Combining Tax Insurance and Business Interruption Insurance To Achieve Tax Credit Qualification and Quantification Certainty

It’s hard to believe that more than a year has passed since the Inflation Reduction Act (IRA) was signed into law. The climate-related impacts of this sweeping legislation are certainly already being felt. Significant investments from a broader investor pool are flowing into the renewable energy space, and projects incorporating various existing and new clean energy technologies are being developed in bulk. 

Developers and sponsors are searching for ways to best maximize tax credit monetization, either through traditional tax equity structures or newly blessed transferability and direct-pay. And investors and buyers –both traditional renewable energy space participants and new entrants looking to enhance ESG participation –are deploying their capital to attractive tax credit-generating projects that strike the right balance of risk and return.

Tax Insurance and the IRA

Before the IRA, tax insurance played a key role in facilitating tax equity transactions by providing tax credit qualification and quantification certainty, balance sheet support, and credit risk protection.

After the IRA, tax insurance is playing a similar role in the newly expanded field as it allows the various parties involved in renewable energy tax credit transactions to come to a mutual agreement and deal with inherent uncertainties presented by the new IRA provisions. Additionally, opportunities exist in certain types of tax credit transactions for other sophisticated insurance products, such as business interruption insurance, to supplement tax insurance protection and bridge remaining exposure gaps.

The IRA provides two main types of renewable energy tax credits, Investment Tax Credits (ITCs) and Production Tax Credits (PTCs).

ITCs are one-time tax credits based on the value of the renewable energy facility at the time the facility is placed in service. For ITCs, a single tax insurance policy provides coverage for both the qualitative and quantitative tax credit exposures.

Common qualitative-covered tax positions include qualification for tax credit bonus adders (PWA, energy community, domestic content), satisfaction of the “begun construction” safe-harbor and other soft factors, e.g., the project constitutes a “single facility” within the meaning of existing IRS guidance. 

Common quantitative-covered tax positions include that the valuation of the project (often including a basis step-up) and allocation between ITC-eligible and ineligible costs will be respected by the taxing authority.   In addition, coverage includes tax credit recapture due to specific events (delineated in Section 50 of the Internal Revenue Code) that interrupt operation of the facility within a certain time period after it is placed in service.

PTCs, on the other hand, are annual tax credits based on the amount of energy produced (or, in the case of 45Q carbon sequestration tax credits, the amount of carbon captured). For PTCs, tax insurance only provides coverage for the qualitative tax credit exposures, which can be very material. For example, failure to satisfy the PWA requirements can have a catastrophic impact on the dollar value of the credit a taxpayer is entitled to.

Common qualitative-covered tax positions include qualification for tax credit bonus adders, (PWA, energy community, domestic content), satisfaction of the “begun construction” safe-harbor, and other soft factors, e.g., the project is a “qualified energy property” or meets the 80-20 test for retrofitted facilities within the meaning of existing IRS guidance. 

But unlike tax insurance coverage for ITCs, quantitative tax credit exposures for PTCs remain outside the scope. While tax credit recapture is typically not applicable to PTCs (other than with respect to 45Q), certain exposures remain that could decrease the amount of energy the facility is able to produce (or carbon it is able to capture for 45Q), and ultimately the corresponding amount of PTCs. 

For example, there is a risk that the facility will not perform as expected, especially if it includes newer, less proven renewable energy technology. There is also a risk that the facility could be shut down for a period if it is damaged or destroyed by an event of force majeure, such as a hurricane or hail storm. These exposures that fall outside the scope of tax insurance coverage present an opportunity for other sophisticated insurance products, such as business interruption insurance, to bridge the gap.

Bridging the Gap With Business Interruption Insurance

At its core, the quantification component of protecting PTCs is similar to traditional business interruption coverage within a property policy. Even prior to the IRA, developers of wind assets had been protecting this facet of the revenue stream for some time by reporting the annual value of the credit to insurers as a function of [% credit] x [MWh], grossed up for taxes.

This figure, coupled with any PPA, merchant position, and RECs, comprised an asset’s “business interruption exposure,” with a project owner’s ability to declare revenue on the basis of generation (kWh or MWh) being the key differentiator of quantification coverage. Post-IRA, the process is effectively the same, other than any changes to the value of the credit to be applied against the generation figure as well as the fact that the process is no longer limited to just wind technology.

Business interruption coverage is based on the premise of actual loss sustained, with the trigger tied to physical loss or damage. This then begs the question of how to address the following two scenarios outside the scope of traditional business interruption coverage:

• Lack of generation results in a reduced value of the PTC; however, the shortfall in generation isn’t a result of physical loss or damage covered under a traditional property insurance policy.
• Asset owners are taking possession of project equipment earlier and earlier in the development cycle to combat supply chain constraints. If a piece of equipment were to be damaged prior to the start of construction (e.g., a transformer in storage), how will the tax insurance markets respond to the safe harbor shortfall?

Neither of these scenarios would look to the property policy for recovery. In the first example, an insurance product could be structured to pick up exposures that extend beyond physical loss or damage. Perils such as OEM defects, lack of radiance, or accelerated degradation of equipment would dovetail with the already well-established perils of a property policy (Mechanical Electrical Breakdown, NAT CAT/Force Majeure), with both products showing the PTCs in the sum insured.

In the second example, a project owner is facing a unique situation. The tax insurance marketplace would have difficulty insuring the exposure because even though the lost value aligns with a safe harbor classification, the trigger is physical loss or damage. Given that the tax insurance marketplace shies away from such triggers, most project owners would look to the traditional property insurance marketplace to support. However, the exposure being an all-or-nothing payout based on that specific transformer making it to operations is outside of the standard business interruption reporting structure.

The McGriff Tax Insurance team works with clients to develop creative insurance solutions to mitigate risk associated with the IRA and advises on insurance strategies related to renewable energy tax credit transactions. We’re always happy to discuss what we’re seeing in these markets as they continue to develop and/or how they apply to specific renewable energy projects underway or being considered. Please do not hesitate to contact us with questions or to discuss further.