoring issues like that.”
Certainly, MacKinnon believes it “makes sense” for directors to be held accountable. “Climate change is happening and directors have a responsibility to be aware of it, to plan for it, to prepare for it, to think about the consequences and look at the potential exposures to their business.”
It is clear that climate change should, and must be, at the forefront of the mind of directors and leaders in general.
Ronnenberg adds: “Proactive directors, even if they decide not to act, will be in a far better position than those who ignore the situation, particularly given the opportunity to seek relief under a statutory defence.”
Second, under ASX Listing Rules, directors who determine that climate change does pose risks to their business should consider the degree to which they are disclosed by the company.
On this point, Ronnenberg notes that there is a “variation” in the approach of Australian companies in their disclosure of climate change and sustainability risks within annual reports and that a uniform approach could perhaps be a proactive way in mitigating risk from a litigation perspective.
In terms of insurance, “D&O insurance will look to defend directors against actions in respect of defence costs and compensation awards,” he adds. “However, appropriate risk management, mitigation and understanding of the risks faced by the company is the best defence in avoiding D&O litigation.
“While a D&O policy will assist with dealing with litigation it will not protect the ultimate reputational damage that may be suffered… This can only be done by proactively managing the risks in question and anticipating concerns before they become an issue. Insurance is only a small part of the overall risk management and needs to be looked at in the wider context.”
Climate change impacts
Australia is “highly vulnerable” to increasingly intense storms, and the annual frequency of such storms are likely to rise, according to a recent report “Super-Charged Storms in Australia” from the Climate Council. (http://ow.ly/ ctNi3074mCe) In fact, Sydney is likely to see a 30 per cent annual increase, Melbourne 22 per cent rise and 14 per cent for Brisbane by the end of the century, it states.
Additionally, based on Lloyd’s City Risk Index 2015-2025, climate events like flood and drought, are in the top five threats to Australia and New Zealand cities, with GDP@Risk at $7.6 billion and $2.5 billion respectively. Not far behind are wind storms ($2.18 billion), solar storms ($2.11 billion) and earthquakes ($0.78 billion).
What’s in it for brokers?
“Every client is exposed to climate change,” MacKinnon puts it bluntly. “Get the discussion going, download reports, find your customer and ask them if they’ve read the reports and thought about what weather events could do to their business, their supply chain.”
“This is a chance for brokers to highlight that you are there to help your clients make their businesses long-term sustainable and less volatile. Engage with them in all aspects of their business, not just the transfer of risk, and understand what is important to them,” he advises. “It is something that brokers can use to differentiate themselves, so you are looking at how you can protect your client’s business, not just how you can protect client’s business’s assets and liabilities.”
Michael Herron, Arthur J. Gallagher national practice leader in Financial and Professional Risks, concurs.
“Providing risk and market insights to clients is key. This highly topical legal opinion provides an opportunity for brokers to engage with clients and demonstrate the value of advice and consultation. In a soft/transitioning market where placement strategy and premium savings have dominated client discussions, this is an opportunity to demonstrate the value of quality advice and risk consultation,” he told Insurance Adviser.
“It’s really about getting in and understanding clients’ needs and providing genuine insight into how they can best present their position to the insurer, and to consider the strengths and weaknesses that you think will be accepted or challenged by insurers.”
Herron explains that insurer sentiment is influenced by legal opinion and expert commentary. So: “Brokers and clients have to be very mindful of presenting factual, calm responses which address their specific situation… because that is what insurers are looking at carefully… How the insurer regards the client can be heavily influenced by the broker, so there needs to be care and skill when dealing with emerging issues. Brokers must ensure the quality and focus of communications are well managed.”
Asked about any immediate risk of climate litigation, he paints scenarios that could play out and that directors will need to take into account. It is indeed a warning to get on the front foot.
As Booth cautions: “I think litigation against directors for climate change is very likely. Companies that are not taking steps to protect themselves from related events could potentially face class actions. The advice is out there, it has been widely publicised. The risk is there, the law has been stated through the opinion, it hasn’t been challenged, so the class action financiers will no doubt support this if they get a chance to do so.”