COVID-19: Can Tax Insurance for Renewable Projects Help

Date: April 23, 2020
Good morning or good afternoon, and welcome to McDermott Will & Emery’s Thursday webinars on COVID19 issues relating to the renewable energy industry. I’m Ed Zaelke, head of McDermott Will & Emery’s project—energy project finance practice. And today we’re going to be talking about whether tax insurance for renewable energy projects can help, with special guests from Marsh. Before we get started today, I do want to remind folks that McDermott has a COVID 19 resource guide, maybe one of the best in the business, and we are proud of it. We put a lot of resources and energy into it. And it is available at www.mwe.com. And I direct you all to that for a number of, a number of issues you’re, you’re all facing, I’m sure. Before we get started, we always have a few polling questions for the audience. I want to start with the polling questions, and then we’ll move into our program. They’re insurance related this week, since we’re talking about insurance. First question is, where is the biggest need for tax insurance for renewable projects in 2020? FMV, or fair market value or cost basis, the tax structuring risk, continuous efforts or continuous construction, the begin construction or 5% safe harbor or physical work issues, or other. So why don’t we all vote, and we will see, see what the audience thinks. They help guide our discussion today. The results are, and by about 41% are looking at continuous efforts or continuous construction as a way to use insurance products. That seems to be winner. The other things following are tax structuring or beginning construction issues. Let’s move on to the next, next insurance related question. Are there any tax, are the tax credits assisted with your project impacted by the COVID 19 crisis? And the answers to the question are very at risk, potentially at risk, probably not at risk, or not impacted by the crisis. So again, going back to how we’re going to be thinking about insurance, we start with the basic questions on the tax credits associated with your project’s impact at all. And the answers are about 60% are saying potentially at risk, but this is a timely discussion, and we look forward to what the experts have to say. One final insurance question, completely unrelated to the renewable sector. But since we got the insurance guys on the on the line, we might as well ask. Is your car insurance company lowering your rates or sending you a refund during COVID 19? The answers are, could be yes, no, or are you kidding? The, we’ll take the are you kidding as part of the no answers. So, let’s see how, how the, the insurance of … About 42% are, are getting some break from the insurance companies on their car insurance. The balance are split 29/29 between just no and are you kidding. So, we’ll start that with the insurance guys having to deal with a hostile audience. We’ll go quickly through the agenda. One topic today and that’s the insurance of products that available under, during COVID 19 for renewable projects. I want to remind the audience that we do have a question and answer button towards the end—at the end of your page or bottom of your page. Please click on that and you can ask the experts questions directly. Today I’m joined by Phil Tingle, who is the head of our energy tax practice, who will be speaking with Antony Joyce and Mark McTigue from, from Marsh. And with that, Phil I’m going to turn it over to you. Thanks, Ed. I just want to thank Mark and Anthony for, for joining us today. Just a brief background on Antony and Mark, if you’re not already aware. They’re both senior vice presidents in the transactional risk practice at Marsh and jointly lead the tax insurance initiative. Marsh is an insurance broker that works with a dedicated pool of tax underwriters to craft cost effective tax insurance solutions to facilitate M&A activity and to aid the financing of the renewable energy sector. With that, let’s just get right into it, because I know we only have what’s left of the half hour. So Mark and Antony. Well, we’ll just start off here. I think we know where this is going to focus, probably a little bit on continuous efforts. But I think the question here is what, what insurance mitigation strategies are you seeing that are related to COVID 19? What, what range of inquiries have you received on, kind of, risk mitigation for this crisis? Yeah. Thanks, Phil. And thanks to the McDermott team for hosting us today. Mark and I are delighted to be here virtually, and thanks for introducing ax insurance into the scope of your webinar series. Just to respond to your, to your question, Phil, I mean, there’s been— much of the activity is in the wind space. In the solar space, we continue to see the usual deal flow related to qualified basis. So tax insurance policies that stand behind the fair market value used to compute the investment tax credit. Much of that activity has been recently in wind, and particularly as it relates to COVID 19. And the, the activity really falls into two baskets and they’re reflective of the way that projects begin construction. We have policies looking at delay and policies looking at mitigation strategies. The delay policies tend to be projects that started under the 5% safe harbor and are subject to the continuous … test. Prior to COVID 19, we were actually working on a number of policies for projects where there was concern or it was known that the project would go beyond the four-year safe harbor. With COVID 19, you know, that dialogue has exasperated with long lead times and some of the effects of COVID 19. So pre—prior to COVID 19, we had concerns with permitting and with interconnection. Now with COVID 19, we have concerns about turbine component delivery, a shortage of labor, potentially someone on site infected, getting infected, or government mandated outage. And then finally, concerns about the availability of specialized equipment