Insuring renewables
Alternative energy powers captives forward
As climate change becomes an increasingly significant area of concern in the US, captives may become an important tool in insuring alternative energy assets. Captive International reports.
“A captive could be used to retain the risk of a category 1, 2 or 3 hurricane. A parametric trigger could then be designed to cover a category 4 hurricane.”
AXA XL report
Renewable energy might not seem like an area that makes many people think of captive insurance, but there is a growing need for it as energy companies increasingly move away from traditional fuels like coal and look to alternative sources such as the sun and the wind instead.
A report into the use of parametrics in renewable energy by AXA XL in June 2021: “When the wind blows: the role of parametric insurance in renewable energy”, pointed out that around the world, countries are increasing their focus on generating energy from renewable sources as part of their commitment to achieving the goals of the Paris Agreement on Climate Change, to lower the rate of carbon emissions. According to Bloomberg New Energy Finance, wind and solar energy will amount for 48 percent of installed capacity and 34 percent of electricity generated worldwide by 2040.
As a result, offshore and onshore wind farms are an important and fast-growing sector of the renewable energy space, with installed capacity projected to quadruple worldwide by 2030.
As AXA XL points out, the issue is that some of these farms might be built in places that are risky, as they need to be situated in areas where winds are reliably strong. For example, in the US the Atlantic and Pacific oceans and the Great Lakes areas are great wind resources. This means, however, that wind farms may be built in areas that can sometimes be affected by natural catastrophes, such as Atlantic hurricanes, earthquakes and tornadoes.
In Latin America and Asia, two areas which are seeing increased demand for wind energy, suitable sites for wind farms may have exposure to cyclones that form over the North Tropical Pacific or South Pacific oceans, for example.
In addition to this, built-up urban areas are often, understandably, the largest energy consumers, and to meet this demand and optimise the provision of energy to those conurbations, more wind farms are being built near to urban centres.
The increasing demand for wind farms means that, since construction has likely already taken place on the more accessible sites, new installations are being located in more difficult-to-access areas or areas prone to other natural catastrophe risks, such as earthquakes.
By design, wind turbines are top-heavy structures and while they are built to withstand very strong windspeeds, severe weather can cause delays during the construction phase or damage, and result in loss of output during the operational phase.
For example, in 2003, Typhoon Maemi caused extensive damage to onshore wind turbines on Miyakojima Island, off the coast of Tokyo. And in 2013, Severe Tropical Storm Usagi caused $16 million of damage to an onshore windfarm in China.
It’s not just physical damage that companies considering a captive-related insurance product are looking at.
“Project owners and financial institutions backing these projects are looking to protect the risk associated with the projects not performing as expected,” Kevin Kaminski, senior vice president underwriting operations at US-based specialty provider of commercial property and casualty insurance programmes eMaxx, told Captive International.
“For example, if a financial institution finances a solar and battery storage equipment system associated with an electric vehicle charging station over a 10-year period, and the battery system fails to store energy beyond the manufacturer’s warranty, this would cover the cost associated with the replacement of the equipment.”
Kaminski explained why a captive or a protected cell company will work for various stakeholders in this sector:
- End customers: the ability to purchase an extended warranty beyond the manufacturer’s warranty and have peace of mind that the system will be maintained and serviced
- Financial institutions financing the project: the ability to know that the loan is protected from risk associated with failure of the system. They can be afforded the confidence that the repayment of the loan will not be hindered by a lack of system performance
- Distributors: the ability to offer end customers an extended warranty with less frictional cost, creates a profit centre for the distributor and designated capital to pay potential future losses
- Reinsurers: these types of products are better suited for reinsurance than insurance. The product provides that distributors would assume substantial risk exposure, which reduces exposure, reinsurance is less capital-intensive and certainty can come sooner. These products clearly check off the environmental, social, and corporate governance criteria box.
