Introduction

The disastrous impacts of climate, nature and weather-related events in South Africa are far from novel. One needs to only look to the severe drought conditions in the Western Cape in 2015, the more recent extreme rainfall and consequent flooding in KwaZulu-Natal in 2022 and in the Western Cape in 2024 to see that South Africa is increasingly vulnerable to nature and the ever-growing risks associated with climate change, which in turn has an impact on insurers and the manner in which their business is conducted in South Africa. 

Damage occasioned by weather-related events are but one of many already prevalent and emerging risks associated with climate-change. 

Climate risks can be divided into three broad categories, namely:

1. Physical risks; 
2. Transition risks; and 
3. Liability risks. 

The balance of this article sets out to explain these categories of risks, as well as the role that can be played by insurers in respect thereof, by use of practical examples. 

Categories of risks

Physical risks

The physical risks of climate change are those observable events occasioned by climate change which give rise to some form of direct physical damage or loss, as well as concomitant business interruption or disruptions to supply chains. This includes both acute risks that are immediately observable and event driven (such as droughts, floods, extreme rainfall and wildfires) as well as chronic risks pertaining to longer-term shifts in climate patterns (rising temperatures and the loss of biodiversity). The impact that the materialisation of these risks can have is relatively well-documented, but often financially underestimated, especially in developing countries that struggle with unsuitable infrastructure to combat the immediate and long-term aftermath of weather-related events. 

To illustrate this, we make reference to the extreme rainfall and flooding in KwaZulu-Natal, South Africa in April 2022. In summary, in a period of less than 24 hours, parts of the KwaZulu-Natal province along the Eastern coastline of South Africa experienced in excess of 300mm of rainfall, being approximately one third of the average annual rainfall for the area. This extreme rainfall then led to severe flooding which was aggravated by numerous prevalent factors such as high-water table levels from prior rain seasons, ground water saturation, and poor infrastructure and service provision. 

The immediate physical damage and loss was plainly evident in the destruction of housing, and water and sanitation services. However, there were further impacts which were and continue to be severe such as the pollution of rivers, coastlines and the ocean due to flood debris, waste, plastic and sewerage) and the extensive reduction in mobility which led to business interruption and the disruption of supply chains.

Transition risks

Transition risks are those risks that may manifest in the shift towards a more climate-adapt and low carbon economy. A key component of counteracting climate change is the reduction in global greenhouse gas emissions to limit the global temperature increases. This transition or shift towards reduced greenhouse gas emissions is accompanied by a specific subset of risks.  

Examples of transition risks include:

• policy and regulatory risks for businesses either in an effort to constrain actions that contribute to the adverse effects of climate change such as carbon pricing or other forms of green taxation, or those that seeks to promote adaption. In this regard, it is key to note that on 23 July 2024 the President of the Republic of South Africa assented to the Climate Change Bill which is aimed at ensuring South Africa it on track to meet its commitments of reducing greenhouse gas emissions and to build climate resilience within the South African economy; 
• technological improvements and innovations, and the development and deployment thereof; and
• market impact due to shifts in supply and demand for certain commodities, products and services that are more climate-friendly or centric, which could be coupled with reputational risks for businesses and brands as well. 

A key example of a transition risk is that posed by “stranded assets”, being assets that are, prior to the end of their economic lifetime (as assumed at the time of investment decision), no longer able to earn an economic return. In simple terms, these are assets that turn out to be worth less than expected as a result of changes related to the transition to a lower-carbon economy. The extraction industry in Africa (given the numerous coal-fired power stations and high reliance on mineral assets at various levels of the extraction process) is at particular risk in this regard, but other sectors that use fossil fuels as inputs for production or which are otherwise carbon intensive, are similarly at risk. 

Liability risks

Liability risks relate to the legal liability exposures that may arise, either directly or indirectly from an entity’s business activities and could include claims against companies who are seen as responsible for causing or contributing to climate change, or engaging in harmful environmental practices. 

