December 15, 2011

Solar Warranties, Part 3:

What happens if my manufacturer goes under? Insurance carriers may have an answer for that question, both as backers for lengthy manufacturers' warranties and as underwriters for extended warranties. Homeowners want peace of mind and so do the investors behind the huge projects.

In the alternative energy industry, many of the manufacturers act like teenagers: they think they're gonna live forever, and their products will never break.

They write 25-year performance warranties because the competition is doing it. They accrue one percent of revenue to pay for those warranties, because everyone else is too. And while they're sad when a competitor closes shop, they think that could never happen to them.

Try selling insurance to customers like that. Try selling any kind of insurance to teenagers who think they'll never get sick, never suffer damage from an accident, fire or flood, and never be out of work.

It's bad enough that most of these solar manufacturers are so young. But they're also making promises that will last until the year 2036, warranting that their products will continue to exceed 80% of their when-new performance levels for 25 years.

The risks are tremendous. It's a situation that's just crying out for insurance, which transfers risk to companies that make their living trying to measure, quantify, and price it.

Not Gonna Live Forever?

Now that Solyndra LLC has joined the ranks of AstroPower Inc. and BP Solar/Solarex Corp. in the solar equipment makers' graveyard, it's becoming obvious that solar manufacturers need life insurance. And their products need health insurance.

It's not that we doubt their products will outlast their warranties. We just think it's a bit presumptuous for a five- or ten-year-old company to make 25-year promises backed by nothing but their hopes and dreams.

Outside of used car dealers and a handful of retailers, most service contracts are usually backed by an insurance underwriter. With manufacturer's product warranties, insurance is less common, but it's becoming increasingly demanded in niche markets by customers who've been burned before by disappearing manufacturers.

We'd suggest that photovoltaic equipment manufacturers are next. The biggest customers who count their solar panels in thousands of units and their power output in millions of watts are beginning to demand fully-insured product warranties or service contracts from their manufacturers and/or builders. And if they're not, their investors are.

In Part One of this series, we detailed the claims and accrual rates of the top solar manufacturers. In Part Two, we trawled through their annual reports, looking for what they themselves had to say about warranty and insurance. In this concluding Part Three, we'll take a look at both a manufacturer and an insurance company that are among the first to back their promises with insurance.

Youthful Responsibility

Canadian Solar Inc. is one of the largest solar panel manufacturers. Total revenue last year was $1.5 billion, and the power output of last year's shipments exceeded 803 megawatts. The company turned ten years old this year, and has been listed on the NASDAQ exchange since 2006 (Ticker: CSIQ).

Canadian Solar began to insure its product warranties in April 2010, purchasing contractual liability insurance policies from three different A-rated insurance companies on an annual basis, to cover customers in the U.S., Canada, and Europe.

"Under the policies, the insurance companies cover the liabilities listed on our warranty statement up to certain maximum claim limits and subject to certain deductibles," the company stated in its most recent annual report. "This insurance applies to our warranty against workmanship and material defects and our warranty against power output. This insurance cost is amortized over the 25 year coverage period provided under the insurance policies. However, our customers will enjoy an irrevocable warranty, which may improve the marketability of our products and entice them to pay more for products with warranties backed by insurance."

Canadian Solar said the unamortized carrying value of its prepaid insurance was $5,593,524 as of December 31, 2010, and was included as a component of other non-current assets in the consolidated balance sheets. At the end of last year, the company's warranty reserve fund balance was $31,224,906. During the same year, it reported warranty accruals of $14,707,513.

Competitive Differentiator

Ken Rowbotham

Ken Rowbotham, the vice president of finance at Canadian Solar Solutions Inc., said that having an insurance policy backing up his product warranties has turned out to be a valuable point of differentiation for the company.

"In a largely new market, it's proven to be a good tool to give comfort to the end buyer," he told Warranty Week. "Entering into Canada, the U.S., and these other new markets, we felt it's a very good selling and marketing tool."

Even among customers looking to put a small solar system on top of their roof to heat water or produce electricity has become aware of the risk that their chosen manufacturer could go bankrupt. And though the political commentators who harp about the government loans taken out by Solyndra haven't said much about the company's worthless warranties, that issue is also gaining traction.