such as, such as cranes. So with the right facts and circumstances, the underwriting community said the insurers that stand behind the tax insurance policy have become comfortable that those symptoms of COVID 19 can be captured within a tax insurance policy. And provide certainty to develop or raise or procure capital. The second pool of policies, the mitigation strategy policies are responding to situations where the project commenced construction under the physical workspace, either on-site or off-site. And now, with the contemplation of falling outside, the four-year safe harbor, it’s going to be very difficult to demonstrate a continuous program of construction. And so, in that context, we’re seeing clients try to flip from continuous construction to continuous efforts, either through a joint venture strategy with a holder of safe harbor equipment, or themselves acquiring safe harbor equipment in 2020, say, and trying to lock in a minimum 60% PTC. That, that’s very helpful. Let me, let me ask this, and I think the way I think about that is, well it’s really two strategies. One is the continuous efforts and being able to prove that out on the 5% safe harbor. And then kind of the 80/20 strategy under the notices that, that people are using to try and mitigate some of the physical work strategies. One other question. Just, just off the top here, are you seeing anything for people who are, for example, beginning construction with safe harbor, and then in an alternate year, or, say in 2020, are using physical work or vice versa? Have you seen anything like that? And is that something that may have some, some availability to the insurance market? That’s something not, that we have not seen to date. But it is a situation where, to the extent that a capital provider is concerned with the facts and circumstances before they invest, a tax policy certainly could respond to a situation like that. So let’s, let’s, let’s maybe talk a little bit, I don’t want to spend the whole time on this, but let’s talk a little bit about the continuous efforts insurance and, and what’s out there. You know, how much of this continuous efforts insurance has actually been underwritten? And how active are you guys seeing that market right now? Yeah. Thanks, Phil. So we’ve, we’ve bound several policies in this space, and currently we’ve got about $2 billion in insurance limits around the continuous efforts tax issue. So, you know, certainly a very robust market right now. We’re finding, you know, given there’s been a dislocation in the market with respect to COVID 19 and reps and warranty, which is the, the other product that we work on in transactional risk. You know, since M&A has sort of fallen off the cliff a little bit, you know, there is plenty of appetite in the in the marketplace for other transactional risk products like tax insurance. So we view capacity is being, you know, pretty strong at the moment. We’ve also got about 16 insurance carriers that will specifically do primary tax insurance risk, and so when you add on the other insurers that are doing rep—only reps and warranties at the moment, they will come and step in and do excess insurance. So capacity right now is very strong. I should say, though, you know, we sort of view this as, obviously, with the safe harbor coming to an end right now, without anything from the stimulus bills extending it at this point or anything from treasury, you know, we view, you know, the third and fourth quarter, we expect to see a ramp up in interest in this insurance. And you know, my only warning to the marketplace is you don’t want to be the last person. Because insurance carriers, you know, they do fill up on risk. So, you certainly, you certainly want to speak to us now about something like this, because ultimately, if people, you know, fill up on the risk, then there could be an increase in premium towards the end of the year, as well as a loss of capacity. Great. So that kind of leads me to my next question. I’m sure people have, you know, this is probably top of the, top of the list on interest in something like continuous efforts insurance. What is the cost, generally? I mean, if you could maybe give some kind of estimate of what that might be. And then, probably another important question is what is, how are they sizing it? Are people sizing at 100% of the PTCs? Are they sizing at 60, 40? Is there any kind of, kind of, anything that you can see that, that’s kind of a trend and how people are approaching that? Yeah, sure. I’ll talk a little bit about the cost and then Antony can, can chime in on how we’re sizing the policies. But, you know, it really depends, I know people hate that answer, but it obviously depends on the size of the policy. So for, for a large tower where you might have several $100 million of insurance limits, as you go up the tower, the premium decreases. So, you know, you might see on $3, $400 million tower, you might get down to sort of an all-in cost a blended rate online, as we say, of around 2%. But you know what a smaller policy, it, it could be higher. It could be 3%, it could be 3.5. It also depends, obviously, on the risk that the carriers are taking. The level of advice that’s been provided by outside counsel can have an impact as well. We typically are seeing, you know, should level opinions on the continuity in the begun construction space. We, we typically see should, but we have seen a few will opinions cross our desk as well. Antony, maybe you can talk about the sizing? Yeah, so in terms of sizing, … is designed to cover the tax at risk plus any interest in penalties that may apply if the virus were to be … a contest. It will also cover legal fees or contest costs. And finally, a gross-up the basis that is regarded payment on a tax insurance policy isn’t, in itself, a taxable item. But really, the sizing is a commercial question. So we can, we can size the policy to whatever makes sense. And what we’re seeing our clients