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Hydro Risky Insurance Business

posted 19 Sep 2014, 13:39 by olnf Admin   [ updated 19 Sep 2014, 13:40 ]
Author: Suparas Singhi


Natural calamity forces every Insurerto reassess their underwriting practices. In one such recent incident in Uttarakhand, has forced the Insurer Co. both Life and Non-life to come up with creative and innovative solution to underwrite the business as well as settle the claim. Coming back to State of Uttarakhand, wherein more or less around 135 Hydro power plant projects have been either been under construction phase or nearing commissioning. Corporate houses involved in development, construction of Hydro power plants are scratching their head to find solution for recovering from losses where the entire topography has changed or wherein the cost of reinstatement will shoot up the budget beyond their control.

The paper in simple way tries to explain the basic issues that Insured needs to review while availing an Insurance cover for Hydro Project.

Hydro - Risky Insurance Business

Recent natural calamity in Uttarakhand have left Insurance Companies reassess their underwriting practices. There have been loss of life and loss of property both personal as well as corporate. Corporate houses involved in development, construction of Hydro power plants are scratching their head to find solution for recovering from losses where the entire topography has changed or wherein the cost of reinstatement will shoot up the budget beyond their control.

Everyone will agree on the fact that loss resulting from Act of God will be huge in terms of social and economic front. One can refer to the example of earthquake plus Tsunami incident which affected Japan. Prediction of exact date for such scenarios is yet not possible for human but Prevention of such loss of property and life is in our hand.

In no way this paper aims to find out the faults of our loving and caring government. This paper will simply restrict itself to the topic towards Projects and Project Insurance. 
We all are aware that the following major Insurance policies are to be opted whenever a project is undertaken irrespective of type of project:

1. Marine Insurance
For covering the transit risk like overturning, derailing, collision of vessel, earthquake, lightning, fire, etc. which the consignment/Cargo faces during transition.

2. Marine Delay in Start Up (MDSU)
For covering the financial loss/Business Interruption sustained by the principal due delay in project commissioning caused by loss/damage of critical equipment during transit.

3. Contractor All Risk / Erection All Risk (CAR/EAR)
For covering the project activity defined in the scope of work of the contract involving civil and mechanical work. EAR policy is suitable for those projects wherein installation and erection of plant & machinery cost amounts to substantial portion of the project whereas projects wherein the civil portion forms substantial portion of the project cost, CAR policy is advisable.

4. Advance Loss Of Profit (ALOP)
For covering the loss of projected profit which the principal would have earned/gained if the project would have commissioned as per the schedule but projects never go as planned and there may be incidents wherein project commissioning is delayed due to operation of Insured Perils. In such situation the principal tends to be at loss. ALOP can only be claimed once, after the project has been commissioned for commercial operation.

Coming back to State of Uttarakhand, wherein more or less around 135 Hydro power plant projects have been either been under construction phase or nearing commissioning. The area hit by the flash flood, landslide / Rockslide have not only resulted in huge loss of property in terms of material, plant & machinery , etc. but will also result in huge loss in terms of Advance loss of profit.

Sustaining direct damage to the property & loss of profit due to such natural calamity is the common pattern in risk modeling, but let’s imagine the scenario which might affect severely and are normally missed i.e. not perceived at the time of placement of policy.

Due to operation of such AOG perils, situation may arise that the site is inaccessible resulting, which day to day activity linked to project or operational plants comes to an abrupt halt. Such scenario will aggravate the (Advance) Loss of profit. Such loss in income will only be covered if such denial is a result of the insured peril. Few example of Denial of Access are hereunder:
  • Approach road to the site being washed away
  • Obstruction to power generation building/ substation, etc.
Project management is a tool to construct & prepare the schedule for the project with provision for contingencies, but it is not necessary that all contingencies are considered and mapped. Natural Calamities are the contingencies that tend to delay the operation. The delay in operation will only affect the (Advance) Loss of Profit.

Insured will come across the word called Indemnity Period during his tour of Business Interruption part of the policy, in other word (Advance) loss or profit. Indemnity period is the time frame or period for which business interruption loss is payable by the Insurance Co. given that cause of such interruption is due to insured peril.

