MITIGATION OF HYDRO PROJECT DEVELOPMENT RISK - INSURANCE NEED

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1 MITIGATION OF HYDRO PROJECT DEVELOPMENT RISK - INSURANCE NEED Alok Choubey, GM- Hydro Projects ABSTRACT Development of Infrastructure projects including Hydro Power Projects are becoming riskier due to sudden change in the socio-economic environment, political uncertainties and recently due to court interventions. Hydro projects have become more vulnerable due to increase in frequency of natural disasters in the recent times. Ensuring Risk Mitigation has therefore become more challenging due to inability of various stake holders to absorb their share of risks in tough economic environment and uncertainties in the project development due to varied reasons. Risk Mitigation through various means is now available and seasoned project proponents along with other stakeholders are embracing the well documented approach in the form of Project Risk Register which is now being taken seriously at all levels. Some of the risks associated with project execution can be indemnified by taking commercially available Insurance covers. It is true that some of the big risks in project development cannot be mitigated through commercially available insurance covers and therefore it is advisable to have proper mapping of the Risks vis a vis Insurance cover available where ever possible.this paper attempts to provide some insight into likely major risks for project development, mitigation measures for identified risks through Insurance covers where ever applicable and scope of various commercially available insurance covers. 1.0 INFRASTRUCTURE PROJECTS DEVELOPMENT Major hydro power projects involve complex execution methodology, challenging regulatory frame work apart from fast changing market dynamics. After opening up of the economy, Government of India is trying to speed up the growth of infrastructure including energy generation / hydro power projectsby engaging the private developers as owners to meet the overall objective of faster economic development.after opening up of Indian economy in late 1990 s there are some good examples of successful execution of the major infrastructure projects including energy generation projects however there are still big gaps observed in the actually executed project vis a vis potentially identified projects, which puts a big question mark on the overall environment for development of infrastructure projects. Gaps in execution are due to various issues involving frequent changes in policies, nonfunctioning of sector specific regulators, lack of single window clearance system resulting in multiple regulating agencies providing same set of approvals apart from difficulty in achieving financial closure from financial institutions. 405

2 ICHPSD RISKS OF PROJECT DEVELOPMENT Risk is defined as the combination of the consequency (or severity) of a hazard and its likely hood. A proper risk management system is to be developed for successful project execution. Risk Management is the system or process of : a) Identifying hazards and associated risks, through Risk Assessments, their impact on a project s outcome in terms of costs and programme, including those to third parties. b) Quantifying risks including their programme and cost implications c) Identifying pro active actions planned to eliminate or mitigate the risks d) Allocating risks to various parties to the contract A hazard is defined as an event that has the potential to have impact on matters relating to a project which could give rise to consequences associated with a) Health and Safety b) Environment including social issues c) Design of Project d) Construction of the project e) Cost changes due to any reasons including Design, Construction f) Third parties and existing facilities including surface and subsurface facilities like building, bridges, tunnels, roads etc. that shall be affected by the carrying out of the works. Hazards shall be identified and evaluated on a project specific basis and their consequent risks can be identified and quantified by Risk Assessment through all stages of the project i.e. Project development stage, construction contract and procurement stage, design stage, construction stage and operation stage for any stipulated period. This means that nature of hazard (and its consequential risk) will be dependent upon the stage of project development. Risk Assessment Risk assessment is the formalized process of identifying hazards and evaluating their consequences and probability of occurrence together with strategies as appropriate for preventative and contingent actions. Risk assessment required at each stage of a project shall be summarized in appropriate Risk Registers which shall clearly indicate the party responsible for the control and hence management of an identified risk (respecting any contract responsibilities and liabilities), as well as contingency measures available for the mitigation of the risk. 3.0 MITIGATION MEASURES OF RISKS OF PROJECT DEVELOPMENT After development of Risk Register, mitigation measures are to be identified in consultation with all stake holders. Successful and seasoned project developers have acquired good 406

3 exposure / means to mitigate initial project development risks like socio political issues, regulatory issues, economic/ financial uncertainties by means of careful planning and engagement of all stakeholders at every decision making. It is known fact that all risks are not insurable but all parties, whether they are Owner, Contractor, engineer or supplier can mitigate some of the risk through insurance covers where ever possible. The cornerstone of insurance philosophy is the principal of the equitable contribution of many for the benefit of a few individuals suffering a loss (loss sharing) but to make insurance a viable commercial transaction, insurers impose certain limitations on what they will insure. Construction/ Erection related risks can be mitigated through proper commercially available insurance covers taken through a prudent Insurance agency. Insurance covers are also available during the operation period through standard policies. Like any other commercial activity, Construction insurance is subject to some limitations and therefore insurance cover can be arranged within these limitations. Premium for insurance cover will be paid by Owner or Contractor (Insured) to Insurance Companies (Insurer) for the sum insured. Due to increase in complexities in construction methodology / execution or more uncertainties in likely earnings, taking the right insurance coverage is becoming quite complex exercise and help from experienced Insurance broker will be an added advantage. 4.0 PROJECT INSURANCE An Insurable risk must be a risk that is acceptable to the insurance market through appropriate selection methods. Additionally Insurable risks must pass some broad parameters for taking Insurance before the risk is covered by the Insurers. The risk must be fortuitous i.e. accidental in character. An insurable risk must be measurable in quantitative terms and in such a way that the theories of probabilities and the law of the inertia of large numbers may be used. An insurable risk must be such that cause of any event which results in damage can be determined. And last but not the least is that the insured must have an insurable interest in the object of the insurance contract. It is however, important to note that if the extent of the hazard or risk is difficult to quantify, it is the assessment of the premium and not the insurability that is in question. 5.0 INSURANCE COVERS AVAILABLE FOR PROJECT DEVELOPMENT Following are the major insurance covers available for mitigating the risks of the project execution: 407

