Energi, a leading provider of specialized insurance and risk management solutions, and the National Renewable Energy Laboratory (NREL) partnered in October 2013 to analyze and begin to quantify the uninsurable risks of energy efficiency retrofits in small office buildings.
Uninsurable risk is one of the largest barriers to financing energy efficiency in small buildings. These risks associated with energy efficiency retrofits can limit investment in energy efficiency.
Small buildings comprise a large segment of commercial buildings, so finding ways to bring energy efficiency to scale in that sector is important. Small commercial buildings account for 95 percent of United States commercial buildings, 51 percent of their square footage, and 44 percent of the energy they consume, said Rois Langner, project manager at NREL.
“It’s a fragmented and diverse sector out there – it’s the convenience stores, karate studios,” said Langner. “We’re trying to categorize who they are.”
The project’s focus of categorizing building stock and isolating risks is intended to encourage lenders to participate in the market. Once this is achieved, lenders and energy efficiency service providers can prioritize reducing costs and interest rates. Crowdsourced funding and new alternative tax-advantaged investment vehicles will also help to drive private lending and bring down lending costs.
Pooling these energy efficiency project loans and selling them as securitized products to investors poses challenges.
“It’s one step at a time. We don’t know that we’re ready to dive into the securitization market in regards to energy efficiency,” said Angela Ferranti, vice president of alternative energy solutions at Energi. She said this project will produce tools that can help facilitate securitization.
This two-phase Department of Energy-funded project will measure the transaction costs of energy efficiency investments and analyze the uncertainty of uncontrollable influences acting on building performance.
For the first segment, researchers extrapolated from one building type and one climate zone in Michigan to predict energy savings for various types of small office buildings. The first pilot study has been completed. NREL is currently analyzing the results and looking into how to expand this approach to other building types.
“The idea is to roll results out to key partners through Energi and through Michigan State, collect feedback on how this information is used, and roll that into an extension of a project we’re anticipating in the future,” said Langner.
The second component of the project will examine economic risk associated with building performance uncertainty.
NREL is currently working with Energi to understand the company’s energy efficiency insurance model in order to hone in on variables that are not typically covered by performance guarantees.
In doing this, lenders and energy efficiency providers will have more refined tools to estimate the risk of uncontrollable influences acting on performance of buildings – including occupancy changes, changes to temperature set-points, and behavior changes such as running equipment at night.
According to Ferranti, investors considering these projects ask questions like, “What if energy savings aren’t achieved because of occupancy change, which would require an adjustment of insurance?”
With this in mind, last year Energi and NREL began exploring how to assess and control for risks like occupancy change and extreme weather, what that assessment might look like, and how that might be incorporated into financing. They are now in the phase of determining how to design tools for banks and how to help lenders fully understand every element of risk.
Developing appropriate analysis tools will assist banks to fully understand every element of risk if they are interested in doing so. According to Ferranti, the results of this effort will allow lenders or energy service companies to estimate a buffer so that they can be confident of the predicted energy savings of a building.
For example, if a contractor installs a diversified set of efficiency measures that will achieve 100,000 kWh of guaranteed energy savings per year, that guarantee and the contractor’s insurance on that guarantee are only good if the building owner follows the guidelines for occupancy that were established in the agreement.
Therefore, in cases like this, there may also be a stipulation in the agreement that the building occupant must stay within 3-5 percent of current energy usage. This will prohibit the occupant from significantly increasing energy consumption, such as by increasing the number of operating hours that the building is being used.
If the building occupant violates the agreement about meeting energy usage limits, the energy savings will not be guaranteed because that change in use directly impacts realized savings. This issue poses a serious concern for insurers. Energi and NREL are exploring how banks can assess this risk.
The private sector can play an important role in bringing the energy efficiency market to scale. According to the American Council for an Energy Efficiency Economy’s newly released white paper, “Engaging Small to Mid-Size Lenders in the Market for Energy Efficiency Investment,” these entities could invest more than $279 billion in energy efficiency across the building sector. Yet growth has been slow. The report states that small to mid-sized lenders are well-positioned to help realize the full market potential of energy efficiency, particularly with small commercial customers.
Although institutional lenders are beginning to serve small businesses, small to mid-sized lenders offer advantages to small business energy efficiency customers, who may benefit from these lenders’ connections to local resources such as contractors with experience working on similar projects.
These lenders include community development financial institutions, mission-driven green lenders, community and regional banks, credit unions, small commercial entities linked through utility programs, and a few conventional banks.
For these lenders, uninsurable risk is not the only challenge – insufficient demand, validation of projected energy savings, regulatory hurdles, and the need for uniform underwriting standards are all important, especially for the underserved and challenging small commercial and multifamily markets.
Since small commercial buildings’ energy efficiency projects are difficult to insure, research like this can help develop tools for banks seeking to bridge the gap and offer loans to this market.
This article was originally published by the Clean Energy Finance Forum, a publication produced by the Yale Center for Business and the Environment.