Insurance Coverage for Renewable Energy Projects

Changes in the insurance market in 2020, including significant increases in premiums and limited coverage for hail, named windstorm, earthquake and wildfire, among other perils, led sponsors to request modifications to insurance requirements in tax equity and loan documents and prompted increased scrutiny of those requirements and insurance policy terms. The following outline describes the types of insurance coverage that are frequently available for renewable energy projects and how insurance terms are typically addressed in tax equity and loan documents.

Insurance for Casualty Events and General Liability

Types of Coverage (typically set forth in a Schedule to the LLC Agreement or Loan Agreement; also required by Power Purchase Agreement).

• All-Risk Property: Covers cost to repair the Project after property damage from breakdown or from effects of earthquake, storm, etc. Builders all-risk policies (or “BAR” policies) are in place during the Project’s construction, and they cover the cost to repair the project as of the date of loss. In other words, if the Project is only half complete, the policy will cover the cost of repair up to that point of construction. Operational all-risk policies (or “OAR” policies) generally cover the replacement cost of the completed Project once it is placed in service.
  • The amount of required coverage is often the full replacement cost, but coverage may be capped or “sublimited” for losses caused by certain perils, as insurers’ exposure tolerance has flagged.^[1] For example, sublimits for earthquake or hail coverage could be 125% of the probable maximum loss (“PML”) of a 1-in-500-year event.
  • Policy typically excludes coverage for physical damage losses to the Project to the extent that they would otherwise be covered under a manufacturer or supplier warranty (but losses from downtime may be covered under business interruption policy).
  • “Microcracking” or “microfracture” endorsements restrict or sublimit coverage for microfractures in PV panels. To establish coverage for microfractures in the first place, the Project must show that the microfractures are the result of a covered peril, like fire or hail, and not manufacturing defects.
  • Other common exclusions are terrorism, pandemic or national emergency.
• Business Interruption: Compensates, following the expiry of the “waiting period” (which operates as a deductible for time element coverages), loss of revenue during downtime of the Project, plus, in many cases, downtime of substation and interconnection facilities.
  • A common policy limit is coverage for up to 12 months of gross revenues, minus non-continuing expenses.
  • For wind projects, lost production tax credits (“PTCs”) are often included as part of business interruption insurance, because any downtime will decrease the PTCs that may be claimed by the Project over the 10-year PTC period.
  • During construction period, a BAR policy covers losses from the resulting delay in start-up. An OAR policy covers business income losses incurred due to a suspension or reduction in output caused by property damage.
• Commercial General Liability: Covers property damage or bodily injury to third parties and provides limited coverage for liabilities assumed in an indemnification agreement.
• Workers’ Compensation and Employer’s Liability: Workers’ compensation policies provide wage replacement and medical benefits to employees injured in the course of their employment. Employer’s liability policies cover lawsuits brought by injured employees or their family members.
• Pollution Liability: Although renewable energy projects have a relatively lower risk of pollution liability, policy covers bodily injury, property damage, cleanup, and related defense costs as a result of pollution conditions (sudden/accidental or gradual, as defined). Pollution liability coverage may be desirable for project sites with recognized environmental conditions.
• Auto Liability: Although most projects do not use or own automobiles, most maintain coverage for liability arising out of the use of hired or non-owned automobiles during the course of construction and operation.
• Umbrella/Excess Policies: Provides additional coverage for claims in excess of primary general liability coverage.

Deductible/Self-Insured Retention (also typically set forth in a Schedule to the LLC Agreement or Loan Agreement).

• Under an SIR (Self-Insured Retention), the Project Company is not insured, and therefore bears the loss, for amounts up to the retention amount. Insurer pays losses in excess of retained limit.
• Under a deductible, the Project Company is insured, but the insured amount will be reduced by the amount of the deductible before proceeds are payable to the insured. The difference between a deductible and SIR is material with respect to, among other things, the insurer’s duty to defend, which would apply first-dollar under a deductible but not until a SIR has been exhausted.
• Deductibles could be set at a dollar amount or as a percentage of the property damage. Deductibles for DSU and Business Interruption generally are time-based waiting periods.
• Deductibles on hail, wildfire, and earthquake coverage have increased significantly over the past 12 months (up to $5 million or 5% of the Project’s total insured value).

Application of Insurance Proceeds under LLC Agreement or Loan Agreement.

