Australia’s renewable energy sector should be thriving in an era where consumer demand and environmental awareness is driving a boom in technology, along with heightened affordability and accessibility.
There are billions of dollars’ worth of projects in the pipeline for Australia for wind, solar and hybrid technologies such as solar/hydrogen plants. These, as well as a host of established plants, already have a host of issues confronting them; now they have a new challenge, and it is coming from the insurance industry.
Renewables in Australia have long battled such problems as a lack of policy direction from the federal government, connection delays, marginal loss factors and the need for greater investment to ensure power grid security. Now, underwriters are setting them a stern test as a result of significant losses in the sector, during both construction and operations. A number of insurers have exited the Australian market and capacity is dwindling - even those underwriters who remain have markedly less appetite for providing the same amount of capacity that they have historically deployed, leading to hardening market conditions.
Australia is at the forefront of renewable solar technologies. Available land for projects is vast and relatively cheap, there’s an abundance of sun, and geo-political risks are generally stable, notwithstanding the differing attitudes to the sector from state and federal governments.
There are some innovative approaches to energy production, such as renewable energy hubs pairing wind, solar, hydrogen and battery storage. While this is attractive to financiers and developers, it represents an aggregation of risk, stretching already compromised underwriting capacity. This is exacerbated by developers seeking opportunities further afield in regions that have natural catastrophe exposures.
Risk engineering will be particularly crucial in the proposal stage to ensure there is enough capacity and appetite from the insurance market to back these projects. Coverage restrictions are not only resulting in increased premiums and retentions, but they also have the potential to affect the viability of both existing and proposed projects.
Essentially, revenue models which were developed with flat insurance premium estimates - and assumptions that coverage would be consistent over the life of the project - can no longer be counted on. The market is hardening in Australia to the point of a doubling in insurance costs for 2020 and beyond, compared to what would have been budgeted for in the 2018/19 financial year.
On top of increased risk financing costs, the renewables sector must come to terms with the reality that coverage previously offered may no longer be available.
LEG3 Design Cover is a case in point. Up until early 2019, LEG3 was widely available; however, in response to a market push towards a holistic review of underwriting methodology, it can no longer be assumed to be a given. As part of the technical underwriting, prospective insureds must now review evidence that the increased design coverage is not taking on original equipment manufacturer (OEM) research and development risk, whether that be from evolution of technology or, in more recent times, complete prototypical technology.
This could mean that existing contractual agreements will be breached – the required level of coverage may no longer be economically possible to obtain. Insurance advisors have a crucial and early role to play here in projects to ensure that the insurance provisions within the Design & Construct (D&C) and Operation & Maintenance (O&M) contracts are available in the market.
The hardening insurance market is also being driven by the increasing number of natural catastrophe claims, locally and globally, arising from perils such as flood, hail, bushfire and cyclone. These claims are intensified where organisations are looking to reign in project costs by using inferior equipment, or where issues arise from faulty workmanship by contractors. This is particularly an issue for Australian projects where the availability of experienced contractors is already stretched. Australian losses have already led to key insurance markets ceasing to underwrite projects here.
Indeed, the quality of the submission presented to the insurance market, both in Australia and globally, will have a major influence on the terms received. If companies in the renewables sector are not willing to provide the required level of information and engage with insurers, there is a real risk of projects potentially being left with sub-standard coverage that will not satisfy their financing arrangements.
This is of particular concern to projects at the proposal stage; details of the experience of all contractors and subcontractors to be used are essential, as insurers will only look to underwrite projects that are being managed by a proven team.
There have been renewables projects in Australia where contractors and subcontractors have gone into liquidation or become insolvent. This has increased the risk to the project through extended build times, not only while alternative contractors are sought, but also raises a host of other issues. These include the question of pre-insolvency build quality, and issues with onboarding new contractors with the part-built projects, as well as with unviable warranties.
Technology is also playing its part, but not necessarily in terms of improving the outlook. The push by Original Equipment Manufacturers (OEMs) for new prototypical technology, along with developer appetite to maximise project outputs, is pushing the insurance market to a place of discomfort.
Is the insurance market really the default location for the OEMs’ Research & Development (R&D) risk prior to certification? Insurers do not believe so and they are pushing back hard. It is becoming difficult to get design coverage, with certain risks becoming uneconomical to transfer. The push to prototypical is also being exacerbated by question marks over the suitability of the technology for the harsh Australian conditions.
It’s not all about projects in the pipeline. Unless the renewables sector addresses the level of detail now being required and demonstrates some common sense when agreeing Power Purchase Agreement (PPA) prices that move in line with increased insurance costs, then existing projects will fail. In the current environment, it would be difficult to see new investors prepared to invest against the backdrop of the issues that confront the sector.
Larger operators may be in a position to consider the use of other risk financing options. These could include captives, as insurers push for higher retentions, particularly for Business Interruption exposures. While fundamentally this will not alter the underlying cost of the risk transfer, it may enable operators to smooth out losses, thereby ensuring that project financiers have a greater level of comfort in consistent project returns.
There also needs to be heightened planning and strategy around the renewal process, particularly when looking to utilise global insurance markets. This must be undertaken in a co-ordinated way to ensure the best solution can be found. It’s no longer possible to have a “hands off” relationship with underwriters.
Each organisation needs to set a timeline of major renewal milestones that is regularly reviewed. Importantly, they must remain flexible and be open to possible changes in direction. The insurance market’s attitude to renewables is evolving at a rapid rate. Risk management remains paramount – addressing risk early and failing to demonstrate the quality of projects can only result in substandard outcomes.
The temptation to blanket the market in a hope of obtaining the cheapest deal via multiple insurance brokers is not the best way forward. In the short-term, this strategy might produce some limited upside on premium outcome, but it will generate a longer-term negative insurance market sentiment. Insurers will not actively look to partner with those organisations; in a market where there is a shrinking number of insurance carriers and capacity, those that are willing to work with and build relationships with selected insurers will win out in the longer term.
Mick McKeever is National Sales Director, Willis Towers Watson, Australia.
Geoff Babbage is Director, Property and Casualty, Willis Towers Watson, Australia.
Mark Thompson is Broking Manager, Construction Risks, Willis Towers Watson, Australia.