How Insurance Companies Pursue ESG Targets

People working on ESG goals in insurance

ESG aspects play an increasingly important role when it comes to allocating insurers’ monies. Apart from these legal requirements insurers have already installed many ESG measures in their companies on a voluntary basis.

ESG and Sustainable Risk Management

Media headlines are dominated these days by the tragic news of the Ukraine war, the threat of further SARS-
CoV-2 mutations leading to new pandemic phenomena as well as the spectre of inflation that is haunting the global community. While these problems may be overcome in the medium-term, the fight against climate change and other widespread problems is here to stay.

Insurance as key stakeholder in the Green Deal

In their function as both risk carriers and investors, insurance companies are expected to contribute to many measures within the framework of the European Union Green Deal and to influence society in general. Although they offer intangible products and will thus probably not pollute the environment, there is a lot of things insurers can do. EU legislation has set out the rules for this part of the financial market through the:

  • Taxonomy regulation (2020/852 EU) applicable to all branches of the economy
  • The Regulation 2019/2088 “on sustainability-related disclosures in the financial services sector
  • The Delegated Regulation 2021/1257 concerning “the integration of sustainability factors, risks and preferences into the product oversight and governance requirements for insurance undertakings and insurance distributors and into the rules on conduct of business and investment advice for insurance-based investment products”, in force as from 2nd August, 2022
  • A set of Regulatory Technical Standards issued by European supervisor IOPA to be published during the course of this year.

Apart from these legal requirements insurers have already installed many ESG measures in their companies on a voluntary basis, the details of which are published in annual sustainability reports – attached, in most cases, to the annual financial reports. There is no standard yet regarding content and presentation of these reports, unlike financial reports that follow specific standards (e.g. IFRS –International Financial Reporting Standards). Although reports tend to look like marketing presentations, their contents are impressive, showing first substantial results and the direction further developments may take. Exemplary activities comprise the following fields of operation.

Underwriting and insurance products

Major international insurance groups founded the Net Zero Insurance Alliance in 2021 with the target to reduce insurance of coal risks (mining, transport, thermal use) to zero and to decrease the capacities for oil and gas risks (prospection, production, transport, thermal use). Other insurers will follow.

Moreover, there is a clear increase in offering insurance capacity and services for new, green technology despite
initial experiences that new technical applications may constitute a higher risk exposure.

It can be expected that insurance questionnaires will contain queries not only in respect of traditional risks
but also regarding details of ESG in general. After 2023, sustainability reports will become one of the basic documents for underwriting decisions and the calculation of insurance rates.

Investment and financial products

ESG aspects play an increasingly important role when it comes to allocating insurers’ monies. The Net-Zero Asset Owner Alliance, established by large asset owners stipulates that there will be no purchase of shares or granting of loans for industries engaged in coal and other environmentally critical business or for those who cannot give satisfactory answers in respect of their general ESG behaviour and measures.

These monies will be reinvested in promising new green technologies and projects that develop both enviromental and social sustainability on a world-wide scale. Investments focus not only on energy production but also on projects for the sustainable use of water and other natural resources or for cleaning polluted areas. Deciding on an investment therefore means considering not only the enterprise itself but also its suppliers, clients and cooperation partners.

This change in investment strategies not only concerns insurers’ own investments but extends to the creation of
investment products in connection with life and pension insurance, the so called PRIIP. First data show that billions of Euros have already been re-allocated in this manner.

Insurance operations and ESG

As the main operation costs of insurance companies consist of expenses for personnel, IT, energy and office space, many decisions can be made in compliance with ESG targets.

Remote working, which had its breakthrough during the pandemic, will be maintained. It reduces traffic volumes
because employees no longer commute every day, and cuts on costs for heating and cooling office spaces. Energy supply will shift to green energy produced on the spot by e.g. solar panels mounted on rooftops. Corporate build-ings with a glass facade will be equipped with better shading, and (air) travel for business purposes will be reduced to a large extent. The supply of office equipment and energy is constantly evaluated, material will have to be produced in a sustainable way, and energy will need green certificates. The use of paper has already been reduced through electronic communication with clients, partners and within the company.

Social and Governance targets

Some companies are running skills enhancement programmes to make employees aware of and fit for ESG
requirements, while increasing job satisfaction.

Gender diversity, up to management board level, has already been given much more attention than in the past
years. The focus is now on equal training opportunities for both sexes at an early stage with clear perspectives for further career options that are based on skills and knowledge.

Many companies and their employees support initiatives that reduce the vulnerability of society beyond the scope of insurance indemnities by lending a helping hand in catastrophes, assisting and supporting our elderly, refugees or even precarious households both financially and through direct action.

Subsidies and grants are given to non-profit organisations, educational facilities, research laboratories and other institutions in order to overcome the problems we are facing in the entire world.

The insurance sector is very well capitalised, there is knowledge about opportunities and risks as well as an acute sense for catastrophes and how to avoid them. These factors provide the grounds for the industry contributing its fair share to making the world a better and safer place. This is it what ESG is about.


This article is a part of our latest Spotlight publication focusing on supply chain issues. Read the publication and learn more about how you can protect your business from changes and unpredictable supply chain disruptions.

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Rethinking the Energy of the Future

Rethinking the energy of the future

Insurers are faced with a big challenge during the energy transition: The past loss experience on which they have based their forecast models can no longer be used for predictive future scenarios. On top of that, new risks will emerge.

We are at the crossroads of the fastest and most profound disruption the energy sector has seen since the beginning of the indus- trial revolution. It is an irreversible process driven by key technologies: solar power, wind power and battery storage systems. Hydrogen and bioenergy are still underrepresented because their technological progress is only in its infancy. We yet have a long way to go because a successful energy transition, i.e. a 100% substitution of fossil fuels with renewable energy, including green hydrogen, hydropower and biomass, might only be reached by 2050.

