Author: Kirsten Bonke
Wind farms and solar plants have long used automated monitoring systems to detect faults, and these have become increasingly sophisticated. The latest can detect problems sometimes years before they lead to significant damage.
Yet from an insurance standpoint, these Condition Monitoring Systems (CMS) have now become so good that they can pose some tricky questions. When a tiny potential fault is detected, is it the operator's responsibility to replace the unit at once — or wait a few years until it affects production? Who pays for the replacement? Did an insurable loss occur at all — and in what policy period?
These questions are not theoretical. The rapid improvements in monitoring technology are having significant impacts on insurance covers, which are not yet being adequately considered by either insurance or industrial companies.
CMS — a new canary in the coal mine
In the early 20th century, coal miners used to carry canaries in small cages1 to detect the buildup of dangerous gases, such as carbon monoxide. If the canary fell dead, it was an early warning.
In renewables, our modern canaries are called Condition Monitoring Systems, and they are employed not only in wind2 and solar farms3, but also for geothermal energy4, and to monitor related cable connections5.
CMSs keep a continuous watch on components that are critical to safety and operation, such as bearings, gearboxes, cables, coolants and lubricants. They'll also monitor grid access and the general operating parameters. They check variables such as vibration, heat, noise, strain or speed, alerting if they stray too far out of normal ranges.
Over the past 10 years, there have been significant improvements in these systems. The best can now improve themselves by learning from past data. Operators can fine-tune them to find the most cost-effective time to plan a repair or replace a faulty component. This could even be years from the moment of detection.
Crucially, this can have big implications for insurers, whose policies run for set periods (and are often renewed annually).
Insurance policies applying to renewable energy projects mostly require a physical damage as a triggering event. This is the case for construction, operation all risks and machinery breakdown insurance policies. (An insured event that's part of a product liability policy is different and is outside the scope of this article).
So, for the purposes of the policy, does the 'physical damage' occur at the point of early failure detection, or when the technology is no longer able to operate? Insurers might even take it to the extreme — and argue that there has never been a physical damage, only a 'latent defect' that was caught early. Some regulatory systems may even encourage this approach.
There are implications for insurers right across the insurance contract life cycle. This issue affects not only potential losses, but also what information insurers are entitled to ask for at the start.
Pre-contractual phase
Before an insurance contract is agreed, the insured party must usually disclose certain 'pre-contractual information'. The rules around this vary considerably between countries.
In Germany, for example, insurers must ask specific questions concerning any information they want to know,6 and the insured party is not usually expected to disclose more information than they currently possess. They are not, for example, expected to seek out extra information for purposes of disclosing it to an insurance company.
This contrasts with the position in the UK, and in many other 'common law' systems. Here, the insured party must act in 'utmost' good faith — implying that they are obliged to disclose all information that a prudent insurer would wish to know.7 A reform of the UK's relevant insurance law in 2015 changed this slightly to the benefit of an insured. The insured should disclose any material circumstance which they know or ought to know.8 This implies that the insured may still be required to provide information which they may be able to obtain with reasonable effort. However, the 2015 Act added that if an insured party gives sufficient information to put a prudent insurer on notice that it needs to make further enquires, this would also be sufficient.
In the specific context of CMSs, the insured party — the operator — may not have full knowledge of expected future failures at the point when the insurance contract is being agreed. If this knowledge exists, it may be in the hands of the manufacturer.
Depending on when the fault is detected, when the insurance contract is agreed, and who has what information at what time, the answer to the question 'what must be disclosed to the insurer?' may be different in Germany and the UK.
In Germany, the insured party might not have to disclose anything they were unaware of at the time. But in the UK, an early fault may be something the insured party could reasonably obtain by requests to those monitoring. So, they may be obliged to provide it, or face consequences such as premium adjustments, denial of cover or the voiding of the entire insurance contract.
Contract execution
If a CMS detects a fault during the cover period, the question of whether it is a physical damage, or a product defect becomes crucial.
Most policies will exclude a pure defect — but a physical damage caused by a defect is often covered. In many regulatory systems the transition from a defect to a physical damage is a fine line. In this context, insurers may want to revisit their contractual definition, and their understanding of the applicable legislation, to double-check what constitutes a triggering insured event.
Provided those trigger conditions are met, an 'all risks' policy will usually pay out no matter what the cause. Insurers' ability to recover money from an at-fault manufacturer has been covered on this blog before.
Under some regulatory systems, again for example Germany, insured parties may also be required to declare any CMS-discovered fault during the policy period to the insurer, because it leads to an increased risk of loss. This may allow the insurer to obtain additional premiums, but they may also wish to carefully review the additional risk of a severe consequential damage in case the failure pattern progresses in an uncontrolled way.
Again, though, the rules differ depending on jurisdiction. At common law in the UK, insured parties are not obliged to disclose any material occurrences during the period of insurance, except for the disclosure of information relevant to a claim.9 Thus, the detection of a failure pattern by a CMS may not require a notification by the insured.
Contract renewal
In common law systems such as the UK, a renewed insurance contract is seen as a fresh contract, and therefore once again subject to pre-contractual duties, such as the disclosure requirements discussed above.
But in other legal systems, such as Germany, automatically renewing insurance policies are treated as an ongoing contractual relationship. This implies that CMS-discovered early failures are arguably to be disclosed as a risk-of-loss increase, as described in the previous section.
Further complicating the picture, such early failures may be regarded as physical damages, and as such belong to the ending contract period, rather than to the new contract period.
Conclusion
The dramatic improvements in CMS technology over recent years make it increasingly important for insurers to get to grips with these questions. They are also relevant for any reinsurance covers, as different policy periods could be affected.
Insurers will need to consider whether an early fault detection — for which often no change in material substance can be visually observed — constitutes a physical damage, or a pure defect that's not covered by the policy.
Of course, it is generally a positive thing for the industry to have a better, more predictive view of likely faults and failures. But it may still create wrong incentives for manufacturers and final clients if insurers simply deny coverage for any failures detected very early during operation. In fact, (re)insurers have an interest in encouraging manufacturers to share this information — they also want preventative interventions to improve.
There's no quick and easy answer, not least because of the regulatory complexities outlined above. But the issue is not going away, as fault predictive technology continues to improve. Insurers need to examine their portfolios, speak to their policyholders, and consider their approach when and if a fault emerges.
It's good to have a more sensitive canary, but you also need a plan for what to do when it stops singing.
