Rethinking Insurance; The 3rd layer of project protection
Enhance project bankability through strategic risk transfer
The third of the five stages of project development – the mid-stage- focuses on protecting the project through contracts, compliance, and insurance.
Previous notes have covered risk identification and allocation, which should be the first step taken in this stage, then discussed compliance, which is necessary for project legitimacy, and then covered contracts for legally embedding and securing rights and obligations.
This note will speak to insurance, the third layer of project protection.
While the first two form the core of project documentation that underlies the project, in addition to providing a legal and regulatory standing for the project, insurance provides a cover, just in case something goes terribly wrong despite all your best intentions, plans, actions, and prayers.
Insurers shift the uncertainty associated with potential high-impact losses from the project company to themselves, in exchange for steady, consistent payments of a percentage of the sum or value insured – the premium
Insurance directly protects project cash flows from a wide array of perils during construction and operation phases and enhances project bankability through strategic risk transfer.
This strategic transfer of risk is vital to lenders who will provide the larger share of capital and are more risk-averse. It acts as one more critical layer in providing them with the assurance that financial exposures can be adequately absorbed, in situations where preventive measures fail.
The long-term horizon of a project creates exposures to a myriad of risks – from unforeseen natural disasters to political upheavals to construction delays to operational disruptions. Insurance is a robust shield against these unforeseen, difficult-to-predict events.
A "bankable" insurance program is central to a project's ability to attract funds, as the cost of financing is directly influenced by the extent of retained project risk and the effectiveness of its mitigation. While insurance does not eliminate risks, it significantly enhances project resilience and attractiveness to financiers by providing quantifiable financial assistance when risks do materialize.
You will need some type of insurance for your project and the project company, what will vary will be the types, sources, and premiums paid.
Types of Insurance Policies: Across Project Life Cycle
I. Construction Phase Insurance
The construction phase of an infrastructure project is characterized by significant capital investment and unique risks before revenues begin to flow. Insurance at this stage addresses risks relating to construction completion or delays. Types of insurance during this phase include:
Construction All Risks (CAR) / Erection All Risks (EAR) / Builder's Risk Insurance: This is a cornerstone policy for the construction phase. As a minimum, you must have this policy.
It covers physical loss or damage to the work, however caused, whether at the manufacturer's premises, during transit, or on site, and generally terminates upon project acceptance. It typically covers "all perils not specifically excluded," including damage resulting from defective design, material, and workmanship, and provides protection during start-up and testing. The coverage is broad, extending to free issue materials, spare parts, fuels, oils, and other consumables intended for incorporation into the project. The geographical scope can include the entire jurisdiction where the project operates for on-site work.
Solar Mini Grids: During the construction of a solar mini-grid, CAR insurance would cover physical damage to solar panels, inverters, cabling, battery storage units, and structural components of the mounting systems or construction errors during installation and initial testing. It also covers damage during the transport of these components to often remote rural sites.
Toll Roads: For a new toll road, CAR insurance would cover physical damage to the roadbed, bridges, tunnels, and toll plazas caused by construction mishaps, equipment failures, during the building phase.
Logistics Parks: In the construction of a logistics park, CAR insurance would protect against damage to warehouse structures, administrative buildings, loading docks, internal roads, and any specialized material handling equipment being installed, or damage during the erection and testing of complex machinery.
Marine Transit, Aviation Transit, Transit ‘All Risks’, and ‘Goods in Transit’ Insurances: These policies are essential for covering against all risks involved in transporting materials, equipment, and supplies (excluding contractors' plant and equipment) while in transit by sea, air, road, rail, or inland waterway to the project sites. All projects will need this insurance too, because there is some type of movement of material, equipment to project sites.
Construction Delay in Start-Up (DSU) / Advance Loss of Profits (ALOP) / Advance Loss of Revenue Insurance: This crucial policy protects against financial losses that result from delays in achieving the project's scheduled completion to commence generating revenue. Reasons covered could include physical loss or damage to the contract works during construction, testing, or commissioning. It compensates the project company for lost profits or additional costs, such as debt interest and fixed operating costs, as well as any penalties for late project completion. DSU coverage pays an agreed amount per day of delay for a specified maximum period. This cover is expensive and often a point of significant negotiation. May not be taken for the project, subject to the scale and complexity of the project.
Third-Party Liability Insurance (including Accidental Pollution Liability): This policy provides coverage for claims made by third parties for physical damage, death, or loss or damage to their property, including sudden and accidental pollution that occurs during the construction works. For projects with significant environmental aspects, a more inclusive "contractor's pollution liability" insurance can be purchased.
Other Non-Material Insurances: Lenders may also require certain insurances to be in place to satisfy statutory legal requirements or as part of the project company’s obligation to act as a prudent developer or operator. These include:
Automobile Liability Insurance: Covers liability for claims of bodily injury and property damage from the operation or use of vehicles related to the project.
