January 5, 2012

Insurance for Crossing the Valley of Death

Renewable Energy World, Paul Frankel

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To achieve a modest reduction in atmospheric carbon dioxide emissions, global investment in renewable energy assets would need to increase from current levels of about $100 billion per year to $500 billion per year. Some of this increase can be accomplished by investment in existing, commercially proven technologies; but to meet the challenge of rapidly scaling renewable energy, we also need to roll out cutting-edge technologies.

Financiers often hesitate to fund the first commercial deployments of new technologies because such projects carry an unidentified level of risk around reliability at scale and long-term performance. This dubiousness prevents capital from reaching technologies poised for commercial scale –– technologies that have gone through lab and pilot-stage testing, but are just beginning to be deployed in commercial scale projects. For example, enhanced geothermal generation, which requires accessing heat deep within the earth, integrates new drilling methods with relatively unknown risks, making it relatively difficult and/or prohibitively expensive to finance.

New Solutions for New Problems

Currently, a handful of insurers, brokers and supporting service providers have ongoing initiatives focused on clean energy. Some have tailored their traditional business insurance offerings to the needs of clean energy companies by developing non-traditional products that address warranty, performance, and related risks. TheCalifornia Clean Energy Fund (CalCEF) proposes a set of new insurance tools to improve the investment environment for projects employing these emerging clean energy technologies. Insurance products tailored to mitigate the unique risks associated with these projects would eliminate a significant barrier to investment. Along with establishing insurance providers, our solution includes an industry effort to collect data on new technologies’ performance and government support for insurers.

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specialty insurance has a long history of managing risk and closing financing gaps for other industries that initially operated under big unknowns: nuclear energy, commercial satellite launch, aerospace, property catastrophe, and industrial-scale crop production.

The role of innovative insurance products in enabling nuclear power to pass from the lab to ubiquity is especially instructive. To ensure that America’s nuclear power industry continued to grow in the 1950s, Congress created a liability insurance program, which would protect the power plant owner from uncapped exposure for a catastrophe like a meltdown. The plant owner is required to buy the maximum coverage available in the market. The owner’s total liability is capped at a specific, manageable amount –currently approximately 1.5 times the total private insurance coverage. In cases where losses would exceed that ceiling, the government would act as a reinsurer and make direct payments to claimants.

The insurance industry isn’t starting from scratch in creating risk mitigating insurance models for clean energy technologies. The current core offerings – equipment warranty insurance for the solar PV industry, carbon capture and sequestration insurance and PV installation insurance – cover certain performance-related risks for established technologies. They do not address the system performance risks that first- and early-commercial technologies face, but they do establish a precedent for the kind of “efficacy insurance” CalCEF suggests is necessary. This broad category can be defined as any insurance that provides financial protection against the failure of a product or system to perform its intended function.

Recommendations

In imagining a practical solution, CalCEF recommends three fundamental components: databases of technology-specific and system performance data, new insurance providers focused on specific segments of the clean energy market and a federal reinsurance program.

Since insurers must perform sophisticated statistical analysis to design products, they require abundant data. Unfortunately, there is very little historical performance data from leading edge energy technologies. To address this shortfall, formation of new databases should be focused on emerging energy technologies. CalCEF will start with the solar industry, in collaboration with industry group SolarTech and other partners – 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 energy systems and sub-systems.

Once data is aggregated, the industry must launch new insurance underwriters. There is an opportunity for an insurance solution comprised of two entities: mutual (or captive) insurers and a managing general agents (MGA). The mutual insurer – the entity with the assets and financial power to underwrite policies – would focus on the needs of industry segments and facilitate pooling of risk by parties who have a direct financial interest in the application of such products. Profits resulting from better-than-expected underwriting results would be rebated or reinvested to support the industry through growth in underwriting capacity.

MGAs would more directly interface with emerging technology projects. Since they would have the advantages of dedicated, expert resources without the burden of raising massive amounts of capital, MGAs we envision would have the flexibility to develop comprehensive products that address system performance risk concerns of potential investors for specific large-scale energy projects.

As with insurance for nuclear energy, natural disasters and large-scale crops, government policy has a central role to play. Government should share some of these insurers’ risk, or ‘reinsure’ the policies. This would encourage private insurer participation in new clean energy insurance schemes by limiting industry losses while ensuring affordable and reasonable policy terms and prices for renewable energy insurance purchasers.

The lion’s share of the $400 billion needed annually to meet our clean energy challenges will need to come from the private sector. From where CalCEF sits – at the intersection of clean energy policy, finance and innovation – these insurance innovations are among the most promising tools we have to encourage such investment. We invite you to join us as we build a powerful solution to one of the core financial challenges faced by emerging technologies. With this challenge addressed, the market can look forward to a flourishing of innovative projects with the potential to solve many of our environmental problems while delivering broad financial reward.

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