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Hodgson Russ's Clean and Green Law

Wind Farm Insurance: Avoid the Risk of Loss

Posted in Renewable Energy

Wind turbineWind energy is a force to be reckoned with. U.S. wind power capacity represents more than 20 percent of the world’s installed wind power with a utility scale of 60,000MW.

In 2012, of the 39 states with utility-scale wind installations, Texas, California, Iowa, Illinois, and Oregon led the pack with the most wind capacity installed. A wind turbine has a life expectancy of 20 years, but mechanical breakdowns and lightning are the largest risks. Without the right type of insurance in place—including a wind farm insurance package—the risk of loss increases exponentially. Limits of liability can range from $5 million to $20 million, with deductibles ranging from $20,000 to $1 million.

Wind farm insurance packages can include: construction insurance, physical damage, and third-party liability insurance coverage for delays in building of a wind farm, loss of earnings, and business interruption once the operation is running. Specifically, wind turbine coverage can compensate the policyholder for production losses if the wind farm’s annual wind levels fall below forecast.

This blog entry discusses property and warranty insurance. The presumption is that the wind farm has statutory and discretionary coverage—workers’ compensation, employer’s liability, professional liability, commercial auto, and general liability—in place.

PROPERTY INSURANCE

Property Insurance encompasses: construction all-risk, including property damage and delay in startup (DSU); multiyear property all-risk, extending from construction through 12 months after operation; and property all-risk with business interruption (BI) for wind and energy-related businesses.

A. Builder’s Risk or Construction All-Risk

Builder’s risk or construction all-risk insurance covers property damage and delay in start-up. This type of insurance covers turbines, foundation, transmission, substation, and balance of plant. Coverage begins when the wind turbine components are being transported to the site (transit   physical-damage). The transportation of a wind turbine is challenging because nacelles can weigh more than 50 tons and the blades can be 150 feet in length.

Each turbine is covered from the time it is erected, tested, and commissioned. All-risk insurance provides coverage for machinery breakdown, short circuit, storm, and fire. Damage from machinery breakdown such as pitting, backlash, and breakage usually happens because of defects in material, fatigue, use of wrong oil or wrong temperature, vibrations, and overloading.

1. Time Delay Coverage

This type of coverage insures against lost power-production revenue due to transit delays, lost revenue due to construction delays (advance loss of profits), and operational revenue losses (business interruption).

2. Fire

If a wind turbine burns down, it can result in months of downtime and loss of income to a wind farm operator. Technical fault is a main cause of fire, but fire can also occur from a component failure. Some examples illustrate how wind farm fires begin. If a bearing starts failing and runs dry, the resulting buildup in the component, especially if combined with oil and grease, leads to fires. A fail-safe brake running hot during a sustained brake action could cause a nacelle fire.

Fire protection insurance is necessary. The cost alone of replacing a blade is in the hundreds of thousands of dollars. Insurance usually pays the entire cost of replacing a turbine destroyed by fire. Even if the insurer or the wind operator can prove a fire was caused by failure of a part, the warranty usually only pays for the costs of replacing the faulty part, not the entire turbine. Fire damage is usually caused by overheated bearings, a strike of lightning, or sparks thrown when the turbine is slowing down. Risk of damage from a storm can result in a collapse of the tower and loss of rotor blades and gearbox due to runaway spinning under extreme wind conditions.

Wind turbine being struck by lightning3. Lightning

Lightning is a major cause of damage. The most common insurance claims filed by wind farmers are for lightning strikes.

The damage increases with the wind turbine height. Damage from lightning can range from damage to: (a) the control panels that include the sensors, actuators, the motors for steering the equipment, rotor blades, gearbox, generator, and control system; (b) the use of carbon fiber in the larger blades—as a way of adding maximum strength with minimum weight—increases vulnerability from lightning; (c) the electronics, including the transformer, frequency converter and the switchgear elements; (d) the blade, as a lightning strike to an unprotected blade will raise the temperature to as high as 54,000 (°F) 30,000 (°C) and result in an explosive expansion of air within the blade. This expansion can cause delamination, damage to the blade surface, melted glue, and cracking on the leading and trailing edges; (e) generators; and (f) batteries that can be destroyed or detonated.

