Decarbonisation takes its toll

Decarbonisation takes its toll

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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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