Even with what appears to be a brief reprieve in California, the last 22 years have proven to be the Western United States’ driest in at least the last 1,200 years. Before the current megadrought began more than 20 years ago, California already had a historical groundwater overuse problem. In many areas, such as the San Joaquin Valley, groundwater pumping has been greater than what naturally replenishes it for the last century. The groundwater decline is not entirely surprising, considering that there were virtually no groundwater use regulations in place prior to the 2014 Sustainable Groundwater Management Act (SGMA).²

Several decades of overuse compounded with long-term drought conditions amplified by the climate crisis, have driven a sharp drop in water levels in both Lake Mead and Lake Powell, the nation’s largest reservoirs that provide water for drinking and agriculture to millions. In addition, the Colorado River, which provides water and electricity to more than 40 million people across seven states, including Utah, Wyoming, Colorado, New Mexico, Nevada, Arizona, and California has seen record lows. After an epic winter full of record-breaking snow and rainfall in the West, state water officials have indicated in the spring that pressure on the Colorado River system is easing, but there remains a long-term trend of continued drought and water shortages.³

WATER ISSUES SPARK WILDFIRE, FLOOD, & OTHER RISKS

In April, fire experts weighed in on Accuweather’s 2023 U.S. wildfire forecast predicting that 400,000 to 1 million acres will burn in California wildfires in 2023, putting the Golden State at average or slightly above average risk for fire danger later in the summer. Although the winter storms helped with drought conditions, they also blew down an abundance of trees, branches, and limbs which will add to the availability of wildfire fuel.⁹ A recent UCLA-led study determined that increasing forest fire activity is significantly disturbing western U.S. stream flow from its historical predictability. In areas where more than 20% of the forest had burned, stream flow increased by an average of 30% for six years after the fire. On the surface increased stream flow may seem like a boon for drought-stricken areas, but too much water also comes with hazards, including increased flooding, debris flows, and erosion.⁸

This means that the conversation around water in the West must increasingly account for fire. Adapting quickly is vital because while fires are increasing in intensity and size, the hydrological infrastructure is not suited to adequately handle it. At this point, the three big water basins of the Sierra Nevada - the Tulare, Sacramento, and San Joaquin - should be nearing the point of having experienced enough recent forest fire to result in surprisingly high stream flows.⁸

The relationship between wildfire and water is one that is still in the preliminary stages of being understood, but pressure is mounting for federal agencies to develop a sustainable water use plan. Much of the west’s water infrastructure and management system was designed around the climate and landscape of the previous century, making it less suited to current climate realities. Some have suggested that large Western cities, including Phoenix, Los Angeles, and Las Vegas take the brunt of water cuts if Lake Mead’s levels continue to drop as these areas are considered to have a lower priority claim to the water in comparison to the claim of Native tribes and farmers. Even so, it would have a major impact on those cities as 90% of Las Vegas’ water comes from the Colorado River and 40% of Phoenix’s water supply originates from the river system. Others have suggested spreading water cuts equally among cities, farmers, and Native tribes, which many have warned could result in prolonged litigation between the federal government and individual states. Regardless of the final path chosen, one thing all can agree on is that doing nothing is not an option.³

WATER SHORTAGE PRESENTS RISKS FOR BUSINESSES

While wildfire, flooding, and erosion, are tied to the water crisis, water shortage itself remains one of the most dramatic effects of climate change. But many companies have yet to fully understand the wide variety of impacts that water risks could have on their business. It’s estimated that more than $300 billion of U.S. business value is at risk – requiring companies to innovate around water use. In contrast, the cost of responding to the crisis is estimated at $55 billion.⁷ Every industry relies on water to some degree, especially those dealing with raw materials, direct operations, or suppliers. Research shows that 66% of businesses have substantial water-related risks either in direct operations or elsewhere in their value chain.⁵ Agriculture is one that comes to mind easily, but beverage and food companies rely on water as a key product ingredient. Clothing companies depend on water for growing their raw materials as well as washing or dyeing apparel. Technology and automotive sector businesses and their suppliers need ultra-purified water to support manufacturing processes. And the list goes on. In light of climate change concerns, many companies are striving to adapt the way they consume energy. Some are also trying to reduce reliance on public utilities, but when it comes to water it’s a more complicated issue. There comes a point at which businesses are still beholden to utilities and infrastructure that are beyond their control.

This brings to light the very real potential for increased business interruption and property damage claims due to water risk. Businesses across many industries need water to operate, and it’s possible that an extended loss of water services could result in damage to property, machinery, inventory, or other supplies. If water shortages interrupt water service, businesses may sustain significant financial losses due to direct property damage or business interruption. Many companies maintain commercial property insurance, including some type of business interruption coverage. However, coverage for utility service interruption can vary substantially among policies.

In addition, business interruption and service interruption property damage coverage are often subject to sublimits that may be only a fraction of the coverage available for other covered perils. For mid-market size or smaller accounts, there is typically very little coverage provided for service interruption. It’s generally added as an extension of coverage tied to additional premium. If added by endorsement, then the coverage is sublimited and a waiting period applies. While most people automatically think about the interruption of power, interruption of water is typically included as an additional service.

