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United States

Insurance: It pays to prepare for the worst

UNITED STATES: Insurance is a relatively small item on a wind farm owner's balance sheet - but it is an important one. Indeed, the repercussions of poor decisions can easily add millions of dollars of avoidable expense. It is also an area that has seen a rapid shift in the past few years.

The insurance sector has grown more comfortable with wind as it has developed and the number of underwriters providing coverage has gone from one or two firms to around a dozen today, with more waiting in the wings. This growing competition is resulting in some of the lowest prices ever seen for wind project insurance.

Meanwhile, insurance is playing a role in absorbing some of the risk from wind projects as turbines move out of their warranty stages, which is happening to a high proportion of the US wind fleet.

The cost of insurance for a wind project is usually in the low single-digit percentages of overall annual costs and is mostly devoted to covering risks to the turbines and all other on-site hardware and equipment, known collectively as the balance of plant. Risks are mainly environment-related, such as fires, earthquakes, devastating storms and lightning strikes. By far the most common insurance claim filed by wind farm owners is for lightning strikes, which often damage blades, requiring repairs or full replacements.

In these claims, most policies will also cover the associated loss of income. Modern wind turbines can produce well over $6,000 a day of revenue from electricity sales and related tax credits, so every day a turbine is locked down waiting for a blade repair could quickly add up to losses for an unprotected operator.

Few operators, however, are unprotected. Most projects were built with heavy upfront financing and long-term debt repayments, so the underlying value of the equipment and its ability to continue producing power must be protected to ensure lenders are paid off by a set date and at a targeted return for project owners.

Fortunately for wind developers, while the cost for wind projects continues to rise, the cost for insurance is at historic lows as more competitors enter the space. According to Mike McMullen, managing principal for PowerGuard Specialty Insurance Services, the average cost for a developer to insure $100 of property value annually has dropped from a high of $0.34 to $0.07 for big projects and $0.09 for smaller projects.

"Never have prices been so low in the wind farm insurance business," says McMullen. "General liability prices are down and property insurance is down." He jokes: "We have done an absolutely wonderful job of driving the profitability out of the marketplace."

Wind plant operators have seen the trend. Oak Creek Energy Systems has been running wind farms in California's Tehachapi pass since the 1980s. "The market has improved," says Edward Duggan, executive vice-president at Oak Creek. "There was a time when there was very little competition and the rates were very high. I think a lot of insurance companies have become interested in the business because it doesn't look like there have been too many disasters out there, and now more reliable equipment and better products are available."

The increasing competition in the industry is not just from new entrants, but also from experts who split off in the past few years from wind industry insurance leader GCube, formerly known as Windpro. McMullen is among a number of former Windpro executives who peeled away to lend expertise to new businesses. Because of the company's long history in the US, it provides insurance to around 60% of all operating wind projects in the US.

The other major players in the US market are Chartis (formerly AIG), PowerGuard, Liberty Mutual, Hartford, Zurich, Travelers and Axis. These companies are the underwriters with the financial backing necessary to support their coverage. Brokers, however, are increasingly adding to the face of the wind insurance industry. Companies such as Marsh, Chubb and Holmes Murphy & Associates act as retail brokers who start insurance conversations with clients and bring in the backing of the deep-pocketed underwriters.

Expiring warranties

Many of these conversations start as wind plant owners approach the end of the warranty phase on their projects. By some accounts, there are more wind turbines coming out of warranty in 2010 than are being installed. This is because many of the wind turbines installed in the deployment boom of 2007 and 2008 are reaching the end of their two-year warranties.

Opinions are split on how much insurance coverage can protect a wind plant owner in case of a failure. "We insure the physical assets themselves and any loss of revenue as a result of the physical assets failing," says Pat Stumbras, executive vice-president of GCube. "It's an all-risk policy that covers mechanical breakdown, fire - pretty much anything you can think of that could happen to a turbine."

However, insurance policies are not a replacement for a warranty and will not protect an owner against recurring or multiple losses. These serial losses are often the result of defective manufacturing or design flaws that lead to early and repeated failures. For example, in the past few years some original equipment manufacturers (OEMs) have experienced serial failures in blades and drive trains, resulting in hundreds of blade sets needing replacement and remediation needed on drive trains. These cases are well documented and are not a risk that can be covered by insurance.

Like most insurance companies, GCube has a serial loss clause in its policy. This covers faulty equipment on a sliding scale, so the first blade or gearbox is covered by 100%, the second by 75% and so on, until no coverage is paid. "Then its not fortuitous anymore, which goes against the point of insurance," says Stumbras. "Then you're just paying for something that's defective."

There can be some very sensitive and high-stakes conversations when things go wrong. In February, a storm passed through southern California and damaged the majority of blades at the 50MW Kumeyaay wind plant owned by Australia's Infigen Energy, an offshoot of now defunct Babcock & Brown (B&B). A disagreement followed between Infigen and the turbine provider, Gamesa, over whether the blade cracking was caused by deficient blades or by the pitch control systems being improperly set by the operator.

The insurer, GCube, was closely involved because it might have to pay on a claim, depending on the results of the negotiations. None of the parties involved would disclose the outcome, but Stumbras says the example highlights the complexities around damage claims. "It's a very sensitive conversation, because eventually somebody has to step up," he says. "Some may say it's a serial loss, some don't think it is and, if you're providing insurance, you might be paying for it. We've been able to work these things out."