do, I guess, is really three different approaches. The first, and the most common, is just size it to the delta between your original begun construction date, so say 2016, and an alternate construction date, you know, should you have lost continuity somewhere after that original construction date. So, for example, 100% PTCs in 2016, you know, maybe I break ground in 2020 and I highlight that as my alternate date, and the policy would cover the 40% difference plus interest penalties contest costs numbers. The second approach has been sizing the policy to 100% of the credits. And so the 14 years of credits. And the thinking behind that is twofold really. One, I guess not everybody is 100% comfortable with the concept of having a full back begun construction date. And secondly,…. where you have a project that some turbines in that single facility will place in the service within the safe harbor and other turbines will place outside. In that case, the sizing has been 100% of the turbines that we’ll miss. And then finally, kind of a dramatic approach, which is just buy enough insurance to make my investor hold in the event that I’m wrong. Okay. Thanks, Antony. I think that’s helpful. That’s consistent with, kind of, what I’ve seen. And, you know, different people have different views on whether or not you can kind of re—you know, become eligible for the 60 in 2020 if you began in 16. So that makes sense. One, one thing that I think people are interested in is, what, what do you have to do? What is the undertaking to get a quote? And I’ll list out a few things and then let me know if there’s some additional information to be said there. You’ve talked about, excuse me, you’ve talked about a, should level of opinion, what other material do you need to quote insurance? Yeah, so I think the critical items, as you mentioned, I mean, with tax insurance generally, we always say, you know a good written memorandum or tax opinion. You know, I think in the, in the continuity case a tax opinion would be strongly preferred. We can enter into, obviously, nondisclosure agreements, have the carriers sign jointers, we can use common interest agreements. And obviously the carriers will sign non-reliance letters, so they’re not relying on the advice. Specifically, they’ll hire outside counsel. So, so yeah. So the tax opinion is critical. And then, probably, the other critical piece is sizing of the policy. So what we call a tax loss exposure calculation, which is, you know, the tax liability that we’re looking to insure. And then you build in the interest penalties, contest costs and a tax gross up. Those would be the two critical items. Once we get quotes, you know, when we go into underwriting, the carriers will typically want to see a timeline or logs of what was done to meet the continuity requirements under the notices. So they’ll, they’ll dig a little deeper. But, you know, to get a quote, I would say the two quick critical items will be the tax opinion and the loss exposure calculation. And then in underwriting as well, they’ll ultimately want to look at some of the transaction documents. And I assume they’ll want to see a, a robust, kind of, detailed timeline. And then that would be where they spend some of their due diligence, I would guess. That’s correct. Yeah. So a timeline or logs of what was done to meet that continuity. So two, two more questions. One is, so if somebody is going to go out and get insurance today, you know, we’re in April of 2020 but the project doesn’t get placed in service until sometime in 2021. How do, how do you see that insurance being, kind of, going all the way through COD? In other words, you’ll sign something up today, but you need kind of an ability to re up that insurance and make it effective as of the COD date. How does, how do you see that working? Yeah, that’s, that is a good question. And, you know, the key here is obviously to provide certainty to our clients. When we look at that forward-looking period from buying the policy through to COD, the goal, at least our goal is to reduce or a eliminate any subjectivity conditions. The way that we have constructed the policies to date is, at the point of binding, so let’s say April of 2020, that locks in coverage and certainty as to your continuous efforts from begun construction to binding. In the, in the policy, it will identify any specific concerns, such as permitting turbine delivery delay, and to the extent once those are rectified, the project is synchronized within a commercially reasonable period of time. That bring down is automatic, so you have coverage, automatically, through COD. To the extent there is an unforeseen event that causes further delay, then we have a bring down opinion. And provided the bring down tax opinion is at the same level as the opinion that was in place at binding, so, for example, attributable opinion, then it will again be, the covers will be automatic through COD. And is there an additional cost of that, or is that kind of included in the, in the original premium? Yeah, that’s included in the original premium. You know, the goal there is to make sure we have a policy that’s a holistic solution to cover the entire period from begun construction to COD. Right. One, one other question. I want to keep going here, and this is probably one that’s relevant, particularly with respect to the COVID 19 delays. Let’s say somebody signs up insurance today, but as it turns out, there’s a legislative or an administrative fix to the, to the 2021 issue. There’s a year’s extension on the safe harbor. Is there a new ability or what is, I guess what I’m thinking about is, is there a refund? Or is there, what, is there ability to get some of the premium back? Or, or how would that work? Yeah, so I guess the question is, is there a way to structure the tax insurance policy as an option, right? So effectively bind it today. So I have, I a client have certainty of cover, but if either my project