While climate litigation historically was directed against governments, there is a proliferation of litigation emerging against companies for, inter alia:

• ‘polluter pays’ cases that seek damages from companies (amongst others) based on their purported contribution to harm caused by climate change;   
• ‘greenwashing’ or ‘climate washing’ which can summarily be defined as false or misleading statements about the environmental benefits or soundness of a product or practice, such as the recent decision delivered by the District Court of Amsterdam regarding advertising used by the Dutch airline, KLM. More locally focused, in May 2024 a ‘greenwashing’ complaint was lodged with South Africa’s Advertising Regulatory Board against Total Energies, but no ruling has been made as yet; and
• ‘corporate framework’ cases regarding policy reforms and enforcement of climate-related duties such as the reduction of global emissions, as detailed in the case of Milieudefensie v Shell[1].

The Role of Insurers

So, what role does insurance, as a risk transfer mechanism, play in respect of the abovementioned three categories of risks? Insurers must ensure that they are not participating only at a responsive level (i.e. reacting to a risk that has already materialised for a policyholder) but in a proactive manner, predicting, preventing, and mitigating against these categories of risk through underwriting and their own business strategies. 

Insofar as physical risks are concerned, insurers should consider inter alia:

• collaborating with industry experts on the factors that contributed to past weather-related events such as droughts, extreme rainfall, flooding as well as the financial impact thereof, so as to improve predictability and proper assessments of a value at risk which incorporates a nature/climate element for purposes of underwriting; 
• the inclusion of policy conditions and underwriting requirements regarding the physical resilience of properties and assets as a means to assist with mitigation of physical risk; 
• reinstatement/replacement practices that are focused on ‘building back more resiliently’ so as to ensure the longevity and future resilience of insured assets; and
• given that losses associated with the physical risks are often widespread and extensive, insurer are encouraged to ensure that the reinsurance structures in place are sufficient and aligned. 

Insofar as transition risks are concerned, some aspects that could be considered include:

• the insurer’s own investment portfolios, so as to be cognisant of the financial risk and implications posed by potential stranded assets in a carbon-dependent economy;
• the imposition of conditions in existing products that require or incentivise a shift towards a low-carbon economy for policyholders; and
• the development of new/bespoke products that incentivise entities to become involved in decarbonization and carbon sequestration. 

In respect of litigation risk, most liability policies do appear to afford cover for legal liability in these circumstances. Insurers are therefore encouraged to carefully track and assess climate litigation trends regard so as to more accurately assess their potential exposure for various classes of policyholders in this regard, and to make informed underwriting decisions on the scope of this cover as against their own risk and commercial appetite. 

To this end, a recent report published by the Grantham Research Institute on Climate Change and the Environment[2] on Global Trends in Climate Litigation (“the Report”) indicates that globally there are around 2666 climate-related litigation cases across various forums and causes of action including ‘government framework’ and ‘corporate framework’ cases, human rights violations, ‘failure to adapt’ lawsuits, transition risk cases regarding the management of transition risks by directors and officers, ‘climate-washing’ and ‘greenwashing’ cases. 

Furthermore, the Report anticipates future trends in climate litigation to encompass inter alia recovery efforts following climate disasters (i.e. post-disaster cases) and environmental crimes and the development of the concept of “ecocide”. 

Concluding thoughts 

In summary, climate-related risks are present, growing and evolving. So as to properly adapt, insurers must be cognisant of their exposure to the abovementioned overarching categories of risks, their emergence and potential for continued emergence, and the impact thereof not only on policyholders, but on the business and commercial strategies of insurers as well. In doing so, insurers are encouraged to be proactive and establish mechanisms through which to better the prediction, prevention, and mitigation of each of these classes of risks. 

For more information on climate-related risks, the role of insurers, and how Clyde & Co can assist you in this regard and the services that Clyde & Co can offer you, please contact Amelia Costa or Celeste du Toit. 

[1] We note that this decision is presently under appeal. 

[2] Setzer J and Higham C (2024) Global Trends in Climate Change Litigation: 2024 Snapshot. London: Grantham Research Institute on Climate Change and the Environment, London School of Economics and Political Science.