It's one thing to offer a longer warranty. It's another thing to offer a better warranty, or at least a warranty with a better chance of reaching old age. And that's what Canadian Solar offers in its sales pitches.

"Anyone that reads the press right now is worried about consolidation in the industry," Rowbotham said. "Knowing that this is irrevocable, non-cancellable provides that extra comfort to the end buyer."

Rowbotham said prospective customers generally understand what he's talking about when he explains the concept of warranty insurance. "It's relatively simple," he said. "Basically, what you see in our contract is it's backed by insurance companies A, B, and C, and here's how the deductibles work."

But he concedes that the concept is better understood and more valued by the company's utility-scale and commercial rooftop customers than by the one-time residential buyers. However, even the residential customers like the peace of mind that comes with knowing there's an insurance company backing up the manufacturer, just in case. For commercial customers and utilities, the value of the insurance is the peace of mind it brings to their investors and financiers.

Helping Customers Secure Financing

This past May, for instance, Canadian Solar scored a deal to supply a Spanish company with materials to build three solar farms in the UK. Under the agreement, Canadian Solar will supply 15 megawatts of solar modules to Isolux Corsán, which has already project-managed the construction of more than 30 large-scale plants across Europe, including one of the largest -- a 72 megawatt solar power plant in Rovigo, Italy, southwest of Venice.

In a May 26, 2011 press release, Manuel Codes Diaz, CEO of Isolux, listed the reasons behind his company's selection of Canadian Solar for the UK projects:

"Canadian Solar's solar modules have an attractive cost-performance-ratio, high reliability and top quality, along with a 25-year, non-cancellable warranty backed by A.M. Best-rated insurance companies in Europe and the U.S.," he said in the press release. "Canadian Solar's leadership and warranty insurance policy definitely helped our project finance on the bank side. This way, we can guarantee our systems' high performance."

Rowbotham said the mere mention of warranty insurance has raised the perceived creditworthiness of many other solar projects the company has worked on. "It's proven to be a very significant conversation with all of our large transactions," he said. "They do a great deal of due diligence, and from what I'm hearing, it has really helped in the credit committee decision-making."

So in that respect, the insurance is not only making customers feel good about doing business with Canadian Solar. It's actually helping to seal the deals, or to help those deals to get financing, which in many respects is the same thing.

"It's definitely a differentiator, and the feedback we received from our end customers is that it has helped them secure their financing," Rowbotham added.

Others with Fully-Insured Warranties

Product warranty insurance is still fairly unusual, however. Outside of Canadian Solar, only one other manufacturer has announced that they have it. Outside of the solar industry, it's relatively unknown.

Many manufacturers have product liability insurance policies, and some of those have clauses that impose a maximum ceiling on the amount of claims a company must pay. So in one respect, they could be seen as product warranty insurance policies with huge deductibles. Or they could be called catastrophic warranty insurance policies for those instances where everything comes back broken.

But product warranty insurance that pays claims if a manufacturer no longer can? The only other instance we can think of also comes from Canada, though in a completely different industry.

The customers of SRI Sports, who installed the company's AstroTurf artificial grass surfaces on their fields, know what can happen when a manufacturer doesn't outlive its long product warranties. SRI's promise of eight-year warranties became null and void when the company declared bankruptcy in 2004. Stadium operators could only watch as their fields badly deteriorated, catching athletes' feet in exposed seams and breaking bones in hard falls.

Into the void came companies such as FieldTurf Inc., which claimed to have not only a better product, but also a better warranty. The warranties were still only eight years in duration, but they were also fully insured in the event that something happened to the company. And something did happen: most of the largest stadiums got rid of their billiard-table-like surfaces and installed FieldTurf instead.

Extended Warranty Underwriting

Insurance is much more common with extended warranties. In fact, because of the demise years ago of so many unscrupulous retailers who took their extended warranties with them to the bottom, and because of efforts by the Service Contract Industry Council and others, we'd dare say that insurance is the rule rather than the exception, at least within the consumer markets.

Yet every holiday season, consumer watchdogs go out of their way to list the reasons for and against (mostly against) making an extended warranty purchase. One reason they always seem to miss, and one which carries even more weight in the residential rooftop solar industry, is the disappearance of the manufacturer. What happens if your product warranty becomes worthless?

