By Kevin Mo
In March 2019, the Chaoyang District government in Beijing announced the historical signing of a green insurance contract for securing green performance of a new building. It had taken three years from the Paulson Institute’s innovative green insurance model in a policy paper to the development of insurance products to the actual signing of a green insurance contract, which broke the longstanding deadlock troubling the green building market worldwide.
A brief history of green buildings
Green buildings have been touted as a promising solution to transform the building industry into a more environmentally responsible one, featuring energy efficiency, resource efficiency, healthy indoor air quality, and a series of other green considerations.
One of the most popular green building certification programs has been the Leadership in Energy and Environmental Design (LEED) program, developed by the U.S. Green Building Council in 1997. At almost the same time, the U.S. and China started to collaborate on a historical energy efficiency demonstration building project in Beijing, eventually owned by China’s Ministry of Science and Technology. The building was occupied in 2004 and earned the first LEED certification in China.
China started to develop its own national green building certification standard in 2006, the so-called Three-Star Program (TSP), and certified its first green building in 2008. In the program’s first five years, the total floor area of TSP-certified green buildings was less than ten thousand square meters, almost negligible compared to the 10 billion square meters of new buildings constructed in China over that period.
In 2013, the State Council released a National Green Building Action Plan, significantly jumpstarting the green building market. In the following three years, TSP certified 472 million square meters of green buildings, surpassing LEED as the world’s top green building certification program by total certified floor area.
China’s Green Building Program Has Grown Quickly Since 2013 (10,000 square meters)
The design-performance mismatch
A common problem in most green building certification programs is the design-performance mismatch. In both the U.S. and China, green building certification programs started with a checklist of design details. As long as a building’s blueprints earned enough points to qualify for a certain green level, the building received a green building certification regardless of its actual performance after construction.
Unfortunately, a green building design does not guarantee green performance after construction and occupancy. Although green-certified building design does not necessarily mean green performance, developers usually charge higher premiums to sell buildings that have green-certified designs.
To address the design-performance mismatch, one solution could be to add another layer of certification for the performance stage, after a building has been occupied. Again, many developers simply ignore the second certification—by the time a building is ready for its performance rating, the developers have already made out with a ‘green’ profit. In fact, among all of China’s certified green buildings, less than five percent hold green performance certificates; most are green-certified by paperwork only.
The mismatch between design and performance has been a universal impediment to green building programs in the world.
Financially reinforced deadlock
As if this problem was not serious enough, governments worldwide promoting green development often jump on the bandwagon by offering incentives to green buildings. It is convenient for governments to demonstrate their green commitment by incentivizing certified green buildings. But if those buildings are certified by design on paper only, the gap between design and performance certifications will only be further widened. And when government incentives reward undesirable behaviors, it builds nothing but distrust between developers and consumers, eventually damaging the credibility of green building programs.
The green building market gets further skewed when bankers enter the fray.
A December 2017 report released by the former China Banking Regulatory Commission (CBRC) showed that 21 major Chinese banks had issued green credits totaling RMB 8.22 trillion among 12 green categories in the first half of 2017. Category Nine, for green buildings and energy efficient buildings, was issued a whopping total of RMB 730 billion in green credits from 1H 2013 to 1H 2017.
The banks decided whether or not a building was green based on design certificates. Therefore, banks probably cannot be blamed for missing due diligence, as they simply did not have the necessary institutional knowledge to make good judgment calls.
What if banks could issue green credits based on performance certificates, rather than design certificates? Regrettably, it would be simply too late, since construction loans are made before construction.
The term mismatch, between credit issuance before construction and green performance certification after construction, presents a huge dilemma that is financially reinforced by the current approach to green credits.
Green Loans for Energy-Efficient and Green Buildings are Rising Steadily (100 million RMB)
An innovative scheme to break the deadlock
In 2016, the Paulson Institute published a policy paper ‘Financing Energy Efficient Buildings in Chinese Cities,’ sponsored by the Bloomberg Philanthropies. The paper identified huge financial needs and gaps in the Chinese green building market. It proposed an innovative model that introduced the concept of green insurance for scaling green performance-centered green buildings, addressing the two mismatches: one between building design and actual performance, and the other between credit issuance and performance rating.
In 2017, People’s Insurance of China (PICC), the largest property and casualty insurance group in Asia, signed an agreement with the Paulson Institute to develop a line of insurance products based on the concept. In 2018, the city of Beijing—already one of the most active cities in promoting green buildings—agreed to pilot the green insurance model, with funding support from the World Bank and Energy Foundation.
The newly signed green insurance contract between PICC and a green developer in the Chaoyang District signified the embodiment of the green insurance concept proposed in the Paulson Institute policy paper. It also marked a perfect representation of the Paulson Institute’s “think-and-do” motto.
There remains much left to be done
The concept of a green insurance model to break the deadlock is not exceedingly difficult to understand. Under the model, a green developer buys an insurance policy before construction to guarantee a building’s green performance after construction. A banker then issues green credits based on the insurance policy. Once the building is constructed and occupied, the insurance company will be liable if performance ratings do not meet the original promise.
However, implementation of the concept proved to be much more challenging under the pilot.
First of all, the insurance company and the bank participating in the pilot differed in risk-averse preferences. Under current regulatory policies, the bank had little flexibility to adjust its credit issuance practices. An originally designed insurance-banking interlocking mechanism ended up not being implemented. If banks were to issue green credits based on performance-guaranteed insurance policies, it would significantly boost interest from green developers. The newly established China Banking and Insurance Regulatory Commission, merging former banking regulatory commission and insurance regulatory commission, shall have incentives to encourage the insurance-banking interlocking mechanism for green buildings.
Architects and building energy professionals were challenged by the new model as well. They had been used to designing green buildings based on the prescriptive checklist offered by green building standards. Rarely were their design models sophisticated enough to accurately predict actual performance, and their green building design capacity still needs to be enhanced significantly.
Improvement of all related regulations and policies proved to be a critical tipping point. Central and local government agencies must streamline current pro-green policies to foster more market-oriented innovations.
Furthermore, banks, insurance agencies, and governments must share credit reports among each other so that all involved parties can track and share the profile of a building project, from design to construction to occupancy.
Finally, the most important task that has not yet been fully achieved is to quantify the insurance premium based on the risks presented by developers, projects, green levels, and other factors. Hopefully, the first project will help improve the actuarial model.
Nevertheless, the first pilot of the green insurance model proved to be capable of breaking the green building deadlock. Further pilots will test a policy framework that can scale performance-based green buildings through coordinated efforts between green insurance and green credit. The Paulson Institute is committed to helping expand this innovative solution to addressing crucial challenges to green building development in the world.