How the Insurance Industry Could Bring Down Fossil Fuels

Late last year, Lloyd’s of London announced plans to stop selling insurance for some types of fossil fuel companies by 2030. In the world of insurance, it was a huge move: the centuries-old institution not only took a clear stand in the industry’s debate on climate change, it also cast doubt on the value of the business it intends to give up.

And Lloyd’s isn’t the only one with concerns about the future of fossil fuel. Insurers and reinsurers around the world are grappling with issues related to both climate change and the impact of energy transition on their portfolios. Some have made the same commitment that Lloyd’s did, and others are likely to follow.

This tracks with a larger trend of the environmental, social, and governance (ESG) movement gaining momentum in the insurance industry that PCS, the team I lead at data analytics firm Verisk, has observed over the past two years. Specifically, we’ve noticed a distinct increase in client discussions — and pressure from investors — around ESG and the coverage insurers and reinsurers (who effectively provide insurance to insurers) are willing to offer. But pressure from end investors isn’t the whole story.

For insurers, pivoting from some fossil fuel classes might just be good business. Some reinsurers are telling us they want to avoid this sort of risk simply because of the loss history. The PCS team recently reviewed 30 years of onshore and offshore large risk losses for the insurance industry — generally insured losses of at least $100 million each — and the results were stunning. Insurers sustained roughly $60 billion in losses from fossil fuel companies during this period with only another $30 million or so coming from other companies. With 113 separate losses, it’s easy to question the class of business — and that’s before even considering the dire environmental implications.

This sounds like solid motivation for an “out with the old, in with the new” strategy, right? For that to work, though, you need to know what the “new” is, and whether it can generate enough revenue to replace the historical fossil fuel business that groups like Lloyd’s and other insurers are planning to leave behind. And in this case, that means replacing lost — and potentially substantial — revenue from the fossil fuel sector with new sources of revenue that are environmentally friendly. Insurers are looking at how to pivot from fossil fuel to renewables, but doing so means reckoning with new and little-known risks, both of which tend to make these companies uncomfortable. So, what should insurers do?

Can renewables fuel insurer growth?

Renewable energy should seem like an intuitive alternative to fossil fuel revenue for insurers. Growth projections for that corner of the energy industry look promising. Solar’s rapid growth could lead to as many as 42 million new jobs. That’s backed up by a 38 percent increase in utility-scale solar markets in 2019.

The percentages are eye-popping, but you need to keep in mind they show the early, rapid growth of a small sector. That means the renewable energy space would still have to grow considerably in order to provide a sufficient client base for insurers to tap as replacement revenue for the fossil fuel sector. So far, renewable energy is still a tiny portion of the overall energy insurance category, which sees roughly $14 billion in premium a year worldwide. In fact, the PCS team learned in recent client conversations that the renewables sector in insurance generates premiums estimated to be $250–500 million a year. What’s keeping such a high-potential sector so small?

The short version is: While green energy tends to be safer and have fewer insured loss events than fossil fuel extraction and transport, there are ways in which it’s a higher risk bet. The biggest concern is that there just isn’t much of a track record yet. And without a large footprint, insurers haven’t had the chance to truly find all the risks that could come to bear in the future.

Insurers are in the business of taking risk but they also need to turn 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 frequency and severity — potentially big losses are easier to cover if they are remote. When it comes to solar farms, for example, the exceptions for certain types of catastrophic events leave serious gaps in protection, and it’s easy to see why. Most solar installations in the United States are in Texas, California, and Florida. While ostensibly suited for solar power, these three states are also among the most-prone to natural catastrophes — specifically wildfires (California), hail (Texas), and tropical storms (Texas and Florida) — which means that when solar energy producers need insurance, they really need it. Solar facilities have sustained increases of as much as 400 percent on their insurance premiums since 2018, and that’s when insurance is available at all. In some cases, projects may be seen as too risky to cover at all, particularly based on a combination of location, weather risk, and the technology implemented.

This doesn’t mean that solar and other renewables are out of the question for the insurance industry. Quite the contrary — renewables are the future of insurance as much as they are the future of energy. Insurers just need to figure out how they can understand, model, and price policies more effectively, especially as alternative energy continues to evolve.

How bright could the future be?

In talking to underwriters in the renewable energy business, we found that they’re aware of improvements in solar panel technology and how that could make the sector easier to insure. The problem is that insurers consider both the engineering information and traditional historical insurance metrics, which in the case of the solar industry could raise a big red flag. Even if you think the new equipment makes a real difference, the sector’s history of past losses is pretty hard to ignore. And if you lose, the only thing your boss will look at is the loss history.

The development of industrywide insurance data assets could make a difference. Right now, just about every insurer has serious blind spots in the renewable energy insurance market, which means they’re hard pressed to make informed decisions about it. The market is still small, with coverage provided by a number of U.S. and European insurers, as well as the Lloyd’s market. Because the space is new and fragmented, nobody knows enough about what they don’t see directly. Smaller lines of business don’t generate enough anecdotal evidence (or even gossip) to help attract possible new entrants. Simply being able to form a view of the entire renewable energy insurance environment would enable new thinking, fresh ideas, and ultimately the deployment of more risk capital to this new and important class of business.

To start, the renewables space could benefit from the same sort of centralized loss data aggregation that we see in the traditional energy insurance markets (not to mention other sectors, like terrorism, cyber, and marine). The loss data my team has collected in other areas has become part of the process for benchmarking, evaluating, pricing, and transferring risk. Such transparency could help the renewables market too.

The stakes couldn’t be higher. The threat of climate change looms large, with implications for decades to come. If we wait for clearer proof than we have today, it may be too late to make a difference. In the meantime, decisions to move away from fossil fuel companies could save insurers tens of billions of dollars, as three decades of PCS data has revealed. The shift to renewables won’t be easy, but as Lloyd’s and other insurers have figured out, the near-term financial benefits may just be a prelude to a cleaner and more sustainable future.