It has been and it is always advisable to have longer indemnity period i.e. 12 months + if major supply of equipment is though import or site is located in natural risk prone zone. The premium calculation for the same depends on the longevity of the Indemnity Period. Longer Indemnity period can truly provide some relief but at a cost.

Imagine a situation wherein because of such natural calamity the entire terrain and topography of the project/plant site is altered. What if such alteration makes it impossible for reinstatement of the property? Will the insurance policy still be in force and protect Insured interest?

In such situation if Insured decides to abandon the project as the reinstatement will erode away his balance sheet. It is completely up to the discretion of Insurer and IRDA how they want handle and settle the claim badly affected region whereas a provision under operational policy (Mega/IAR/Fire) insured can request from settlement of the claim on market value basis i.e. at a depreciated price.

Such huge loss badly affects the cash flow and liquidity of the Insured. Insured may not be in a position to reinstate the property. Under such scenario request for On Account Payment can be made for material damage to the Insurer. The payment will help the insured to begin with the reinstatement work and the advance payment will be adjusted at the final settlement.

The list of some ideal coverage, which the principal / owner of the project need to avail during the project phase, is listed hereunder:

Common CoversSpecial Covers
EarthquakeContinuity of cover for common utility & structures till all the units are commissioned
Storm Tempest Flood & Inundation (STFI)Pro-rata extension Clause
Riot, Strike & Malicious damage (RSMD)Waiver for put to use clause for internal project roads, bridges, camps and stores
Removal of Debris including external debrisAdditional cover for provisional repair not forming part of the final repair
Owner's Surrounding Property with FLEXADenial of access clause
Extended Maintenance Cover / Defect Liability CoverLiquidated damage cover restricted only for losses covered under the policy
EscalationCover for overtopping and washing away of cofferdam
Additional Custom dutyCover for Tunnel Boring Machine / Deletion of TBM Exclusion or Insuring it under separate policy
Professional FeesMR 1203 : Liability consequent upon vibration, removal or weakening of support
Automatic Reinstatement of Sum InsuredMR 1209: Cover for Oil, gas and/or geothermal drilling rigs and equipment
Offsite Storage and FabricationMR 101: Special conditions concerning the construction of tunnels, galleries, temporary or permanent subsurface structures or installations
Loss minimization expenses(*MR – Stands for Munich Re)
Expediting expenses including Airfreight
Third Party Liability with Cross Liability
Third Party Cover during maintenance period
Design Defect (DE 3 & DE 4)
Waiver of subrogation & contribution
50/50 Clause
72 Hrs. Clause
ALOP cover for AOG Perils

After the huge material & ALOP losses sustained in one of the Hydro project in the state of Sikkim, the insurance companies revisited their underwriting principles and came up with guideline that ALOP cover shall be granted for all AOG perils except for Earthquake.

Therefore any hydro project being carried out in Earthquake prone zone will not have ALOP resulting from Earthquake. At present though cover for ALOP with Earthquake is being granted but on loss limit basis but in any such catastrophic situation will only be peanuts in relation to the loss retained & sustained by Insured.

Hope that Uttarakhand incident should not result in establishing of such underwriting practices wherein entire AOG peril cover for ALOP is excluded or restricted to a loss limit.

Uttarakhand incident and above scenario might have raised some eyebrows on coverage. Those who have faced the wrath of Nature will learn from their experience and those who were somehow lucky will learn by observation and self-analysis.

There may be situation where environmentalist petitions force the government to review the award of hydro project in the state. This review process may also result in cancellation of projects. The investment done will drain down the ditch.

Cessation of work partial or full is not covered under the project insurance and financial loss sustained due to political/government order are also not covered under the project or operational Insurance. Therefore, it is always advisable have a proper PESTLE study of the state or country before investment.

In above cases insured who considered Insurance to be compulsion rather than a proper risk transfer mechanism will pay for their negligence. Till date and for years to come Insurance will be treated as an investment wherein the management will aim towards obtaining claim worth double or triple the premium amount. It’s not an allegation to all insured but they need to change their mindset towards Insurance. A risk transfer tool like Insurance needs to be handled and should be taken care by domain expert and the management should keep their mind & soul open towards that domain expert.