How can clean energy producers navigate uncertain weather?
July 11, 2022
We’ve seen a major push for clean energy in recent years as the world strives to meet carbon goals; renewable power is at the forefront of this movement. According to the International Energy Agency’s 2022 Energy Policy review, over 90% of electricity generation is slated to come from renewables by 2050.
But despite increasing demand for green power, renewable energy projects are having a hard time getting off the ground at all. Why? Weather variability, as well as an upswing in extreme weather events, threaten infrastructure, energy output, and revenue streams, making it tough to obtain insurance and investor funding. It’s a deadlock for power producers: climate change—the very thing you’re trying to combat—is what’s keeping you down.
So how do you protect your business—and your business income—when the weather just isn’t on your side? How do you attract lenders when you don’t know if you’ll meet the expected output? How do you escape from being in between a rock and a hard place? Keep reading to learn more about your risks and how you can protect yourself with an alternative risk transfer solution like parametric insurance.
What is parametric insurance?
Parametric insurance is a type of coverage that pays a fixed amount following a corresponding trigger event. Payouts are based on an “index”: set criteria that defines how much a particular event will cost. For this reason, parametric insurance is also known as index-based insurance; the policy automatically pays out when an event hits a certain threshold specified in the index, like the intensity of an earthquake or wave height during a hurricane.
For example, a parametric policy would pay $100,000 in coverage if wind speeds exceed 90km/hr during a storm or there was an earthquake with a magnitude of 6.0 and higher.
How does it work?
Parametric insurance is driven by data. While the specific trigger events are tailored to your individual risks, the payout amounts are calculated using objective, measurable data from credible third-party sources, like government institutions, official reporting agencies, and public authorities. The data itself can include anything from sensors to radar and satellite imaging to historical loss records and more.
With extensive risk assessment and modelling, insurers can determine the rough impact of different scenarios on your performance and earnings and set coverage amounts accordingly. In this manner, parametric solutions can be applied to a wide range of risks, like weather events, cyberattacks, transit strikes, and even pandemics, as long as there’s enough data to measure and model an event and create a reliable index.
How’s it different from a regular insurance policy?
Traditional business interruption insurance policies are damage-based; the amount of coverage you get depends on how much you lost, up until your policy limit of course. Plus, they’ll only respond if your physical assets are directly harmed, like property destruction or equipment breakdown. As a result, they also take time to determine your losses, so you might have to wait months before the insurance proceeds are received.
In contrast, parametric policies respond to the magnitude of the event itself rather than the actual loss. Losses that would otherwise not be covered under traditional insurance can be covered, such as non-damage related business interruption. It doesn’t matter how much damage there was or whether you even incurred damage at all; once an event falls within a certain range, you’ll be paid regardless.
How can parametric solutions help the renewable energy industry?
While parametric policies have been around for decades, they remain largely unknown by the general public. But with climate change putting weather conditions in constant flux, parametric insurance is picking up more steam in the alternative energy sector. Because they’re based on a pre-existing scale of payment, parametric solutions can protect against losses that are typically too risky, too difficult, or in some cases, impossible to insure, making them ideal for green power projects.
Here are four common risks faced by clean energy firms and how parametric insurance can help you protect your interests.
1. Project Insurability
Power production depends on natural conditions. That means renewable energy facilities have to be built in resource-rich areas where wind, water, and sunlight are stable and consistently strong. Unfortunately, their location could also make them more vulnerable to natural disasters, storms, and other weather-related risks. Regardless of what stage your project is in, damage to infrastructure and equipment can delay timelines and halt operations, which will have significant impacts to your bottom line.
Even worse? You might have a tough time finding insurance to cover you. Given the high cost of sustainable technologies, damages for a single incident can easily reach millions. In 2013, Typhoon Usagi toppled turbines in China, causing $16 million in losses. In 2018, a single hailstorm caused over $70 million USD in damage to a solar farm in Texas—more than 400,000 solar panels were affected.
With storms rising in intensity, frequency, and severity, insurance companies are struggling to keep up with mounting claims costs. Consequently, alternative energy producers might face higher premiums and deductibles and stricter terms and conditions for coverage to apply.
THE PARAMETRIC SOLUTION:
Parametric policies offer more certainty regarding insurance coverage (and more affordable premiums) by attaching set values to events. The amount you’ll get is unaffected by the total loss, which means insurance companies can save on an excessive claims payout. And while your coverage might be less than the actual cost you incurred, you’ll still have a minimum level of protection in case of a severe weather event; it’s a win-win situation.
2. Output Variability
Even if the risk of a natural disaster is low, weather fluctuations are only getting harder and harder to predict as climate change worsens. No matter how much research or testing you do, prolonged periods of drought, cloudy skies, and low wind could throw your estimates off base and drastically reduce expected energy output. And in an increasingly plugged-in world, production declines can lead to major income losses for all project stakeholders, especially during a time when colder winters and record-breaking heat waves are driving up energy needs across the country.
If you fall short of your targets, you won’t just lose out on business earnings; you could also face penalties if there are performance guarantees in your contract. And remember: a traditional insurance policy will only cover lost profits if there’s a direct physical loss—it won’t kick in if too little sun, wind, or rain affects your revenue flow. Without any protection against weather, output, or revenue variability, you’ll have to absorb the loss and find a way to keep up repayments to your lender.