4 ICHPSD-2015 a) Construction/ Erection Related Risks- Major Engineering construction/ erection projects are adequately covered under standard Erection All Risk / Construction All Risk (EAR/ CAR) policies available in market with well settled rules/ clauses, defined exclusions and good number of critical add-on covers for covering some defined risks at the time of construction. Typical policy covers the whole of construction period plus testing period and sum insured is the landed cost at site (Import/Indigenous) + Cost of construction/erection + Permanent Civil works + In built escalation in contract which implies total contract value for the works. b) Transportation of Equipments Related Risks Transportation risk of major equipments forming part of permanent works can be adequately covered through Marine policy which can be taken either by Owner or Contractor depending upon the final contracting strategy adopted for the project. Also, risk of transportation of construction equipments can also be covered though Marine policy which can be taken by Contractors directly. Typical Marine policy covers the cost of machinery/ goods transported to site and insurance cover is available till machinery/ goods are delivered at site storage location. The policy is typically governed by the limitation on size of equipment for transportation and inherent risk on inland or water transport. c) Business Interruption Risks As experienced in recent past, IPPs are facing difficulty in execution of project on time resulting in cost overrun due to various reasons not necessarily attributable to IPPs fault. This puts big risks on the project execution and is taken seriously by lending institutions due to strain on economic exposure. To cover some of the risks which are not attributable to the developers, there are some insurance policies which share the risk to some limited extent. These policies are only to be issued to Owners and as these are typically not issued on standalone basis so it needs to be taken along with EAR/CAR policy for construction phase called Advance Loss of Profit (ALOP) policy and with marine policy called Marine DSU for consequential losses. This policy generally covers loss of projected annual gross profit or fixed charges + debt services cost for defined period of policy and limit of indemnity is provided as 1 year or so and premium is typically high. This Policy triggers only in case there is a delay in start of business due to the event happening under insurable events. d) Third Party Liability Risks During the construction it is quite possible that there is damage to 3rd party property/person which also needs to be adequately covered to meet the compensation to be paid as per statutory provisions including The Public Liability Insurance Act Insurance policies issued by companies typically cover the risks with agreed limit of indemnity. e) Professional Indemnity Insurance This insurance cover is to be taken up by the professionals carrying out planning/ estimation or detailed design or doing some major survey/ investigation/studies for the project. As Insurance business is subrogation driven there are chances that after assessment of loss by surveyors it is possible to recover the loss amount from the concerned professional if loss is found due to defect in design/ estimation, which are quite common in developing markets. This policy operates on claims made basis which in simple terms means that claims 408

5 made much later than the actual works done and insurance policy must be effective at that time for settling of claim. f) Industrial All Risks Once Project is commissioned, a new set of risks requires fresh insurance cover. Risks related to loss of operation in case of any major accidents on the site or loss due to natural events happening at site are covered through standard Industrial All Risk (IAR) policy provided by all insurance companies. This typically covers property damage for full value of property and business interruption for definite period. g) Terrorism Insurance This is standalone insurance cover which covers the loss due to an act of terrorism, incidences of which are increasing now a days. This policy is typically issued by all the major insurance companies in India covering property damage only. h) Workmen Compensation This insurance is required as per statutory provisions by every employer to cover its financial obligations to employees who may suffer work related injuries. Principal Employer may become liable to pay outstanding workers compensation insurance premiums or to meet the financial obligations of the contractor to employees who suffer work related injuries, in the event the contractor does not hold adequate workers compensation insurance covers. i) Automobile Insurance Standard Motor insurance policies need to be taken by Owner and Contractors for the vehicles mobilized at site including construction equipment. j) Storage policy- This policy is to be taken by Contractors for storing of the construction facilities and various items stored in their camps. 6.0 CONCLUSION It is important to identify the risks in project development and make a comprehensive risk register. Detailed risk mitigation plan is to be identified along with appropriate budget and time factor. As elaborated above some of the risks of project development particularly during construction phase can be mitigated by taking various Insurance covers available commercially. As there are multiple agencies working during the development phase, it is very important to know the thin line of risk sharing between the multiple agencies involved in the project execution. A well elaborated insurance policy with proper Add on covers, placed with experienced Insurance company, will help in mitigating the losses suffered in case of any unfortunate insurable event occurred during project development. 409