An analysis conducted by RethinkX, an independent think tank, has shown that 100% clean energy from a combination of the above-mentioned sources is both physically possible and economically affordable. And this is just the beginning. Coal, gas, petroleum and nuclear assets will become stranded during the 2020s because investing in these technologies will no longer be rational.

The role of insurance

Insurers are faced with a big challenge during the energy transition: The past loss experience on which they have based their forecast models can no longer be used for predictive future scenarios. On top of that, new risks will emerge as technological developments associated with solar, wind and battery storage infrastructure advance even more rapidly.
 
It may become more difficult to put a price tag on physical risks because the transformation from hazard to exposure to damage and its manifestation in cash flows will be hard to model. According to a Harvard Business Review research, onshore and offshore large risk losses amounted to 60 billion USD in the last 30 years.
 
Insuring renewable energy should present an intuitive alternative to fossil fuels. Indeed, prospects for insurers look very promising. However, the renewable energy sector must still grow considerably to replace the revenue generated by the fossil fuels sector. To date, renewables still play a minor role in the worldwide energy insurance sector, which generates roughly 14 billion USD in premiums each year. Renewable energy insurance only generates an estimated 500 million USD in premiums per year.
 
Insurers are in the business of taking risks, yet they also need to make a profit. They allocate capital, using historical data and other factors to calculate the right mix of aggressive and conservative risks, and tend to balance both frequency and severity. This does not mean that solar power and other renewables are unattractive to the insurance industry. On the contrary, renewables are the future of insurance just like they are the future of energy. Insurers are therefore challenged to understand, model, and price policies more effectively, especially as alternative energy continues to evolve.
 

Rocky road

If energy transition is to succeed in the next 32 years, two goals will have to be reached:

  • The renewable share of electric power would have to increase from currently 15%-20% to 100%
  • The share of electricity in the global energy mix would have to increase from currently 18% to 100%;

This means that the current renewable production would have to increase by a factor of 60!

The American climatologist Ken Caldeira has estimated that we would need to develop the equivalent of the energy produced by a nuclear power plant every day in a fifty-year time span. At the current rate however, the energy transition will take 363 years.

Although renewable energy has clear benefits with respect to reducing greenhouse gas emissions, it has some inherent limits. Five major obstacles would have to be overcome on the road to energy transition:

  • Space: Regardless of wind, solar or battery storage, these facilities require large areas of land. Solar parks and wind farms are usually placed on agricultural land and therefore can cause land shortages, a displacement of the population, and they have a negative impact on biodiversity.
  • Resources: The dependency on huge amounts of material and natural resources such as steel, concrete or rare natural metals accelerates the rapid depletion of our planet’s resources. Economics teach us that these supplies will not be depleted because prices increase, and technological innovation will enable the use of poorer quality ore to maintain production levels. However, obtaining poorer quality ore means more invasive and energy-intensive methods. The outcome is a vicious cycle: to produce more energy, more metals are necessary, and to produce more metals from low-grade ore requires more energy. Already there are bottlenecks in the production facilities for solar modules, wind turbines, blades, transmission and distribution lines.
  • Transmission: We are used to having electricity when we need it. Since it cannot be stored, it must be consumed when it is produced. Wind and solar energy, which are available when the wind blows, and the sun shines cannot meet these two conflicting demands.
  • Non-substitutability: Renewable electricity cannot replace all the benefits of liquid fuels. For example, batteries simply cannot meet the energy needs of heavy machinery, aircraft or merchant ships. Certain industrial processes simply require liquid fuels, e.g. the manufacture of steel, plastics and fertilisers. For other industries that rely just as heavily on uninterrupted, smooth production processes, such as aluminium and cement production, intermittency is a serious stumbling block because stoppages damage the infrastructure.
  • Financing: Given the poor financial returns and major risks associated with renewables, the energy sector remains cautious. For a successful transition to occur, about 14 trillion USD in investments in solar and wind energy would be needed by 2030. But spending in the battery sector will not exceed 10 billion USD, including research and development.

We are dealing with the “known unknown” phenomena, as the new energy system that emerges will be much larger. Its architecture will be completely different and will operate in a yet unknown way. One of the most unique characteristics of the new system will be its ability to produce much larger amounts of energy – a superabundance of clean energy.

This energy will be available at near-zero marginal cost throughout the year for nearly all populated areas of the world. Computers and the internet serve as an example. The marginal cost of information has been slashed and hundreds of new business models were created only to transform the core of the global economy

There’s a need for Risk Management 4.0 

Businesses are cautioned to not only rely on industrial insurers as some, to date insurable risks, could suffer the same fate as cyber insurance. Just think about climate change or coverage against natural disasters. Besides, there are many – often new – risks which cannot be insured and which change just as rapidly.

Industrial companies must increasingly come to grips with future risks, strengthen their risk management in the process and place it at the top of their agenda. This, however, means more than just implementing the risk improvement measures which insurers impose upon them – something which almost all market players have propagated at an inflationary level, and which only addresses the past. It is rather a matter of defining future risk changes, determining their possible consequences for one’s company and preparing accordingly – a forward-looking risk management 4.0, so to speak.

A partner who not only focuses on mere risk transfers but acts as a risk adviser, who sends out the right signals and provides expertise through a know-how pool can create real added value for industrial companies. By working in tandem with clients the insurance partner can help to meaningfully shape the future in an ever more complex, interconnected, and fast-moving world.

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

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Geopolitics Shapes the World to Come

Our multipolar world and its myriad of geopolitical forces presents us and our clients with a vast, multidimensional array of risks. As bleak as this may sound, geopolitics and its impact on energy also offers a number of opportunities.

