Brokers and underwriters eye renewables windfall
South Africa’s frantic public-private-partnership (PPP) led push for renewable energy helped save local businesses and households from an electricity crisis while creating unprecedented demand for specialist finance and insurance solutions.
Cost and complexity
The cost and complexity involved in constructing large-scale battery storage and solar and wind plants explains why local brokers have had to turn to international insurance and reinsurance markets to place these projects on cover. The invaluable role of international insurance placements was discussed in a recent FAnews piece, titled ‘Insurance brokers navigate the onshore-offshore placement riddle’. Today, we take a practical look at the type of infrastructure project that local markets cannot dream of underwriting without international risk capital.
Sophie Maggs, Head of Renewable Energy and Infrastructure at Crawford Dougall Insurance Brokers, used her platform at the Insure Talk 60 webinar to remind attendees of the economic growth and market development role of the short-term insurance sector. “Today marks our 307th consecutive day without load-shedding; South Africa has added around 10 gigawatts of energy supply to the grid,” she said, before naming insurers among the stakeholders that gave Eskom much-needed “breathing room” to maintain its existing coal-fired assets.
Local insurance brokers and underwriters deserve much of the credit for helping many of the country’s renewable energy projects off the ground. Maggs said that her firm was involved in the renewable’s energy field on two fronts. First, in placing insurance on behalf of clients who were contractors, developers or independent power producers (IPPs). Second, as advisers to the financers or lenders who put up the cash to fund these projects. She also demonstrated how the insurance sector “rose to meet the challenge” of the country’s load-shedding nightmare.
A tightly regulated resource
The first step was to explain why South Africa could not take an ‘anything goes’ approach to electricity generation and distribution. There are rules for every function from setting electricity prices to environmental emissions guidelines to a detailed Integrated Resources Plan that prescribes the desired mix of national energy generation over time. “There is a lot of regulation around how power generation projects are awarded; how we bid for projects; how we develop projects; and ultimately, how we finance them,” Maggs said.
It can be argued that South Africa’s long-term energy sustainability hinges on achieving a just transition from coal-fired plants to something better. “Coal-fired power still makes up about 77% of our total energy supply; but these plants are ageing, dirty, expensive and in desperate need of maintenance and overhaul,” Maggs said. Coal is slowly making way for renewables such as solar, contributing about 11% to our energy mix, and wind, about 5%. It is these utility-scale solar and wind solutions that demand a unique response from financers and insurers.
Maggs reminded the audience of peak load-shedding, when businesses and households faced up to 12 hours per day without power. “We were able to pull ourselves out of this crisis because government undertook a series of legislative reforms that allowed IPPs to produce at scale,” she said. The statistics show a 310% growth in installed capacity thanks to 40-or-so utility-scale wind farms; 63 independently owned, utility-scale solar power stations; and 1735 private renewable facilities registered with the national energy regulator. The total energy generation from renewables has rise from 3% in 2014 to over 13% presently.
The general insurance angle
“Every single one of these projects needed to be insured, and our markets needed to react pretty quickly to be able to do this,” Maggs said. Building battery storage or solar or wind plants was described as “complicated and risky endeavours” subject to varied and constantly evolving risks.
In the South African context, new builds faced the so-called construction mafias preventing workers from accessing sites, contractors going insolvent and a shortage of large construction firms, to name a few. Projects also had to contend with climate volatility, parts availability and unexpected price fluctuations.
Loss or damage to assets during the construction stage are considered insurable and are typically protected through both principal and contractor purchases. The former uses a blend of marine insurance and construction and operational All Risks covers. The latter will take out plant All Risks in addition to their own professional indemnity (PI), workmen’s compensation and motor covers.
“These packages are relied on by a number of parties involved in the project including the principal (or the owner or employer); the main contractor; sub-contractors; other professionals; and the financers or lenders who are going to be committing capital to allow these projects to be developed,” Maggs said. “Each one of these parties needs to be insured.”
The mechanism that a broker or risk specialist uses to achieve this is called a principal-control programme, where the interests of all of project role players are aligned. “We do this because we anticipate there might be large and severe claims,” the presenter explained. Solar farms, often the size of a small Karoo town, are at high risk to hail and fire; wind turbines are susceptible to extreme weather such as high winds or lightning storms; and battery centres run the risk of thermal runaway fires that are extremely difficult to put out.
The basics of insurance covenants
Something that insurance stakeholders tend to overlook is that an insurance contract goes beyond asset protection to serve as a mechanism to unlock project finance. “The lenders are taking on risk when they invest in these projects, so they need to have the most robust insurance in place [alongside assurances] that the insurance policies they take out on the project will do the job,” Maggs said. In practice, the loan agreements include insurance covenants, which are detailed specifications of the type of insurance, and who benefits from it.
An insurance covenant goes into detail on how claims are paid; what accounts they are paid into; what insurance brokers the project is allowed to use; and the minimum-security requirements for the insurance markets that are allowed to hold the risk. This loops back nicely to international insurance markets because financers need to know that the project insurers will be able to honour large claims.
According to Maggs, the rapid influx of challenging renewables projects exposed serious shortcomings across the domestic ecosystem of brokers, insurers, reinsurers, lenders and insurance advisers. “We had no project volumes; nothing to learn from; no claims experience to refer to; no capacity; and no wordings,” she said. “The lenders were BREAK uncomfortable with placing insurance into markets without adequate levels of expertise.”
The South African insurance market was simply too small to onboard all of the risk exposures related to an accelerated renewables build-out, with the result billions in premium were being placed offshore to cover projects financed by local banks.
Attracting energy-intensive investments
The good news is that lenders are finally starting to accept South African insurance markets as suitable security on renewables programmes, allowing local underwriters to retain more of the risk. “We will never walk away from the international market because we cannot keep pace with the rate of development that is happening on our own,” Maggs concluded.
An optimal solution is to leverage local and offshore underwriting capacity to manage concentration and exposure risks. In so doing, we can change the conversation and promote South Africa as an attractive destination for energy intensive investments.
Writer’s thoughts:
South Africa’s renewables boom created meaningful opportunities for short-term brokers while exposing the limits of local underwriting capacity. How should brokers strike the right balance between domestic and offshore risk placement for these and other large, complex risks? Please comment below, interact with us on X at @fanews_online or email us your thoughts [email protected].