Workmen’s Compensation/Employers’ Liability Insurance: Provides cover against injury to workers, including medical costs, disability benefits, and death benefits.
Directors’ and Officers’ (D&O) Liability Insurance: Crucial for attracting prospective board members, as it protects against financial vulnerability arising from poor decisions or litigation.
II. Operation Phase Insurance
Once a project transitions from construction to operation, the nature of risks shifts, and so does the required insurance coverage. The focus moves to ensuring continuous revenue generation and covering incidents that impact the generation of cash flow.
All Risks Property Insurance (Material and Direct Damage): This policy provides the widest possible "all risks" coverage for the operational phase. Its primary purpose is to indemnify the owner and lenders for material damage to the plant components, including spare parts and fuel, based on their new replacement value. The project SPV typically sets up this policy, listing the operator, lenders, and any O&M contractor as additional insured parties.
Solar Mini Grids: Covers physical damage to operational solar panels, inverters, battery storage, and transmission infrastructure from events like fire, natural disasters (e.g., severe storms, floods, earthquakes), or machinery breakdown.
Toll Roads: Protects the physical infrastructure of an operating toll road, including the road surface, bridges, tunnels, toll booths, and electronic tolling systems, against damage from accidents, vehicle impacts, natural catastrophes, or other unforeseen events.
Logistics Parks: Covers the physical structures of warehouses, offices, and handling facilities, as well as the specialized equipment within them (e.g., conveyor belts, robotic systems), against perils such as fire, explosion, or structural collapse during normal operations.
Business Interruption (BI) / Loss of Revenue/ Consequential Loss Insurance: Once the project is operational, this insurance provides protection against a loss of revenue and increased costs of working capital where such loss is caused by interference or interruption to commercial operation, resulting from physical loss or damage indemnifiable under the property damage insurance. The sum insured is typically set for the longest period estimated to reinstate the revenue stream, known as the "maximum indemnity period". This type of insurance. Adaptations of this insurance can include:
Operational Downtime Insurance: Specifically designed to cover financial losses arising from extensive downtime that leads to the inability to operate the project.
Environmental Liability Insurance: Covers the costs associated with environmental clean-up and liabilities arising from pollution during the operational phase.
Parametric Indemnity Coverage: While traditionally used for catastrophic events, this has evolved to cover specific triggers relevant to infrastructure, such as "Lack of Sun" or "Lack of Wind" for renewable energy projects. This pays a fixed amount if a pre-defined parameter (e.g., insufficient solar irradiance or wind speed) is met, helping to complete the traditional insurance package for investment costs not covered by other policies.
III. Special risks Insurance
These are insurance policies designed to cover force majeure, change in law, disasters, catastrophes etc. They are taken in addition to those already discussed for the construction and operations phases.
Political Risk Insurance (PRI)
Political risk is a significant concern for international infrastructure projects, especially in developing countries where regulatory changes, political instability, or government actions can severely impact project viability. PRI is designed to mitigate political risks that traditional commercial insurance does not cover, and could include coverage for:
Expropriation: Direct or creeping expropriation of assets without adequate compensation.
Currency Inconvertibility and Transfer Restrictions: Inability to convert local currency revenues into hard currency or transfer them out of the host country.
Political Violence: Losses due to war, civil disturbance, internal revolts, terrorism, or sabotage. Note that commercial motivations for sabotage may not be covered.
Breach of Contract by Host Government: Failure of the host government to honour its contractual obligations, provided the insured party has exhausted dispute resolution mechanisms. This can include refusal to repurchase the structure or unilateral rejection of contracts.
Regulatory Risk / Change in Law: Risks arising from adverse changes in government laws, regulations, or policies that materially impact the project's economic viability.
Forced Abandonment: When local conditions make it impossible to continue construction or operation, even if the project is not physically damaged.
The principle to remember in selecting your insurer for PRI is they must not be subject to that risk as well, hence effective PRI is better obtained from.
Public Agencies: Public agencies are often better suited to cover sovereign risks and can also act as mediators between host governments and investors to mitigate the probability of default. These include multilateral development banks like the World Bank's Multilateral Investment Guarantee Agency (MIGA), regional development banks such as the Asian Development Bank (ADB) and European Bank for Reconstruction and Development (EBRD), and export credit agencies (ECAs) of industrialised countries
International commercial insurers: A growing number of private insurers (e.g., Lloyd's of London, AIG, Zurich-American, ACE, Axa, XL, Chartis, Chubb) also offer PRI. They are generally more flexible as they are not constrained by public policy considerations, allowing for tailored programs. They sometimes co-insure with public agencies, instead of alone.
Special Perils & Force Majeure Insurance
These insurance policies can provide an additional layer of protection against particular disasters and major events that materially impair project viability.