Companies will also find that there can be key differences in policy terms related to service interruption property damage and business interruption coverage, which may or may not cover damages due to drought-driven water shortages. Some policies predicate coverage for service interruption time element losses on a covered physical loss or damage to a supplier’s property, which results in the lack of service. Others require a loss of water service to be the result of an “event” or “occurrence” at the service provider’s facility. Still, other policies expressly require “complete suspension” of all operations, while some may allow for a partial cessation of operations. Coverage may also be subject to qualifying periods or as well as specific exclusions.⁴

HOW AGENTS CAN HELP

Many companies are becoming more concerned with how they’re going to comply with the need to be more climate-conscious, making Environmental, Social, and Governance (ESG) concerns a growing motivator for adapting operations. From a risk management standpoint, it’s important to address the risk of extreme climate situations as insurance policies are renewed. From a first-party standpoint, service interruption coverage has often been more of a secondary concern that is typically sublimited and not heavily focused on. However, it should likely have a higher profile in the renewal dialog when it comes to reviewing terms and increased sublimits.

Companies have been very innovative in how they approach resource use and will need to continue to do so going forward. From L’Oréal’s “waterloop factories,” Nissan’s rainwater harvesting and water recycling, or Unilever’s development of no-rinse shampoos, companies are innovating around processes and products that can dramatically reduce water use.⁷ Insurance agents and brokers should also work to help clients understand, assess, mitigate, and transfer their unique water shortage risks. Because policies can vary significantly, and the risk of water shortages continues to emerge across the U.S., agents and insureds should make it a point to familiarize themselves with the terms governing service interruption property damage and business interruption coverage in their specific policies. Depending on the facts of each account, it may also be wise to obtain the broadest coverage available with appropriate limits at renewal.⁴ When it comes to underwriting, carriers want to see at least 3-5 years of currently valued loss runs, confirmation of utility service contracts, and information regarding how the insured is sourcing additional or backup utility sources.

BOTTOM LINE

The continuing U.S. water crisis and its ripple effects will require communities, governments, and businesses to evaluate their water use and take appropriate action to plan for the future. This crisis will also require insureds to examine and prepare for the emerging risk of service interruption property damage and business interruption losses.⁴ No business is completely insulated from the issue of water-related risks. And in almost all sectors, the cost of action is far less than the cost of inaction when it comes to being prepared for water-related risks.⁵ Reach out to your local CRC Group producer to learn more about the coverage options available to your clients today.

CONTRIBUTORS

• Chris Carlson has 20 years of experience in Global Property Insurance and is the Director of CRC Group’s Property Practice.

END NOTES

1. California Will Be Cool and Wet in May. Here’s What More Rain Means for Drought Conditions, The Sacramento Bee, May 10, 2023. https://www.sacbee.com/news/california/water-and-drought/article275055516.html
2. Causes and Consequences of Epic Western U.S. Drought, Union of Concerned Scientists, March 7, 2022. https://blog.ucsusa.org/pablo-ortiz/causes-and-consequences-of-epic-western-us-drought/
3. Los Angeles, Las Vegas and Other Major Cities Could Face Huge Water Cuts in Feds’ Proposed Plan to Save the Colorado River, CNN, April 11, 2023. https://www.cnn.com/2023/04/11/us/colorado-river-water-cuts-federal-analysis-climate/index.html
4. A Bridge Over Troubled Water: Service Interruption Coverage and The Water Crisis, Haynes Boone, March 6, 2023. https://www.haynesboone.com/news/alerts/a-bridge-over-troubled-water-service-interruption-coverage-and-the-water-crisis
5. Insurers Have a Huge Role in Addressing Water-related Risks, Insurance Business, April 26, 2021. https://www.insurancebusinessmag.com/us/risk-management/news/insurers-have-a-huge-role-in-addressing-waterrelated-risks-253304.aspx
6. Global Fresh Water Demand Will Outstrip Supply by 40% by 2030, Say Experts, March 2023. https://www.theguardian.com/environment/2023/mar/17/global-fresh-water-demand-outstrip-supply-by-2030
7. Cost of Water Risks to Business Five Times Higher Than Cost of Taking Action, CDP, March 19, 2021. https://www.cdp.net/en/articles/media/cost-of-water-risks-to-business-five-times-higher-than-cost-of-taking-action
8. As Drought Lingers, Larger and More Destructive Wildfires Pose New Threats to Water Supply, Los Angeles Times, February 21, 2022. https://www.latimes.com/environment/story/2022-02-21/growing-wildfires-pose-new-problems-for-water-supply
9. What Will CA's Wildfire Season Look Like? Here's When It's Expected to Peak, What to Know, ABC7 News, April 17, 2023. https://abc7news.com/ca-wildfires-bay-area-wildfire-2023-season-drought/13144926/#:~:text=Fire%20experts%20weighed%20in%20 on,danger%20later%20in%20the%20summer