Building a wind farm is no small undertaking. With costs ranging from US $2 million to $5 million per MW installed, the financial backing of a strong insurance partner is a must in order to put stakeholders’ minds at ease.
But how do insurance companies evaluate risks and determine premium pricing for projects that are “firsts” such as the first U.S. offshore wind farm or the first use of a new MW-class turbine? We asked four insurance experts to weigh in. Our roundtable discussion follows.
Murray Haynes, Partner, Alesco Risk Management Services
Maarten Mulder, Head, Renewable Energy, Sompo Canopius
Eileen Kauffman, Head, Global Renewable Energy, Travelers
Jonny Allen, Offshore Underwriter, GCube Underwriting Ltd.
Runyon: How does an insurance company go about insuring a new project, such as the first offshore wind farm in the U.S., which is being built in Rhode Island?
Haynes: Arthur J. Gallagher & Co. is the appointed broker to the Block Island Wind Farm so we are very familiar with this project as well as various other wind farms in Europe. [note: Alesco is a wholly-owned speciality business subsidiary of Arthur J. Gallagher & Co.] Project-specific information is the starting point in the underwriting process. Insurers look for a clear breakdown of project elements and costs and want to understand the construction methodology and allocation of responsibilities between project partners.
Insurers set considerable store in the experience of project developers and principal contractors. However, the offshore wind industry is young, especially in the U.S., so insurers may need to look beyond specific experience and assess based on broader indications of competence and transferable skillsets.
Mulder: Insurers start off with studying the project information available and will ask questions when information is incomplete or missing. For offshore wind construction projects, it is essential that the project developers and contractors are experienced in marine contracting, that the ships they use are fit for purpose and that the technology installed is proven and not prototypical. Any possible lack of experience of the project management should be compensated by the use of experienced consultants and execution of the project should be secured by a Marine Warranty Surveyor.
Kauffman: One of the first steps in insuring a new project is to obtain every possible piece of information on the project – from the sea bed conditions, movement of the water, background on vessels, and the list of suppliers for all of the component parts. Do the contractors have good risk mitigation and safety procedures in place? The foundation design is a huge element we assess through the partnership of our in-house engineers. One of the most important factors is to assess the experience of those working on the project. Have they been engaged in building and operating offshore wind energy projects in the past? We also ask for a copy of the O&M contract to see what is covered and what isn’t.
Allen: First, we engage with the project team at an early stage, particularly those responsible for risk management and technical due diligence. This is an opportunity to give our opinion on risk practice, technology choice and aspects of the construction rollout that may affect provision of insurance coverage and risk premium. We then provide comprehensive analysis of the typical hard and soft risk factors to understand the risk profile of the project.
Second, we communicate extensively with the project’s insurance broker to elicit the exact risk appetite of the client and investigate which insurance options may be available from GCube. First-in-market insurance requests, such as offshore wind in the states, bring a particular set of challenges, and it is imperative that all parties agree on the extent of the risk transfer that is being negotiated.
Runyon: What about the first of a piece of new technology, i.e. a brand-new 8-MW or 10-MW wind turbine that is being placed in service for the first time? In other words, how do you figure out the risk of failure on something that has no track record?
Allen: From an insurer’s perspective, the technical due diligence required for a new turbine is similar to that which is carried out by financiers, but we will also look at the whole lifecycle of risk, especially from a property damage or mechanical breakdown perspective. It is unusual for an OEM to produce such a large capacity wind turbine from scratch; this type of machine is usually developed by drawing on the evolution of smaller turbine models, where insurers have a wealth of claims information to hand. This allows for a focus on changes related to the size and output of the turbine, enabling us to develop an understanding of how these modifications affect technology risk.
Kauffman: We are currently involved in some projects under construction that are using 8-MW turbines, but there aren’t any operating with this new technology offshore at this time. There are, however, prototypes that have been installed onshore. To understand the risk of technology that doesn’t have the benefit of a track record, we work closely with our engineering staff. The new technology can be a re-engineered version of an existing turbine. We also take a close look at the top-tier suppliers who are making the components. While it’s difficult to assess the full spectrum of risks, we can assess the design risk which is assumed by the turbine supplier.
Haynes: Insurers are naturally cautious of new technology and the more revolutionary, as opposed to evolutionary, that technology may be the more cautious their stance towards premiums and conditions of coverage. However, they have a vested interest in meeting the requirements of their customers and the key to all informed underwriting decisions is an understanding of the technology. For this reason, it is common for technical workshops to be held by manufacturers in order that key design details of new products may be explained and for interested parties, including insurers, to ask questions. Indeed, this practice was followed by GE (Alstom) during the launch phase of their Haliade 150-6 MW offshore turbine, the model currently being installed at the Block Island site and for which the project will be the first commercial deployment.
Ultimately, where an insurer is unable to get comfortable with a new technology, the option remains open to impose coverage restrictions that exclude or limit losses directly arising from the most prototypical aspects of a new product.
