How the insurance industry can reduce fossil fuel consumption

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More and more insurance companies are severing ties with fossil fuel companies that they previously covered. A new study by data analytics firm Verisk shows that over 30 years insurers have suffered an estimated $ 60 billion in major onshore and offshore risk losses from fossil fuel companies, and only another $ 30 million or so were obtained from other companies. The author calls for a move towards renewable energy, exploring the obstacles that lead to industry hesitation and how to overcome them.

At the end of last year, London-based Lloyd’s announced plans stop selling insurance for certain types of fossil fuel companies by 2030. In the insurance world, this was a huge step: the centuries-old organization not only took a clear position in the industry debate about climate change, but also questioned the value of a business that it intends to abandon. And Lloyd isn’t the only one worried about the future of fossil fuels. Insurers and reinsurers around the world fight with issues related to both climate change and the impact of energy transitions on their portfolios. Some have made the same commitment as Lloyd, while others are likely to follow.

This is due to the broader growth trend of the environmental, social and governance (ESG) movement in the insurance industry that PCS, the team I lead at think tank Verisk, has seen over the past two years. In particular, we have noticed a clear increase in discussions with clients – and pressure from investors – around ESG, as well as the insurers and reinsurers (who actually provide insurance to insurers) that are willing to offer. But pressure from end investors is not all.

For insurers, ditching certain grades of fossil fuels might just be a good thing. Some reinsurers tell us that they want to avoid this kind of risk simply because of a history of losses. The PCS team recently analyzed 30 years of major onshore and offshore risk losses for the insurance industry – typically at least $ 100 million each – and the results were stunning. Insurers incurred an estimated $ 60 billion in losses from fossil fuel companies during this period, with only another $ 30 million or so from other companies. With 113 separate losses, it’s easy to question the class of the business – and that’s even before the dire environmental impacts are taken into account.

This sounds like a strong motivation for the “do away with the new” strategy, doesn’t it? For this to work, however, you need to know what “new” is and whether it can generate enough revenue to replace the historic fossil fuel business that groups like Lloyd’s and other insurers plan to leave behind. And in this case, it means replacing lost – and potentially significant – income from the fossil fuel sector with new sources of income that do not harm the environment. Insurers are thinking about how to move from fossil fuels to renewable energy, but this means they will have to deal with new and little-known risks that tend to be inconvenient for these companies. So what should insurers do?

Can renewables help insurer growth?

Renewables should appear to insurers as an intuitive alternative to fossil fuel revenues. Growth forecasts for this energy sector look promising. Solar’s rapid growth could lead to up to 42 million new jobs… This is backed up Growth by 38 percent in the solar energy market for utilities in 2019.

The percentages are impressive, but you have to remember that they show early and rapid growth in a small sector. This means that the renewable energy industry will still have to grow significantly in order to provide a sufficient customer base that insurers can use as replacement income for the fossil fuel sector. Until now, renewables still make up a tiny fraction of the overall energy insurance category, and therefore about $ 14 billion in premium a year all over the world. In fact, the PCS team learned from recent customer conversations that the renewable energy sector in insurance generates premiums that are estimated at $ 250-500 million per year. What keeps such a high potential sector so small?

The short version is this: while green energy is generally safer and has fewer claims than fossil fuel extraction and transportation, there are ways in which it is more risky. The biggest problem is that there aren’t many track records yet. And without a significant presence, insurers were unable to truly identify all the risks that could arise in the future.

Insurers take risks, but 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 strive to balance frequency and severity – potentially large losses are easier to cover if they are distant. For example, when it comes to solar farms, exceptions for certain types of disasters leave serious protection gaps, and it’s easy to see why. Most solar installations in the US are located in Texas, California and Florida. While these three states are allegedly suitable for solar energy, they are also among the most prone to natural disasters – especially wildfires (California), hail (Texas), and tropical storms (Texas and Florida) – which means when solar producers need insurance, they really need it. Solar installations have increased by as much 400 percent on their insurance premiums from 2018, and then insurance is generally available. In some cases, projects may be considered too risky to be covered at all, especially due to the combination of location, weather risks and technologies employed.

This does not mean that solar and other renewable energy sources are out of the question for the insurance industry. On the contrary, renewable energy sources are not only the future of energy, but also insurance. Insurers just need to figure out how they can better understand, model and pricing, especially as alternative energy continues to evolve.

How bright can the future be?

In interviewing renewable energy underwriters, we found that they are aware of the improvements in solar panel technology and how it can simplify the insurance sector. The problem is that insurers are considering both engineering information and traditional insurance history, which could be a big red flag in the case of solar. Even if you think the new hardware makes a real difference, the sector’s past loss history is hard to ignore. And if you lose, the only thing your boss will pay attention to is the loss story.

The development of industry-specific insurance information assets can make a difference. Almost every insurer right now has serious blind spots in the renewable energy insurance market, which means it is difficult for them to make informed decisions about this. The market is still small, with coverage provided by a number of US and European insurers as well as Lloyd’s Market. Since space is new and fragmented, no one knows enough about what they cannot see directly. Small businesses don’t generate enough anecdotal evidence (or even rumor) to attract potential new entrants. The simple opportunity to gain insight into the entire renewable energy insurance environment will provide new insights, fresh ideas and, ultimately, increased risk capital for this new and important class of business.

For starters, the renewable energy field can benefit from the same centralized aggregation of loss data that we see in traditional energy insurance markets (not to mention other sectors such as terrorism, cybernetics and shipping). The loss data that my team collected in other areas became part of the benchmarking, valuation, pricing and risk transfer process. This transparency can help the renewable energy market as well.

The stakes couldn’t have been higher. The threat of climate change looms large, with consequences for decades to come. If we wait for clearer evidence than today, it may be too late to change anything. Meanwhile, decisions to ditch fossil fuel companies could save insurers tens of billions of dollars, according to PCS data over three decades. The move to renewables will be challenging, but as Lloyd and other insurers have found, short-term financial gains may be just a prelude to a cleaner, more sustainable future.

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