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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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.

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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