This blog was authored by Peter Tufano, Baker Foundation Professor at Harvard Business School and Senior Advisor to the Harvard Salata Institute for Climate and Sustainability, with support from the Environmental Defense Fund, including Andrew Howell, Senior Director for Sustainable Finance. Any references below do not constitute an endorsement of the firms or products mentioned.
This is the second in a multi-part series on how insurers can support the energy transition. The series explores climate-related opportunities and challenges and highlights emerging insurance innovations. This will help us build a greater understanding about how the insurance industry can support emissions reductions and new climate solutions. In this second post of the series, we discuss how insurance can support the emergence and scalability of clean tech solutions and innovations.
To combat climate change and adapt to a warming planet, we need new technologies that have yet to be invented, piloted, or commercialized. According to the International Energy Agency’s 2020 estimates for its Sustainable Development Scenario of net-zero by 2070, nearly three-quarters of the innovations needed to reduce emissions by 35 gigaton (billion tonnes) per year by 2070 are still far from commercialization. If we include innovations to help us adapt to the changing world, the technological gap is likely much larger, with a recent Global Adaptation & Resilience Investment (GARI) working group study suggesting that only 11% of firms offer “adaptation solutions” products. This call for innovation may not sound immediately relevant to the insurance industry, but it is.
Conversations around insurance and climate change typically focus on how insurers can reduce emissions from firms that they finance or insure (in their roles as investors and insurers, respectively). They examine how insurers measure climate risks and signal these risks through premia they charge, or how insurers can make coverage more available and affordable as climate intensifies extreme weather. But insurers in the climate space have another role: to support needed technological innovation through “insured solutions.”
How can insurers help support innovators? Surely, it’s not possible to “insure” the success of a new ventures? Correct! But to make projects easier to finance, insurers can derisk climate innovations by applying risk engineering approaches and offering new contracts to offload certain risks.
Capital providers—shareholders, lenders, and others—not only provide funding, but they also bear risk. The more that a firm can transfer or reduce risks, at a reasonable cost, the happier capital providers are. For example, by selling products abroad in a foreign currency, a firm is exposed to foreign exchange (FX) risk. Various FX derivatives can reduce this risk, protecting equity- and debt-holders. Uncertainty regarding future customer orders means that firms are exposed to market risk. Through off-take agreements or advance market commitments, firms can transfer that risk onto buyers, reducing risk to capital providers.
Insurers routinely provide property and casualty protection against various hazards—which benefit homeowners and lenders. They also provide insurance for construction projects, benefiting developers and lenders. But insurers are also beginning to offer new contracts to transfer risks inherent in innovations that address climate change. For example:
- Performance guarantees that insure a renewables project, like wind and solar power, will produce a certain level of energy output, reducing investment risk and lowering capital costs.
- Hydrogen is a highly capital-intensive technology that can reduce our dependence on fossil fuels. A number of insurers are offering new programs that seek to offer comprehensive coverage across a variety of hydrogen project hazards.
- Another clean energy technology, geothermal energy, can be partly derisked through insurance covering the exploratory drilling needed to find suitable underground heat sources.
- A potentially important climate solution is the emerging marketplace for reducing emissions and storing carbon. Carbon credit insurance could address the risk that projects do not deliver on promised climate benefits, increasing confidence of buyers of these credits and allowing the market to scale up significantly.
While some insurers and brokers have started to talk about the opportunity in insuring climate tech, fully grasping it will require doing some things differently. A number of experts, both within and outside insurance and startups, have begun to advance the concept of bringing “insurance thinking” to inform the growing space of climate tech. A recent two part Geneva Association report lays out the case for this work, but much work is needed to bring this to life.
At our Salata Institute-EDF gathering during New York Climate Week, we brainstormed with experts from traditional insurers, “insure tech” startups, clean tech, start-up financing, non-profit organizations, and government about how to align insurance with clean tech innovation, deployment, and scaling. If insurers and climate innovators are to work together, we have to bring innovators and insurers to the table, ensure that the table is comfortable for all, and expand it to invite other key players: government and civil society.
Bringing innovators to the table
Innovators are focused on their ventures, and insurance is not always the first thing on their minds. To increase their awareness of this tool, we can:
- Leverage trusted advisors. Startups may benefit from insurance advice, but they might not know they need it, that it’s available in the insurance industry, or even whom to ask. Equity and debt providers and legal advisors should be engaged as trusted advisors who can help direct innovators to gain the risk advice they may not realize they need.
- Use success stories. Real life success stories share the benefits around how insurance can make products that are less risky and have greater customer appeal, thus speeding adoption in the economy.
Bringing insurers to the table
Insurers, especially large firms, have many other opportunities and constraints. To better engage with them, we need to:
- Consider the norms, structures, and scales of large insurers. As interesting as a small innovative product may be, a large broker or insurer may decline to consider underwriting innovative technology when the scale is small. It may be useful to bring together similar ventures to pool specialized risk expertise and attract insurer attention. Pooling could also help to build shared learning across innovation.
- Acknowledge the critical role of data in insurance. For risk transfer to take place, there needs to be data—both across projects and over time—to turn uncertainty into risk. Underwriting first-of-a-kind technology requires firms or project sponsors to be forthcoming in providing as much risk data as possible to minimize the uncertainty. This suggests a need for more transparency and disclosure than firms have historically practiced.
Setting the table
Hosting a party with guests from different worlds requires some careful planning to make sure that everyone is comfortable—and will return for another event.
- Language matters. The language of insurers can seem foreign or even off-putting to innovators—and visa-versa. Bringing these two worlds together will require education and the development of common simplified language that both can understand.
- The process should be informed, impartial, trusted and relevant. Innovators reaching out to insurers may be skeptical if advice comes from someone trying to sell them a product. A formal structure such as a sandbox, set up by a reputable third party, could bring together experts from insurance with clean tech firms and their investors. Such sandboxes have been used in a variety of industries and sometimes government bodies, such as the UK’s regulatory sandbox set up by the Financial Conduct Authority. There, FinTech firms could interact with regulators and others to pre-emptively broach potential concerns that might otherwise emerge far later when they would be harder to address. An insurance sandbox would bring together experts in insurance with ventures and their funders in a safe conversation about the potential role of insurance in de-risking some aspects of their business
Expanding the Table
Adding a few more guests may make everyone more comfortable.
- Government funding in the form of the Inflation Reduction Act has been catalytic to accelerating climate solutions. Innovation-insurance collaboration might be enhanced with government participation. A proposed CleanTech reinsurance fund would deploy government monies to bear the majority of the insurable risks of first of a kind climate ventures, with the private sector co-insuring not only to cover some of the risks, but also to gain direct experience with these new technologies. First of a kind climate ventures, with the private sector co-insuring not only to cover some of the risks, but also to gain direct experience with these new technologies.
- Civil society actors—universities and nonprofits—can keep the conversation on track by balancing out the various interests and demanding evidence and accountability.
In the crowded climate agenda for the insurance industry, insuring solutions seems like a worthwhile direction to investigate. Bridging the worlds of innovation and insurance holds potential to lower risks and accelerate progress in bringing new mitigation and adaptation solutions to market.