Shit happens!

All economic activity can result into damage to the environment. Some activities are riskier than others. When shit happens, when damage occurs remedial actions are necessary. Such actions are more or less costly depending on the damage.

The European Union has adopted in 2004 the Environment Liability Directive (ELD), the purpose of which is to implement the ‘polluter pays’ principle, i.e., the one who has caused the damage also pays for the remedial action. There are now plans to renew the ELD. One of the difficulties of implementing the ‘polluter pays’ principle is that the actor responsible for the liability might no longer exist when the damage is found out.

Insurance means collecting assets in advance to cover losses arising some time in the future. An essential part of insurance is that this collection is risk-based, i.e., based on a scientific assessment, more risky undertakings pay a higher premium than the less risky ones.

The use of insurance means that each undertaking participates in the costs of pollution in a fair risk-based way. The use of insurance techniques does not mean that only insurers can offer the cover. At least in principle it is also possible to create financial market instruments that provide the financial means to finance the costs of the remediation of pollution.

Insurance is about creating incentives to take care and prevent risks to the extent possible. As losses still happen, as shit happens, insurance covers the losses arising after good risk management. The aspect of insurance being risk management is of particular importance to environment liability. As damage is often irreversible, actors should always be required to take best possible care of their activities. Preventing the risk is important – financing is not an alternative to that. But as shit happens there needs to be a backstop.

The AAE has published a discussion paper to help in the renewal of the ELD. The paper concludes that insurance could be one possible tool to implement the ‘pollutes pays’ principle. There is however much technical and market research to undertake before final conclusions. Actuaries should bear their social responsibility by offering their expertise to be utilized in the renewal of the ELD.

This column was originally published by the Actuarial Association of Europe AAE on 27 September 2022.