• LLC Agreement (application of loss proceeds or allocation of loss proceeds between the Class A Member and the Class B Member):
  • If insurance proceeds are sufficient to repair or rebuild the Project, insurance proceeds are generally applied to the cost to repair or rebuild. Loan Agreements typically have the collateral agent benefit from a sole loss payee endorsement.
  • After any construction loan is repaid, if insurance proceeds are insufficient to repair replace, insurance proceeds are generally first allocated to the Class A Member to, at a minimum, maintain an expected flip date.
  • Potential effects on investment tax credit (“ITC”) for a solar project following a casualty event:
    • insurance proceeds should cover the cost to buy replacement panels and restore Project (subject to policy limits);
    • the destroyed panels are subject to ITC recapture if taken out of service within the 5-year period after the Project is placed in service;
    • the partnership is entitled to a new ITC on the replacement panels; and
    • if the ITC rate for the replacement panels is the same as the ITC rate for the destroyed panels (i.e., the “begun construction” date for the replacement panels is the same as the destroyed panels), there should not be an ITC-related delay in the flip date and therefore not an extra insurable tax loss. Whether the new panels have the same “begun construction date” depends on the value of the original project that remains after the casualty event and the cost to rebuild the project.
  • In some older deals, the tax equity investor was able to obtain extra coverage under the general liability policy so that insurance pays the ITC recapture amount for a casualty event (included as a “stipulated loss”). This coverage would apply where:
    • the Project is not rebuilt and insurance proceeds are less than the amount needed to cause the Class A Member to reach the flip point (i.e., shortfall following application under clause (b) above); or
    • the Project is rebuilt with insurance proceeds but ITC is recaptured and the replacement panels have a lower ITC rate/did not begin construction at the same time as the original Project, in which case there could be a significant delay in the flip date (effects of (c)(4) above).
  • Back-leverage Loan Agreement: Often requires prepayment of any loans with the Class B Member cash flows that are not used to rebuild.

Loss Payee.

• During construction period, if there is a construction loan, the Collateral Agent is the sole loss payee.
• If there is a hedge agreement, the Collateral Agent under the Hedge Agreement remains the sole loss payee during the operation period.
  • Intercreditor Agreement includes a waterfall showing how insurance proceeds are applied (to buy down the hedge if the Project cannot be repaired).
  • The defined term “loss proceeds” frequently carves out Business Interruption proceeds, which would mean that those proceeds are deposited into the general revenue account of the Deposit Account Control Agreement. Also, many times following tax equity funding, the hedge collateral agent is sole loss payee with respect to property insurance proceeds, and there could be more than one loss payee for Business Interruption. That is primarily an issue on wind deals when Business Interruption includes PTC coverage, and the partnership requires PTC coverage at the partnership level.

Post-Closing Changes in Insurance Markets.

• Insurance is typically issued for successive one-year policy term. The insurer is under no obligation to offer a renewal of the policy on the same terms.
• LLC Agreement (and loan agreement) typically provides that the Managing Member’s obligation to maintain insurance on a schedule is subject to the insurance being available on commercially reasonable terms, meaning that the tax equity investor and the Sponsor share in the risk that insurance is unavailable (or available subject to increased deductibles, lower sublimits, and other, less favorable terms and condition) due to changes in the market.
• For hail risk in solar transactions, the risks of uninsured losses may be mitigated by technical solutions, such as turning the panels away from the direction of the storm based on a weather forecast.
• In certain markets, coverage for wildfire loss may be subject to the Project Company’s compliance with certain conditions, such as a mitigation and vegetation management plan.

ITC Insurance

Coverage. A typical ITC Insurance Policy insures the risk that:

• IRS disallows ITC based on a successful challenge to the ITC eligible basis of the Project; and/or,
• IRS disallows ITC because construction of the Project did not begin before the designated date (i.e., the Project is not eligible for the projected ITC).

Limits. An ITC Insurance Policy limit is generally equal to a portion of the amount of expected ITC at the outset plus gross-up costs (approximate amount of tax due to the receipt of insurance proceeds), contest costs, interest, and penalties.

Term. Unlike insurance above, the ITC Insurance Policy term is typically seven or eight years from the date that the Project is placed in service.

Relation to Sponsor Indemnity Obligations.

• ITC Insurance Policy may be in addition to indemnification from the Class B Member/Seller for a breach of tax representations, which is supported by a cash sweep and Sponsor Guaranty (“double-trigger” insurance). ITC Insurance Policy is often required as credit support for the obligations of the Guarantor and/or if the cash sweep is capped.
• ITC Insurance Policy may cover the indemnification obligation of the Class B Member/Seller for a breach of tax representations without requiring the Insured to seek indemnification from the Class B Member/Seller (“single-trigger” insurance).

Title Insurance

Owner’s Policy.

• Owner’s policy insures the Project Company’s real property interest against:
  • Title being vested in another party;
  • Defect in title (issue with chain of title and previous transfers or recordings);
  • Lien of real estate taxes;
  • Encroachments that would be disclosed in a land survey (e.g., violation of setback requirements);
  • Mechanic’s liens having inception prior to date of policy; and
  • Rights of access.
• Policy is updated once construction is complete to remove survey exceptions. This could be a condition to final tax equity funding or a post-funding covenant.
• Coverage is typically for fair market value of the Project.

Lender’s Policy. Lender’s policy that insures the lender’s interest in the deed of trust, for the same issues listed above.

Term. Policy continues in effect as long as the insured party has an interest in the property or is secured by a mortgage.

Relation to Sponsor Indemnity Obligations. Coverage is in addition to indemnification from the Class B Member/Seller for a breach of real estate representations, which is supported by cash sweep and Sponsor Guaranty.
 

^[1]The insurance industry cycles between “hard markets” and “soft markets.” In a hard market, premiums increase and capacity for most types of insurance decreases. On the flip side, a soft market is characterized by lower premiums, higher limits, and increased flexibility and availability of coverage. A number of factors influence whether the market is hard or soft, including regulatory changes or a particularly bad catastrophe year.