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Credit insurance is critical in supporting global trade. According to the International Credit Insurance and Surety Association, Trade Credit Insurance supported 12.07 billion Euros in total trade volume in 2020. Overall, 15-20% of global trade relies on credit insurance to stimulate economies and create a liberal, stable market for goods, services, labor, and capital. As economies and nation-states invest in clean energy markets, credit insurance can continue providing a stable marketplace by mitigating risks for stakeholders.

How did we get here?

The first records of credit insurance date back to the 1860s, when Johns Hopkins endorsed promissory notes from individuals and firms that he judged to be worthy of credit risks. Hopkins promised to fulfill the obligations under the note in the event of default, and made it easier for the note bearer "to sell it to another firm or to a bank." Hopkins's method of endorsing promissory notes, as cited in Arthur Farquhar and Samuel Crowther's book The First Million the Hardest: an Autobiography, also includes historical anecdotes considered to be the entomology of financial derivatives.

Over 100 years after Johns Hopkins began the tradition of factoring, European nation-state borders began solidifying after WWII, and merchants selling goods throughout the continent needed methods to protect themselves against risks. The risks at the time included nationalizing assets (this promoted economic recovery after the war but restricted the scalability of private enterprise) and sovereign and foreign corporate defaults. Merchants were worried about sending goods across newly constructed state borders to buyers with unknown financial histories.

Legal methods to enforce payment "may be either unavailable or too expensive to pursue." To solve this, the Marshall Plan included the creation of the U.S. Export-Import Bank (Eximbank), where the U.S. government worked with corporations to help foreign buyers receive direct financing and have their own streams of revenue insured. After WWII, private-sector groups, like the American International Group (AIG), Zurich Insurance Group (Zurich), and Ace Limited (now Chubb), emerged to provide assurance to offset risks - sellers could pay a premium to transfer payment and recovery risks to other entities.  

Despite advancements in factoring, there is a considerable gap between what lenders are prepared to provide and what borrowers need. The total gap in funding is estimated to be between $2 trillion and $30 trillion USD. This gap in financial resources represents a loss of untapped opportunity for the global economy as these funds are illiquid.  

Resources to support small and medium-sized enterprises (SMEs) exist but are withheld due to traditional lenders' perceived risk. Specifically, compared to large enterprises, only 10% of SMEs have access to financial resources, while 90% of small and medium firms are disproportionately denied access to funding. SMEs face challenges from traditional lenders because there is a perceived high risk in lending to these firms. Traditional lenders rely on conventional risk assessment methods, which consider factors including historical financial records. Just as in previous iterations of global trade, credit insurance provides an avenue toward unlocking and adding funds into the market that otherwise would not have been available.  

The Role of Credit Insurance

Credit insurance has been critical for expanding global trade, particularly for SMEs with low credit scores, simply because they are relatively new to the market.  A similar challenge is emerging for SMEs as the United States transitions to clean energy. SME are viewed as inherently risky.  

Low credit scores and other risk factors are barriers to acquiring clean energy. Specifically, SMEs struggle to secure capital from traditional financial lenders to update or install infrastructure. Riskiness here refers to factors such as location and financial history. Just as in the case of global trade, credit insurance can help with the clean energy transition as it provides factoring services to traditional lenders for borrowers new to the market. Credit insurance assumes the risk and guarantees that the lender will be fully compensated.  

The global economy misses out when capital is withheld from the market based on risk. As the United States and countries worldwide transition to clean energy, providing that financial backstop is critical for unlocking otherwise illiquid capital. When SMEs are denied funding, entire markets lose out on immediate cash flows that can be dedicated to innovative technology and scalable solutions for countries, states, and communities. Where traditional lenders gatekeep resources, credit insurance unlocks the value SMEs can immediately put towards installing or retrofitting renewable technology for everybody. When working alongside government incentives, such as tax breaks and grants, and private capital from traditional financiers, credit insurance is critical to transitioning the world to a more sustainable future.

At Energetic, we mainly see our insurance policy applied to enhance credit and help optimize terms of financing.  There is an implicit benefit to lenders as well – who can treat the insured offtaker cash flows as investment grade. We are inclined to ask whether there is a more explicit impact might be available to banks and corporates alike. Credit insurance is routinely applied as an instrument to substitute credit rating and reduce risk-weighted assets or improve Tier 1 capital ratios.  New Current Expected Credit Losses (“CECL”) rules have been in place for ~2 years, and we are inclined to ask:

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‍Why aren’t Insured’s considering Insurance to reduce CECL?

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What are Current Expected Credit Losses or CECL?

