Navigating insurance products for climate companies

In a project finance transaction, each party perceives risk differently. Insurance exists to bridge that gap by transferring risk to the balance sheets best placed to absorb it (generally insurance companies), making projects viable that otherwise wouldn't get off the ground. So, what's available for climate tech companies, and when should you pursue insurance and surety bonds over the alternatives?

Jeff McAulay is CEO of GreenieRE. We sat down with him to discuss insurance products and surety bonds, how to navigate buying them, and other ways of mitigating risk.

An intro to insurance

When you’ll need these instruments
Insurance is a form of unfunded risk capital, meaning you won't get any money upfront, but have it in your back pocket if something bad happens. It’s necessary because your funded risk capital – debt, equity, tax equity – needs to be repaid, even if your project falls apart. There are risks these entities are willing to take, like operational or execution risks, and there are risks they're not, like a fire or a hurricane. Plus, it’s not just your investors who want protection, it’s also your project partners, operators, and customers. 

However, insurance products are applicable far beyond complex project finance. They could be used for something as basic as leasing office space, because your landlord requires a deposit, a letter of credit, or a surety bond. Or in supply chain finance, your vendor wants to get paid early, your customer wants to pay late, and if you can provide a credible promise in either direction, you can use a surety bond to bridge the gap.

Market vs. non-market products
Products that sit outside of the commercial market include those that are state or federally run, such as a loan guarantee from USDA; green bank loan loss reserves; and philanthropically funded products such as the Community Investment Guarantee Pool from Locus. 

Market products, on the other hand, are those you can buy from a bank or broker. They're typically standardized and will be readily recognized by lenders or investors.

Insurance vs. surety bonds
Insurance – property insurance, liability insurance, etc. – is a two-party agreement between the insurer and the insured. Surety bonds, on the other hand, involve three parties: a principal who's doing something (i.e. your company), an obligee who you’re doing it for, and the surety who steps in and makes it right if you don’t deliver, either by paying a penalty or finding someone else to complete the job. Surety bonds can often be out of reach for many climate tech companies, as your balance sheet and track record might not win the provider’s trust.

Note that not all surety and insurance products are the same. What’s available varies widely, from what risks they'll cover, to what projects they apply to, and their cost, which tends to be commensurate with the complexity and risk of the transaction. For instance, with surety, the price is typically standardized (say, 2.5% to 3%) but the variable is how much collateral you have to post. So, you might always pay 3%, but one deal requires 10% collateral and another requires 90%, which makes it hard to compare between products.

Alternatives to insurance and surety

When your counterparty brings up insurance, it may be possible to negotiate other options to mitigate risk without this upfront cost.

A parent guarantee
A parent guarantee is unfunded but means the parent entity is liable if something goes wrong. It can be a useful lever, as long as the deal is at the project level. If it's a corporate contract, your corporate entity will be on the hook anyway.

A personal guarantee
Personal guarantees should generally be avoided, because the risks are simply too high – you’re putting your credit score and perhaps even your house on the line. Only in very rare exceptions, where you have a very established, profitable business with no material risk on the horizon, will this trade-off make sense.

A deposit or letter of credit
Some counterparties will require a deposit as a condition of doing business – an interconnection deposit from a utility, for instance – which you can either satisfy by posting cash or a letter of credit (LC). They might insist on the latter because they want the bank's credit rating behind it. 

Either way, both options can tie up your cash, as with an LC, the bank will typically require you to hold cash collateral equal to its face value. You should try to avoid this where possible, as there’s an opportunity cost attached to having this cash locked away. Plus, you’ll often pay bank fees that are equivalent to what you'd earn in interest.

What to know about insurance and bonds 

Get clear on the problem you're solving
Insurance products can be very focused – surety bonds in particular are often tied to a specific contractual obligation between two parties. The more precisely you can define the risk you're trying to cover, the better.

Find the right broker
Look for someone who really understands project finance, not someone who’s moonlighting from another sector. 

As well as making sure you have the right amount of coverage, a good broker will help you use these products effectively in negotiation. For instance, if your contract includes a parent guarantee or letter of credit but not a surety bond, they’ll help you get it written in as an option, even if it only comes into play down the line.

Go where you can negotiate 
Historically, surety bonds have been difficult for startups to get, but they may become available as you grow. Collateral requirements can be high early on, but they’re still worth considering over a letter of credit. You can negotiate with an underwriter, but not with a bank – and you won’t have to change the underlying contract with your counterparty.

Remember insurance is an enabler, not just a cost
Don’t get stuck on the upfront cost of an insurance product. Even if it won’t bring down your cost of borrowing, if the counterparty is asking for it, your project simply won’t be viable without it. There are also other benefits: getting coverage will allow you to access different lenders, and even if the interest rate doesn't change, the advance rate, term, or amortization might – there are all kinds of factors that influence financeability beyond the interest rate alone.

Jeff McAulay is an entrepreneurial leader with a technical background in distributed energy systems, software product management, and technology development. Jeff has previously held leadership positions at Energetic Capital, ADL Ventures, and EnerNOC. He has an undergraduate degree in Biomedical Engineering from BU and an MS in Technology & Policy from MIT.