The Carbon Countdown: Captive Insurance Strategies for Energy’s Ticking Time Bomb

As the urgency to combat climate change intensifies, the energy sector faces unprecedented financial risks. One of the most pressing issues is the risk of stranded assets. This challenge was first brought to widespread attention by the Carbon Tracker Initiative’s 2011 report, which highlighted the financial risks associated with unburnable carbon. Now, the risk of stranded assets extends beyond fossil fuels to encompass a broader range of high-emission industries.

Numbers underscore the increasing intensity of this risk. For instance, a 2021 study in Nature highlighted that to avoid catastrophic climate impacts, 90% of coal and 60% of oil and natural gas reserves must remain untapped. However, despite a plethora of “net zero” targets, companies continue to pursue new extraction projects. According to an April 2024 assessment by Carbon Tracker, few companies are planning to reduce production. An article by Chemistry World referenced the World Benchmarking Alliance (WBA), stating that the industry does not have a credible transition plan.

This ongoing investment in fossil fuel extraction further increases stranded asset risk. As environmental regulations tighten and market dynamics shift toward renewable energy, assets tied to fossil fuels are likely to become obsolete or devalued, posing significant financial risks to energy companies and their investors.

The consequences of failing to address this risk have already been seen in prior years. For example, in a press release by As You Sow, it announced the U.S. Securities and Exchange Commission (SEC) allowed Sempra Energy and Dominion Energy to omit shareholder resolutions addressing the potential for stranded natural gas assets. This decision leaves investors in the dark about how these companies are managing the risk that climate action and market forces will reduce demand for natural gas. Both companies are continuing to build significant gas assets despite aggressive climate change targets in their respective states, increasing the likelihood of these assets becoming stranded.

This growing risk places energy companies in an increasingly vulnerable and costly position. The challenge? Carbon footprint stranded asset risk is highly complex and multi-faceted and thus it’s a risk that’s extremely difficult to effectively address. There are no specific insurance policies for stranded asset risk, and attempting to cover the potential fallout with commercial insurance would fall short given the evolving shifts in market conditions, regulations, or technological advancements.  However, captive insurance has emerged as an innovative financial strategy to not only address these risks but also to aid energy companies in the transition to renewable energy.

The Role of Captive Insurance in Managing Carbon Risks

Captive insurance is a form of self-insurance where a company sets up its own insurance subsidiary to cover risks that are otherwise hard to insure or very expensive. This allows companies to tailor their coverage to specific risks, offering more flexibility and control compared to traditional insurance models. For the energy sector, captive insurance can address unique risks associated with carbon footprints and stranded assets.

One of the primary advantages of captive insurance is its ability to provide customized coverage. Traditional insurers may be reluctant or unable to cover emerging risks related to climate change and stranded assets. In contrast, a captive insurer can create bespoke policies that directly address these challenges such as:

• Cost Savings. Captive insurance provides lower premiums and greater financial flexibility. The savings realized can be reinvested into sustainability projects, further enhancing the company’s green transition efforts. For example, a company might use these funds to upgrade infrastructure or adopt smart technologies to optimize energy consumption.
• Enhanced Risk Management. Captive insurance allows companies to have control over their risk management practices. This proactive approach enables companies to identify and mitigate risks before they become critical issues, enhancing overall resilience and stability. Companies can implement tailored risk management strategies, such as investing in sustainable initiatives and improving energy efficiency, to proactively address potential risks.
• Investment in Research and Development (R&D). Funds retained within a captive can be allocated to R&D of sustainable technologies. This investment drives innovation in cleaner energy solutions, reducing the company’s carbon footprint and promoting long-term sustainability. For example, a captive insurer might fund projects focused on improving energy efficiency or developing new renewable energy technologies.
• Boosting Investor Confidence. A robust captive insurance strategy demonstrates a company’s commitment to managing climate risks and transitioning to a sustainable business model. This can significantly boost investor confidence, as it shows that the company is proactively addressing potential threats and is prepared for the future. As investors increasingly prioritize environmental, social, and governance (ESG) criteria, having a solid risk management framework in place can attract more capital and support for the company’s initiatives.

Captive Insurance in Action

Consider a power company that recognized the financial risks associated with its coal-fired plants. Anticipating stricter regulations and market shifts toward renewable energy, the company established a captive insurer. This captive provided coverage for the financial losses associated with decommissioning coal plants and transitioning to renewable energy infrastructure. By doing so, the company achieved financial stability during the transition and was able to invest in new technologies without the fear of sudden regulatory or market changes jeopardizing its financial health.

Another energy firm used captive insurance to manage risks associated with evolving environmental regulations. Faced with new carbon taxes and stringent emissions standards, the firm’s captive insurer provided tailored coverage for these regulatory risks. This strategy not only ensured compliance with new laws but also protected the company’s financial stability, allowing for a smoother transition to sustainable practices and maintaining investor confidence.

Challenges and Considerations

Establishing and managing a captive insurer involves navigating complex regulatory environments. Companies must ensure compliance with both insurance regulations and evolving environmental laws. This requires specialized expertise and diligent oversight to maintain compliance and leverage the benefits of captive insurance effectively.

Managing a captive insurer effectively requires a deep understanding of both insurance and sustainability issues. Companies need to invest in skilled professionals who can develop and implement comprehensive risk management strategies tailored to their unique needs. This involves continuous monitoring and adaptation to new regulatory and market developments.

Future Outlook

The use of captive insurance in the energy sector is likely to grow as companies increasingly recognize its benefits for managing climate-related risks. This trend will be driven by ongoing advancements in renewable energy technologies, evolving regulatory frameworks, and heightened investor and stakeholder expectations. In fact, a report by Aon found 40% of the energy sector utilizes captive insurance with another 10% considering pursuing captive insurance. As more companies adopt captive insurance solutions, we can expect to see a broader impact on the industry’s transition to a low-carbon future.

Captive insurance has the potential to significantly impact the energy industry’s transition to a low-carbon future. By providing tailored risk management solutions, captives enable companies to invest in sustainable practices and technologies, aligning their operations with global efforts to combat climate change. This proactive approach not only mitigates financial and operational risks but also ensures long-term viability and competitiveness in a rapidly changing market landscape.

The risk of carbon footprint stranded assets is a major concern for power and energy companies as they navigate the transition to a sustainable future. Captive insurance offers a powerful tool for managing these risks, providing financial stability and flexibility while supporting investments in renewable energy and innovative technologies. By leveraging captive insurance, energy companies can enhance their risk management strategies, boost investor confidence and ultimately align with global sustainability goals. This proactive approach ensures that companies are better prepared to face the challenges of a low-carbon economy, securing their long-term success and contributing to a more sustainable world.

—Christopher Gallo spent his career in risk management as a regulator with the Connecticut Insurance Department. After retiring from his regulatory career, he joined CIC Services in 2020, and is currently the managing director of the company. He consults directly with business owners, CEOs, and CFOs in the formation, and as a regulatory liaison, of captive insurance programs for their respective businesses.