The Current Expected Credit Losses (“CECL”) accounting standard was designed to change how financial institutions account for expected credit losses. This standard, ASC-326: Financial Instruments – Credit Losses, significantly impacted two previous standards: FAS-5: Allowance for Loan and Lease Losses (“ALLL”), and FAS-114: Accounting for Creditors for Impairment of a Loan. CECL applies to any institution that issues credit (such as banks, savings institutions, and credit unions) and files regulatory reports in accordance with US GAAP. Public business entities have already adopted CECL, while calendar year-end private companies were required to adopt CECL on January 1, 2023.

CECL requires financial institutions and other covered entities to recognize lifetime expected credit losses for a range of financial assets based not only on past events and current conditions, but also reasonable and supportable forecasts. Under CECL, provisions for expected losses over the entire life of the loan are reserved when the loan is originated or purchased. The previous accounting standard utilized an incurred loss methodology (“ILM”), whereby a loss allowance was recognized once it was probable that a credit loss had occurred and the amount of such loss could be reasonably estimated.

What is the Impact of CECL?

CECL was issued to replace ILM as policymakers determined that the increase in allowances occurred too late in the business cycle. This was particularly evident in the wake of the 2008 financial crisis. As such, CECL generally increases the responsiveness of provisioning for credit losses to changes in economic outlook. However, lifetime loss allowances applied at loan origination or purchase potentially result in higher provisions in each reporting period and possible reduction and/or volatility in capital ratios and profitability metrics (particularly during periods of outsized loan growth). This may also directly impact:  

• How loans are priced.
• How much capital is allocated to a portfolio lending strategy.
• Which products are offered to customers.

The degree of reserve movement and related impacts are naturally influenced by economic conditions, as well as the nature of an institution’s portfolio and process for recoveries, among other factors.

The Value of Credit Insurance for CECL

The use of credit insurance, when properly structured and attached to a loan, is an appropriate means to offset expected credit losses and achieve capital relief under CECL.

As it relates to credit insurance, guidance under ASC 326 states that a freestanding insurance contract may not offset an institution’s estimate of expected credit losses. In other words, an entity would estimate its allowance for credit losses under ASC 326 without contemplating recoveries from credit insurance.

Freestanding Insurance Contract is defined as being entered into:

• Separate and apart from an institution’s other financial instruments or equity transactions.
• In conjunction with some other transaction and is legally detachable and separately exercisable.

Examples of freestanding contracts:

• Insurance acquired separate and apart from the original transaction, such as credit enhancement after the origination or acquisition of the underlying financial asset.
• Purchase of credit default swaps.  

Determination of how credit insurance can be used to offset CECL reserves is based on the nature of the credit insurance contracts and its attachment to individual, or set of, credit transactions. Requirements for an insurance contract to be deemed Non-Freestanding include the following:

• Named insured or the named loss payee is the institution extending the credit transaction.
• Exercise of the contract is explicitly tied to the status of the credit transaction.
• Term of the insurance is equal to or less than the term of the credit transaction.

By meeting these requirements, a correctly drafted insurance policy can be seen and non-freestanding in nature and should therefore qualify to directly offset the expected credit loss calculation.

Read Energetic’s full whitepaper, Using Credit Insurance to Manage CECL Exposure, researched and written by Cassandra John, to learn more about how credit insurance can reduce the impact of CECL.

Find more of Cassandra's work on her website.Have questions on how Energetic Insurance can help you implement a programmatic partnership to deploy energy efficiency and/or renewables across commercial real estate sites? Contact us here.   

  This article does not constitute and is not intended by Energetic Insurance to constitute financial advice or a solicitation for any insurance business.  

The U.S. Department of Energy Loans Program Office (LPO), along with Sunnova Energy International, recently announced a conditional commitment to provide up to $3 billion in partial loan guarantees for distributed energy resources, such as rooftop solar, battery storage, and virtual power plant (VPP)-ready software for residential homeowners. This initiative is a combined effort to provide more renewable energy to any eligible project, focusing on projects that benefit disadvantaged communities. Government-sponsored funds working alongside private enterprise, particularly to mitigate risks and increase resource access, is nothing new. However, initiatives like this partnership often struggle to scale, lack accessibility, and are slow to respond quickly to market instability. Private enterprise, when armed with federal funding, protects tax-payers from risk and provides stability during market fluctuations.

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The project, coined “Project Hestia,” provides disadvantaged communities with increased access to Sunnova’s residential services. Consumers, especially those with low credit scores, will be able to secure loans from Sunnova to purchase Sunnova’s services and equipment. The LPO loaned Sunnova that funding specifically to provide renewable energy resources to communities that would otherwise be unable to procure those services. This type of transaction is called a loan guarantee, and it is a way for a lending agency (Sunnova) to offset the risk of borrowers (consumers) who have low credit scores to an entity (LPO) that guarantees loans or bills will be paid. Loan guarantees can foster economic development and advance public policy.

