4.3 Role of Insurance Advisors and Insurance Companies in Project Finance Deals
4.3.4 Types of Conventional and Financial Insurance Products Available for Project Finance Deals
Following is a list of conventional insurance products and those providing financial insurance coverage used in project finance deals.
. Nonpayment risks: These are policies covering damage for the SPV due to political or business reasons. Such accords can concern both medium- and long-term receivables and also leasing contracts and documentary credits.
. Investment risks: These are policies that cover the SPV for risks of currency inconvertibility, expropriation without compensation, war, and other political upheavals.
. Collateral deprivation risks:These policies guarantee the SPV protection against risks of loss of assets and failure of the concession authority to repurchase the structure.
. Contract frustration risks: These policies cover wrongful calling of guarantees and failure to deliver parts or pieces that are functional for the implementation of the project.
. Credit enhancement: Insurance can be required to guarantee a credit from a third party and to make asset securitization transactions easier to set up.
. Transfer risks:These policies are very frequently used in international projects in countries where there is very little stability. They cover risks of failure to retransfer investments back home, to service the debt, or as regards payments for leasing contracts.
. Political risks:Coverage for political risks is a very specialized field of insurance (see Chapter 3). In fact, by definition in this case the project is implemented in a country marked by political uncertainty and instability or with a fragile legal structure. It is quite obvious that, compared to normal situations, the question of insuring an investment or the position of a lender becomes a much more significant insurance issue. Political risk insurance is available to cover various events, such as:
- Confiscation, expropriation, and nationalization - Forced abandonment of the venture
- Transfer risks
- Host government’s refusal to repurchase the structure - Unilateral rejection of contracts
- War, civil war, internal revolts, acts of terrorism
There can, however, be parties interested in coverage for political risks even for projects implemented in countries that are not unstable. In effect, the need for political risk coverage is an issue not only when the project concerns emerging or developing countries; it can also depend on the specific features of a deal set up in industrialized countries in which a change in political situation or global economic trend could damage the venture concerned. The key point in this case is if the country has been given an acceptable credit rating by major international agencies in relation to the contractual terms proposed to lenders, particularly if the deal is not limited to banks or investors from a single country. Ratings for any one country can be revised and downgraded, sometimes even unexpectedly.
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It is very difficult to fix parameters to determine if political risk coverage in one of its various forms is necessary or not. This is exemplified in the fact that today, for certain projects in several countries, even well-developed ones, insurance is required against acts of terrorism or revolts. A further example is based on the widespread conviction that a company in a given country cannot raise money at a lower interest rate than the corresponding sovereign debtor. Use of insurance-type risk mitigation that has the effect of achieving credit enhancement by removing part of the risks can easily lead to a lower cost of funding than would be required for the country risk in which the project is domiciled. In any event, insurance coverage can be very effective in this sense even in countries with very robust economies.
When speaking of coverage for conventional risks, a distinction must be made between the project implementation phase and the operations phase. While construc- tion is under way, the most common forms of coverage used are as described next.
Transport Policy: This policy covers all materials, including plant, equipment, and spare parts, from the moment the material leaves the supplier’s warehouse to be loaded onto the transport vehicle. Coverage continues during transit and includes any intermediate stocking, until such time as the material is delivered to the point where works are being executed.
Start-Up Delay Caused by Transport: This policy is closely linked to the previous one and is a solution for protecting the financial plan by guaranteeing the debt and project cash flow from damage or losses resulting from the transport policy.
It provides coverage for loss or damage to project materials during transport that cause a delay in the date established for start-up of business operations.
Third-Party Liability and Accidental Pollution: This policy provides insurance coverage for claims against the insured made by third parties for physical damage, death, loss, or damage to third-party property, including unexpected and accidental pollution.
Employers’ Third-Party Liability: This policy protects the insured from legal action that may be taken by their employees or by legal representatives or agents appointed by employees and, in general, by all contingent, temporary, or permanent workers following death or injury for which the insured is liable. Each party involved in the project must take out such a policy for its own employees working on the project.
All Assembly Risks Policy: The main purpose of this coverage is to guarantee project materials during stocking, construction, assembly, installation, commissioning, and testing up to the time ownership is transferred, enabling the parties involved to recover the repair or replacement costs for the goods damaged as a consequence of the event guaranteed. Coverage includes damage caused by preexisting works. The tenor of the policy will include the works period and all commissioning and testing activities up to the issuance of the provisional acceptance certificate and must also cover the extended maintenance period up to issue of the Final Acceptance Certificate.
Delay in Start-Up Due to Assembly: This covers financial losses caused by a delay in start-up of plant operations as a result of an interruption during the construction, assembly, installation, commissioning, or testing phases due to an event covered by the all assembly risks policy that gives rise to a loss of profits or payment of fixed costs.
All Site Equipment Risks Policy: This policy is usually part of the all assembly risks policy and covers equipment, machinery, and temporary buildings used on the construction site by the contractor, subcontractors, and suppliers during con- struction of the works.