Czytaj dalej …

Decarbonisation takes its toll

Decarbonisation takes its toll

It is no surprise that the industry, prompted by progressive political and environmental activists and industry regulators has taken action and encouraged some of the major polluting industries to transform their processes so that they produce lower or no greenhouse gas emissions.

Although the topic of global warming sparks many controversies in the world’s media, political circles and everyday discussions, few people would deny that the climate patterns have recently been changing, bringing about an increasing number of natural catastrophes. Published in August 2021, the Sixth Assessment Report of the UN-backed Intergovernmental Panel of on Climate Change shows alarming trends affecting the global economy and the well-being of the world’s population.

Amongst those most affected is the financial services industry, such as equity investors, lenders and insurers. It is no surprise that the industry, prompted by progressive political and environmental activists and industry regulators has taken action and encouraged some of the major polluting industries to transform their processes so that they produce lower or no greenhouse gas emissions. This step has often taken an extreme form of providing reduced access – or no access at all – to risk capital, effectively cutting the worst offenders from access to equity and debt financing, and to insurance.

In many cases these policies prohibit the financing of the very projects that are aimed at transformation towards greener technologies, such as the development of renewable energy sources by incumbent thermal coal-fired power producers. Whether this dogmatic and inflexible approach will contribute to reaching desired goals or prove itself to be counterproductive, remains to be seen. The seemingly unlimited capital resources available worldwide may be channelled to new players and technologies on the power utility scene, effectively pushing the incumbents into extinction. It is worth noting that all  these woes do not only befall coal- fired power producers. Next in line are gas-fired power plant owners and operators as well as industries such as oil and gas, cement, steel, transport and others that contribute to greenhouse gas emissions.

Fate of the incumbent power suppliers

Although we cannot foresee which different scenarios the future may unveil, we believe that it is still possible to arrange insurance coverage for operations that produce power from fossil fuels, including thermal coal. However, increasingly this requires careful planning, a flexible and realistic approach to the scope of cover and, finally, competent execution. Companies need not (and often cannot) go this route alone. An insurance and risk consultant can help you through the transformation process despite the pressure from activists and other key stakeholders.

Tips for your risks

  • Improve the risk quality. As long as increasingly challenging economies allow it, invest in improving the risk management framework. Traditionally, insurance has been the cheapest form of risk capital. Certain operators have abused this by consciously not using good risk management practices, which may have been effective in the short term during the final stages of the soft market. Today’s hard market no longer tolerates such an approach. Underwriters who still write carbon-intensive business can choose from the entire range of clients. They will choose those who display the desired traits such as a proactive attitude to risk management.
  • Seek outside opinion. Hire a seasoned and respected engineer to survey the business and produce a risk engineering report. It will come with useful risk recommendations backed by years of experience as well as actual loss scenarios that happened around the globe. It will also provide realistic insights into the possible costs of catastrophic losses, which can be used as a basis for discussions on how to fund those costs (especially in tough times).
  • Be realistic about the coverage sought. Low deductibles and full value policies are becoming things of the past. Not only are insurances with higher deductibles and realistically set limits easier to place, they also demonstrate the client’s commitment to loss prevention and robust risk management. Capital requirements imposed on insurers and reinsurers by financial market regulators have reduced and will continue to reduce market capacity – perhaps as much as the pressure from activists and investors.
  • Companies that have an internal decarbonisation strategy are advised to communicate it effectively. The strategy must be credible, measurable, and supported by the company’s top management. Adhering to standard measurement and reporting rules will be helpful to integrate the decarbonisation strategy into the insurers’ internal reporting systems. In the future, markets may require the progress of the strategy’s implementation to be verified by an independent auditor or a similar body.
  • Companies lacking a decarbonisation strategy may still rely on using existing assets until the end of their technical lifecycle. However, they will have fewer options to choose from as time passes. There will still be certain risk financing tools available, such as industry mutuals, captives and other alternative risk transfer techniques, parametric insurance, and so forth. An experienced, creative and open-minded risk management consultant to structure and implement risk financing strategies in the ever changing financial and regulatory landscape.
  • Careful and skilled carrier management should be exercised to optimise coverage terms and pricing, find the right balance between the requirement for broad insurance panel diversification, differing risk appetites, portfolio and territorial considerations, varying credit rating, etc. We expect certain insurers to be pushed out of writing carbon-intensive risks by their stakeholders, whilst they may or may not be replaced with new entrants. That is why accessing worldwide insurance markets and understanding the individual market characteristics, business targets and constraints is an ever more important issue.
  • The market approach should be a mixture of nurturing long- term relations with key stakeholders and accessing opportunistic capacity as it becomes available. Unfortunately, today’s market environment for carbon-intensive risks is characterised by uncertainty. There is no guarantee that an insurer, declaring a long-term commitment in good faith, will not soon be forced out by investors at short notice. Therefore, while working towards the best-case scenario, one should be prepared for the worst.
  • Submission quality is just as important as risk quality. Information provided to insurance markets should be kept up-to-date, accurate, to the point and presented in a clear and attractive manner. Distressed risks with challenging loss histories will obviously be much more difficult to place in the current environment. However, the direct involvement of a senior risk manager giving account of lessons learned and improving the robustness of the asset and risk management framework may make all the difference between a challenging placement and a failed one.

The first focuses on infrastructure (office buildings, car parks) and digitisation (less office space and business travels, working from home, which may enhance social governance as well). The second will result in huge support for innovation projects and green measures taken by both public and private business as insurers have to invest their reserves to be able to pay future claims. The decision where to place this money has to be driven by security aspects (for this reason there is a relatively big share of public investment) and with a long-time perspective in mind.

Insureds facing an ever more difficult market environment that is likely to remain challenging in the years to come should accept the reality and maximise their efforts to prepare themselves and their companies for the future.