A captive solution
In 2021 eMaxx started to offer the ability to provide its alternative energy warranty products through a variable cost captive solution. The suite of warranty programmes provide support to manufacturers, developers and owners for renewable, alternative and energy efficiency projects by providing an insurance-backed solution to product and performance shortfalls backstopped through excess of loss quota share reinsurance.
The alternative energy warranty products provide a variable cost captive solution for project owners, developers, manufacturers and financiers to insure the performance of these projects and reduce credit exposure. Programmes include energy savings warranty, solar performance warranty, manufacturer’s product warranty and performance warranty.
eMaxx offers a turnkey approach for businesses wanting to offer these warranties including a Vermont-segregated cell captive, proprietary policy forms, captive management and reinsurance brokering.
Once in a lifetime
AXA XL points out that over the lifetime of a wind turbine, whether on or offshore, there are several distinct phases during which risk transfer plays an important role. Delay-in-startup coverage is a form of risk transfer that can help protect against losses caused by insured events that halt or prolong construction of wind farms.
In addition, wind farms are often reliant on private equity funding for their construction and can therefore be cash-flow sensitive. If there is a delay in construction subsequent to an insured loss because of severe weather, for example, clients need to find a way to quickly recover any lost revenue caused by the delay to be able to keep up repayments to their lender.
“Wind turbines are large, technical constructions and if they are damaged during their operation then insurance coverage can play a vital role in ensuring they can resume operation,” said the AXA XL report.
“The role of risk engineers is vital here. Their understanding of the technical nature of these turbines and the risks involved in their construction and operation can help both clients and underwriters to make sure that there is appropriate coverage in place should anything go wrong.”
AXA XL added that one area that offers an alternative and complements traditional insurance is parametric insurance. This offers buyers a pre-specified payout based upon a pre-agreed trigger and it is playing an increasing role in covering the risks associated with wind farms.
For example, in the case of the construction of an offshore windfarm, such a trigger could be wave height that would cause a delay. Clients and risk experts can devise the trigger based upon a wave height that likely would cause a delay in construction and agree a payout level based upon the cost of the delay.
When the policy is triggered by waves reaching the pre-agreed trigger level, the policy payout is swift and not dependant on a visit from a loss adjuster.
Another area where parametric can be extremely useful for clients after windfarm construction is in the management of accumulation risk. Frequently wind farms are clustered in those areas that offer the right conditions for them to operate, meaning that operators may have a large number of wind farms that could all be affected if a major extreme weather event occurred over a wide area.
Parametric coverage can complement traditional insurance coverages to help mitigate this risk—and captives have shown increased interest in this area, with this year’s Vermont Captive Insurance Association conference having a session on it.
Parametric can offer an alternative in areas where traditional insurance coverage may be scarce or highly priced, such as non-damage business interruption coverage in today’s market, said AXA XL. A parametric trigger can be designed to cover loss of revenue caused by a non-damage event.
Operators of wind farms may also buy parametric insurance coverage to cover them if they face a capacity issue—for example if there is not enough wind to produce the amount of power that they had budgeted for.
Parametric coverages can be used to work alongside a self-insured retention and can swiftly pay out a deductible if a pre-agreed trigger is met. For example, a captive could be used to retain the risk of a category 1, 2 or 3 hurricane. A parametric trigger could then be designed to cover a category 4 hurricane. Underwriters can reinsure this via a quota share arrangement.
Climate change and a drive towards greater sustainability are likely to dominate the agenda for companies of all types, and notably those in the energy sector, for many years to come. Innovative solutions such as using parametric coverages, protected cell companies, warranties and captives as a whole will therefore drive many conversations on this topic.
Finally, some US domiciles are marketing their states’ alternative energy policies as a reason for captives to move or set up there. Nevada’s captive insurance division cites alternative energy as a key reason for captive owners to relocate their captive to the state, saying that: “Nevada’s emphasis on expanding into renewable energy, information technology and other essential new sectors of the future underline a bright economic future.”
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