Energizing Insurance Underwriting

While renewable energy sources, ranging from wind power to ethanol, are hitting the headlines, to date only a few insurers have considered how to cover these risks in Canada. Fortunately, progressive insurance companies and brokers are proving receptive to finding the right coverage solutions for alternative energy suppliers.

ALTERNATIVE ENERGY RESOURCES

How we use energy is a dominant discussion in today’s public discourse. Consumers grouse about the high price of gas for their cars, or the rising electricity costs as we enter what is expected to be a long, hot summer. Environmentalists express concern about Canada’s response to the Kyoto Accord and the issue of greenhouses gases and climate change.

Much of the debate has focused recently on the use of alternative, or renewable, energy resources. Traditional fossil fuels, such as oil and coal, still account for the majority of our energy generation, whether for transportation or electricity. Nuclear power is another major energy source, but the uranium necessary for its production is non-renewable (and poses storage problems). Many see natural gas as a “transition fuel,” but there are concerns about price volatility, long-term supply and high pipeline costs.

Globally, countries are looking at alternatives to reduce their dependency on non-renewable energy supplies and limit the effects of pollution.

Renewable energy includes small-scale, hydro-generating plants, biomass, wind (offshore or onshore), energy from waste, solar photovoltaic, geothermal, tidal and wave. Some tout “clean” fuels like ethanol as replacements or supplements to our reliance on gasoline. Hybrid cars, which use a combination of battery power and gasoline, may represent a “greener” solution than traditional vehicles.

INSURANCE OPPORTUNITIES

In this search for renewable energy, the insurance industry is just starting to pinpoint the opportunities and challenges of new technology, different business models and inherent risks. Commercial insurance solutions are well established for the oil and gas industry, but the market is still evolving in order to provide capacity and proper coverage for alternative energy firms.

There are several important differences with renewable energy projects. In Canada, the industry is still in the early phases; it has not yet experienced enough growth for economies of scale to take effect however, this is changing quickly. A range of infrastructure costs are associated with creating a greener energy supply – including research and development, prototype technology, transit, construction, operation and distribution.

Insurers are often not dealing with a major public facility or large oil company; rather, they are dealing with smaller, entrepreneurial firms with new or prototype technology. There may be different business models and balance sheet sensitivities for these firms, as well as unique technology or production facilities with which underwriters have to become familiar.

Where does renewable energy fit in Canada’s current energy picture? In context, Ontario currently has just over 30,000 megawatts of generation capacity. The biggest share is nuclear power, representing about 36% of total supply. Hydro-electricity accounts for 26%, while coal is 21% and oil and gas runs 17%. Renewable energy currently accounts for less than 1% of the province’s generation capacity. These numbers, that vary by province, are typical in their dependency on fossil fuels.

However, there are signs of change. The Ontario government committed to a plan to phase out Ontario’s four remaining coal plants by 2009. The Ministry of Energy has set a target for the province to produce 5% of its electricity from renewable sources by 2007 and 10% by 2010. Also, in March the Ontario government announced a program to set a fixed price for small renewable energy projects such as wind, biomass or small-scale hydro. Over the next 10 years, this will help add up to 1,000 megawatts of renewable energy to Ontario’s electricity supply.

There are some indications that renewable energy is starting to grow and mature in terms of project size and scale. In mid-April, the largest wind farm in Ontario opened on the north shore of Lake Erie. The 99-megawatt project, at a cost of CD$186 million, is the most recent of three new Ontario-baseed wind farms that opened in the last two months. Earlier, the 40-megawatt Kingsbridge I wind project near Goderich, ON and the 67-megawatt Melanc-thon wind project near Shelburne, ON both began commercial operations. Three more wind farms are expected to come on line by the end of 2006, with enough capacity to power up to 80,000 homes.

WIND POWER

Wind is the fastest growing source of energy in the world. Today, wind energy accounts for only 0.5% of all of electricity produced in the country, according to statistics from the Canadian Wind Energy Association. However, the association also expects the amount of wind power generated in Canada to increase 10-fold over the next five years. Even then, wind will only provide 3% of the electricity Canada needs. That compares with 6% in Germany, 8% in Spain and almost 20% in Denmark.

In Europe and North America, insurers and reinsurers have been providing many of the traditional products such as property damage, business interruption, machinery breakdown and construction – all risks for renewable energy technologies related to wind farms, small scale hydro and some biomass and energy from waste projects. Companies such as Lloyd’s global insurance facility Windpro, Codan (Denmark), R&SA, BI&I, Temple – to name a few – have provided varied forms of coverage for wind farms for more than 15 years.

Some progressive insurers, such as R&SA, are beginning to seize the opportunity to release new “cradle-to-grave” products after consulting with brokers such as Jones Brown and their clients. This is a good example of an innovative solution covering transit, construction, liability and operational risks. That said, there is still much room for innovation in the traditional insurance sector.

As more renewable energy projects open, a key challenge will be the new or prototypical nature of the technologies. This can make it difficult for the industry to model accurately future loss projections and price risks appropriately. The lack of data on historical loss patterns, coupled with the conservative risk nature of many insurance underwriters, can slow the growth of new product development. There are also concerns about low insured values associated with small-scale projects, financial viability and the ability to achieve underwriting profit.

OUTSIDE THE BOX

One of the biggest obstacles may be the tendency of the insurance community to try to put the newer forms of energy into old product boxes built for traditional suppliers. There is a need for customization of coverages and linked products that provide a total solution for green and renewable energy firms. Some of this may involve using existing expertise in fields like manufacturing or agriculture to understand the technology and facility risks, and then applying that to alternative energy production. It could also include the potential bundling of small-scale projects and packaging of risk to achieve economies of scale. Improved actuarial data and technical risk information could help facilitate the development of solutions in renewable energy. Particularly important will be the ability of the marketplace to address facility expansions and the convergence of diverse technologies.

Insurers need to build solutions that make sense for these new technologies and actually tailor coverage to their particular risks. Progressive brokers can help facilitate that movement. If this can be done in a consumer-friendly format, those brokers will be well positioned to educate renewable energy firms about these solutions. Several progressive insurers – and brokers – are testing these ideas out in today’s evolvi
ng energy marketplace. As a specialist in the traditional oil and gas industry through JB Oil and Gas, Jones Brown Inc. is committed to being on the front lines of this innovation in alternative energy.