One’s approach to risk management and investing often depends on your time horizon. We see this every day with people who drive rental cars or maintain exotic, garaged collections. Similarly, we see stark contrasts between the risk management philosophy of project developers that divest before the first crane arrives and those who look to buy and hold a wind project (nearly) forever. Some project owners and developers transfer risk via contract, regardless of the efficiency of that risk transfer. Others assume additional risk or liability to win a bid, enhance revenues, or achieve a specific financial or investment target. Ultimately, a project’s insurance program needs to provide contract certainty and provide coverage for the risks that the project retains. Given that insurance is often the largest single line expense for most wind project budgets, it is essential to achieve the most efficient total cost of risk for the project’s timeline. And yet, such a straightforward task is fraught with risk and financial leakage.
Insurance evolved to mitigate the catastrophic financial impacts of low-frequency, high-severity events by contractually transferring the risk to insurers. In other words, it’s an effective way to delegate risk off your project’s or company’s balance sheet. As risk changes over time, insurers develop new products and evolve to meet the needs of those wanting to delegate away more risk. Throughout the course of history, commercially available insurance products evolved in response to emerging risks and trends from General Average & Salvage to Pollution, from Terrorism to Cyber-attacks, and everything in between. Most importantly for wind projects, Insurance also mitigates the risk of earthquakes, lightning, mechanical breakdown, and offers financial and legal protection against lawsuits alleging injuries of all sorts. Insurance also evolved to guide investment, direct proactive risk management, and provide a financial lifeline to businesses and individuals. It even unlocks project bankability. One thing is certain about insurance: it is ever-changing.
When facing uncertainty, insurers and their underwriters opt for a conservative approach until reality dictates otherwise. This steadfast and disciplined underwriting approach was undermined by a soft market cycle, resulting in aggressive insurance terms, conditions, and pricing for wind projects during the last 7-10 years until mid-2018. The soft market and associated competition for insureds left insurers vulnerable to losses such that their reactions, while unsurprising, are shocking to many who have not previously experienced a truly hard insurance market. The financial sensitivity of wind projects only magnifies the pain of this ongoing market correction towards underwriting profitability.
For a wind project, there are many variables to control that contribute to the total cost of risk*. These include site selection, technology and design, contractor pedigree, and power supply and demand dynamics. Once chosen, understanding the implications of each choice could compel you to earn a PhD in insurance and risk management. Ultimately, it is critical to understand that all these choices make dynamic contributions to the total cost of risk over time. Therefore, your risk management philosophy should be equally dynamic to remain in control.
OEMs face supply chain and serial defect risks that threaten their viability. Power offtakers, shaken by completely unrelated events, threaten the viability of long-term PPAs. Insurance companies struggle to keep up with the changing risk profile of every evolutionary and revolutionary design change. Changing weather patterns impact wind profiles, extreme temperatures, hail, lightning, and flooding. And yet there is plenty of room for improvement with AI, drones, material science, logistics, manufacturing methods, and even old-fashioned engineering.
In this increasingly dynamic and dependent industry there are limits to what you control. Politics, climate change, corporate strategy changes, social media, technology, sustainable investing – the list goes on. Each of these will impact your cost of risk as well, and corporate boards, investors, and other stakeholders would agree that there is no excuse for being unprepared.
How does one prepare? How should your company play its role, starting at any given point along a project lifecycle, and achieve risk optimization over your time horizon? Develop a dynamic risk management program to delegate and transfer what you can; and control and mitigate the rest.
*TCOR is the sum of all costs that relate t orisk, including self-insured losses (through deductibles and/or self-insurance), loss adjustment expenses, risk control, risk transfer, and related administration.