A risk for operators of wind farms shopping for insurance is to assume that too much will be covered in the policies. "It's a myth among most people who run wind farms that, when their warranty runs out, all they need to do is buy property insurance and just give future losses to the insurance company," says McMullen. "Well, the property insurance carriers don't work that way."

Extended warranty coverage from an OEM for a wind turbine varies from $30,000 to $100,000 per year, depending on makes, models and other factors, and OEMs have been making brisk sales as warranties run out. PowerGuard competes in this sector with coverage that is tied to the overall likelihood of losses rather than to specific turbines.

Because of the costs and risk involved with wind plants, insurance companies have sometimes driven certain practices in operations maintenance. GCube, for example, partners with blade repair company Knight and Carver to rapidly respond to blade failures, which minimises downtime and, therefore, the amount of money GCube pays to an operator for lost income.

Just as safe car drivers get better insurance rates, some wind plant operators may find better insurance rates if they hedge risks with technology. In fact, some insurance policies may require it. "We've heard anecdotally about a requirement for condition-monitoring systems to reduce insurance premiums," says Toby King, UK managing director of motion-control-systems company Moog. As the name implies, condition-monitoring systems, or CMS, are sophisticated systems that monitor critical wind turbine components for signs of fatigue and abnormalities that suggest incipient failure. US-based Moog manufacturers pitch-control systems, slip rings and a range of blade and rotor CMS - including some that are designed to detect ice build up on blades.

"We've also heard from a number of sources that there are requirements from certain local authorities and planning bodies to put ice-detection systems on turbines in order to prevent turbines from throwing ice from blades," says King. The application of these rules and associated insurance is done region by region, he believes.

Wind plant operator Oak Creek Energy Systems tries not use property insurance unless it absolutely has to - and has not had to file a claim in ten years. "In the old days, people were making insurance claims all the time and it was a big problem," says the company's Duggan. "We've taken the view that regular mechanical failures are not the sorts of things we're looking to file a claim on. We've cut way back on the coverage for our older turbines and on our new turbines, our strategy is to be well covered in the event of a catastrophe, but not expect to be slugging it out with the insurance company over minor events."

While property coverage is the greatest insurance cost for the wind sector, insurance during construction is also an important short-term requirement. Most insurance companies that write policies in the wind energy sector also provide liability and damages coverage for the engineering procurement and construction (EPC) companies that build wind plants.

Lary Wehr, a senior consultant with insurance giant Zurich, works with the company's construction business unit and deals with worker compensation and general liability policies. Zurich insures, to some degree, nearly 90% of the top 100 contractors in the US, he says.

Wehr says Zurich looks at three things when analysing a new client - wind-related or otherwise: paper trails, word of mouth and actual observation. "We look for contractors who have good procedures in place," he says. "We want to go in and look at their operations and see how they do it."

A construction company, rather than its individual projects, is what gets insured - and there is room for rate adjustment by year-end audit. "If they're going to work five million man-hours, that's what you base your costs on," Wehr explains. "And if, at the end of the year, they work six million man-hours, whatever rates you worked out for them - we're going to get that difference. Likewise, if they worked fewer hours, there's probably money going back to them."

Different rates

Rates can vary from state to state, as can the ability of workers. "Some places you've got more of an ageing workforce," Wehr says. "You've got union and non-union and sometimes there's a training discrepancy. Those factors have to be contemplated when you're pricing a company."

Rates can also differ between a well-established, billion-dollar company and a fledgling operation with only $10 million in revenue. "But if a guy falls from 300 feet, he's just as dead from either company," Wehr says. "I go back and look at how their operations work and how they mitigate and control what they're doing."

Larger companies are often in a financial position to take on more risk through high-deductable policies where they make out-of-pocket payments on most claims. "A large company might take a half-million-dollar deductible and, basically, you're going to insure them for catastrophe," Wehr says. A smaller firm is more likely to pay more on an ongoing basis for insurance, so the insurer would absorb more of the risk and pay more when claims are made.

The wind power industry calls on workers for plenty of overtime hours - which can result in fatigue. "There comes a point where everybody breaks down," Wehr says. "That is happening and it's kind of an operational thing that companies need to look at when they man the job."

One of the bigger elements of risk relates to driving cars and trucks. Lodging for workers is often many miles from isolated worksites and return trips can happen at night after a long day on the job. Moving and operating cranes is another factor, as is transporting oversized loads in remote areas, where poor roads can create hazards.

Wehr describes a challenging wind farm site where the landowner is also a wood manufacturer. Vehicles need to travel 35 minutes from the main road to the site and the road narrows to one lane near the top. "They were bringing logging trucks down the hill towards the traffic going up the hill, trying to fight over one lane," he says.

Companies keep rates down by mitigating just such risk. "It depends on what kind of controls they can offer, to show us how they're going to take care of it," Wehr says. If there are risks that cannot be mitigated, then insurance is provided for that. But if companies can prove that they can control a risk, the probability of an accident reduces and, with it, the premium.

Wehr believes the wind industry as a whole is improving. "The main thing that's making it better is the learning curve for a lot of companies is gone," he says. "You're always going to have new players coming into the market. But companies that have been out there for a few years know what they're getting into now, and they can manage that very well."

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