Mulder: Wind turbines are usually tested extensively by their manufacturers before they are brought to the market. It is also common that independent third parties carry out a type certification, where the overall concept of the turbines is assessed (safety, design, construction, workmanship, quality) in accordance with a certain wind turbine class. Once the testing period has been successfully concluded and a certificate is issued, insurers might consider providing cover for this new turbine, although the track record is limited and technology not fully proven. Needless to say the scope of the manufacturer’s warranty is also of great importance here. The extent of the insurance cover, the deductibles and/or the premium will in the end reflect all these factors.
Runyon: What is the ballpark amount that a developer should expect to pay for basic insurance on a new project? Is there a cost-per-megawatt range you could offer?
Mulder: The different projects are unique and they all have their specific risk profiles and there are simply too many factors that need to be taken into account. So there is no such thing as a ballpark amount for insurance I’m afraid. But it is safe to say that insurance costs for a comprehensive CAR insurance are usually well below 1 percent of CAPEX.
Kauffman: Insurance rates are set by looking at each project on its own merit. We assess many factors including the main contractor, turbine technology, location, CAT environment and warranty periods. We also look at cable, pipeline and technology line crossings below the sea bed to assess the type of third party damage that could be caused.
Haynes: A lot of variables feed into the premium modelling exercise that will guide an insurer towards the premium charged for a given project. Aside from the actual value of a project these will include technology choice, contractor experience, location, environmental conditions and project duration.
Understandably, some care is required in offering ballpark figures and as broker to the Block Island project we obviously need to respect client confidentiality. However, insurance premiums for the construction phase of commercial scale offshore wind farms will usually be in the seven figure number range.
Runyon: In theory, as more offshore wind farms are built in the U.S. would developers expect insurance rates to go down on subsequent wind farms? Why or why not?
Mulder: Generally, in a new market where developers and contractors are not experienced yet, rates tend to be higher. When more wind farms are built and the industry matures, the number of incidents tends to decrease and the risk for insurers improves. In that case rates would probably go down.
Kauffman: In theory, this would appear to make sense – but there are so many variables that need to first be reviewed. Offshore wind farms are a new area for U.S. contractors, some of whom may not have worked on these types of projects. A contractor may feel comfortable with offshore cable installation, but may not have the experience with jacket installation. Similar to the UK, the rates have gone down over time due to the experience level of the contractors and the loss performance.
Haynes: We would generally expect this to be the case with a few caveats. Firstly, and unsurprisingly, if the loss experience of earlier projects was to be unfavorable then insurers would maintain a cautious rating stance until the position was seen to improve. Secondly, much would depend on whether succeeding projects were broadly comparable in terms of technology, environment and involvement of project stakeholders that had built experience on previous projects.
The European offshore wind sector, and the UK in particular, has seen an evolution from smaller developments close to shore in shallow water to larger developments further from shore in deeper water. This has been accompanied by the utilization of substantially larger turbine designs. These trends pose additional technical and logistical challenges and, in theory at least, could serve to militate against any potential rate reductions based on successful completion of smaller projects.
Allen: If the project risk profile is to remain incremental as the first commercial projects begin in the U.S., then I would expect to see a modest reduction in premiums as the build out gathers pace. If, however, there is an ambition to build with untested technology, very far from shore, or in regions prone to natural catastrophes, such as the Gulf, then this will introduce loadings to rates which would see premiums increase to account for new risks that the offshore insurance market has to accommodate. Building in areas which often experience natural disasters is a particular unknown for wind energy developers, as nearly all projects to date have been built in relatively predictable areas of wind speed.
Runyon: Do rates go up as turbines go out of warranty?
Kauffman: Fortunately, offshore warranties are typically much longer than the warranties offered to the U.S. onshore market. That said, it depends on the situation because once a turbine is out of warranty, I would highly recommend the owner/operator obtain an extended warranty. Once an extended warranty is in place, it wouldn’t likely affect the rate.
Mulder: As long as the turbines are within warranty, warranty related claims are picked up by the turbine manufacturer. These warranty programs are usually rather wide, not only giving compensation for defective parts, but also encompassing some kind of availability guarantee. In comprehensive insurance policies, design cover is given but manufacturers’ warranty is excluded. Once the warranty period expires, the comprehensive policy will start to cover this class of losses. Usually in these cases the rate will indeed go up.
Haynes: Logically, yes, because after expiry of the warranties it is more likely that the cost of repairs to, or replacement of, damaged equipment will fall within the scope of a typical ‘All Risks’ policy. Whilst losses arising from normal ‘wear and tear’ are usually excluded from insurance policies it is not always possible to ascribe the sudden breakdown or failure of equipment to such causes. However, there are some mitigating factors that may minimize or even negate such increases. These may include a favorable loss record, competitive (‘soft’) market conditions or continued engagement of competent operations and maintenance contractor.
Allen: Absolutely. The offshore turbine market has to date featured robust turbine warranty agreements, which respond to a number of teething issues, particularly with newer turbine models. Once this risk is transferred to insurers after the warranty ends, it is only fair that there is additional premium to insurers to balance the increase in claims costs.
Runyon: Sticking with offshore wind, I’ve read that cable-laying has had a high-frequency of claims. Is that true? Why? If not, what aspect of wind farm development and operation runs the highest risk of something going wrong?
