Water Scarcity: Emerging Risks and Implications

Water scarcity economic impact is expected to increase in the years to come, with industries such as energy, agriculture, and manufacturing among the more likely to be affected, and the insurance market is not the exception.

Issues deriving from water scarcity could be of particular interest for the following insurers:

• Construction: Water scarcity could lead to the stoppage or delay in completion of infrastructure projects, which would result in claims over loss of profit.
• Property: Water scarcity could cause severe damage to buildings and infrastructure
• Energy: Claims arising from the effects of water scarcity on the production of energy from renewables could potentially trigger coverage disputes over these policies.
• Casualty: Water scarcity can result in bodily injury and property damage claims arising from drought and water pollution.
• D&O: Certain industries are more prone to loss of investments due to water scarcity, which could lead to D&O liability. This is the case of the tech industry that highly relies on water supply for the production of semiconductors and the cooling of data centres.
• Environmental Impairment Liability: One of the causes of water scarcity is pollution that could result in environmental damage.

Water scarcity is a pressing global issue with far-reaching implications across various sectors, including pharmaceuticals, renewables, manufacturing, agriculture, and the insurance market. The increasing demand for water, coupled with the effects of climate change, has heightened the relevance of water scarcity risks for stakeholders. These sectors rely heavily on water for production, cooling, irrigation, and maintaining hygiene standards, making them particularly vulnerable to water shortages. The insurance market must adapt to these emerging risks, which include property damage, business interruption, and liability claims.

Causes, effects, and case studies

The causes of water scarcity are multifaceted. Climate change is a significant driver, with global warming leading to the melting of glaciers, increased frequency of extreme weather events like El Niño, and rising sea levels, which impact freshwater availability. Agriculture is another major contributor, with inefficient irrigation systems, water-intensive crops, and over-extraction of groundwater exacerbating the problem. Population growth and increased demand for water in urban areas, as well as for industrial and energy needs, further strain water resources. Poor water management and pollution from nitrogen, pesticides, and industrial waste lead to water quality deterioration.

The consequences of water scarcity are severe. Bodily injury and health risks arise from waterborne diseases and starvation due to food shortages. Environmental harm includes habitat loss, reduced biodiversity, and increased frequency of wildfires. Economic impacts are felt across agriculture, manufacturing, and energy sectors, with significant losses reported. For instance, the drought in 2012 in the United States impacted 80% of agricultural land and resulted in losses of nearly $14.5 billion.[1] Overall, it is forecasted that, due to high water stress, almost a third of global GDP (31%) could be exposed by 2050.[2]

Two significant case studies could be mentioned: California and Spain. In California, the semi-arid climate and uneven water distribution exacerbate water scarcity. The state experiences periodic droughts, with most rainfall occurring in the northern regions while the south remains dry. Key factors contributing to water scarcity include climate change, over-extraction of groundwater, and mismanagement of water resources. Severe droughts have led to significant economic losses and groundwater depletion. Agriculture, which uses 80% of the state's developed water, is heavily impacted, and the energy sector faces challenges due to reduced hydropower capacity. In response, California has implemented infrastructure improvements, water conservation measures, groundwater management laws, and is developing desalination and wastewater recycling systems.

Spain, on the other hand, faces an arid climate with decreasing rainfall and increasing temperatures, affecting water availability. The Pyrenees and Sierra Nevada snowpacks have reduced, impacting water supply during spring and summer. Climate change, overuse by agriculture, urban sprawl, and poor infrastructure are major contributors to water scarcity. Illegal wells and outdated irrigation systems exacerbate the problem. Agriculture, which consumes 80% of water, is significantly affected, and economic losses due to droughts have been substantial.[3] Spain has implemented emergency measures during droughts and long-term strategies like the River Basin Management Plan, which includes modernising irrigation, increasing desalination capacity, and promoting water reuse.

Impacts in specific sectors

Sector-specific impacts were also discussed. The energy renewables sector, particularly hydropower, is heavily reliant on water availability. Fluctuations in water levels affect the reliability and efficiency of power generation. The manufacturing sector, including semiconductors and textiles, faces challenges due to water scarcity. For example, Taiwan's semiconductor sector, which accounts for 90% of the world's production, experienced a 15% decrease in water consumption during 2021 due to dry conditions, nearly causing a supply chain collapse.[4] The textile sector in China faced losses of around $7.6 billion due to drought conditions affecting the Poyang Lake.[5] The impact of water scarcity in certain industries can lead to contractual or management-related insurance exposure.

Insurance issues: Insurance gap and challenges

The insurance market faces significant challenges due to water scarcity.

• Insurance gap

There is a notable disparity in insurance coverage between the Global North and Global South. In Latin America, for example, the economic loss due to water scarcity is much higher than the insured loss, highlighting the need for better insurance solutions. Parametric policies, which provide payouts based on predefined triggers, can help bridge the insurance gap. These policies are particularly useful for sectors like renewables that are vulnerable to water scarcity. Additionally, water scarcity can lead to increased litigation with potential claims against both public authorities and private companies. Recent legal developments in Europe and the US highlight the growing importance of addressing water risks in corporate policies.

• Risk of litigation

Human rights arguments have already been used in several cases concerning climate change, such as the 2024 KlimaSeniorinnen v. Switzerland European Court of Human Rights ruling. The court found that the Swiss government had violated Article 8 of the European Convention due to insufficient efforts to reduce carbon emissions. It’s possible that the same reasoning could be applied to other environmental risks such as water scarcity.

Climate change allegations are also being brought against companies, and corporate duty of care arguments like those used in Milieudefensie v. Shell could similarly translate across to water scarcity issues.

• Evolving regulation

Several new EU laws could impact insurance exposure, including:

• The Representative Actions Directive, which enables non-governmental organisations (NGOs) and consumer bodies to file collective environmental claims;
• The Corporate Sustainability Reporting Directive, which requires large companies to disclose sustainability risks, including water stress and water governance; and
• The Corporate Sustainability Due Diligence Directive, which requires businesses to identify and mitigate environmental risks throughout their supply chains.

Therefore, companies would be well-advised to embrace sustainability and incorporate water availability and usage considerations into their risk assessments and policies. For insurers, the combination of litigation and regulatory risks means demand could well increase for coverage for environmental liability, including cover for legal costs, and D&O insurance for those involved in water management decisions.

Water scarcity is a critical issue that demands immediate attention from all stakeholders. The implications for property claims, business interruption, and potential legal liabilities are significant. Insurers must stay vigilant and adapt to these emerging risks to mitigate their impact effectively. The case studies of California and Spain highlight the urgent need for comprehensive strategies to address water scarcity and ensure sustainable water management for the future.