Eligible projects must be equipped with Sunnova’s technology and accessible by a personal electronic device. Through this methodology, Sunnova aims to expand access to its additional offerings, including future virtual power plant activities, decrease greenhouse gas emissions, and increase the demand response impact of residential power systems. Sunnova is mainly focused on historically underserved groups to increase their access to services and tools to participate in innovative solutions for climate change, dedicating 20% of resources to homeowners in Puerto Rico.

Beyond the program’s goals, LPO’s partnership with the program highlights their strong belief in the strength of cashflows from residential solar financial traction, even if some percentage of participants in the program are below traditional FICO metrics or have no FICO score. LPO, along with the EPA’s new Greenhouse Gas Reduction Fund, is responding to market circumstances and capitalizing on the incentives introduced by the Biden administration to encourage residential real estate owners to implement clean energy solutions, including adding heat pumps, solar, and net metering to lower their utility bills.  

The challenge now is how to make this kind of program more pervasive. The LPO has extensive capital resources to deploy. While the administration has made great strides to make the program faster and more accessible - there are still significant barriers to entry. Applying for such a partnership requires a lengthy application process that can extend over months and high application fees that fee organizations are prepared to pay. These barriers, while reasonable for a $3 billion transaction, leave organizations with fewer resources wanting. The Greenhouse Gas Reduction Fund’s goal of uniting government-sponsored funds private sector with grant funding (rather than requiring projects to take on additional loans) serves a much larger pool of applicants is one avenue for exploration.

Federal funding for clean energy solutions capitalizes on path incentives through tax breaks and programs. Unified, those forms of assistance provide one avenue for residential real estate owners while protecting them from incurring risks. However, these programs often leave communities lacking fast, scalable solutions that can be applied to neighborhoods, towns, and cities.  

In the most mature markets in the world, Government-Sponsored Enterprises (GSEs) transfer risk in senior tranches to private sector insurers. Credit Risk Transfer (CRT) relations have been a major program over the past 15 years to shift risk from implied taxpayer support to private sector reinsurers in the U.S. Mortgage market. By transferring risk from tax-payers over to private financial institutions, tax-payers can limit their risk exposure, while private enterprise helps provide stability, liquidity, and affordability to the market. Energetic Insurance was founded to increase access to renewable energy for underserved businesses and communities. Often these entities are left behind because they are deemed risky by traditional metrics, and we provide risk mitigation to unlock the community’s access to renewable energy quickly.  

The new partnerships between Sunnova and the DOE provide further evidence of how enterprise and government initiatives can lead to positive outcomes for individuals and disadvantaged communities. But given experience with large programs, underserved communities can remain as such without the resources or knowledge to apply for programming. As financial markets continue to develop better risk management tools, federal funding, and private enterprise can continue to work together to provide scalable financial solutions that work for everyone.

Conversations about climate change are centered around what tools organizations and individuals have at their disposal to accelerate the transition to green energy. One key question the insurance industry contends with is how to address adaptation and mitigation challenges of climate change.  

The risks of clean energy installation are real, and insurers are particularly exposed. Transitioning to a resilient carbon-neutral economy requires stepping up global financing of climate mitigation and adaptation measures with a more integrated approach. Insurers, as risk managers and investors, play a critical role.  

Insurance providers should be actively providing solutions through risk management strategies and investment into projects in areas that need additional assistance. They are positioned to take on risks that are unique to project developers actively working on mitigating carbon emissions and working to create sustainable energy solutions.  

1. Insurers can take on weather and infrastructure risks exposed to changing climate and are therefore positioned as leading authorities on the costs of business-as-usual approaches.
2. Insurers can take on risks of holding back deployment of renewable and distributed technologies to mitigate carbon emissions and contribute to resilient energy grids. The physical risks of climate change are rising in severity, with widespread effects on people, communities, businesses, and governments globally. Investing in clean energy to mitigate changes in the global climate is necessary. Clean energy’s creditworthiness often struggles to recover from energy shocks in the market. Government funding does not provide all the resources necessary for a developer to rise to meet market demand. Entities conducting risk analyses must actively contribute to the solution.  
3. Insurers can deploy their investment arms to be an essential source of capital for sustainable infrastructure projects. Significant capital is needed for the large-scale deployment of new technological solutions to enable and expedite the decarbonization of key sectors. Capital from tax equity entities, private investors, private and public grants, and financiers are necessary to fuel the next steps in advancing clean energy. Yet new technologies and infrastructure systems come with myriad risks that must be assessed and managed with a full life cycle view to attract large-scale capital.  