Haynes: Cable losses have, unfortunately, remained a significant source of insurance losses to the sector. In part, this has been attributable to inexperienced contractor teams and to vessels which weren’t especially well-suited to the role. Over time purpose-built cable-lay vessels have become more common-place and a deeper pool of experienced personnel has developed. Nevertheless, the offshore environment remains an inherently challenging one, both in terms of construction logistics and the wear and tear it imposes on cables and other assets post-commissioning.
Furthermore, cable damage can be expensive to repair, especially post-commissioning once the wind farm construction vessels have moved on to other projects. Lengthy minimum hire periods for specialist cable-lay vessels can mean that hire costs far exceed the actual replacement cost of the damaged cable.
Mulder: Yes, you could say that incidents relating to installation and operation of high voltage subsea cables are the main cause of losses in the offshore wind industry. Globally, over 40 percent of all claims are cable related and the total claims costs account for more than 80 percent of all offshore wind losses. Cable incidents can cause project delays and create cost overruns. The financial impact of these incidents for parties involved is increasing and managing this impact is essential. Whereas most cable losses in the past seemed to be attributable to the transport and cable-laying activities themselves, recent operational losses might raise some doubts about the robustness and durability of the cable design.
Allen: Having insured the vast majority of offshore wind projects to date, there are clear indicators from our data that cable construction in the offshore wind market is a major driver of claims, so much so that we estimate that 2/3rds of all construction claims are the result of poor manufacture, installation or initial operation of both export and array cables.
There are a large number of contributing factors to why cables have such a propensity for failure, but for the majority of cases, the root cause is some form of human error. The installation process is complex and takes place in a testing marine environment — and the industry has learnt some hard lessons as to what does and doesn’t work in this regard, with insurers largely footing the bill for the inexperience of a small number of contractors and developers.
We recently studied the causes, financial impact, and mitigation of these subsea cabling incidents in our Down to the Wire claims report, which we authored for our community of brokers and insureds. The report highlights a growing need to create more effective communications channels and improve data collection procedures, in addition to ensuring high standards of quality control during the laying of cables.
The good news is that this trend has started to improve in the latest round of projects, but it is too early to say if there has been a definite increase in construction performance when it comes to cabling.
Kauffman: I’d agree that cable-laying has had a higher frequency of claims. We’ve seen a spectrum of different issues with cables that fail. For example, laying cable in difficult weather conditions can lead to installation issues such as cutting the cable which could affect proper connections. As more projects are completed, cable companies continue to learn from these lessons and make the corrective steps in their operations.
Runyon: What are some risks that developers might not realize they can insure against? For example, do you have coverage for policy changes?
Kauffman: There are certainly insurance products that can mitigate the tax-credit recapture risks and lack of wind.
Haynes: Most insurance policies are triggered by property damage in some form and the consequences thereof, such as loss of revenue whilst the damaged asset is being repaired. Insurers of such risks will tend to broaden or restrict specific coverages in response to loss experience and market competition.
However, some less familiar risk transfer products may be triggered by ‘non-damage’ events. These include weather hedges which respond to periods of unfavourable weather which may delay the completion of a construction project (and delay revenue flow) or lead to lower than expected operational-phase revenue flow (e.g. lack or wind or, for solar projects, lower irradiation levels).
Developers are understandably alive to the financial costs of possible contractual breaches by counter-parties and unexpected regulatory changes that government authorities may impose (e.g. retrospective reduction in renewable energy tariff schemes). Insurance markets can offer a measure of risk transfer but the breadth of cover is quite tightly defined. For example, it is possible to insure against breach of a power purchase agreements by an electricity off-taker but only after the case has been to arbitration and found in favour of the generator (i.e. the trigger is failure of the off-taker to abide by an arbitration decision). Unfortunately, in the case of policy change, governments have shown themselves to be rather too willing to make such changes for this to be insurable.
Allen: One area that’s featured prominently in the news agenda over the past year or so is weather risk. US onshore wind projects have recently suffered the effects of some of the lowest wind speeds since records began – which in turn has affected the ability of project and portfolio operators to generate stable returns.
As a result, we have seen increased demand for tailored weather risk transfer solutions that can counteract the impact of financial performance by providing payments to the buyer in the event that wind speeds fall below an agreed threshold. Insurers such as GCube have offered these profitability-smoothing mechanisms for some years, but recent low wind conditions have raised awareness and encouraged considerable uptake over the past few months.
The effects of policy and regulatory changes are harder to mitigate – however GCube does offer a Political Risk Insurance (PRI) product, targeted at developers and project owners in emerging markets, where market volatility and currency issues are arguably more of a concern.
Mulder: There are a lot of risks that developers can insure against. For example, perhaps weather related coverage is not very well known: it is possible to insure against weather downtime (wind, wave height) during construction. An unexpected period of high wind or waves during a construction period can determine whether a contractor or developer writes a profit or a loss at the end of the project.
In the end, the transfer of certain risks to an insurance company should be governed by the risk appetite of the developer. An experienced broker will be able to help identify and manage the developers’ risks and transfer some of these risks to insurers.