INDECS – INSIGHT 20

Risk and Insurance

The UN Climate Change Conference of the Parties (COP26) summit in Glasgow brings parties together to accelerate action towards the goals of the Paris Agreement and the UN Framework Convention on Climate Change. Many economies are expected to pledge to develop more renewable projects.  In this INDECS Insight we will focus on the challenges, from a risk and insurance perspective, likely to be faced by developers of offshore wind projects.

With more money being invested in the offshore wind sector and larger and more complex projects being sanctioned there is likely to be an intense degree of competition for financing, expertise and insurance capacity.

Development challenges

Design defects

A wind farm consists of the same components being installed in the same manner multiple times. Foundations, cables, turbines and blades of standardized design will be fabricated and installed multiple times across the field. Each completed structure might have a value of US$ 10-20 million. Whilst the geographical spread of the risk is beneficial to the overall risk profile of a project, the standardised nature of the structures introduces a different risk exposure in the form of a “Serial Defect”.

A Serial Defect is any failure or non-conformance that has occurred with respect to several units of any particular item of equipment, with such failure or non-conformance resulting from the same cause. Developers will seek to manage the risk of Serial Defects through robust assurance processes in design, fabrication and installation and good supply chain management.  However, the risk of Serial Defects is significant and represents a significant potential source of financial loss.

Financing

The bankability of large scale offshore windfarm projects is heavily dependent on the existence of guaranteed long term revenue streams via power purchase agreements or subsidy arrangements. Without such arrangements, international lenders (including developmental banks and export credit agencies) are unlikely to provide financing.

Risk Allocation “Company Group – Contractor Group”

The principles for the allocation of risk between the “Company Group” (i.e. the developer) and the “Contractor Group”, under contracts for offshore wind projects remains similar to those used in the offshore oil and gas sector, with some variations.

One such variation is the amount of liability that the Company Group seeks to transfer to the Contractor Group during the development phase of a project for the rectification of defects.  In EPCI (Engineering, Procurement, Construction and Installation) contracts the Company Group often seeks to make the Contractor Group liable for rectifying defects for a period after completion which is far greater than that seen for oil and gas  projects. These longer defect rectification obligations are usually capped, but remain significant and could be a concern for contractors as they may accumulate if several separate projects are undertaken in close succession.

It is possible for defect risk to be passed along to sub-contractors thus limiting or reducing the liability of the lead contractor.

Frequently, the Company Group will take on the obligation to arrange a Construction All Risks (CAR) insurance policy for the benefit of the project, with the Contractor Group included as a named insured party. In such instances it would be standard for the contractor to be liable to conduct repair work following physical damage but then recover costs from the CAR insurers. The contractor would usually be liable for any deductible appliable to the CAR policy claim.

Insurance challenges

Specialised wordings

The insurance product for offshore wind developments has evolved out of the market standard product for oil and gas exploration and production projects (WELCAR).  This WELCAR wording has been adapted and rebranded as WINDCAR, and is the principal product available to offshore wind projects. Insurers have introduced a Series Loss Clause that addresses Serial Defects in two ways:

1. multiple instances of the same series loss are grouped together and have a single deductible applied. The deductible applying in relation to the Series Loss Clause may be higher than the main policy deductible; and
2. the Series Loss Clause will limit coverage by applying a decreasing percentage of recovery for incidents arising from the same Serial Defect. For example this might be 100% for the first loss, 80% for the second loss, 60% for the third loss, 40% for the fourth loss, with no coverage for any subsequent losses. It is important to note that the clause remains subject to the requirement for physical damage to occur for a defects claim to be valid.

Insurers cite the poor performance of the renewable insurance sector to justify restriction in cover and increases in premiums.  Key areas of concern to insurers include cables (estimated to be responsible for around 70% of claims), foundations and turbines. Furthermore, the pace and increase in scale of developments has also contributed to the nature of the losses being experienced.

It is quite possible that for larger projects some insurers will seek to apply different coverage terms from the leader, meaning that some parts of a loss may be settled on a different basis from others.

Capacity

The poor loss experiences incurred by many insurers in recent years in the renewable sector has resulted in significant reductions in capacity with a number of leading insurers worldwide restructuring their portfolios and no longer providing cover for this sector.

Premium

It is estimated that, on average, premiums for offshore wind projects have increased by more than 50% since 2018.  The increase in premiums has been mainly a result of the insurance “hard market” and the losses experienced by the market with the offshore wind industry. These significant increases in premiums in the last few years present a threat to the overall viability of some projects as economics do not have the ability to absorb such volatility and financiers’ requirements on insurance prove challenging to fulfil.

Lenders requirements

Many offshore wind farm projects depend on the availability of debt from financial institutions. Such institutions are usually risk averse and insist on extensive insurance requirements to be in place for the duration of the loan which include:

• lenders to be insured parties;
• the borrower entity to be responsible for arranging all insurances;
• specific lenders provisions (including loss payee, non-cancellation, non-vitiation); and
• assignment of the insurance documentation to the lenders.

HOW CAN INDECS HELP?

INDECS has extensive experience working on renewable projects worldwide, including large scale offshore wind projects. Whether the current insurance market conditions are temporary, or whether they represent a “new normal” remains unclear.

What is clear is that limited insurance capacity, higher premiums, and limited coverage present challenges to all stakeholders in the offshore wind sector. The key to addressing and resolving these matters, and where the INDECS team can assist, is to adopt a holistic approach to the management of insurance risks from an early stage in a project lifecycle.  Ideally this would be at a point where key project contracts relating to the financing, fabrication, transportation and installation are under negotiation.

INDECS can assist with the early identification of risks and the development of an insurance plan to manage risks appropriately.  This will ensure that risks are allocated to the correct parties under the contractual framework and that the insurance programme meets the lending requirements. Such an exercise will pay dividends throughout the project life-cycle as insurance costs are minimised whilst adequate protection is in place.