IEEFA Australia: Captive insurers threaten an orderly coal exit

The good news is that coal is rapidly becoming uninsurable. Coal has been one of the largest contributors to climate change in history, and COP26 recently identified its elimination from energy sources as a prerequisite to meet the Paris Agreement’s 1.5℃ warming target.

European insurers like AXA, SCOR and Zurich have led the way in banning coal insurance. Now almost all the major European insurers have followed suit, and U.S. and Asian insurers, like Chubb, AIA and Tokio Marine, are joining them.

But in desperation, the coal industry is turning to self-insurance.

What is self-insurance? In simple terms, companies set up their own insurance companies, normally called captives because they are owned by the parent company. The parent then pays the insurance premium into their captive instead of paying it to a third party insurance provider. Captive companies are often set up in offshore tax havens where they can obtain tax benefits and freedom from regulatory oversights.

There is absolutely nothing wrong with captives in principle. They can often make good economic sense for some companies, especially large multinationals with strong balance sheets that can diversify their own risks. All types of risk can be insured in a captive, from standard property risk, such as fire and flood of the insured’s factories or offices, to professional indemnity, terrorism and cyber risks.

And captive insurance is big business. Indeed, captives are currently booming. Captive insurance premiums grew by a whopping 64% in 2020, according to the global reinsurance broker, Marsh. There are now more captives than traditional insurers, according to Swiss Re, which estimates there are 7,000 captives in 70 jurisdictions.

Why are captives so popular at the moment? The main driver is simply the fact that traditional insurance is getting more expensive. This is due to two main reasons: first, low interest rates mean lower investment income for insurers; second, rising natural catastrophes have pushed up the cost of insurance claims, and hence premiums.

When we look at the energy sector in particular (which includes oil and gas as well as renewables), according to Marsh, there has been a notable growth in the use of captives. Insurance premiums put into captives grew by 151% in 2020, twice the market average (64%).

This may be entirely legitimate, and indeed could be because of growth in renewable energy. However, some coal companies are looking at captives to pool risk in a marketplace that is increasingly avoided by traditional insurers.

An example of this is Adani Enterprises’ Carmichael thermal coal mine in Australia, which has attracted widespread international condemnation. Almost all major banks and insurers have shunned the project.

Coal mining companies in Australia have reportedly been in talks to investigate self-insurance with the help of Picnic Labs, a captive insurance provider.

This is an extremely worrying development for two reasons.

First, Picnic Labs is totally ignoring the call made by the International Energy Agency (IEA) to stop investing in new coal, oil and gas projects if there is to be any hope of meeting the Paris Agreement’s target of limiting the rise in global temperatures to 1.5 degrees by 2050.

Second, it is well known that, in the absence of a viable commercial insurance market, it is notoriously difficult to price insurance risks. This makes it potentially dangerous for Picnic Labs to insure risks that the traditional sector has shunned. For example, who knows whether Picnic Labs’ captive will be able to pay its potential claims? Without commercial insurers offering coal insurance, there will be no commercial benchmark against which to measure the adequacy of Picnic Labs’ proposals.

In addition, coal mine long-term liabilities are becoming increasingly uncertain due to growing awareness of the environmental clean-up costs. A good example in Australia is BHP’s Mt Arthur coal mine in the Hunter Valley. BHP now faces about $1bn in clean-up costs for Mt Arthur. A real danger is that, should the mine’s legal entity collapse, the wind-down and clean-up costs are then externalised onto taxpayers.

For regulators and governments, we suggest these questions pose a considerable oversight challenge. How will they be able to assess the true financial security of what Picnic Labs ends up proposing? We don’t see an easy solution.

In conclusion, there is absolutely nothing wrong with captive insurers if they are used in a responsible manner. But one thing that captives should not be used for is to obtain insurance cover for a type of risk that is widely regarded as environmentally unacceptable with open-ended, long tail risks. Is that what the Australian people really want?

IEEFA guest contributor Nick Holmes was an equity analyst and is a former Managing Director and Head of Insurance at Société Générale Investment Bank.

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