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

General Manager GrECo Specialty

T +43 664 962 39 04

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