Illuminating Climate

Illuminating Climate

Performance insurance solutions for breakthrough technologies

Innovative sustainable technologies may find it a challenge to access affordable finance through traditional routes, partly because they are new and untested, even if performance risk is likely to be low. Tom Dickson, CEO at New Energy Risk, explores risk transfer solutions through insurance and looks at how technology risk can be transformed into credit risk
Tom Dickson
Tom Dickson
CEO, New Energy Risk
22/07/2021

Mitigating and reversing climate change is arguably the greatest opportunity for innovation ever seen by humanity. Technology developers and their partners are stepping up to this enormous challenge with creative solutions that are both impactful and commercially viable. However, new technology comes with risks and uncertainty, both real and perceived.

Common doubts for technology advancement stem from new technologies’ lack of extensive long-term performance data at a commercial scale. This hinders teams from securing low-cost capital, getting to market, and achieving mass customer adoption.

Traditionally, a project developer attracts low-cost debt financing to a project by transferring key risks, including budget, timeline, and performance risks, onto other counterparties. For most large-scale infrastructure projects, an engineering, procurement, and construction (EPC) contractor will assume these risks through lump-sum fixed-price contracts or guaranteed max-price contracts. Only the most proven technologies, with known costs and construction timetables, can attract project finance without these ‘wrapped’ EPC setups.

Unfortunately, EPCs are limited in their ability to provide performance guarantees for technologies or processes that they have not previously built or delivered. This leaves an unmitigated risk in place for first-commercial projects that capital providers are poorly positioned to understand. For many of these projects, the actual performance risk is low, but the perceived risk from the EPC or capital provider prevents access to low-cost financing.

Insurance as a solution to transform tech risk to credit risk

However, this performance risk – when evaluated by an underwriter with sufficient technical expertise to understand the technology – can be mitigated through an insurance policy, enabling more efficient financing.

This risk transfer is an excellent solution to advance new and lesser-known technologies. Allay the concerns of investors and customers via an insurance policy that protects the insured technology from a performance failure, in effect transforming technology risk to the credit risk of an insurer. From this risk transfer, financiers and customers rest assured, and previously inaccessible low-cost capital is unlocked.

Practical example: Sierra BioFuels

As a case study, consider Sierra BioFuels, a project of Fulcrum BioEnergy, a first-of-its-kind initiative which aims to convert 175,000 tons of household garbage into 10.5 million gallons of ultra-low carbon fuel each year. Like many startups in the cleantech industry, Fulcrum was seeking low-cost financing from institutional capital sources to drive its growth. These sources are reluctant to lend when working with first-of-a-kind projects, and are ill-suited to understand the performance risk of new facilities with no commercial-scale analogue.

Our firm, New Energy Risk (NER), a California-based majority-owned indirect subsidiary of AXA SA (‘AXA’), operating under the global brand division of AXA XL, quantified these risks by bringing both a financing and an engineering understanding to risk assessment. Working with a dedicated team of engineers, scientists, and insurance professionals, NER performed detailed diligence on the technology, structured an insurance policy that met lender needs, and worked with AXA XL to execute the policy in support of the project.

In the event of a failure at Sierra BioFuels, projected performance data allowed NER to determine how long it would take to alleviate and whether there would be enough capital to handle the problem. NER also assessed whether delays could cause a shortfall in output great enough to impact loan covenants and debt payments.

NER’s insurance and warranty solutions helped Fulcrum BioEnergy attract financing options that were previously closed to them. We created a custom-built insurance policy that assessed and covered the risk of underperformance, helped pave the way for product adoption, and ensured that future financing would be minimally dilutive.

Through our partnership, Fulcrum BioEnergy secured over $175 million in bond financing for its Sierra BioFuels project. Ultimately, they estimated that our performance insurance solution saved them 2% annually on their 20-year bonds, equalling $35 million in savings.

Performance insurance to help sustainable projects scale

Performance insurance solutions can similarly support a wide range of energy technologies and related infrastructure projects and technologies that have a major impact on our world, from reducing emissions, to creating more sustainable fuels, to finding new uses for municipal and industrial wastes, to new models for low-carbon transportation. To meet today’s environmental challenges, it is imperative that these technologies scale to accelerate a more sustainable society.

The projected growth in capital investment is at historic levels for climatetech. This investment capital is coming from the private sector: the largest institutional and fund investors, venture capital, growth capital investors, public market investors, and yes, insurance companies. And it is also coming from the public sector, driven by new legislation and carbon-free mandates across many states, countries, and international organisations.

Many insurers have publicly committed to targets aligned with the Paris Agreement and to collectively investing many tens of billions of dollars in renewable energy over the coming years. We support this proactive step to advance sustainable innovations and technologies and are proud to be a part of the insurance industry as it evolves with our changing world.

Describing what insurers will do, not just what they won’t

Sustainability-focused insurers have generally described what they will not do: by limiting or withdrawing underwriting capacity from activities that contribute excessively to greenhouse gas emissions, like coal. However, insurance is inherently set up to lead in sustainability by deciding what we will do. As an industry, we need to send a clearer message about our unique core competences: risk assessment, risk selection, and the permanent capital to hold and manage these illiquid risks. Insurers can take advantage of these core competencies to expand and promote underwriting capacity for activities that contribute to the reduction of emissions as well as other sustainability measures. Reversing the script from ‘won’t’ to ‘will’ can allow the insurance industry to embrace its potential for leading sustainability efforts.

A new class of risk

NER follows this ‘green underwriting’ approach – a more forward-leaning perspective on sustainability in the insurance industry. We believe that the insurance industry is uniquely situated to deploy its risk capital to support new technologies and business models and advance their sustainability impact.

By transferring specific and carefully calibrated technology and financial risks to the insurance markets, more technologies can access efficient capital (faster, minimally dilutive and optimally priced), accelerate their time to market, and achieve commercial scale (with greater customer adoption).

This new class of risk brought to the insurance market will better help address major environmental issues while diversifying the insurer risk book and attracting significant premium volumes, as well. This approach can benefit a variety of industries including renewable energy, fuel cells, energy storage, energy efficiency, waste to energy, biofuels and chemicals, nuclear technologies, power generation, water treatment, indoor farming, industrial processes, carbon capture, biomass processing, anaerobic digesters, grid technologies, and more.

Within our own firm, NER has already paved the way through $1.3 billion in total insurance capacity deployed to date for clients ranging from Bloom Energy (a leading supplier of solid-oxide fuel cells) to Brightmark (a plastic waste-to-product technology company). These policies have unlocked over $2.5 billion in capital for first-commercial technologies.

Furthermore, the contributions from these projects to sustainable economies include the processing of 449,000 ton/year of waste (producing valuable products like low-carbon fuels and waxes), the generation of 695 MWh/year of clean energy (powering the equivalent of 63,000 US homes), the production of 50 million gallons/year of alternative fuels (filling the equivalent tanks of over 88,000 US drivers), and the avoidance of 320,000 tons/year of CO2 equivalent (preventing harmful greenhouse gas emissions). Where new technology risk might have limited any of our client’s successful financing, an insurance solution provided better terms and faster outcomes.

Taking on the crisis of a changing climate is critical, but that does not mean investors are willing to make uninformed sacrifices. By offering bespoke risk analysis and risk transfer, insurance can enable technology developers and their partners to step up to this enormous challenge when we need it most – now.

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