Crossing the "valley of death"

Paul Frankel

Part 2. Could a new type of insurance provide a helping hand for emerging renewable projects?

The first article in this series presented the first portion of a new white paper from the California Clean Energy Fund (CalCEF), outlining market need, and explaining how current clean energy insurance offerings are limited.

Part 2 below discussed CalCEF's recommended insurance mechanisms and public policy elements, and maps out steps for expanding the capital base and product offerings of the clean energy insurance market.

New insurance entities

CalCEF has proposed a new generation of insurance solutions for emerging clean energy technologies. These target the financing gap between pilot project and the initial buildouts at commercial scale.

Primary insurer – pooling clean energy risk and expertise

Establishing a new primary insurer focused exclusively on clean energy technologies would encourage more capital to flow directly into the clean energy sector. This would avoid some of the difficulties faced in convincing existing insurers to commit to underwriting new, non-traditional products.

Satellite developers faced similar financing hurdles as their technology approached commercial scale and as a result, speciality insurance and reinsurance markets began to take form. The fast pace of technology and market changes, along with the absence of a meaningful history of launch and in-orbit data made it difficult for insurance companies and their actuaries to determine the probability of satellite-related losses.

Dedicated clean energy insurance providers would primarily market non-traditional products, so they would have a strong incentive to develop thriving niche offerings and risk control expertise; whereas, a large existing insurer would have numerous new opportunities competing for internal resources and management attention.

However, to support the issuance of meaningful limits of liability, a new insurer would either have to raise large amounts of capital or purchase reinsurance from existing reinsurers, which in turn must be convinced that pricing adequately reflects the risks.

A new insurer's offerings would include component warranty; system performance insurance (SPI); and other custom products designed to meet clients’ specific needs. Warranty and SPI, especially for emerging technologies, will be considered risky and historical loss information will be relatively sparse. As a result, the insurer's required capital levels will likely be high; CalCEF's white paper estimates that the amount needed to support emerging technology efficacy insurance across the industry is in the range of US$125 million to US$300 million (based on Figure 2 on page 23 of the full white paper). This represents total capital needed from the insurance industry—both existing and new insurers.

A single insurer could build a diversified portfolio with US$40 million of risk capital, along with sufficient reinsurance support.

While an insurer could be capitalised to meet these needs, investors without direct interest in mitigating clean energy risk may not be quick to enter this market. Instead, the significant capital required is more likely to come in the form of a mutual or captive insurer, which on one hand could assess policyholders with limited additional premiums if extra capital is needed, and on the other hand could share in underwriting outcomes and pay out dividends from excess profits.

Reinsurance – building a foundation for primary insurer participation

Primary insurers that offer non-traditional products for the renewable sector are challenged to obtain reinsurance for new product lines due to uncertain underwriting outcomes. This lack of reinsurance capacity prevents some insurers from offering products altogether, and causes others to set limits of liability too low to meet customer needs.

A new reinsurer dedicated to renewable energy insurance products would increase gross underwriting capacity to end customers, mitigate primary insurers’ concerns regarding loss severity, and encourage entry and innovation by primary insurers to serve the industry. The creation of a reinsurer would also allow existing primary insurers that have adequate credit ratings to then provide assurances to project financiers.

Reinsurers are typically large, well-capitalised firms that construct diverse portfolios of insurance risk. Starting a new reinsurer would require large amounts of capital to attain some measure of creditworthiness, and would require Government support (see later).

The Government has acted as a reinsurer in a variety of capacities before, such as in supporting U.S. property insurers in the event of catastrophes. Following Hurricane Andrew in 1992 and the Northridge Earthquake in 1994, rates and restrictions actuarially required by existing private insurers were often economically unpalatable, so States established new insurers and reinsurers, which helped to rationalise prices.

Energy-focused managing general agent – a direct path to dedicated insurance

New energy-focused managing general agents (MGA) would represent a simple, powerful step toward dedicated insurance for emerging clean energy technologies. They would require relatively little capital, industry coordination, or regulatory compliance, and could leverage existing pools of insurance capital. An MGA is a wholesale insurance intermediary with the authority to accept policy placements from retail agents on behalf of an insurer. MGAs generally provide underwriting and administrative services, such as policy issuance, on behalf of the insurers they represent. An MGA focused on emerging clean energy technologies could be a new entity or could be formed within an existing multi-product MGA or intermediary.

MGAs could be helpful in introducing new insurance products to the clean energy sector by offering specialised expertise and focus. They may also reduce underwriting overhead costs for insurers and bring confidence that an independent assessment of risk has been performed. A new entity would have the flexibility to develop comprehensive new products that adequately address performance concerns of potential funders and investors in large-scale energy projects.

Under the MGA model, risk would be assumed by one or more existing insurers, which would receive the premiums and be responsible for claims payments. Having the risk assumed by existing insurers is an important advantage of the MGA since such insurers have greater access to capital, may benefit from diversification with other business lines, and possess credit ratings sufficient to meet customers’ requirements. As a risk intermediary, an MGA has both volume and profit incentives to balance; it can only recover its costs by executing transactions, but its profit opportunity largely relies upon supplying profitable outcomes for its insurance partners.