Special Perils Insurance: Insurance against "Acts of God" or natural disasters that can cause severe damage to an infrastructure project during construction or operation. These could include:
o Fire, lightning, explosion.
o Flood, cyclone, tornado, tsunami, typhoon, windstorm, unusually severe weather.
o Earthquake, seismic risks, volcanic eruption, landslip, subsidence, heave and collapse.
o Damage caused by accidental damage.
Force majeure insurance specifically aims to protect the owner for interest payments due to lenders in the event of project delay or abandonment. It could complement other policies by covering events that may not cause direct material damage to project assets but still impact viability. - Worth noting that this one is particularly difficult to price.
The value insurers add to your project
Insurers are not merely passive providers of coverage; they can be active participants in the project finance ecosystem, and they can influence project structuring and bankability.
Risk Evaluation Expertise and Due Diligence: Insurers are in the business of evaluating and pricing risks. Their willingness to underwrite a project's risks, and the premium they charge, reflects their assessment of the likelihood of loss. The ability of a project to obtain insurance itself serves as an endorsement by an independent party (the insurer) that the project's proposed risk mitigation measures are acceptable. This detailed risk analysis performed by insurers is an essential part of the project's due diligence process.
Reinsurance strengthens creditworthiness: Many host countries, especially emerging markets, require that insurance for international projects be issued by local companies. However, these local insurers may lack the financial capacity or creditworthiness to cover major infrastructure project risks. To address this, local companies commonly reinsure most of their coverage with larger, more creditworthy international insurers. Local insurers successfully reinsuring projects with international insurers to mitigate their own insolvency risk adds another layer of creditworthiness to your project.
Insurers as Institutional Investors: Insurance companies collect a large volume of capital in premiums that they need to find suitable instruments to invest it in. Long-term debts with stable and predictable income streams and moderate volatility are an attractive investment for their asset-liability management strategies. They, along with pension funds, are institutional investors that could be attracted by infrastructure funds and infrastructure bonds listed in capital markets, subject to their regulatory limitations
Practicalities with availability, pricing, and lender controls
Availability: While various types of insurance were covered here, some are more common than others, like Goods in transit and Construction all risk versus political risk insurance and force majeure. Practicality with availability, and necessity need to be considered in designing an insurance program for the project.
Premium pricing: At the heart of insurance is the actuarial science needed to quantify and price risks. It is a delicate balance to price premium payments that cover the likelihood of crystallization of the risk with the impact of the risk if it crystallizes, along with the size of the pool of the insured i.e. the volume among which that risk is shared. Safe to say that commonly available standard policies will be easier to price than specially designed policies.
The premiums on policies during the construction phase are often fixed, while for operating phases renewed annually, premiums factor in historical losses and claims, leading to some changes in prices.
It is a good and recommended practice to ask insurers about adaptations of scope and type of coverage in seeking protection for your infrastructure projects
Also good practice to consider pricing many policies together, lowering the overall value of premiums
Lenders' Specific Control: Just like with project contracts, lenders will want to exert significant control over the insurance program. They will require the project company to procure and control all "material insurance", ensuring it is ring-fenced from other entities' policies and provides comprehensive, consistent coverage, and will require that they are listed as direct beneficiaries of policies alongside the company and any other relevant party.
Bringing it all home
Do not see insurance as just another expense, see it as a strategic imperative that underpins project bankability and long-term viability.
Do not see insurers as yet another group of people taking your money; see them as strategic project partners who improve the project’s risk profile and creditworthiness.
For investors, a comprehensive insurance program demonstrates that the project developers have thoroughly understood and addressed potential threats to future cash flows, which are the primary source of debt repayment and investor returns.
By protecting against delays in construction, physical damage, operational interruptions, and political instability, insurance safeguards the project's assets and its revenue-generating capacity.
This de-risking increases the project's attractiveness to lenders and equity investors, making it more creditworthy and capable of securing the large-scale, long-term capital required for successful infrastructure delivery.
Well-structured insurance transforms potential "oops" moments into manageable challenges, allowing infrastructure projects to deliver lasting value and contribute to societal progress.
Reviewed to complete this note:
Managing Risks & Rewards for Pensions, Insurance Companies & Endowments – Rajeev J Sawant
Financing Energy projects in Developing countries – Hossein Razavi
Principles of Project Finance – E.R Yescombe
The Law and Business of International Project Finance: A Resource for Governments, Sponsors, Lawyers, and Project Participants Scott L Hoffman
Project Finance for Business Development John E. Triantis
International Project finance Law and Practice – Edited by John Dewar
International Project Finance in a Nutshell by John M Niehuss
Project Finance At the World Bank : An Overview of Policies and Instruments World Bank Technical Paper – by Philippe Benoit
Project Finance in Theory and Practice Designing, Structuring, and Financing Private and Public Projects, 4th Edition - Stefano Gatti
Introduction to Project Finance in Renewable Energy Infrastructure Including Public-Private Investments and Non-Mature Markets – Farid Mohammadi