What is Green Enterprise Risk?

If you are not aware, green buildings can have a direct positive impact on the value of commercial property portfolios.

Green strategies, such as energy conservation measures, can have a direct effect on energy consumption which in turn improves net operating income (NOI) and, by extension, asset valuation.

As a result, successful property owners, operators, commercial real estate investors and lenders are learning about green buildings and green retrofits.

Decision makers are also rethinking their due diligence process in order to quantify energy performance.

Building energy conservation measures (ECMs) can result in as much as 40% in energy savings per year, boosting NOI and property value. 

With superior operating performance, it only makes sense that green buildings are less risky...

But understanding green risk requires first having a basic understanding of risk. So what is it?

What is Risk?

Risk is ever-present. At it's most basic level, risk is the exposure to danger, harm or loss. Common sense, right? Well now let’s go a step deeper. There are two primary types of loss:

1) Speculative Risk: Speculative risk involves the possibility of either gain or loss (i.e., investing in the stock market offers the risk that your investment may increase or decrease.)

2) Pure Risk: Pure risk involves only the possibility of loss (i.e., driving a car offers only the downside risk that you may get in an accident.)

As humans we experience classic risks every day, such as the risk of stubbing our toes, to tripping and falling down, to being bitten by a dog, to becoming critically injured in a car accident. Risks can be worsened, or increased, through hazardous conditions, or hazards.

"Hazards" are variables or conditions that increase the likelihood of risk (i.e., an icy patch on a walkway or a roadway, or speeding while driving), whereas "perils" are the causes of loss, such as wind or fire.

What is Green Enterprise Risk?

According to Stephen Bushnell, founder of Stephen Bushnell + Associates, risk management is an effective, time tested approach enterprises and individuals can use to identify and manage the entire landscape of future risks.

This includes addressing the rapidly evolving energy, environmental and other sustainability challenges, or "green risks".

Enterprise risk management adds a second dimension: The benefits that accompany risk. Green enterprise risk management is simply pursuing strategies that may provide "triple bottom line" benefits.

The most successful enterprises manage their exposures to risk in order to increase their success, reduce their losses, increase profitability and create high-functioning employees. Understanding integrated risk and reward optimizes decisions and drives success.

In the case of energy efficiency, as described above, the returns on investment (ROI) can be substantial. Today, real estate professionals needn't worry about investing in green retrofits because of green insurance policies and products, such as energy savings insurance, that transfer risk.

Energy Savings Insurance - Reducing Green Risk Even Further

According to Evan Mills, Energy Savings Insurance ("ESI"), also known as energy savings warranty insurance or energy savings warranty (ESW), transfers and spreads both types of risk over a larger pool of energy efficiency projects.

In exchange for a premium, the insurer agrees to pay any shortfall in energy savings below a pre-agreed baseline, less a deductible.

Deductibles may range between 5-10% of a given loss, and losses may be capped at an upper number.

The premium is typically a percentage of energy savings expected over the life of the contract (such as 3% with a 10% deductible) or for a period of time as close to the payback period of the investment as feasible.

The premium may also be structured as a percentage of project cost.

The premium is paid only once, in the first year of operation, and policies are non-cancelable.

The premium is paid by the contractor (ESCO) with the client (investor/building owner) as beneficiary.
The client and/or other key stakeholders of the property undergoing the energy savings measures are added as additional insureds on the ESI policy.

ESI insurers reduce their exposure to losses through a combination of risk transfer (deductibles), contractual methods (exclusions) and technical methods (quality assurance, measurement and verification), which may include:

• 1) An energy audit of the Energy Conservation Measures (ECMs) by certified professionals, such as a professional engineer (PE)
• 2) Commissioning, a process of measurement and verification over time that installed renewable energy systems, heating, ventilation, air-conditioning (HVAC) and other systems are performing as designed
• 3) Exclusions which may include failing to properly maintain equipment, physical damage to equipment including wear and tear, financial default, sabotage/misuse/vandalism, changes in laws or codes, changes in building use (such as adding an energy intensive project such as a data center), changes in energy prices, environmentally unsafe materials released during operation, malfunction of data collection or acquisition systems

Sounds great, right?

However, while products such as energy savings insurance are increasingly available, they remain niche products because of a lack of understanding of green risk management.

And without considering the upside benefits of green building investments, public and private sector stakeholders can become too risk averse and miss enormous opportunities.

Take our "Green Risk Quiz" to test yourself on how prepared you are for today's green risk challenges!