4. Wind

Yes, wind turbines are produced to capture wind power, but high velocity wind can destroy a wind turbine. Wind speed, gust, and direction changes can damage the rotors with high wind speed.

5. Mechanical Damage

The most frequent damage is to gears, but it can also happen to bearings because of breakdown or wear, backlash, and tooth breakage. Damage may occur from defects in material, fatigue, the use of wrong oil or wrong oil temperature, vibrations, and overloading. The project owner usually bears the risk and expense of insurance, but that risk can pass to the engineering, procurement, and construction contractor if the risk is included in the contract.

What happens if all the turbines have been erected and the commissioning is underway, but one week before the keys are turned over and the commercial operation date has been reached, the substation transformer is struck by lightning? If the substation transformer needs to be replaced and the lead time for the next available transformer is ten months away, the expense for the project’s loss of production could be in the millions.

Project owners who procure all-risk construction coverage should also consider negotiating an endorsement for non-production soft costs such as extended financing charges, interest for the construction loan, and legal and accounting fees related to the delay of the loan closing.

B. Operating All-Risk Coverage

This coverage is activated once the commercial operations begin, and all the turbines are fully operational. This insurance is provided to the operating company and its financiers to protect against all risks of physical loss of damage to the entire wind farm project. Operating all-risk coverage should include full, non-warranty mechanical and electrical breakdown coverage to eliminate the need for a separate boiler and machinery policy.

Operating all-risk coverage includes: (1) damage to wind turbines, including mechanical and electrical breakdown (with or without warranty protection); (2) full catastrophe coverage for flood, windstorm, and earthquake; (3) business interruption to cover loss of gross revenue or gross profit arising from damage to wind farm assets including wind turbines, ancillary plant, buildings, and associated building and civil works; (4) interruption in the supply of electricity to the grid following failure of owned or non-owned substations; (5) terrorism coverage; and (6) public liability insurance.

WARRANTY INSURANCE

A wind farm must avoid the gap between property coverage and warranty coverage. A property policy does not provide warranty coverage. A wind farm should purchase a separate warranty policy.

By way of summary, a property policy provides coverage for mechanical and electrical breakdowns, subject to the policy’s exclusions and limitations, which may include:

  • Defects or faults in material, workmanship, or design
  • Wear and tear
  • Gradual deterioration
  • Inherent vice (e.g., hidden defects in the equipment or material that cause deterioration)
  • Latent defects
  • Serial losses

Warranty policies, on the other hand, provide coverage for product defects that lead to losses. Warranty policies typically offer coverage for: five years with a “toolbox” approach; product defect, serial defect, noise, power curve, and availability; parts and labor “backstop”; self-insured retention/deductible buy-down options; and warranty and loss control.

A wind farmer can purchase an extended warranty policy from the original equipment manufacturer (OEM). OEM warranties are sold on a per-turbine, per-year basis and cover the full value of the turbine with little to no deductible. Or a wind farmer may opt to purchase a third-party warranty policy that can be wrapped around the turbine supply agreement to continue coverage supplied by the OEM. The third-party warranty product can cover additional risks or modify the risks covered in the original turbine supply agreement. The third-party warranty covers serial defect, product defect, availability, parts, and labor. Optional coverage for power curve and noise are also available and can be added by endorsement. This is usually sold in “blocks” of limits that are usable for a five-year period. The third-party warranty has an annual deductible structure.

Once a wind turbine warranty expires, the operator may decide to assume responsibility for 100 percent of the costs and losses resulting from warranty-related incidents. In other words, the operator decides to pay out-of-pocket for costs to secure the effected turbine, obtain and ship replacement parts, hire and transport the repair equipment, provide the labor for repairs, and assume lost income and production tax credits. Or an operator may rely on the property insurance to cover costs, which does not provide warranty coverage.

