Taking Cover
Since subsidies can no longer be taken for granted, the renewables sector now has to look at alternative sources of capital, which means a rethink of its risk management

A changing investment climate for renewable energy projects is providing a stern test for the insurance industry. How is the industry responding?

Richard Baillie

The renewables sector is undergoing a period of turbulence with cuts in government subsidies calling into question the development potential of many projects, especially in Europe where cuts in solar feed-in tariffs range from 15 per cent in Germany to 70 per cent in the UK. The good news is that the global view remains upbeat, with the worldwide market for renewable energy insurance continuing to track the growth enjoyed by the renewables sector as a whole and expanding at more than 20 per cent a year.

Meanwhile, governments are increasingly turning towards sustainable, renewable, low-carbon sources of energy, with the EU bloc alone installing more renewable power capacity in every year since 2008 than gas, coal or nuclear. The caveat is that to continue to compete in this changing environment where subsidies can no longer be taken for granted, the sector has had to access alternative sources of capital while taking steps to increase its risk-management protocols, all of which means changes to the insurance market.

“The renewable power/energy industry is driving forward innovation in the insurance market,” says Steven Munday, renewable and clean-tech power team leader at London-based broker Marsh. “Insurers are expecting business from renewable energy projects to grow, notably in protecting them against a lack of natural resources.”

“Additional investments into renewable energy are needed to achieve the transition to a low-carbon economy,” says Agostino Galvagni, chief executive officer of Swiss Re Corporate Solutions. “Risk management measures such as insurance will be key to encourage further private sector investment.”

Changing economic landscape

The trend nowadays is very much for operators and financiers of renewable energy generation to demand ‘all-encompassing’ coverage, including commercial risks that may previously have been held by a project’s equity investors, delays to installation because of poor weather and political risks.

“The biggest challenge in the EU is that renewables are still more expensive than other types of energy, and they are supported by various EU countries’ subsidy mechanisms, so subsidies affect the long-term financial viability of projects,” says Munday.

Munday says he tends to look at the broad project risk. “What most people are worried about is changing regulation and subsidy mechanisms at a national level, especially in countries such as Spain and the Czech Republic, where subsidies have been cut recently.”

As the demand for insurance grows, new products, including alternative risk-transfer solutions, are starting to appear on the market. The use of solutions such as weather-based financial derivatives is slowly picking up, but still only around 4 per cent of wind-power producers apply them to their projects, partly due to the limited availability of suitable risk-transfer mechanisms.

Previously, most weather-risk coverage was provided by the capital markets, but more traditional reinsurance and insurance companies are becoming active in this area, including Chartis (formerly AIG Europe), Munich Re and Swiss Re.

That said, and despite some resistance to change from some insurance providers, Munday says there are real innovations to be found in the types of insurance currently being offered, and Marsh has just put in place a EMEA Renewable Power & Cleantech Practice, which Munday describes as a “more collegiate network among its offices worldwide as a way of sharing best practice” among the firm’s EMEA construction, power and energy teams.

“There has been a rise in esoteric products, including lack of wind and solar performance warranties. Some people build in the wrong place because a lot of high wind sites have been used, and although the data’s there, it might not have the longevity of other data sets, so the site might be worse than you originally thought it would be. Lack of sun is also an issue, for similar reasons.”

Indeed, wind and hydropower projects are leading the way in seeking coverage against lower-than-expected wind and rainfall. For example, hydropower operators in South America and Asia that use diesel or natural gas back-up generators to meet electricity delivery obligations have insured themselves against high prices of fuel, in the event of low rainfall. Most of the wind risk cover is being written for farms outside Europe with contracts typically covering three to five years.

Solar is one of the fastest-growing sectors, but cable theft is becoming a real issue that impacts on insurance cover

Getting the pricing right

A major issue in renewable energy projects is its costliness in the early stages. The projects are often capital-intensive and highly leveraged, with up to 70–80 per cent financed through debt.

Munday explains: “Larger coal, gas and nuclear tend to be funded by large power utilities, so have a greater risk tolerance that they can take on their balance sheets, whereas renewables tend to be financed through non-recourse project financing without the support of the likes of E.ON or SSE, but with lots of private equity and pension fund money. There are also a lot of private utility companies trying to diversify their portfolios, so we do see it as something of a growth area.”

This view is shared by Fraser McLachlan, chief executive of GCube, a provider of insurance to wind, solar, biofuel, marine and hydroelectric power projects. “If you look where insurance rates have come down from in the past few years, then it remains a very competitive market. Now it’s easier to say who my competition is, and it’s due to this competition that the premiums for renewables projects are going down,” he says.