A competent, experienced and dedicated insurance broker and risk management consultant can assist in achieving the risk financing goals required by owners, lenders, government authorities, clients, and other key stakeholders whose well-being and prosperity depends on the successful operation and resilience of the business in question.

Pawel Kowalewski

Practice Leader Power & Renewables Division

T +48 507 085 066

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Delivered Duty Paid for a Green Future

Delivered Duty Paid for a Green Future

Insurers have shifted their focus from topline premium and growth towards rate adequacy. New modelling and technical tools are being utilised more than ever as insurers want to understand the complex technicalities of cargo risks.

The major international cargo insurers are reconsidering the insurability of cargo of concern (for example thermal coal) in relation to zero emissions targets as companies dealing with such cargo, such as miners, traders or major users may have difficulties to secure the insurance they need in the future.

With regard to thermal coal it still seems that cargo insurers who do underwrite the commodity business tend to focus on those accounts where the volume of thermal coal provided is within a certain tolerance limit, i.e. below or about 20% of the total turnover or revenues. Discussions are rife, especially in the lead-up to the UN Climate Change Conference (COP26) being held in November 2021 in Glasgow, UK, and with the IEA Report on net-zero emissions by 2050 and the latest UN Report having recently been issued.

In December 2020, Lloyds issued their Environmental, Social and Governance Report which included various undertakings, the two most prominent being:

  • Lloyds managing agents will be asked to provide no new insurance cover in respect of thermal coal-fired power plants, thermal coal mines, oil sands or new Arctic energy exploration activities from 1 January 2022.
  • To support Lloyds customers through this transition, Lloyds managing agents will be asked not to renew insurance coverages for thermal coal-fired power plants, thermal coal mines, oil sands or new Arctic energy exploration activities after 1 January 2030. This also applies to companies with business models which derive at least 30% of their revenues from either thermal coal-fired power plants, thermal coal mines, oil sands or new Arctic energy exploration activities from 1 January 2030.

Furthermore, eight of the world’s leading insurers and reinsurers, working together with the UN Envi- ronment Programme Finance Initiative, are currently in the process of establishing a pioneering Net-Zero Insurance Alliance (NZIA).

Overview & Expectations

We expect the London and mainland European cargo markets to be pressing for some continued base rate increases where business warrants it and where they are able to do so. However, through the first half of 2021 we have begun to see some softening of general increases and with some insurers beginning to look quite aggressively for new business opportunities available to them. If this trend develops, we expect the renewal business with little or no adverse claims histories and the right profiles to be considered “as before” renewals as we reach the end of 2021 and the beginning of 2022.
 
Marine Cargo renewals have been subject to price increases of between 15% to 40%. Automotive, pharmaceutical, commodities and retail stock throughput accounts will continue to be the most affected.
 
Specific changes to the underwriters’ appetite include:

  • Excess stock – insurers have reduced the capacity in many market sectors, no longer willing to underwrite excess stock.
  • Many marine insurers are no longer underwrite distilleries or wineries.

Insurers have shifted their focus from topline premium and growth towards rate adequacy. New modelling and technical tools are being utilised more than ever as insurers want to understand the complex technicalities of cargo risks. As natural perils remain a key focal point globally, we expect longer turnaround times for quotes as well as significant rate changes for most exposures in the region. Good data quality, including surveys, COPE, risk management forms, and so on, will help us to provide our clients with more favourably rated insurance contracts.

Lead lines are expected to remain conservative, and the expected reduced capacities will come with the added difficulty of some insurers not wishing to reinsure their competitors.

We will continue to see a disconnection between the local Eastern European markets and international markets in terms of rates. However, this gap is slowly closing as most local insurers face an increase of reinsurance costs and are thus unable to sustain reduction demands

Kristo Ristikivi

Group Practice Leader Cargo

T+372 506 9809

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ESG Agenda Revolutionises Risk and Insurance Management

Environment in danger

 The insurance sector has adopted the ESG targets with every company developing an ESG strategy. The sector is particularly affected by climate change, since a rise in temperature means more energy in the atmosphere and thus more natural catastrophes (Nat Cat) such as storms, tornadoes, and floods.

When the average baby boomers – now at around retirement age – look back on global threats that occurred during their lifetime, they will be happy to have survived the danger of mass extinction by nuclear warfare and nuclear catas­trophes, cancer and pulmonary diseases due to air pollution and acid rain or IT breakdowns or even mass diseases.

It is thanks to mankind’s spirit of invention and unwavering determination that these threats were overcome, challenges tackled, and problems solved. For the average baby boomer, the fear of global warming and population growth has been equally present during all this time. Still, there is no solution in sight yet, despite good intentions and declarations made at big conferences.

Global warming has already turned into climate change, accompanied by temperature increases and drastic events: atmospheric phenomena, windstorms, heavy rainfalls, snow blizzards, desertification, wildfires or the slow but steady rise of sea levels. Leading industrial nations, the EU, and even the USA now seem to be willing to act. According to the new Paris Agreement1, the global temperature shall be kept at 1.5° C above pre-industrial era levels. Better education and social perspectives are aimed at contributing to a slowdown in demographic growth and solutions to feed the world’s population in a healthier and more sustainable way.

Green targets

These targets have been included in the scope of ESG measures introduced by both the European Union and the new Biden Administration. The EU has implemented the Taxonomy Regulation that demands a commitment and a special legislation to decarbonise and clean up Europe until 2050 from all member states based on the following objectives:

  • climate change mitigation
  • climate change adaptation
  • sustainable use and protection of water and marine resources
  • transition to a circular economy, waste prevention and recycling
  • pollution prevention and control
  • protection of healthy ecosystems

It is obvious that these targets can only be reached if everyone – citizens, enterprises, decision makers, and authorities – changes one´s behaviour. Whether this requires huge technical innovations or less consumerism remains to be seen. We will probably need both.