INSURANCE PRODUCTS TO CONSIDER

A wind farm operator should discuss the available insurance products with a broker who specializes in wind farms and has the expertise to determine which products best suit the project. The products available include:

  • Original equipment manufacturer warranty
  • Extended warranty
  • Wind availability insurance products
  • Builder’s risk
  • Transit/ocean cargo
  • Property all-risk insurance, including business interruption
  • Equipment breakdown
  • Engineering and loss control
  • Project performance
  • Supply bonds
  • Performance bonds
  • Professional liability
  • General and umbrella liability
  • Workers’ compensation
  • National resource damage (environmental/pollution)

HOW TO AVOID RISK

First and foremost, do not rely on a standard property policy (fire and storm) to cover a wind farm. The market has adopted specialized insurance products that apply specifically to a wind farm and wind turbines. It is important for a risk manager to work with a commercial insurance broker who has the expertise to understand the project exposure and technology. In negotiating premiums, factor in the manufacturer’s guarantee, inspection, and maintenance; faulty design; the types of material used; and upgrading of performance. Also consider fire prevention measures such as a fire-suppression system to reduce the premium.

RECENT CASE

A recent case demonstrates the significance of ensuring that even a single wind turbine should have the proper insurance. Without careful analysis of a policy’s terms, conditions, and limitations, the risk of loss can shift to the policyholder. In Ass Kickin Ranch LLC v. North Star Mutual Insurance Company, the South Dakota Supreme Court decided in favor of the insurer who denied coverage for two unassembled wind turbines that were destroyed in a fire on a ranch (Ass Kickin Ranch, LLC v. N. Star Mut. Ins. Co., 822 N.W.2d 724 [S.D. 2012]). Coverage was denied based on a specific policy exclusion for “fences, windmills, windchargers, or their towers;” regardless of whether they were assembled or not. The lesson to be learned from Ass Kickin Ranch is to ensure that the proper coverage is negotiated (e.g., an endorsement that carves out certain types of exclusions).

INSURANCE COVERAGE LITIGATION

After the wind farm has purchased the insurance products best suited to the project, the next step is for the policyholder to comply with the policies’ terms and conditions.

Coverage disputes often arise under the “notice” provision of a policy. A policyholder is required to provide notice of a claim or a potential claim. When a wind farm policyholder provides notice, the insurance carrier can disclaim coverage or refuse to defend the claim. If the insurance company, however, has a defense obligation, it can agree to defend the claim but reserve its right to disclaim coverage based on the policy’s terms and limitations if certain facts in the litigation reveal application of an exclusion or policy term and condition. In this instance, coverage counsel is important to review the policy and understand the nuances of the policy language. Coverage counsel can also monitor the underlying action to determine whether any facts develop during litigation that will fall within the exclusion or defenses asserted by the insurance carrier in the reservation of rights. If facts reveal one or more claims in the action constitute an uncovered claim, then an issue of allocation between covered and uncovered claims may also arise. In this instance, coverage counsel is imperative to negotiate an allocation with the insurance carrier.

If the policyholder and the insurance carrier cannot come to an agreement on application of the policy’s terms, conditions, and limitations, and if the policyholder is not receiving the benefits of the policy, then the policyholder may consider filing a suit. The parties should consider avoiding coverage litigation unless negotiations to resolve the insurance disputes reach an impasse. The optimal resolution is to avoid a two-front battle: one against the claimant and one against the insurance carrier. This type of dual litigation is time-consuming and costly. Unless experienced coverage counsel is retained, policyholder beware—“enter at your own risk”—in connection with a coverage dispute with an insurance carrier.

CONCLUSION

Wind farm insurance is a highly specialized discipline that requires the expertise of a broker that can guide the owner through the nuances of the available insurance products and has a background in the energy industry. The insurance carrier, in turn, should have specialists provide insurance premium estimates for individual projects and perform reviews of the insurance provisions of project documents. Unless a wind energy company elects to pay an uninsured loss, out-of-pocket expenses, or accepts the insurance company’s preliminary evaluation of a claim, coverage counsel for an insurance coverage dispute should first be retained when the insurer issues a coverage position letter that either denies coverage or raises defenses that affect immediate coverage afforded under the policy.

 

Alba Alessandro is a partner in the Insurance Coverage Practice at Hodgson Russ LLP. You can reach her at aalessan@hodgsonruss.com.