A fully-insured service contract is more secure than a product warranty. But that won't really become apparent unless and until something happens to the manufacturer. If the manufacturer closes unexpectedly, they may stop paying warranty claims. Or a bankruptcy judge might allow claims payments to continue while the company reorganizes. Or there might be a delay while the attorneys argue their motions and the judge decides which payments to make and when.

At the end of the day, product warranties are only worth as much as the manufacturer says they're worth. And when a company goes bankrupt, a judge or a trustee may decide they're worth nothing. They're on the books as unsecured liabilities, and there may be little left after all the secured creditors are paid.

Giving Away RV Extended Warranties

In such a case, an extended warranty may be the only coverage available. For instance, when the panic of 2008 caused sales to plummet, several of the top makers of recreational vehicles collapsed, closed, and ceased to exist. But many of their unsold vehicles were still on the lots of RV dealers.

When an RV maker shuts down, there's little chance that a warranty claim on such a product would ever be honored. So the dealers have a choice: either sell the vehicles "as-is" at a severe discount, or buy a vehicle service contract for the customer using their own cash. In essence, a purchased extended warranty could take the place of a worthless product warranty.

And it didn't stop three years ago. Just last week, Interstate National's StarRV unit announced one-year extended warranties for RV dealers, with which they can cover unsold units on their lots made by defunct manufacturer Carriage Inc., which now lack valid warranties. It was the third time StarRV has offered warranty coverage on RV units whose manufacturers have become victims of the economic downturn, the company said.

The value of such a dealer giveaway is the peace of mind it instills in the customer. Yes, the manufacturer is out of business, but the extended warranty remains in force and is backed by insurance. So the lack of a manufacturer's warranty is no longer perceived as a negative. Insurance is the key. A fully-insured service contract is more secure than an uninsured product warranty.

That model is fine for the low end of the solar industry, where homeowners buy a rooftop system to reduce or eliminate their electric bills. Some might even start selling excess power to their local utilities. But they might also want to buy an extended warranty from their local dealer or installer, just in case.

Commercial Service Contracts

More problematic is the middle segment of the industry, where commercial landlords or entire retail chains might want to "go solar" by installing systems on multiple properties. And even bigger are the landowners, cities, and utilities that want to install alternative energy systems to power thousands of homes and businesses. They might think about the demise of their manufacturer's warranties, but what can they do about it?

Teresa Chan

Teresa Chan, senior vice president of Advanced Energy Solutions at Chartis Inc., said her team has been working on a solution to that very problem.

Chartis, formerly known as AIG, is already one of the largest insurance carriers in the energy space, she said. It provides property and casualty insurance policies to electrical utilities, oil companies, offshore drilling companies -- you name it.

"Anything that you can think of in the energy space worldwide, we cover," Chan said. "And that includes conventional energy as well as alternative energy."

In response to customer requests, engineers from the Advanced Energy Solutions unit sat down with the actuaries from Chartis Warranty, to see if they could develop and price an extended warranty policy for alternative energy system operators. Though their systems are thousands of times larger than the residential rooftop installations, their owners and investors had the same need: the peace of mind that comes from knowing that the cost of repairs will be covered.

"The investment banks, the investors, and the equity partners don't necessarily have the engineering expertise to evaluate the technology. And so, if we have our engineers review it and we are willing to put a policy behind it, that gives them a certain amount of comfort that it is going to be a project that works, and therefore they should lend or invest in the project," Chan said.

She also mentioned three additional reasons why commercial operators might want to buy extended warranties. One is that the government, especially agencies such as the U.S. Department of Energy, look more kindly on projects that have passed muster with an insurance company. Two is that the operators value the fixing of their repair costs through purchased extended warranties. And three is to give the operators a reputational edge since they can state, "We have an insurance company that's willing to stand behind us."

Engineering & Actuary Meetings

James Mostofi

James Mostofi, president of Chartis Warranty, said such an offering had to come from an insurance company with experience in both energy projects and extended warranties.

"The break/fix and serial defect coverage expertise is on the warranty side. But all the engineering and other expertise on these energy products is on the energy side," he said. "When you put the engineers and the warranty actuaries together, they can put together a product that's just unmatched in the industry."