The role of the insurance sector

The insurance sector has adopted the ESG targets with every company developing an ESG strategy. The sector is particularly affected by climate change, since a rise in temperature means more energy in the atmosphere and thus more natural catastrophes (Nat Cat) such as storms, tornadoes, and floods. The average cost of insured claims due to Nat Cat currently amounts to about 70 billion USD per year, with peaks exceeding the 100 billion USD mark. Reinsurer Munich Re expects claims to soon reach the “mid-three-digit million Euro range”. The growing percentage of Nat Cat claims because of atmospheric events increasingly depletes the premium generated in the entire property insurance portfolio, leaving less room for paying classical fire and explosion claims. The answer may be to increase the total premium.
Nonetheless, once a certain point is reached, the risk becomes uninsurable – as we have seen with the pandemic risk. Another example are the wildfires, seen in many regions this summer and caused by another climatic scenario – drought due to stable high-pressure areas and a disturbance in the global wind circulation system.
 
Insurers are challenged to pursue their own sustainability policy, using three methods of leverage:

  • their own corporate behaviour,
  • their investment policy,
  • and their underwriting policy.

The first focuses on infrastructure (office buildings, car parks) and digitisation (less office space and business travels, working from home, which may enhance social governance as well). The second will result in huge support for innovation projects and green measures taken by both public and private business as insurers have to invest their reserves to be able to pay future claims. The decision where to place this money has to be driven by security aspects (for this reason there is a relatively big share of public investment) and with a long-time perspective in mind.

Added to this is the increasing focus put on sustainability and the ethical value of projects, measures taken, and targets set by companies or public entities for creating financial products for clients and for placing the insurer’s own assets.

Ecological underwriting

For the insurer as a risk carrier the underwriting policy plays a major role with regard to the sustainability strategy as mentioned above. In an effort to contribute to decarbonisation targets, major insurers have taken the first steps by deciding to stop the underwriting of coal risks in their entirety (production, refining, fuelling, transport). The newly founded Net-Zero Insurance Alliance will provide new industry leadership to carbon-neutral underwriting.
 
Besides the ban on coal, other bans, for example on excessive meat production, soya or palm oil farming, could follow suit. At the same time, green companies could be encouraged with a higher insurance capacity at a better price or a bonus for new installations that increase sustainability.

However, insurers as risk carriers always look at the so-called quality of the risk, i.e. at the (mathematical) probability of loss linked to the risk. For instance, when considering to offer a client a panels on the home´s roof, the insurer, although he may be happy that the client is taking this step, must calculate which one of the two heating methods would cause less claims.

This causes a dilemma because not all innovations will produce better results for the client’s risk portfolio. Statistics about fire claims caused by (bad quality) solar panels or by car batteries prove the point. The technical hull premium for a fully electrical vehicle must be higher than that of a traditional car of comparable size. Then there is the old underwriting principle: Do not insure prototypes! No one knows whether they are harmless or not. At this point in time, insurers face the predicament of either bad experiences or none at all with fires and Nat Cat risks of solar panels and windmills, new food production methods, crop Nat Cat exposure, and so forth.

Risk engineering is the key

The solution to overcome this dilemma and foster new, green industries and insure new risks at an acceptable price is called risk engineering and risk dialogue. A close investigation of new projects, technical procedures and industrial sites should enable insurers to find a good balance between the opportunities and risks presented by new technologies. The results may indeed be positive – for instance, when old coal furnaces are replaced with electricity generated by wind farms, when explosive chemical processes become obsolete and undesirable, or when human factor risks are reduced because excessive overtime working has been banned.

Finding the right balance between opportunities and risks will be the focus of new, so-called ecological underwriting. Purely price driven underwriting will cease to exist as better risk concepts, evaluations, and simulations mirror a company’s changing situation. By giving clients coverage for new risks, insurers will contribute to reaching the ESG targets set for the entire economy.

The broker’s role is changing as well. In the past, the broker was a service provider who advised clients about existing insurance solutions and negotiated the best cover and price. He is now increasingly involved as risk manager and risk engineer in his clients’ change management projects. More than ever, the broker will focus on mediating between his innovative clients and conservative insurers. They, however, are now more open-minded when it comes to contributing to the success of green progress.

Globally, the initiatives to prevent climate change present an opportunity to invest the money generated in the past few years. The outlook is optimistic as new and innovative industrial methods add tremendous value to finding new ways of tackling climate change.

Andreas Krebs

Andreas Krebs

Head of Insurance Mediation Services

T +43 5 0404 229

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Offshore Wind Insurance

Companies investing in the offshore wind sector need a risk partner with the knowledge and experience to deliver tailored risk advisory and insurance solutions. In addition, having an insurance partner capable and experienced in managing finance parties’ expectations and working with all interested parties in the setting of realistic and reasonable insurance requirements within the debt facility agreements is crucial – a skill set which GrECo have market leading expertise in. Choosing the right insurance advisory and placement partner will have a significant and long-term impact on the legal, procurement and insurance strategy, with the target of reducing costs and maximizing insurance and risk management solutions.

Supporting the entire lifecycle

We have the knowledge, experience and commitment to provide clients with in-depth, specialist offshore wind expertise. We work with offshore wind projects to offer contractual risk allocation, project and financial risk management analysis and create insurance strategies that enable our clients to protect cash flow and secure scarce capital across the entire offshore wind lifecycle (Bidding, Consent, Development, Procurement, Construction, Operation and Decommissioning.)