The feeling is that prices are currently about as competitive as they are likely to get. “Broadly speaking, insurance is about 1 per cent of capital expenditure year-on-year,” says Munday. “The current pricing structure is very attractive to a lot of insurers and insurance is getting cheaper, but it probably won’t be for very much longer.”

McLachlan also believes that the market has attracted too many players, pushing prices down to levels that are going to be unsustainable in the medium to long term. “It has been a soft market for several years and premiums for renewables projects have come down to a level that is unsustainable,” he says. “We’ll see the fall in premiums flatten out over the next year, and over the next 24 months, we’ll see increases of 5 to 10 per cent.”

McLachlan says that while premiums were likely to rise, the renewables sector will be better served by the insurance industry as the range of policies on offer matures alongside the expanding cleantech industry. This could mean that smaller-scale projects stand to benefit, as more suitable risk transfer products that are more standardised and cost-effective become more widely available.

“GCube got involved in wind energy when it was regarded as a ‘distressed market’, where it was very difficult for these projects to even get insurance cover,” he said. “Now green issues have risen up the agenda, we’re seeing mainstream insurers waking up to the opportunity… there is now capacity for projects to relatively easily get in excess of $1 billion of cover.”

McLachlan warns that some of the more recent entrants to the insurance market might not have the level of expertise and technological know-how necessary to compete over the longer term. “Maybe some of the less-nimble players will drop out of the market so there will be less insurance capacity. New entrants to the market don’t always have the [analytical] data.”

McLachlan says that the industry has been here before. “Back in the 1990s, the market was almost in the same situation as it is now, where everyone was just jumping in — Lloyds of London people and so on — and lots of people were just filling their boots. But then there were lots of claims, and insurance ran for the hills.”

And he warns that history could repeat itself. “These days, it is important to pick the insurance carrier carefully as it is still a claims-intensive business. People should prepare themselves for price rises as some companies drop out of the insurance market. It will be a gradual process — but ever since the aftermath of 9/11, rates have gone down, so unless you see some sort of similar such world-changing event, you are likely to see price rises of 5–10 per cent per year over the next few years.”

Importance of warranty cover

With renewables facing a future that involves less government support and more funding from private sources of capital, the onus is on project developers to have cover that is increasingly watertight.

The pressure to increase premiums will be particularly intense for insurers providing cover for renewables projects because they are being asked to take on greater levels of risk, says McLachlan.

“There are still a few technical issues that arise, and because it is a sellers’ market, more manufacturers are offering limited warranties.

“Wind turbines, for example, which used to be offered with five-year manufacturer warranties, are now only having two-year — or in some cases, one-year — warranties. That is putting more liability on the insurer,” he adds.

“Regular insurance isn’t expensive, but the warranty is the expensive and crazy part of it all,” adds Brian DeBruin, who is regional director for construction, power and infrastructure in North Asia at Aon’s office in Hong Kong. “Warranty cover is being driven by lenders rather than by reinsurers like Swiss Re or Munich Re, because the cost of not doing it is high or because the cost of not doing it is costly accounting-wise. It’s also a trade-off, and both Munich Re and Swiss Re really understand that trade-off, but there is also not much competition in this — it’s just Munich Re and Swiss Re and a few others,” he says.

Close to half of insurance claims from offshore wind farms are due to damage to products during installation

DeBruin believes that when it comes to warranties, the renewables sector is being unfairly penalised in many instances. “The situation as regards renewables is a little bit crazy because when it comes to new technology for gas turbines, then you are looking at something that is a super-technical product where efficiencies are being pushed, but here you have lenders who are only seeking commissioning and testing over an eight-month period, then a maximum default period of 24 months.”

Uncertain subsidy outlook

The challenges involved in renewables insurance vary greatly from sector to sector. Solar is still reeling from falling prices for solar panels and collapsing subsidies across many territories.

However, falling solar prices is not the only problem the sector faces.IMIA, the global association for engineering insurers, has identified solar as one of the fastest-growing renewable markets, but also notes that underwriters often have limited loss data to work from, while theft of solar panels from commercial photovoltaic (PV) sites is an often-overlooked or under-estimated risk. “It still remains a claims-intensive business if I’m honest,” says McLachlan. “Solar has suffered a lot in Europe recently because of theft, which mainly effects cabling, so we have had to increase our deductibles to take that into consideration. Theft of cabling is becoming a more serious problem, particularly in Italy, where I would say it is in danger of becoming a systemic problem.”

“There’s a real need for efficiency coverage,” says Munday, noting that the insurance market is providing coverage for degradation of solar PV modules and covering the insolvency risk of the panel manufacturer. There are underwriters who would consider covering change in policy on a customised basis, Munday says, to absorb the risk of a change in a renewable energy subsidy regime mid-construction. But he adds he is “pretty sure insurers would not respond to the situation that we had in Spain”, where the government made retroactive changes to feed-in tariffs for solar PV. Indeed, says McLachlan, “there is still the possibility that private equity firms could take out a class action against the Spanish government.”

