Part 3: The financial fallout of greenwashing: Navigating D&O insurance in the age of emerging litigation risk
Written by Adam Grossman Ph.D. - Director, Head of Emerging Risk
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In an era in which environmental claims can make or break a company's public image, the rise of greenwashing lawsuits presents a critical challenge for directors and officers (D&O) insurers. As companies face mounting legal battles over allegedly misleading ESG claims, the financial stakes have never been higher. This surge in litigation not only threatens significant D&O losses but also demands a re-evaluation of risk assessment strategies in the rapidly evolving landscape of corporate environmental accountability. For D&O insurers, understanding these emerging risks isn’t just prudent — it's imperative.
For example, an Australian company is currently defending itself in court for allegedly false claims that it had a viable net-zero plan [1]. A California cosmetics company is being sued for falsely claiming its products are plant-derived [2]. Los Angeles recently sued beverage companies over misleading claims that the plastic they use to package their products could be recycled [3]. These lawsuits and others like them can lead to both securities class actions and derivative lawsuits seeking that the directors and officers pay damages to the company’s shareholders. Most companies indemnify their directors and officers via D&O insurance policies.
The suits mentioned above center around specific statements made by the company to its customers, shareholders, or both, which are later alleged to be greenwashing. In most cases these are one-off types of lawsuits because of the company-specific nature of the claims. Even several claims around allegedly false or unattainable net-zero commitments will rely on hyper-specific information about what each company said and how it was misleading. This kind of idiosyncratic risk is adequately managed when underwriting a D&O insurance policy. To make sure D&O underwriters aren’t in the dark about existing or past claims, at Praedicat, a Moody’s company, we’ve built a securities class-action litigation tracker that can link directly to other underwriting and portfolio information to streamline this type of D&O risk assessment.
However, there is another class of greenwashing-related D&O risk — a systemic risk arising from underlying correlated risks caused by commercial activity. These risks manifest when an external event triggers similar consequences for a broad range of companies in the market. At Praedicat, we’ve also developed scenarios that quantitatively model what could happen if some of these events manifest and lead to correlated loss to D&O portfolios. We will discuss three: methane emissions greenwashing under the US Inflation Reduction Act, various claims regarding plastic recycling, and voluntary carbon offsets.
Methane emissions
Methane is approximately 85 times as powerful a greenhouse gas as carbon dioxide in the short term. This has led some scientists to claim that if we could cut our methane emissions by 50%, we could gain several more years of leeway to meet the Paris Agreement’s goal (whether the United States rejoins it or not) and stem the worst consequences of global warming. Recognizing methane’s importance to both the short- and long-term climate fight has led to various regulations and restrictions around the world, including new methane emissions requirements and fees in the 2022 Inflation Reduction Act (IRA) in the United States.
Starting in 2024, the text of the IRA, as written in 42 US Code § 7436, imposes fees on methane emissions from oil and gas extraction activities if the methane emissions cross a set threshold [4]. Companies would then pay a fee for every metric ton of methane emitted beyond the threshold at rates of $900 per metric ton in 2024, $1,200 per metric ton in 2025, and $1,500 per metric ton in 2026 and beyond. The IRA also imposes new requirements that companies directly monitor and measure their emissions rather than using an older method of estimating their emissions based on the equipment they used. The older method has become notorious in the scientific community for being susceptible to manipulation, such as by changing the estimate of how often gas runs through a specific part of the line.
Climate scientists have also recently begun stronger methane emission surveillance operations to help pinpoint emissions that could be stopped. Using a combination of satellite and aircraft data, some companies have been able to model the precise location and identity of US-based sources of methane emissions, including attribution to the oil and gas companies that own the wells.
The influx of new data leaving little doubt about the source of methane emissions alongside potentially significant regulatory fees creates the perfect opportunity for several companies in the industry to simultaneously have to restate past methane emissions numbers while paying large fees that directly reduce their profitability. In turn, this presents investors with the potential devaluation of their holdings in those companies given that fines could reach into the tens of millions of dollars in the first few years.
We’ve modeled the potential stock drops associated with companies having to unexpectedly pay methane emission fees and how that could lead to lawsuits alleging that the companies engaged in greenwashing by understating their past and current methane emissions (including by gaming the older reporting system) and the potential that they would have to pay significant fees for their emissions. In total, the oil and gas industry could be liable for as much as $1 billion in D&O losses that could flow through to insurers.
