The speed at which science and technology are developing means that a huge proportion of plant, machinery and commercial equipment is superseded by updated versions in compressed time frames. Just think of the smartphone in our pocket and the number of times you’ve upgraded it over the past few years.

For insurers and insureds in the renewable energy sector, this is a particularly problematic issue and creates major headaches as equipment comes to the end of its lifecycle.

Renewable energy sector

Focusing on the evolution of onshore and offshore wind technology, there have been significant advances over the past decade. To improve the efficiency and performance of wind farms, engineers have developed and deployed increasingly large (10+MW) wind turbine generator (WTG). But what happens to the older and smaller WTG used in constructing early wind farms as they suffer an increasing frequency of faults and mechanical failures in the later stages of their operational lives?

How does the insurance industry try to bring contract certainty under ‘Operational All Risk’ (OAR) wordings in a way that benefits both policy polders and Underwriters? Currently, there’s a fair amount of uncertainty around just how claims for WTG in the later stages of their lives will be settled to everyone’s satisfaction./

There are a considerable number of renewable wind assets (particularly onshore), reaching the end of their operational life spans and thus the challenge of obsolescence is a current and growing industry reality.

By way of example, if a WTG is lost in the final quarter of its predicted lifespan, then even with a ‘New for Old’ provision, should Insurers pay to replace it with a new and technically improved unit? And if not, how do they calculate an appropriate settlement figure?

The reality is that it’s unlikely the same model of turbine remains in production – it will have been superseded by a larger capacity unit which is unlikely to fit within the existing technical or approved specification of the windfarm. In this case, and unless a previously used model can be sourced and accepted by the Insured, which in itself is debatable, the chance of an uncertain outcome is very much on the cards.

As a result, there’s likely to be disagreement and/or some necessary negotiation unless the original equipment manufacturer has taken the positive but unusual approach of dealing with the inevitable question of obsolescence in its contractual terms.

The following clause from a commercial contract is an example of such an approach:

• “If Supplier plans to cease production of any Parts after the twenty-year period as detailed in Section 2.3(b) above, then Supplier shall provide Buyer with at least one calendar year’s notice of such event so that Buyer may request a “last-time” buy from Supplier for such Parts. If Supplier plans to cease production of any goods (into which the applicable Parts are incorporated) Buyer purchases under this Order within two (2) years from the date on the Order, Supplier shall provide Buyer with at least one calendar year’s notice of such event so that Buyer may request a “last-time” buy from Supplier of such goods.”

Unfortunately, this approach is uncommon and so inevitably it falls to others within the risk transfer mechanism to find a way out of the obsolescence maze. The Renewable Energy Sub Committee of the Lloyd’s Market Association (LMA) tried to come up with a solution on the back of numerous unsatisfactory claims experiences.

The main driver of their work was to move away from the traditional approach and towards a more agile and ‘asset-age appropriate’ policy response. This resulted in the amendment of the Obsolescence Endorsement Clause (LMA5572A) in June 2023, which aims to remove ambiguity and bring a clearer policy response for the benefit of all parties in an onshore wind scenario.

This document can be found on the LMA website (www.lmalloyds.com) and the replacement cost example below shows how it might work in practice.

Replacement Cost Adjustment

This approach caters for when a replacement value for a generation asset is required. The adjustment is based on a ratio between the asset’s actual and projected lifespan, as outlined here:

• Original 2MW WTG = £4m
• Installation Date = 2014
• Design Life = 20 years

Loss occurs in 2024, 10 years after installation and no scheduled policy value exists.

Therefore

• 10 years / 20 year Design Life = 50%

Which results in a replacement limit of: £4m x 50% = £2m

Separately, another option available to Insurers relates to the use of new versus existing WTG output to arrive at an adjustment.

To be clear, this is not an approach referenced in the LMA5572A, but is an alternative for when it’s not possible to replace the WTG with an equal output due to the original becoming obsolete. This is an increasingly relevant concern for ageing assets where site permitting requirements constrain replacement options.

Output Replacement Adjustment

This second approach focuses on extrapolating the generation capacity of the original versus the new unit, then using that to adjust the available indemnity with respect to the new unit, when the proposed replacement costs more than the original unit. This is detailed below:

• Original 2MW WTG cost = <£5m
• New 2.5MW WTG cost = £5m

Therefore

• 2MW / 2.5MW = 80% indemnity

Which results in an indemnity limit of £5m x 80% = £4m

The issue of obsolescence is not going away and will become more common in the years ahead. The market needs a strategy to address it within the realm of Operational All Risk insurance and the LMA clause is a good first attempt to do so

If other market groups can come together to address the needs of their own specific communities, it should be possible to ensure that policy wordings for aging renewables assets remain relevant and do not themselves become obsolete.

 

Neil Armstrong

Associate Director, Natural Resources
neil.armstrong@charlestaylor.com

Andrew Milne

Director, Natural Resources
andrew.milne@charlestaylor.com