Innovative solutions backed by long-term experience

GrECo is independent, privately-owned company; as such our success and reputation depend on strong partnership with each client. GrECo is able to deliver an innovative, holistic approach to offshore wind project risk and insurance in the local and international insurance markets, underpinned by committed service excellence, a thorough understanding of the offshore wind project’s challenges and complete cost transparency for the solutions proposed.

GrECo together with partners have a proven track record of meeting client’s risk management and insurance requirements, offering deep sector knowledge and service excellence throughout the lifecycle of major renewable energy projects to project developers, operators and investors.

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Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

Michał Olszewski

Director – Energy & Mining Specialty at GrECo Poland

T +48 22 39 33 358

#FutureEnergy: Market Update Q2 2021

This is a series of articles related to the news and development of the global energy sector with focus on Europe, Russia & CIS. The Group Practice Energy, Power & Mining comprises of dedicated group of risk and insurance professionals providing risk and insurance related advice to the companies active in broader energy sector.

Foreword

In this edition of our quarterly update we decided to reflect on the changes to the insurance market for conventional power and renewable energy during the past several months.

A lot is being written, said and analysed on this matter. We tried to provide insights from the broader financial services industry, which will shape the insurance market in the future while the energy sector is undergoing significant reforms.

According to the BP Statistical Review, energy consumption in Europe (including Russia) fell by 1.1% in 2019, between 2008 and 2018 energy consumption in Europe contracted by 0.7%. Energy consumption in developed markets such as a North America and Europe has been steadily declining in contrast to growth in the emerging markets. The decline in energy consumption is set to continue in 2020 as the Covid-19 outbreak coupled with the economic downturn across Europe will weaken energy demand, and in the medium and long run, demographic changes in Europe, in particular a rise in the share of its ageing population, will continue to cause a decline in Europe’s global share of energy demand. On the other hand, as fossil fuels will be phased out from the fuel mix of the European Union, United States and other developed economies, the demand for electricity will keep growing, making investments in the power generation, transmission and distribution systems grow at an ever faster pace.

Several countries in the region have pledged to invest in developing their renewable energy sectors and have set internal greenhouse gas emission targets supplementing those set in the 2016 Paris Agreement.

The energy sector has reduced CO2 emission by 63% since 1990s, according to the report published by Energy Research Partnership. In an article which appeared on Business Insurance on March 16, 2021, Swiss Re pledged to exit all exposures from thermal coal in OECD countries by 2030 and the rest of the world by 2040. The move goes together with the investment policy to achieve net-zero emission by 2050. The reinsurer is one of the founding members of the United Nations Convened Zero Asset Owner Alliance, which includes global carriers like AXA, SCOR, QBE, Generali, Munich Re etc., who are likely to follow suit. The Alliance is representing USD 5,6 trillion assets under management and shows unified action to align portfolios addressing Article 2.1c of the Paris Agreement.

Assuming all projects proceed as planned, the current pipeline of projects will deliver 170.6GW of generating capacity in Europe in 2020-2024. Installed capacity is expected to peak in 2023, with 47GW projected to be installed as new capacity.

Europe – Power Generation, Construction Project Pipeline, Top 10 Countries by Value and Stage (US$ million)

Source: Global Data

Europe – Power Generation, Construction Project Pipeline by Type, Value and Stage (US$ million)

Source Global Data

Focus on Wind Projects

There are several important factors contributing to the sharp rise of rates and deterioration of coverages offered by international re/insurance markets from 2019.

  • Projects are getting larger and more complex. This increases severity of risks significantly.
  • Natural catastrophes occur more frequently and are more severe in nature. This is the reason for concern for the insurers and is rated as top 5 risks according to the Allianz Risk Barometer.
  • Defective products, design and quality control losses are on the rise.
  • Supply chain complexity, just-in-time production and interdependencies are more likely to cause project delays.
  • Political tensions, sanctions, compliance and political violence has become one of the top concerns for project risk managers.

All of them are the result of operation of market forces. At this point it is important to keep in mind that the overall performance of an individual insurer, or the market, is the combination of the result on underwriting activity and investment activity. Continuing underperformance results in either re-underwriting of the existing portfolio or complete withdrawal from writing certain classes or business (or less often, winding down of the whole company). It is also important to understand that the insurance market, unlike many other financial markets (such as public equity and fixed income markets) is not transparent and objective market information is not available usually other than at very high granularity information made available by national regulators and industry trade associations.

Market Performance and General Underwriting Considerations – Hard Phase of the Insurance Cycle

The rating of Engineering and Construction classes of business for Onshore Wind would depend on the following factors:

The Profitability of the entire Insurance Industry

2020 was a year of continuing deterioration of underwriting result and net result. For example, in the Lloyd’s market which provides substantial reinsurance capacity to insurers worldwide, the underwriting loss was GBP 2.67 billion, down from GBP 538 million of loss in 2019. As the investment return also contracted significantly, the market ended 2020 with a total loss of GBP 887 million, down from a profit of GBP 2.53 billion in 2019. As in practical terms it means the erosion of capital across the market, the result is the pressure for immediate action by their shareholders or the Society of Lloyd’s (or any other regulator). The Lloyd’s combined ratio (measure of underwriting profitability) was 110%, however, excluding losses from Covid-19 it was down to 97%, still a very poor result for the entire market. It is estimated that the total amount of underwriting losses suffered by re/insurance markets worldwide were in excess of USD 100 billion across 2020.

Withdrawal of Underwriters from writing certain Classes of Business

Since 2019 this affected Marine Cargo, Engineering and Construction as well as Renewable Energy. It was driven either by Lloyd’s which has the power to accept or reject individual syndicates’ business plans, or the insurers’ own management as a result of changes in their risk appetite. There have also been withdrawals of capacity from major MGAs writing Renewables business such as Pioneer, which unfortunately had to be placed into run-off. Having said that, there have been some new insurers launched across 2020 and 2021, taking advantage from improved rating environment and not burdened with previous years’ losses. Several existing markets have also successfully raised new capital to support their business in the hardening market.

