The accelerating transition from fossil fuels to renewable energy is changing the risk landscape for power operators and their investors. Fortunately, risk transfer mechanisms can help stakeholders more smoothly navigate this landscape—and the insurance industry is extremely well positioned to offer such solutions. Today, global insurance markets have more than US$2 billion of capacity available for energy and renewable energy-related risks. And capacity is constantly increasing, as traditional power insurers move away from thermal generation and look to capitalize on the growth of renewables.
Getting projects off the ground
Insurance is critical for the development and operation of energy infrastructure. During the investment and construction phases of an asset, risk transfer solutions can help secure capital, make projects bankable, reduce total cost of risk, and provide all stakeholders with appropriate protections. Insurance can cover everything from delays in start-up, to business interruption, credit, contractual and geopolitical risks, third party liabilities, and natural catastrophe events. The insurance markets’ maturity and understanding of these types of risks is continuously improving as the renewable energy sector grows, and as technologies mature. For example, insurance markets in Asia are quickly learning how to evaluate earthquake risk for offshore wind projects.
The key for investors and operators is to ensure their insurance or risk transfer program is cost-effective and mitigates longer-term exposures—which requires a full understanding of the construction, operational, geopolitical, and location risks over the lifecycle of their asset. Climate change, for instance, might be a key consideration for renewable energy project, since the weather and energy production in the upcoming decades will likely be very different from today. Futureproofing decisions based on location, equipment, and plant configurations is increasingly demanded by investors, stakeholders, credit agencies, and insurers.
Data-driven loss assessments
Marsh risk engineers use a data-driven process to achieve a holistic understanding of project risk and to support the insurance placement strategy. Data and statistical models are used to assess risk quality and to establish realistic estimated maximum loss (EML) forecasts during project design, construction, and operational phases. This approach evaluates possible project exposures, which are assigned a likelihood and impact rating over the lifecycle of the asset.
A project or site technical risk review can further identify the potential for property damage, delay in start-up losses, or business interruption. EML modelling calculates the value of the risk exposure which feeds into the technical underwriting report and establishes appropriate limits of required insurance coverages.
The use of realistic and well-defined EML studies supports the financing of renewable energy projects, as these data-driven assessments are required by lenders to ensure adequacy of protection for project investments. For emerging technologies and industries, such as the US offshore wind industry, EML modeling supports efficient access to insurance capital by establishing credible insurance limits and preventing overly conservative risk financing assumptions. Recent experience shows that this data-driven approach can also reduce the cost of insurance by up to 30%, equalling millions of dollars of savings for investors and owners in large-scale projects. Finally, for a broader distribution of insurance capital across the renewable energy sector, a consistent approach to EML modeling and risk assessment can enable insurers to scale up their offerings and provide affordable coverage to a wider range of projects.
Hedging the weather
Once operational, renewable energy projects have distinct weather-related vulnerabilities that can hinder performance. Solar, hydropower, and wind plants do not generate power 24/7. Wind all but disappears during very hot summer days, when energy demand is often the greatest, and wind turbines can also be halted by icing and high-speed winds. Solar panels can be shredded by hail, and their production is dependent on solar irradiance, soiling losses, and snow cover. Hydropower projects are not immune to weather risk either: In recent years multi-year droughts in the hydropower-dominated power markets of Chile and Uruguay forced generators to switch to expensive diesel generation and energy imports. Though large thermal generators also face weather-related challenges, renewables are generally more vulnerable.
While we cannot control the weather, parametric insurance tools can facilitate efficient weather risk transfer to support renewable energy projects. Parametric insurance affords coverage when certain predetermined event parameters are met, rather than compensating for damages. Solutions designed to protect against lack of wind and solar irradiance have been around for more than 10 years, and more sophisticated products continue to be developed as a reflection of both project needs and weather volatility. Parametric named windstorm protection, for example, can assist solar projects in the Caribbean, where traditional capacity for wind exposure to renewable sources is scarce.
Hail is another natural hazard that has impacted a number of industries in the US, Southern Europe, and Australia in recent years. Solar generators are especially vulnerable to physical damage from hail—in response, traditional insurance markets have either introduced coverage sublimits or excluded hail losses altogether. Improved hail data are now available from various remote and in-situ sources, allowing parametric solutions to offer a unique risk transfer mechanism in lieu of traditional insurance. Parametric structures are premised on these new and persistent data sources and are tailored to unique projects, offering payouts as a function of hail size. The transparent and quick settlement offered by parametric solutions is paramount to loss recovery and creating a financial bridge necessary to satisfy lending requirements.