THE PARAMETRIC SOLUTION:
Since physical damage isn’t required for coverage to apply, parametric insurance is well-suited to manage the effects of resource availability, come rain or shine. Additionally, as an index-based policy, coverage can be tailored to account for specific risks that are unique to your individual exposure, location, energy source, and power generation technology. Advancements in sensor, satellite, and meteorological data have even allowed for weather-based parameters to become increasingly granular, accounting for temperatures, hours of sunlight, or even hail size.
Say your solar farm has a rainier summer than usual. With fewer sun hours, your energy levels are about 80% of what you initially budgeted. But because there’s no damage to any of your solar panels, your business interruption insurance won’t cover you for the income loss. However, a parametric policy will automatically reimburse you for a certain amount based on the rainfall measurements noted in your index.
Given this level of customization, parametric policies can also be designed to account for risks that occur throughout the entire lifecycle of a project, whether they impact start-up, construction, or power production.
3. Claims Settlement
If you’ve ever had to file an insurance claim, you know how complex and time-consuming the process can be. Since most insurance policies are damage-based, insurance companies require proof of damage from an insurable event to first trigger a claim and then determine just how much should be paid out. This typically includes travel, onsite investigation, and a lot of help with accountants to assess the extent of the loss, which can severely delay payment.
Depending on the nature of the claim, this process can take anywhere from weeks to months to even years, especially if there are disputes during the claims process or if multiple parties are involved.
THE PARAMETRIC SOLUTION:
Parametric solutions drastically reduce processing time. Because the payouts have already been set in your index, claims can generally be settled with little dispute in a matter of weeks or even a few business days—there are no claims adjusters and no on-site inspection. Coverage is triggered more or less automatically once the occurrence and intensity of an event has been confirmed by an independent third-party. The party in question is specified in your insurance policy at the time of purchase.
The process is quick, efficient and straightforward, allowing you to protect your cash flow and recover faster following a business interruption without having to spend time and money proving the damages. Rapid settlement is particularly helpful for smaller firms and victims of natural disasters who may need immediate financial relief after a major loss.
4. Project Financing
Renewable energy projects are capital-intensive and often rely on private funding to get started; however, they’re also generally considered high-risk by most lenders. In addition to the cost of the materials, project insurability and the overall unpredictability of the revenue stream are major deterrents for investors who are reluctant to assume such a huge financial risk without guarantees they’ll be protected from lost profits.
THE PARAMETRIC SOLUTION:
Parametric policies are highly transparent, which can help reassure lenders and raise capital. With an index based on objective, easily verifiable data from neutral sources, you can paint a full picture of a project’s risk from design to construction to operation and offer a more accurate estimate of expected revenues. Additionally, by providing a minimum level of cover for weather-related losses, parametric policies can provide balance sheet protection and profit security for all stakeholders.
In short, parametric insurance makes projects bankable, especially for power plants located in offshore or remote areas that are difficult to access or have fewer historical records to support projections.
Is it worth it?
Demand for green power will only continue to build as we move towards a more sustainable world. But without proper coverage or awareness of alternative solutions, a lot of projects simply won’t be approved, setting us back in the race against climate change.
That’s where parametric insurance comes in. Because they allow firms to work with nature rather than against it, parametric policies are key to continued investment in the renewable energy market, with solutions available for more or less any power-generation-related loss.
To be clear, parametric policies aren’t intended to replace your traditional business interruption altogether. You’ll still need business interruption insurance to protect against threats that might physically affect your business, like theft, fire, or property destruction. But parametric insurance can complement your existing policies to cover dynamic, previously “uninsurable” risks like extreme weather and production losses. Simply put, both types of insurance are vital to bridge gaps in protection and eliminate any grey areas that could leave you exposed.
Are there downsides?
Since parametric policies use an index, they won’t cover the full scope of risks you’ll face. Either your payout might not cover all of the costs incurred or you might suffer a loss, but your coverage won’t be triggered because the event didn’t fall within a certain threshold, like if the wind speeds were too low or there wasn’t enough rainfall.
Even so, parametric insurance is still worth exploring as a key part of your risk management strategy. After all, alternative energies require alternative approaches to insurance. And while parametric policies aren’t a perfect solution, they’ll still help to reduce your overall risk, build resilience, and protect your project as comprehensively as possible. Plus, a well-crafted policy can make all the difference when it comes to securing financing.
How can we help you?
As parametric solutions become more mainstream in Canada, it’s critical for alternative energy producers to partner with a risk advisor that understands the unique threats faced by your industry early on—maybe before you even reach out to investors. With over 40 years of experience, a licensed broker like PROLINK can help you adopt a proactive approach to risk management that protects your clean energy assets, controls your costs long-term, and inspires lender confidence.
Our dedicated team of advisors will:
- Identify exposures based on your business model, strategy, and operations;
- Share what best practices others in your industry are taking and advise you accordingly;
- Conduct a robust assessment of your existing insurance policies and determine where parametric solutions can provide extra relief; and
- Align you with a leading parametric insurer to provide flexible and tailored insurance, risk management, and alternative risk transfer solutions for your needs.
To learn more about your exposures—and how you can protect yourself—connect with PROLINK today!
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