Reinsurance Considerations

The market consensus is that the 1/1 2021 treaty renewals for Power and Renewables sector were higher than a year earlier. Also, the restructuring of treaty provisions, in many cases insurers are no longer protected by their obligatory treaties with respect to active loss attrition on their books. This will affect both direct insurers and facultative reinsurers alike.

Portfolio Rebalancing

For the companies that chose to continue providing coverage this took the form of:

  • Increasing rates – from 10-30% year-on-year on loss-free accounts to 90-100% or more for troubled insureds. Similar adjustment took place across 2019 with 25-50% typical rate increases or even upwards of 100% for complicated or distressed accounts.
  • Deterioration in the length and breadth of coverages provided, increased deductibles and decreased sublimits for certain perils.
  • Decreasing line sizes at renewal, sometimes significantly, or
  • Not offering renewal terms for distressed accounts. For example, according to one reputable London market, their retention rate of Renewables accounts was around 40% in 2020.

Accounts Performance

With the trough of the pricing cycle for Onshore Wind in the Summer months of 2018, 2020 was yet another year which brought about deteriorating claims and reserves development experience for the Renewable Energy insurances. For example, the adverse development of losses incurred in 2018 moved the loss ratio for that period for an initial estimate of 66% to 80% as of 2020, which made the 2018 year of account unprofitable. This of course needs to be reflected in rating adjustments for insurances sold in future years.
Notable causes of rating increases for Onshore Wind projects typically include:

  • Natural Catastrophe losses – even though no spectacular losses occurred throughout 2020, smaller scale catastrophes give rise to increasing loss activity.
  • Ageing of the fleet – increasing number of attritional losses and the need to replace ageing assets with modern technology, which is affected by costs, materials and labor inflation.
  • Constant upscaling and upgrading process of generators, which make them significantly larger and more expensive, also in terms of replacement and re-erection costs. Also, the boundary between the upscaled and the prototypical becomes ever more blurred as a result of the process.
  • Adequacy of “old” deductibles is being questioned by insurers, as it the view of many they no longer reflect the specifics of new technologies and substantially larger and more powerful units.
  • Concerns about the performance of the Engineering and Construction book – it has been noted that the contractors may be taking on too much workload (due to fast-increasing demand) which causes them to rush some projects to the point where there is a perceived increase risk of losses in the construction phase. In fact, data from some markets show that for 2020, contractor error losses amounted to about 36% of the quantum of all wind losses. As a result, the construction phase attracts the highest rating increases in the wind farm life cycle. The same applies to the increase in deductibles required by insurance markets. Unfortunately, the increasing demand pressure on major contractors makes them unwilling to give concessions to their clients as their order book is filling up quickly as old conventional assets are being phased out, making their bargaining position ever stronger.
  • The Covid-19 pandemic affected some routine claims handling (such as inspection dismantling, re-erection), risk engineering, as well as manufacturing processes. This affects both loss settlement times and – more importantly – the quantum of Business Income (BI/ALOP/MLOP/DSU/MDSU) losses.

Diminishing Returns on Investing Activity

For many years, deficiencies in the performance of the underwriting function would normally be corrected by returns on the investing activity. It used to be normal that in certain classes of business combined ratio of 110% was accepted for prolonged period (meaning that on every USD100 of premium there were losses and costs of USD110 incurred). With negative interest rates environment prevailing for a prolonged time and increased asset price volatility this is no longer the case and the insurers are pushed towards technical (underwriting) profitability.

Related Insights

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

Ain’t no sunshine

We are debunking four myths about parametric insurance for renewable energy

Parametric insurance has been around since 1990s although the reinsurance industry has been using the parametric structures with catastrophe bonds for more than 30 years. Back then it was considered a novel product, but it may now be reaching new levels of popularity with the renewable energy investors and producers due to rapid advancement of technology and increasing quality of data around the world. For example, insurance companies can now build better indices to approximate the yearly average energy production of a windfarm and the insured can protect his revenues using index based parametric insurance.

One of the key motivators for the companies to purchase such insurance is its efficiency. The wordings have only a few pages, the indemnity amounts are clearly defined and the Insureds avoid lengthy claims investigations, coverage disputes and payment delays.
Flexibility is also another important factor that contributes to the adoption of the product. All the parameters can be tailor made to perfectly suit the risk management objectives and the Insured is also free to use the payouts the way he likes, unlike traditional insurance. Basically, an index is triggered, payout is made – no questions asked.

Another key criteria is the reduction of volatility, hence, the predictability of future revenues, transparency and objectivity of underlying parameters by applying parametric insurance as a protection against weather underperformance.

Despite its efficiency and speed the use of the product has been limited, at best. We decided to investigate the intrinsic details of the coverage and debunk common myths associated with index-based insurance solutions for renewable energy sector.

Myth #1 – parametric insurance is not suited for SME and mid-corporate buyers

Although initially designed to transfer high and catastrophic risks on a country level especially in regions like Caribbean, advances in data science, sensor technology and artificial intelligence have allowed for the creation of a broader assortment of informational indexes. This opened the door to new applications for parametric insurance that go well beyond the traditional natural catastrophe uses. The payout schemes have evolved from the eye of a tornado going through a specific geographical circle through a modular payout based on the speed of wind at a precise location, ensuring incremental payouts according to the exact nature of the catastrophic event.

It is a common misconception that parametric insurance can replace the traditional indemnity-based insurance coverage. It is a complementary coverage and should be purchased together with the traditional property damage and business interruption policies.

