Author: Kirsten Bonke
How risky are wind turbines, and who pays when they fail? For insurers looking to offer protection to this fast-growing industry, these questions are crucial. Unfortunately, a spate of wind turbine collapses over the past couple of years has thrown a spotlight onto the issue.1
These high-profile collapses understandably capture public attention, but smaller failures that require maintenance or the replacement of components can also cause interruptions and financial losses.
While bad weather causes much of the turbine loss and damage, manufacturing problems and defects can also take their toll. If failures happen in the typical warranty period — five years for offshore wind — then manufacturers may pick up the tab. This practice is sometimes reflected in the companies' results.2
Project owners and wind turbine manufacturers will often have 'all risks' policies that pay out no matter the cause of the loss. But if a defect is to blame, insurers may be able to seek reimbursement from the manufacturer — a process known as subrogation.
This process may not be as simple as it first appears, however — so what are the considerations that insurers should bear in mind?
First — the context
There are hundreds of thousands of wind turbines in the world, with total generation expected to have hit the 1TW milestone sometime last year, according to the Global Wind Energy Council.3 Most turbines are producing power for most of the time required; various industry and academic estimates put this availability rate at 95% to 98%.4,5,6
Yet, as observed in our blog about renewable energy mega-projects, turbines are also becoming larger and more complex to engineer, and being installed in deeper waters offshore. This trend is likely to increase the costs of remedying any failures.
Those risks can be covered by multiple insurance policies, but the meat and potatoes of any big energy project is the 'construction all risks' or 'operations all risks' policy. The second replaces the first after the construction phase ends.
These covers bear most of the risks and are where most of the premium is paid. As a result, they're usually the first go-to policy for a claim — and the first place where problems can emerge.
Seven common pitfalls for construction/operation all risks policies
If a wind farm suffers an insured physical damage, and it's believed that the manufacturer is at fault, there are several important issues for insurers to consider:
1. The manufacturer's coinsurance status may hinder a subrogation
Manufacturers and their suppliers will often be named as co-insured or additional insured parties under such policies. This practice can apply even where a construction all risks policy is placed as an owner-controlled insurance program, i.e. under the control of the wind farm owner.
This co-insurance status normally removes the insurer's ability to pursue a claim against manufacturers. Therefore, all parties involved in the project need to carefully discuss the intended limitations of a coinsurance status — before placing the policies.
It's commonly intended and understood that manufacturers' warranties should be paramount after the final client takes over the project. This practice would improve insurers' chances of recovering a loss. However, manufacturers often push for co-insurance status during the operation phase as well.
2. What is the level of cover provided for defects?
Most insurance covers require a physical damage to trigger an insured event under the policy, but the understanding of what the term “physical damage” means may differ between legal and regulatory jurisdictions. Insurers who provide cover internationally need to be alert to this issue.
Furthermore, the extent of cover provided can differ significantly between technologies. For example, two commonly used exclusions in the offshore wind market cover technical defects, known as LEG2 and LEG3. The scope of LEG2 is narrower; that is, it excludes more of the cost consequences of a defect. (Re)insurers and policyholders should always check their understanding of such exclusions.
3. The burden of proof can be a challenge
Assuming there is no co-insurance arrangement, insurers and reinsurers must often rely on their policyholder to support a claim against a manufacturer. Yet the burden of proof remains with the insurer; they must show the manufacturer was at fault. Complex construction projects like offshore wind farms can often involve multiple contractors, and it may not always be clear who caused the relevant loss or damage. Thus, insurers might end up in a difficult situation — obliged to compensate the policyholder but unable to seek recovery from a responsible party.
4. Did the manufacturer limit its liability?
Manufacturers might have restricted their liability within the supply agreement to the cost of replacements; i.e. seeking to avoid having to compensate for any delays to the project, or loss of electricity production.
Contractors mostly commit to provide a specific level of turbine availability, say 93% or 95%, instead of a specific electricity yield. The amount of electricity produced varies with factors outside the control of a manufacturer, such as the weather.
Situations can arise where a defect affects a small number of turbines, but others perform above expectations, so the overall availability rate of the farm might only drop from 98% to 95%, for example. The wind farm client might still claim for lost revenue, but the insurer won't be able to claim redress from the manufacturer.
5. What's the financial situation of the manufacturer?
Most manufacturers involved in big energy construction projects are robust and stand by their products and associated commitments. However, there have been cases of insolvency, such as BVT, the company in charge of the substation of the Nordergründe offshore wind project in Germany.7
6. When does the warranty period end?
Most warranty periods end a few years after project completion. Often wind farm clients renew their full-service maintenance agreements with manufacturers. These agreements usually force the respective suppliers to keep the turbine in a condition to safely continue operation — which isn't the same as full extension of warranty. Attention needs to be paid to carve-outs in the scope of manufacturers' liability.
7. Serial loss clause
Most project policies contain a serial loss clause, which limits the number of turbines that can be claimed as having been affected by the same technical fault. There's considerable variability in how these clauses operate, and how many turbines will be covered against the same fault. Insurers need to consider carefully how many they're willing to cover and not rely on standard clauses.
Keeping these seven potential pitfalls in mind is essential for insurers and reinsurers to have a realistic view of their risk. While there's nothing wrong with providing cover for manufacturers' issues, no insurer or reinsurer wants to be surprised.