McLachlan’s GCube has historically generated around 90 per cent of its revenue from the wind industry, but the firm is now seeking to diversify and is targeting the solar sector as the next big growth area. “We’re very excited about solar, and we’re expecting some big technology leaps in both PV and solar thermal,” he says. “In the next three to five years, we’d like to build a good book of solar business.”

The quality of policies on offer is also improving, McLachlan says, as specialist renewables insurance providers such as GCube seek to differentiate themselves from the mainstream insurance companies entering the market.

That said, the PV sector also has a heavy exposure to financial risk. “My big concern with solar projects is their balance sheets,” says McLachlan. “A lot of PV companies providing these panels are highly-leveraged and yet they are providing 15–20 year warranties with their equipment. I really do question whether they’re going to be around that long.”

The one renewable business that has been the most disappointing to date is wave and tidal. McLachlan says that he has made money from most types of renewables, but wave and tidal remains problematic. “We are continuing to support it because we do renewables and so we should [support it] because we want to encourage it to develop, but it remains very new and it’s going to take several years to develop, just like wind did.”

The bioenergy sector is also widely accepted as one of the riskier areas of renewable energy. “Every project is innovative and presents quite a few different risks, be it from the variable quality of the fuel stock to the components used in the actual bioenergy process,” says Munday. “But biomass is a good option, because it has the capability to provide peak baseload generating, whereas wind and solar are more intermittent and act as a top-up.”

High risk, high reward

By its very nature, offshore wind is always likely to be more expensive to insure than land-based projects. “We tend to work on a broad multiplier of ten, so offshore could cost ten times as much dependent on location,” says Munday. He says he is currently overseeing a lot of offshore wind projects in Denmark and Sweden, as well as across the rest of Europe and in the Middle East, and adds that cover is increasingly dependent on best practice being followed at all stages of the project.

“There are currently a lot of discussions about supply-chain management and the German, French and UK governments will be pitching for big offshore wind farms, but these days cover is only available if appropriate and is often dependent on having marine-warranty surveyors onboard vessels when cables are laid — that’s to say an experienced mariner who has worked with cables, as this ensures best practice is being followed,” explains Munday.

McLachlan adds: “Offshore wind follows the ‘rule of five’ — it’s five times the price, five times the deductible and five times the loss. But if you look at the pricing of offshore wind over the past five years, then we would usually get 1–1.5 per cent of the contract value, whereas now we get just 0.5 per cent. Some offshore wind projects are not going ahead due to economic factors at the moment but given those numbers, I don’t think that insurance is an issue in any of that.”

Meanwhile, almost all the insurance claims from offshore wind arms have been due to physical damage to products during installation —and more than half of those claims relate to damage to the electricity cables. “Cable losses mean that it is hard to make money in offshore wind so now we tend to offer excess-of-loss capacity in the market,” says McLachlan. (‘Excess of loss’ is the method whereby an insurer pays the amount of each claim for each risk up to a limit determined in advance and the reinsurer pays the amount of the claim above that limit up to a specific sum.)

More than £70 million ($113 million) in claims for UK offshore wind farms have been submitted over the last three years, relating to as many as eight installations. “That’s the kind of thing that’s hitting the insurance market, and that affects the appetite for insurance,” says McLachlan. This view is shared by Munday: “Less than 10 per cent of offshore wind projects have been constructed without claims, especially for cable laying,” he says.

“Also, we are now looking at longer terms for offshore wind. Whereas it used to be 24–36 months, we are now looking at 60 months and five-year deals – and this is causing the insurance market problems,” says McLachlan. According to him, given the vast sums of money involved, customers are now looking for insurers to be more hands-on. “Our approach is to be really proactive with our customers. On the claims side, for example, a common claim is for turbine blades that have been hit by lightning strikes. Some insurers can take up to a year to get those blades working again, but because we specialise in this market, we have partnered with a fibre glass company so that we can undertake repairs on site quickly — saving both us and the customer money.”

The next few years look set to be a time of great change in the renewables industry. The economic downturn has hit the old system of financing hard and this has meant that renewable energy projects and the insurance industry have had to keep innovating in order to deliver the kind of products that investors are demanding.

The indications are that this will continue to be the case as the technologies involved are often relatively new or still at the prototype stage, which can make assessment of risk difficult. In addition, sites are commonly in remote and often inhospitable areas, making access for maintenance and repair challenging. And although growing competition in the sector has forced prices down and cut margins to the bone, the skill and experience of insurers will continue to be of crucial importance to ensure that these risks are effectively managed.

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