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Force Majeure: The aim of this policy is to protect the owner for interest due to lenders in the event of a delay in completing the project or if it is abandoned. This policy should supplement the policies covering all assembly risks and indirect damage caused by assembly in order to complete coverage by including events that don’t cause material damage to project assets. The main events insured are:
. Fire and accessory guarantees occurring outside the place where works are being executed, including damage during transport during the construction phase of assets that will be supplied and in supplier plants
. Strikes/shutdowns
. Union disputes
. Changes in law after the policy becomes effective leading to additional costs for the project than those originally planned under the previously existing law Furthermore, in general it covers all other causes not within the control of the owner, constructor, or other participants in the project.
Third-Party Liability of the Board of Directors and Executives: This policy protects administrators, directors, and statutory auditors of companies involved in the project from monetary consequences, expenses as a result of appointing legal representatives, and payment of damages for which the individuals concerned are personally exposed in the event of errors or omissions committed during the exercise of their functions.
In contrast, the following insurance policies concern the project operations phase.
All Risks—Material and Direct Damage: The aim of this policy is to guarantee the widest possible ‘‘all risks’’ coverage for all parties concerned. The main scope here is to indemnify the owner and lenders for material damage to plant components comprising the project, including spare parts and fuel, based on new replacement value. The operator must set up this policy, which should include the owner, lenders, and constructor as additional insured parties, at its own expense.
Indirect Damages (Business Interruption): If an event of material damage concerning the project guaranteed by the all material and direct damage risk policy negatively affects the project’s ability to generate a financial return, then the resulting financial loss will be covered by this policy.
General Third-Party Liability: This policy insures parties involved in operations for accidents and/or damage to assets and/or financial losses affecting third parties during plant operations, including third-party product liability. The operator must set up this policy, which should include the owner, lenders, and constructor as additional insured parties, at its own expense.
Employers’ Third-Party Liability: This policy protects insured parties from legal action that may be taken against them by their employees or by legal representatives or agents appointed by employees and, in general, by all contingent, temporary, or permanent workers following death or injury for which the insured are liable. Each party involved in the project must take out such a policy for its own employees who are working on the project.
Third-Party Pollution Liability: The policy protects parties involved in plant operations for cases of third-party liability as regards accidents and/or damage to property and/or financial losses as a result of pollution (sudden or gradual) arising during operation of the plant. The operator must set up this policy, which should Role of Insurance Advisors and Insurance Companies in Project Finance Deals 95
include the owner, lenders, and constructor as additional insured parties, at its own expense.
Third-Party Liability of the Board of Directors and Executives: This policy protects administrators, directors, and statutory auditors of companies involved in the project from monetary consequences, expenses as a result of appointing legal representatives, and payment of damages, for which the individuals concerned are personally exposed in the event of errors or omissions committed during the exercise of their functions.
4.3.4.1 Bonding
One of the fundamental factors in project finance is a complex structure of guaran- tees that must be set up in which the SPV is the recipient while contractors, suppliers, and operators are the committed parties, in order to safeguard down payments made based on stated performance and other contractual commitments. The strong need for guarantees is to a large extent covered by bank bonding, products that up to now have been those most widely used and appreciated by banks lending to the SPV.
However, because sponsors today are finding it increasingly difficult to obtain this kind of guarantee, competition in the form of insurance guarantees is becoming more intense and effective.
The increasing use of guarantees provided by the insurance market is mainly due to the fact that bank guarantees affect the borrower’s level of indebtedness and so indirectly lower credit capability, which in turn impacts general borrowing power.
This negative effect associated with use of bank bonding has led to an ever-increasing use of insurance bonds. But one of the problems concerning use of insurance instead of banking bonds is that the insurance market, as a general rule, is unwilling to issue guarantees that are not linked to a specific negative event. However, insurance policies can be used to define precise conditions that would reasonably justify the enforcement of the guarantee.
Apart from the impossibility of issuing an insurance policy in the absence of a specific negative event, an insurance bonding offers some advantages for the borrower compared to bank bonding.
. Insurance doesn’t have the negative effect of the borrower’s level of indebtedness.
. An insurance guarantee doesn’t affect bank credit facilities, which can therefore be reserved for other uses.
. An insurance guarantee can sometimes be less costly than bank bonding.
. Such a guarantee can be negotiated with insurers to develop a tailor-made guarantee that is more in line with the reasons for which it is provided to a third party and can only be enforced by the beneficiary based on specific events of default incurred by the party presenting the guarantee.
Apart from this, the two forms of guarantee (bank and insurance) are identical, except for that insurance bonding tends to define conditions determining the payment request in much more detail than in the case of bank bonding. When a beneficiary files a claim, the only difference from the bank bonding case is that in order to request payment the beneficiary must draw up a formal report referring to the specific event of default for its own insurer. This is done at the time the claim is submitted; if the claim is found to be unjustified, then the necessary procedures are activated to recover sums paid by the insurer. This means that beneficiaries must be more cautious at the time they file claims.
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