places in service before the end of 2020 or the government changes the continuity period, you know, can I, can I effectively get a cheap option? And the answer to that is yes. I mean the middle ground that we’ve come to isn’t a free option. However, the ground that we’ve come to with the insurance community is to have a 10% down payment in most cases. And then, to the extent by the end of the year, December 31st, 2020, you decide that you do want the policy, then you pay the remaining premium. If you don’t need it, because either you did COD or the rule, the continuity period was extended, then you just walk away and there’s no obligation to pay any more. So it’s effectively an option, but it comes at a 10% cost. Got you. Okay, that’s helpful. Let’s move on from there. I guess we have five minutes. I want to make sure I pick up some of the questions people had here. Just, just quickly, are you seeing any interest or any inquiries around delayed—I’m switching to solar here, around delays on delivery of, of safe harbor equipment under solar? Is that something you’ve seen? Or is that something you think if people were inclined to do so get, get insurance on? Yeah, we’ve had several inquiries on that recently. You know, we, we continue to see quite a bit of insurance on qualified basis, recapture risk, sort of the traditional tax credit insurance in the, in the solar space for investment tax credit. But, you know, right now we seem to, there just seems to be just an incredible amount of interest in continuity for wind. So, so yeah, obviously, solar investment tax credit insurance is open for business. And we’re seeing some of that. In terms of, Phil, were you referring to the 3.5-month test there? Yeah, I was actually in that case, you know, while were on this, we did have a question from the audience about what is the relative—I mean if you can tell us, what is the relative cost of that basis insurance for solar. What, is that, how is that priced? Yeah, we’re seeing, you know, sort of on the, on the low end, your all-in cost of around 2.5%. Again, you know, depending on the size of the tower, you know, it might creep up north of 3% 3.5%. Again, depending on the level of advice, the, the appraisal that’s obtained, so the ultimate risk in the structure. But that’s kind of the range that we’re seeing for, for a qualified basis and other ITC insurance right now. Okay, great. I had one question that somebody had wanted me to ask. Of course I put the paper in front of me right there. And here’s the question. Is there off take default insurance at this time? And, you know, and who provides it? What’s the cost risk? Any, any, kind of, thoughts on that? I know it’s not tax related, but, but wanted to get that one out there. Yeah, sure. I mean, obviously, Marsh is a huge platform, and we’ve got people that focus on other types of esoteric risks. So we weren’t quite sure if that was specifically around, sort of, credit default insurance, which is obviously something that Marsh can structure, more, sort of, a one off we call a parametric trigger insurance. Obviously, with respect to COVID 19 it would be tough to obtain that now. But let’s just use a different example hypothetically. You know, hurricane risk, you know, you can, you can structure a policy that pays parametrically. So you don’t need an actual loss, you just need the actual event to happen. So if a hurricane, you know, comes over a wind farm and the insurance would then pay, just from the event, depending on, you know, it could be structured around category one pays 0%. Category two pays 20%, category 3 40%, and so on and so forth. And then the payment would be made with respect to the event happening and not actual loss. So Marsh is able to structure those types of insurance products. But that wouldn’t be something that Andy and I would focus on. We would probably refer you to someone else within the institution. Costs, I’ve been told by people that could be a low as 4% rate online or as high as 15%. It really just depends on what the risk is, the underlying risk that we’re insuring, Right, right. All right, well, thank you. Hey, we got one question here and to be honest, this is one I meant to ask, even on a broader scale. But are you aware of any payouts on the basis insurance in the last two years for, for the, you know, the solar basis insurance? And then, probably more broadly, and this, I get asked this question all the time. Has there been policies under which there’s been payment? Yeah so. Go ahead, Antony. Alright, I’ll take it. So we are aware of, of claims in the qualified basis space. We’re not aware of any particular payouts. And obviously tax insurance, you need a final adjudication, which could be settlement, but you need consent of the carrier to settle. So we’re not aware of that. We haven’t seen that at Marsh. But, you know, to get to a final adjudication could take several years in the court. So, I think you’ll start seeing payouts on qualified basis insurance in the next couple of years. We are certainly aware, and Marsh has, has been involved in payments on claims and tax insurance. So, you know, there, there are certainly payment on claims for tax insurance, for other insurance issues. But, and we’re certainly aware of claims in the renewable energy space, but not from any major payouts at this time. Right. Great. Ed, I think we’re at 1:00. So, should we—I’ll hand it over to you then. All right. Well, thank you, Phil, and thank you against Antony Joyce and Mark McTigue for joining us today. This has been extremely valuable information for our, our listeners. And I want to invite everyone to attend next Thursday. The topic is going to be how the utilities IPPs are weathering the COVID 19 storm. We have guests from Edison International and Alpine and we’ll explore that topic. Thanks again for joining us. And, again, thank you to our audience. See you next week.

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