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Credit enhancement and its use as a risk financing tool can attract
financing at more competitive terms, smooth cash flows, and provide
coverage in the event of a catastrophic loss.
The term "credit enhancement" is being used literally, not as insurance
or financial markets' jargon. The term "finite risk" is being used as
a subset of the spectrum of financial reinsurance.
The origin of the concept is that it was designed to achieve more of
a financial or accounting benefit than a pure economic risk transfer
benefit. The structure described in this paper is also known as "Blended
Finite Risk" and incorporates a specific profit-sharing component which
includes investment income.
The history of wind energy turbines has been one of serial losses on
every component but the towers. Insurance has been the foundation for
the large manufacturers of the current market to stay solvent and grow.
The unknown factors, new technology, size, wind risk and severe or atypical
weather conditions give lenders a high degree of discomfort which is
often reflected in their financing terms.
Benefits
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Client can predict and budget exact maximum cost
each year for the Output Guaranty Fund. |
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Client can build in additional enhancements: extended
warranties, availability, performance, output, serial losses). |
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Insurer could provide direct guaranties to financiers
of client's clients. |
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Capital markets required debt/equity ratios for investors
in client's project would be substantially reduced thereby making
funding available at better terms. |
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Experience Account balance is an asset on client's
books (premium is only deposit into escrow account) so fund belongs
to client. |
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No repayment structures-obligations limited to agreed
premiums for the life of the policy. |
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A funded program provides additional tax deferral
opportunities. |
Summary
A Finite Risk solution is unique to the financial goals of the investors.
Its relevance is to stabilize revenues and earnings, thereby; reducing
risk to debt holders, reducing cost of finance, and increasing the amount
of debt capacity.
This solution requires critical mass to be feasible. At least $50 million
in assets, but preferably a starting point of $100 million. The buyer
of a finite risk solution buys a certain defined limit, e.g. $ 50 Million.
Only part of this limit, e.g. $ 10 Million is real risk transfer. The
remaining part of the limit is financed by the buyer via annual instalments
to a partly funded insurance facility which builds up over the years.
If a risk materializes and the claims payment exceeds the fund accrued
at that time, the insurer provides a credit (see green triangle "Credit")
which is then paid back over the remaining life of the finite solution.
The difference between the claims paid during the multi-year life of
the solution and the funds accrued is paid back to the buyer of the
solution at the end of the fund's life.
This structure can be used to build up funds to pay for losses resulting
from malfunction of wind turbines after the end of the manufacturer's
guaranties (if different turbines are used in various projects) as well
as claims dues to delays in construction and repairs due to bad weather,
and claims not covered under traditional insurance policies such as
wind risk and serial loss.
Finite risk products involve less transfer of risk than do traditional
insurance and reinsurance products but obviously more than if the client
had no reinsurance. However, in exchange for less protection, the client
is able to share in the profitability of its writings through good loss
experience profit sharing.
WARRANTY CASE STUDY
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Foreign manufacturer
--- no mechanism to handle domestic losses; |
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No history --- inability
to quantify risk; |
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Escrow --- financers requiring
10% of asset value in escrow account; |
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Cross Border Lawsuits
--- reluctance to deal with claims in a foreign jurisdiction; |
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Serial Loss --- no coverage
in insurance market. |
Solution
Warranty Policy
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Evergreen --- renewable
until canceled; |
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Coverage --- Mechanical
Breakdown, All Risk, Business Interruption, Serial Loss, Power Curve
and Availability; |
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Limits --- high enough
to cover 2 serial losses; |
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Jurisdiction --- issued
on U.S. domestic paper by an AA-rated insurer, all losses handled
by carrier in the U.S. then apportioned with insured after settlement;
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Premium --- minimum premium
to cover 2/3 of first project, quarterly reporting thereafter adjustable. |
Summary
The intent of the warranty policy is to give a comfort
level to financers within the first two to three years of a foreign
manufacturer's entry into the U.S. marketplace. A re-evaluation would
be expected once a history of operation and creditworthiness has been
established.
It also provides a uniform and simple mechanism to handle claims and
losses. A U.S. domestic policy allows all claims to be funneled and
paid directly in the U.S. with no issues of cross border law suits.
The carrier would pay losses at the front end, later collecting any
retained amount due from the client.
This insurance structure will attract investors who otherwise do not
have the expertise to evaluate the technical risk or who are not comfortable
with a new entrant's history in the market. It is expected to create
more financing opportunities as well as to lower the total cost of risk
and cost of financing.
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