Insurers are uniquely positioned to allocate risk capital to proactively combat climate change, as opposed to simply absorbing the risks of the market. Government entities, such as the New York State Energy Research and Development Authority alongside the Department of Energy, are leading the way with resources and funding available for developers and financiers to procure cheaper capital and other resources to supply clean energy to entities that need to comply with public policy.  

Local policies are rising to meet this challenge by assisting all stakeholders in adopting clean energy solutions; 70% of buildings in 2050 have already been built. Environmental retrofits are necessary to further the carbon-neutral economy. Local laws are increasing demand for building retrofits, and financial tools must evolve to provide solutions that work for everyone, including New York City’s Local Law 97.  

But despite targeted government action, financing gaps remain. Financial and credit risks are holding back the clean energy market. Due to the scale of the challenge, blended finance can augment the impact of government subsidies. A combination of policy commitment and private investment is needed to facilitate climate migration, and here is where insurers can easily participate.

All project stakeholders are exposed to risks Insurance provides risk mitigation that can appropriately allocate capital to certain risks and advance all stakeholder goals. Insurers are the long-term investors that clean energy developers and financiers need to meet the long-term policy goals established by international and domestic governing bodies. Private capital is available for regulated, core technologies that can meet goals aimed at addressing climate change. Insurance provides supplemental financial tools to mitigate risks, allow private and public funds to actively respond to community needs, and build a sustainable economy that meets stakeholder needs.  

Scale Microgrids has closed a $225 million energy transition debt facility to fund a wide range of distributed energy projects, including microgrids, solar systems, and battery storage. Backed by KeyBanc Capital Markets and Energetic Insurance, this groundbreaking financing will support cleaner, more resilient energy infrastructure for businesses, schools, and municipalities across the U.S. The deal underscores the growing momentum behind renewable energy solutions and Scale’s leadership in the industry.

Learn more about this exciting development here.

Energetic Insurance attended IMN’s ESG & Decarbonizing Real Estate Conference in early February. The conference focuses on how the energy sector can have a significant positive impact on the environment, diversity and inclusion, social responsibility, and impact investment opportunities. Investors, employees, customers, suppliers, and tenants are all demanding higher standards for ESG strategy. Investors understand that ESG is a driver for long-term value and sustainability, and it has become an important part of the decision-making for capital allocation.

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There is a knowledge gap emerging for property owners who are being asked to report on their carbon footprint for investors and other stakeholders, but really do not know how to do so. Data capture products are emerging from the market to fill this gap. These products help property owners and managers understand their footprint, and provides them with the information they need to invest in resiliency. A process is beginning to form this data capture and reporting structure:  

1. Collect and measure data on building utilities.
2. Analyze data.
3. Assess goals and create a plan.
4. Implement methods to meet goals.

Investors require GRESB (the global entity responsible for creating ESG benchmarks for financial markets) scores and other metrics for their portfolio. These investor requirements force building owners and managers to put emphasis on the first two steps in this process. With robust data, building owners and managers can direct their attention to the third item on the list, but that attention does not extend to the fourth. Property owners have collected data, analyzed and drawn conclusions from the results, then hired consultants to design a plan to improve energy efficiency utilities. But there is little execution.  

Based on the conversations we had at the conference, whether or not a building manager can implement plans is based on individual situations. Some said that the reporting itself suits their needs, and there is no incentive to implement a plan. In some cases, implementation is purely a matter of bandwidth: sustainability teams are often thin (although growing), and individuals have full workloads. Where companies are starting to implement, it seems that financing is case specific. Many cities are introducing rules that require buildings to be more efficient or pay a fine, like New York City’s Local Law 97. Some property owners may opt to pay the fine rather than remediate their emissions footprint. The incentives for installing energy-efficient retrofits are not always aligned with building owners’ priorities. Complying with the law comes down to economics - if the cost of the fine is less than the cost to remediate, then it is hard to argue for further investment in efficiency.

One of IMN’s goals of the conference included discussions of how the energy sector can further diversity and inclusion and talk openly about social responsibility. Stakeholders are trying to understand how the Social aspect of ESG is related to their work. Many property owners and managers are experimenting with ways to make tenant spaces more community-focused in an effort to enhance tenant experience and increase satisfaction in spaces, even if it means lessening rentable square footage or increasing operating costs to do so. Solutions for this part of the equation range from common spaces for collaboration or inter-company events to near real-time transparency of a tenant's environmental impact. Building managers and owners are still collecting data on the outcome of these changes, so real long-term impact of these efforts, but property owners reported a decrease in tenant turnover and an increase in demand for these types of spaces.

Some private property owners take the view that they are "exempt" from growing calls for reporting because they are not subject to new SEC rules or other investor-driven reporting. However, in many cases, the Scope 1 & 2 footprint of these properties account for the Scope 3 emissions of larger entities - so ultimately, they will need to get a handle on their emissions as well.