Improving data quality and access – standardising sharing to facilitate insurance growth

Data on the performance of emerging technologies in commercial operation offers insurers a necessary quantitative underpinning for developing insurance products. Reliable, standardized data can reduce underwriting expenses for insurers and allow them to insure technologies that they might otherwise consider too risky. At present, most industry participants do not collect and share such data consistently or in a standard format. For little industry investment, improving accessibility of data on emerging clean energy technologies’ performance would entice existing insurers to offer new products.

The collection, analysis, and dissemination of such information could be done by an existing governmental entity, such as one of the national laboratories, or by a private entity compensated by insurers, clean energy companies, or both. Both public entities and private companies, such as New Energy Risk and the National Renewable Energy Laboratory have already recognised the need for better performance data tracking and have launched initiatives to improve data sharing.

The information service provider would accumulate data regarding emerging energy equipment and system performance. It could guide counterparties, such as technology suppliers and contract operators, on data collection requirements, such that insurance underwriters would be capable of assessing the distribution of performance outcomes and failure rates.

Public policy strategies

While each of the approaches described in the prior section has the potential to improve the availability of efficacy insurance for clean energy technologies, they require public policy support to function optimally. Such policies could form part of an integrated clean energy technology deployment strategy in partnership with private financial markets. Possible policy strategies include:

U.S. Department of Energy (DOE) supported “Profit Sharing” or “Excess of Loss” reinsurer

As a complement to a possible loan guarantee program, the DOE could provide reinsurance of primary insurers who in turn sell system performance insurance and component warranty insurance. The DOE and insurer may share in both profits and losses. Losses could be capped at no more than a fixed percentage of premium revenue in order to encourage participation, limit downside risk and prevent windfall profits. Coverage may also be structured as more traditional excess of loss reinsurance, in which the DOE takes on only the risk of extraordinary individual or portfolio-wide losses.

New Public-Private primary insurer

Government could partner with industry to create a new, non-profit insurer that would offer various types of efficacy insurance including component warranty, installation performance warranty, and SPI. As a non-profit, the insurer would not be able to raise equity, so its capital would come in the form of subordinated debt instruments and retained earnings. Startup capital could come from a range of private and public sources. The government's financial investment could be capped by the value of the capital instrument, but it would be an essential catalyst to the capital formation and risk funding process.

Provide capital and/or credit guarantee for insurer

To encourage new entry into this market, the federal government could provide a credit guarantee for new insurers, similar to the loan guarantees once provided to manufacturers, power projects, and biofuel production facilities. If a DOE reinsurance program were also in place, then the risk of capital losses would be clearly defined and exposure under the credit guarantee should be limited.

Next steps

Based on the options described in the white paper (see link at the end of the article), CalCEF recommends a combination of both private sector actions and public policy changes: improved sharing of performance data among the industry, a new clean-energy technology focused insurance provider, and a federal reinsurance program. If sufficient industry interest exists, CalCEF would consider an active role in pursuing recommendations and providing startup resources.

We believe the first and most addressable step is to build a better pool of data. Given strong interest voiced by the solar industry throughout this research, we recommend that the data improvement effort focus initially on the solar sector. CalCEF is in the early stages of a collaboration with SolarTech and other partners—including national laboratories, universities, test and certification companies, project developers and project financiers—to develop an industry-wide repository of analytical tools and performance data for systems and sub-systems.

Better data will lay the foundation for a new insurance provider. Clean energy industry technology companies and associations should collaborate to support the launch of one or more new insurance providers focused on the specific needs of their respective market segments. We recommend that a new mutual or captive insurer offer component warranty, installation performance, and SPI to both commercially established and emerging energy technologies – with an initial focus on solar given the market demand and need. A new MGA should focus on efficacy insurance for projects employing emerging technologies.

From government, federal reinsurance is critical to addressing the risk involved in emerging clean energy technologies. The federal government has dedicated significant resources to the development of clean energy technologies through DOE loan guarantees, ARPA-E, and other programs, and it has supported the broader deployment of established renewable technologies through, for example, the Production Tax Credit (PTC) and Investment Tax Credit (ITC) mechanisms. However, these programs have not been sufficient to bridge a key gap between innovation and infrastructure.

Federal support for a reinsurance program dedicated to “first commercial” technologies could help this transition.

Finally, industry action and collaboration is critical to addressing the shared risk issues. In support of these recommendations, CalCEF hopes to partner with interested parties to develop and present more detailed policy rationale and potential structures for federal insurance reinsurance programs, and to invest in relevant ventures where appropriate.

About: Paul Frankel is managing director of the California Clean Energy Fund (CalCEF). Before joining CalCEF in 2008, he was co-founder and managing partner of Ecosa Capital, providing expansion financing to growth stage companies in the clean energy, green building and sustainable agriculture markets.

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