Renewable energy industry is heavily dependent on the availability of the financing. Therefore, index-based insurance, also known as sun or wind resource volatility insurance, provides additional protection to the investors while it stabilizes the revenue streams and increases the risk rating of the project.

Project managers face a project risk transfer gap, which occurs between the contractual warranties and available insurance coverage. Whilst the traditional insurance contracts facilitate the transfer caused by man-made (machinery breakdown, fire etc.) and natural perils, parametric insurance is designed to transfer the weather underperformance risk where traditional policies apply exclusions or simply do not respond to specific adverse events such as insufficient or excess resource availability. According to GCube, the weather risk gap of insurance is estimated to reach over 56 billion USD.

Myth #2 – parametric insurance is complicated

Let’s start at the beginning. The Oxford Dictionary defines the adjective parametric as “relating to or expressed in terms of a parameter or parameters”. When applied to insurance, that means coverage is triggered by a parameter – i.e. a metric or an index – that is easy to determine. An insurable trigger needs to be fortuitous and insurers need to be able to model it. Parameter or index used for the basis of a parametric insurance solution must be objective (i.e. independently verifiable), transparent, and consistent. This is important for investors, as it eliminates the information asymmetry and the moral hazard.

Basis Risk
While parametric insurance has all the advantages of the cost-effective risk mitigation and transfer tool for renewable energy projects, it does have its shortcomings. This phenomenon is often referred to as Basis Risk. It is commonly considered as a “near-miss factor” or the event where the trigger index does not perfectly correlate with the underlying risk exposure, resulting in a situation where a policyholder suffers a loss but does not receive payment. For example, measured wind speed might fall within the insurable range, but the insured did not suffer loss of revenue below the pre-determined index, hence no payout.

Structured Index
When we speak about the sun or wind resource volatility index, we usually refer to the double-trigger policies, which require that a pre-determined parameter threshold is reached and the insured has sustained the actual financial loss, e.g. loss of revenue due to lack of wind.

The index is usually structured as a function of wind speed or solar irradiation level, and plant efficiency factor. The insured can choose the desired protection by defining the Strike, acting as a deductible, and the Exit point. The annual estimated energy production between the Strike and Exit represents the Total Sum Insured. The premium is consequent upon the wind speed historical volatility and the Strike and Exit scenario chosen by the client.

In case production energy production falls below a certain level, e.g. 98% (Strike), the payout is activated until the Exit scenario, e.g. 80%. The magnitude of the payout is determined by the actual loss of generation income for the plant. Hence, the index fluctuates, whereas the actual revenues remain almost constant. The volatility is reduced, and the project delivers revenue streams in accordance with the financing model.

Myth #3 – parametric insurance is expensive

Contrary to the common belief, parametric insurance is very cost-effective provided that correct index has been structured for the specific renewable energy type.

According to Modern Energy Management, the majority of renewable energy projects face significant cost overruns, which are mainly due to the failure to properly identify and transfer project risks. This creates often a huge gap in risk transfer, whereas the investors and lenders end up assuming greater project risk than they should. One of the main reasons is that the project contracts and insurance is often developed in isolation.

Parametric insurance reduces volatility of the projected income, thus enabling a steady, predictable stream of revenues that appeal to lenders and investors alike. Quite often it helps to reduce cost of capital by pushing the interest rates down and increasing the debt/equity ratio.

Investors must juggle with all the characteristics of the project to maximize the revenues generated from their investment. Vaisala has calculated that 33% of the total energy production uncertainty for a windfarm project comes from both the historical and the future wind resource variability. This is exactly what the index based parametric insurance is designed to mitigate.

For example, many solar farms secure their financing at P95 level, hence, leaving a 5% chance of not achieving the planned annual energy production. However, after reviewing over 200,000 solar farm projects, WindAnalytics has found out that the P99 radiance probability of a catastrophically bad year is not 1% as mathematically calculated but rather 6.3%. The consequence is that a project financed for 7 years with a loan size based on 1xP99 metric results has a 37% chance of defaulting in a given year.

Parametric insurance can appear costly when compared to the traditional indemnity-based insurance. The premium may range between 0,5% and 5% of the purchased limit, whereas the conventional policy will have a premium rate much lower than the index-based solution. Such comparison is not entirely correct. Property Damage and Business Interruption policies cover loss of or damage to insured property and the business interruption resulting therefrom. They require a physical loss or damage in order for the coverage to be triggered and have extensive list of warranties, subjectivities and exclusions incorporated in their wordings. Index-based policies, however, do not require a physical loss to reimburse the insured for the economic cost of the adverse event.

The index based parametric insurance can be structured in many different ways. The scenario, which involves a low Strike and high Exit, will result in minimum premium level. On the opposite, if the client choses a very high strike and a low exit, the expected premium will be a lot higher. The Insured will have received larger payouts. The product should be structured to match key project objectives, from securing the lenders and improving the credit rating of the project to reducing the volatility of future revenues to a minimum level.

Myth #4 – regulators do not approve parametric insurance as insurance

Insurers offering parametric insurance have to overcome the regulatory challenges. Those who are already offering such products usually use double trigger policies, which require the proof of loss by the insured even though both types of policies function similarly to derivatives. The main difference is the insurable interest, which derivatives lack. In certain countries, where the regulatory framework does not explicitly address the use of parametric, it is important that the indemnity payment does not exceed the actual sustained loss and that the insured can prove existence of the same.

One of the main issues regarding risk management in renewable energy projects is the confusion on how to best manage weather-related volume risks. In order to provide answers to this, insurance broker should be involved as early as the planning stage of the project, i.e. before the contract is drafted, negotiated and signed. Early involvement ensures the closing of the risk transfer gap and securing the best terms and conditions for the project`s finance. Parametric insurance can be tailored to match project of any size and budget.

Related Insights

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04