Insuring renewables against energy market risk
The Texas winter storm of February 2021 is a prime example of the need for parametric solutions. Record-breaking cold weather resulted in 48.6 percent of generation assets being unable to produce electricity during peak energy pricing in the Electric Reliability Council of Texas (ERCOT) power market, which was coupled with high energy demand. Wind resources were especially affected by the cold weather and icing due to unusually low dew points, forcing wind turbines to shut down. Gas generators suffered instrument failures, and a major nuclear plant was forced into an outage due to cold weather-related issues. Meanwhile, the high demand resulted in a spike in power prices from the usual $40/MWh to $9,000/MWh. This required wind and other renewable energy projects to purchase replacement power at exorbitant prices, jeopardizing their financial viability. Most of this exposure was uninsured due to the unexpected nature of the events— given that summer heat waves were the primary weather-related concern in ERCOT.
To mitigate future such events, Marsh is working with several wind generators to develop a new risk transfer product: A parametric solution based on temperatures, relative humidity, and power prices. In this instance, payout for wind generators could be triggered if wind generators are impacted by freezing temperatures and sudden spikes in power prices. If implemented, such a parametric solution would go a long way to protect renewable projects and ensure that lending terms are met even during challenging weather and power market conditions.
More recently during Winter Storm Elliott, temperatures across multiple states within the PJM interconnection remit plummeted between December 23rd and 25th, 2022 with record lows in some areas as well as record drops in some regions. The storm resulted in high peak power prices and 20 hours of PJM emergency action events. Market pricing averaged around $100/MWh across the PJM in early December—in comparison, peak pricing during the low temperatures of Winter Storm Elliott averaged around $450/MWh, with regional pricing over $1800/MWh. Of the 186 GW of capacity in the PJM generating fleet, nearly 46GW of capacity experienced a forced outage event, resulting in an estimated $1-2 billion in PJM non-performance charges. While many small and independent generators risked default on non-performance charges, generators with capacity performance insurance were able to transfer risk inherently associated with the capacity market. Capacity performance insurance can help protect intermittent resources against non-performance charges (penalties) in the new power capacity market regimes, including PJM and ISO-NE. In recent years, these new regimes have been introduced in select US and Italian power markets as a response to power market failure under extreme weather conditions.
If sufficient data exists to price risk and create an index, parametric solutions can be designed to hedge a wide range of weather and power market risks associated with renewable energy development and operation. For example:
- Proxy revenue swaps, which can create a synthetic power purchase agreement between renewable generators and energy off-takers who would like to decarbonize their consumption, but are concerned about purchasing energy from intermittent resources. Here, the parametric protection provider takes on all of the risk for both the generator and off-taker: overall volume produced, shape (i.e., fixed volume for each hour), and power price.
- Dual trigger rainfall and oil price protection, which can assist with high cost of replacement power generation for hydropower plants during droughts.
Insuring clean technology performance
New technologies used in the renewable energy industry can come with significant performance risks. For instance, there are uncertainties as to whether these technologies will work as intended or will meet the desired levels of output. A small number of specialist insurers have the appetite to underwrite and backstop performance guarantees for green and renewable energy technology. By protecting project owners, lenders, or manufacturers from the risk that the technology underperforms, insurance can ultimately support the financing and development of green ventures by improving lender confidence and reducing the cost of finance. As an established clean energy technology, solar photovoltaics (PV) provide a great example of these types of solutions:
- A photovoltaic (PV) module performance warranty offered through the original equipment manufacturer (OEM) provides a bankable backstop to performance metrics guaranteed in a procurement contract. The solution provides assurance to the project owner that PV modules will perform as guaranteed, which can strengthen reliability of year-over-year production estimates and provide assurance that warranty obligations will be fulfilled in the event of OEM insolvency. In certain cases, PV module performance insurance can be offered directly to project owners via a ‘top-up’ program if diligence on the PV module manufacturer has already been completed.
- A solar production insurance solution can mitigate project-level production risk due to underperformance of PV modules, shortfall in solar irradiance, excessive soiling, and other production losses. Solar production insurance can set a production floor to add additional reliability to the project financial model—additionally, this insurance may also cover higher levels of production to support increased debt sizing.
The financial success of any renewable energy project is dependent on the reliability of the project financial model and underlying production estimates. Performance insurance solutions can be structured for a number of clean energy technologies with the availability of the requisite underwriting data, including project financial models, technical project details, historical performance data, and equipment manufacturing overviews.
Insuring the future
Clean energy, generated from renewable sources, is the future. But as is the case with any seismic shift in how we feed our electricity consumption, new challenges arise. Traditional and evolving insurance products, as well as parametric solutions, can assist project owners, investors, lenders, and regulators to meet this changing risk landscape head-on.