Plastic recycling
We have long been told that it’s acceptable to keep using single-use plastic products and packaging because it can all be recycled. While it was known initially that 100% recycling rates were aspirational, it has recently become clear that far less plastic is being recycled than most people knew — rarely even as much as 10% of plastic makes its way through recycling processes and into new products.
Meanwhile, more than 250 companies have joined the joint “global commitment” from the United Nations Environment Programme and the Ellen MacArthur Foundation to publicly declare their intention to use only 100% recyclable, compostable, or reusable packaging by 2025. Companies who’ve made this pledge are relying on a combination of strategies to meet their declared targets, including moving from plastic to compostable or reusable materials, traditional recycling, and so-called “advanced” or “chemical” recycling.
Unfortunately for those companies, their investors have come to realize that the likelihood of these companies meeting their 2025 goals is essentially nil, as evidenced by a letter from the Dutch Association of Investors for Sustainable Development calling on three dozen companies to move faster to eliminate single-use packaging from their products. The letter specifically states that companies that delay their transition away from single-use plastic risk the company’s longer-term value creation because of lost business opportunities and higher costs to transition away from plastic in the future.
We built a scenario that models the fallout from the growing realization that these companies cannot meet their targets under the global commitment and the increasingly stringent regulatory requirements to eliminate plastic. In this scenario, investors learn that accomplishing the transition will be significantly more expensive than previously disclosed, leading to significant erosion of shareholder value in these companies. Investors who lose money file securities lawsuits alleging the companies engaged in greenwashing by relying on plastic recycling as a way to meet their commitments. Payments to shareholders, potentially covered by D&O insurance, rise into the billions of dollars.
Voluntary carbon offsets
Many companies have made public pledges to reach net-zero carbon emissions by certain dates. To help them achieve these goals while they work on transitioning their businesses to activities with lower emissions intensities, some companies purchase voluntary carbon offsets on the open market [5]. The theory is both simple and appealing: If I can pay somebody to prevent 1 metric ton of carbon from being emitted while I simultaneously emit the same amount of carbon dioxide, I haven’t contributed to the global burden of atmospheric carbon.
This is simple in principle but difficult in practice.
For a carbon offset to accomplish its goal of reducing carbon emissions, it needs to satisfy several criteria. Two of the most difficult and vexing criteria to satisfy are “additionality” and being free of “leakage.” The former refers to the simple concept that paying somebody for a “carbon offset” accomplishes nothing if the payment’s recipient was already going to do the carbon-saving activity. Instead, the offset must induce the recipient to do something “additional” beyond what they otherwise would have done. Naturally, this is difficult to verify, although some climate tech companies purport to offer solutions to this problem.
Leakage, however, is an even harder problem. It refers to the notion that the carbon-saving activity cannot simply push an equivalent carbon-emitting activity to another place. For example, if I provide an offset by planting 1,000 trees on land formerly used for grazing and somebody else cuts down an extra 1,000 trees for grazing land elsewhere, my carbon offset has been nullified by the leakage.
Scientists and advocacy groups have long been saying that carbon offsets will not solve the climate crisis, but recent attention on the specific ways in which they fail to accomplish their goals has led some to speculate that as this understanding spreads, the price of a carbon offset would necessarily trend toward zero and the market would therefore collapse. If this were to happen, companies that have become heavily reliant on offsets to mitigate their climate impact would have to change their approaches at very significant costs. As shareholders became aware of this via reduced estimates of future earnings, they could sue the companies, alleging they engaged in greenwashing by buying unreliable carbon offsets instead of spending the money on reducing their emissions directly. We model the lawsuits’ potential size in the $10 billion range.
Looking ahead
We’ve described here three ways in which exogenous events can lead to large and correlated drops in stock prices across significant segments of the business world that could result in large-scale D&O losses. Each of the scenarios described above is modeled to include details of the specific companies that may be at risk, including their exposure and loss potential in several variations of each scenario. D&O exposure managers can use our models to carefully assess their portfolio’s exposure to these sorts of correlated greenwashing risks. D&O underwriters can use the combination of securities class-action tracking and prospective scenario data to make sure they are getting a premium that appropriately covers both attritional D&O risk and the event-driven D&O lawsuits that may arise in the coming years.
References and Footnotes
[4] While the new Congress and presidential administration could amend the IRA, the below is current at the time of publication.
[5] This discussion and scenario are about the voluntary carbon offset market, not the regulatory carbon credit market that is a common feature of cap-and-trade systems.
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