Mostofi said Chartis is aiming to become a leader in two areas: solar fields, and wind mill farms. "When these facilities are being built, generally you need that insurance coverage to get the financing to build them," he said.

"Whoever is putting up the money wants to make sure that the windmills are going to turn or that the photovoltaic arrays are going to actually work to some minimum standard. And the reason is, as long as it's working to a minimum standard, they can sell the power generated from them, and at least make their debt service payments," Mostofi added.

Chartis Customers

Mostofi said Chartis has signed non-disclosure agreements with its extended warranty clients, so he can't give their names or locations. However, he said their activities could still be described in general terms.

One customer is the operator of a solar field in a desert on the West Coast. The installation focuses sunlight onto a boiler filled with water, which generates steam that turns a turbine and produces electricity. It uses 50,000 solar arrays to produce 400 Megawatts.

Another is a series of wind turbine installations owned by a traditional electrical utility. The five-year product warranties on the first cluster of 35 turbines will expire soon, and the utility asked Chartis to sell them an extended warranty for them.

In future years, there will be additional installations that contain younger turbines, which the utility also wants to cover with extended warranties as soon as they pass their fifth birthdays.

Last year, solar industry veteran and blogger Joseph McCabe wrote an article where he said that, "Performance insurance is a new aspect to the [photovoltaic] industry which can help to assure project financial performance over time. Chartis (formerly AIG), Zurich Insurance Group, The Hartford Financial Services group, ACE Limited, JP Morgan, Chubb Group of Insurance Companies, Munich RE and others are beginning to step into this PV performance insurance function."

More recently, McCabe told Warranty Week he has begun to doubt the value of the performance warranties whose preferred remedy for the settlement of claims is to install more solar panels to make up for any shortfalls in promised power levels. And he said he's begun to see a marked correlation between the quality of a company, as measured by classifications such as their bond ratings, and the quality of their products, as measured by the price of their solar panels. But the arrival of the insurance companies, McCabe said, is a sign of the growing maturity of the industry.

Warranties with Long Tails

Still, Mostofi said he's not eager for Chartis to start insuring the manufacturers' warranties of the solar panel makers. He noted that many of the performance warranties for solar panels have "very long tails" of 25 years. So Chartis is unlikely to try to get into the same business as the other three carriers currently underwriting Canadian Solar's warranties, at least not in the same form as is done now.

"We're probably not willing to do that long of a tail," he said. "It doesn't mean we couldn't insure it in pieces -- like we'll do five years and renew every five years. But to just have a 25-year warranty policy for a technology that's new -- it's just difficult because we have no reasonable data to price it. And when you don't have reasonable data to price it, the premium becomes non-marketable."

Instead, Chartis is going to focus on the owners and operators of the megawatt-size facilities, who worry about their product warranties expiring (from both natural causes and other perils). Despite the newness of the technology, he said, it's not impossible for Chartis to work with facility owners, builders, developers, and municipalities to price an extended warranty policy for their systems.

"If you look at these facilities, what's unique about most of them is not necessarily the technology at a component level, but it's the technology at an aggregate level that's unique," Mostofi said.

For example, he explained that the motors and mirrors that are typically used in a solar array aren't really new technologies. The first electric motor capable of turning machinery was invented in 1832. Silvered-glass mirrors go back to at least 1835. The computers that time the turning and aim the mirrors aren't all that new either.

"We have motor failure rates. We have mirror failure rates. We have computer failure rates," Mostofi noted. It's the silicon that turns sunlight into voltage that's the new technology. That's the challenge for the actuaries. The rest is tried and true.

And then there are the unknowns. But there are enough knowns to allow for the rough calculation of a frequency and severity rate for product failures, and from that a suitable insurance premium, he said.

The Role of Insurance

And that, at its core, is what insurance companies do. They give risk a price. Then they sell it. If you want to get rid of the risk, you pay the price. If you're feeling lucky, you go without the insurance, and assume the risk of doing so.

That's what most teenagers would do. If given the chance, they'd drive without auto insurance and live without health insurance. After all, they're gonna live forever. And 99 times out of 100, they'd be just fine. It's the rest of us, who know that bad things can happen to good people, who need to buy insurance to achieve peace of mind.

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