For the reasons just discussed, the willingness of consumers to pay a premium for green power does not provide an adequate basis for the development of new green generating capacity — partly because the contracts under which consumers purchase green power are too short, but principally because the risk of a decline in the market price of green power is too great.

In theory, a green power marketer could protect itself against price risk by selling to consumers under long-term contracts, but a marketer that insisted on a 10-year commitment in the freewheeling world of unbundled retail electric markets would be unlikely to succeed.¹⁸ The long-term assurances that are needed in order for green power developers to obtain loans on reasonable terms therefore depend on reducing the market price risk by other means.

Green power price insurance can offer such a means. In its rationale and essential elements, the insurance would not differ from insurance against the risks of fire or storm. The insurance would replace part of the risk — in this case, the risk of a decline in the green premium — with a fixed insurance premium.

Over the long run, offering green power price insurance may be an attractive business prospect. Insurance companies do not regard it this way today, however. The potential market for the insurance now is very small. It is limited by the market for green power itself, which can exist only where consumers are able to choose among conventional and green power products. By the end of 1999, retail unbundling will offer that choice in at least five states. Under existing legislation, the choice is expected to be offered in only about a quarter of the states by 2005.¹⁹

Even these figures may overstate the potential near-term size of the green market. Retail unbundling gives consumers a choice, but the market for both green and conventional mar keters depends on consumers exercising that choice. In California, there are indications that green power has captured a large share — perhaps half the total — of the market among consumers who have opted to leave their incumbent utility provider for some other power marketer. But the overwhelming majority of electricity consumers in California have so far not selected any marketer, conventional or green; they are still served by their traditional utility supplier. California may not be representative; Pennsylvanians, enticed by a “shoppers’ credit” for those who switch, have been quicker to do so.²⁰ However, it serves to point up one of the uncertainties that would confront a company contemplating the launch of a green power price insurance product.

A further uncertainty would be the underwriting risk that the company would assume. Here an analogy to life insurance may be helpful. A healthy 75-year-old male may or may not die during the next year; in this sense, the uncertainty is 100%. If one considers 10,000 such males, however, the percentage that will die over that period can be predicted within a relatively narrow range. It is this relative statistical certainty that permits life insurance companies to set their premiums. The relative certainty rests on two bases: actuarial experience that is broad-based and long, and the statistical independence of the individual insured events.

Neither base would exist now for the risk of a decline in green premiums. Experience with the premiums is narrow and short. The individual risks also are independent of one another. Factors such as a shift in public attitudes that would reduce the green premium covered by one policy would be likely to reduce the green premiums covered by other policies as well.

The green power market will grow; experience will provide a firmer basis for estimating underwriting risks. It is possible or even likely that an insurance company would someday offer green power price insurance without government support, but it is impossible to predict when that day might arrive . The purpose of the green power price insurance proposal is to make the insurance available now.

THE INSURANCE POLICY

In the proposal under discussion here, a green marketer would take out a price insurance policy before it entered into a power purchase agreement, and the insurance would apply to the power purchased under that agreement.²¹ The insured risk would be a decline in the wholesale green premium — the difference between the wholesale market prices of green and conventional power.

For illustration, assume that the insurance would cover a 2.5¢ decline in the green premium. A decline of that magnitude would represent a nearly total elimination of the current green premium.²² The insurance would not compensate a marketer for all of the decline. It would be subject to a deductible and would pay only part of the decline in excess of the deductible. It will be assumed here that the deductible is 0.5¢ and that the insurance would compensate the marketer for 50 % of the decline in excess of the deductible.

For the insurance, the marketer would pay a premium based on the annual amount of green power sales covered by the policy. The level of the premium would be set in negotiations with insurance companies that wished to participate in the program. It will be assumed here that the premium would be 0.05¢ per kilowatt-hour (kWh) of coverage.

To use a more specific example, say that on January 1, 2001, a marketer enters into a 10-year power purchase agreement for one-fourth of the output of a 40-megawatt wind power generating facility. At the facility’s expected load factor, the marketer would be obligated to purchase 25 million kWh annually. Before the marketer committed itself to the purchase, it took out green power price insurance in that amount. At an insurance premium of 0.05¢/kWh the marketer’s annual premium is $12,500.

The wholesale green premium on January 1, 2001 is 3.0¢ and it remains above 2.5¢ through 2003. Since the insurance has a 0.5¢ deductible, the marketer has no claim under the insurance for this period. During 2004, however, the premium falls to 1.0¢ — that is, 2.0¢ cents below its level when the marketer took out the insurance. The decline therefore exceeds the insurance deductible.

For the marketer to have an insurance claim, however, it must suffer a loss as a result of a decline in the green premium. In this case, the decline indeed causes the marketer a corresponding loss. To meet competition based on the new lower wholesale green power price, the marketer also reduces its resale price by 2.0¢.²³ Thus there has been a decline on the wholesale green premium that exceeds the deductible, and that decline has resulted in a loss to the marketer. The marketer therefore files a claim for $187,500 under the insurance policy to offset part of its loss:

(2.0¢ loss – 0.5¢ deductible) X 50% coverage X 25 million kWh = $187,500.

As the example illustrates, claims under the insurance depend on two events. One is a decline in the wholesale green premium; the other is an economic loss to the marketer. The marketer in the example would have had no claim if it had been able to maintain its retail sales price without losing sales. The marketer also would have had no claim if it had suffered an economic loss when there was no decline in the green premium.²⁴

COMMITMENTS OF THE PARTIES

Insurance Companies

The insurance companies would be required to offer the insurance during a five-year period, which is assumed to begin in 2000. The policies would remain in force for at least 10 years. From the initial offering of insurance to the expiration of the last policy, the program thus would last at least 15 years.

These obligations are minimum requirements. The companies could insure additional green capacity. They also could continue to offer new insurance after 2005 and could offer insurance for terms longer than 10 years. Indeed, the companies are likely to do all of these things if the insurance is successful. For the analysis in the paper, however, it is assumed that the companies fulfill only their minimum obligations.

Under the proposal, the federal government would contribute $5 million annually for a five-year period that would coincide with the period during which the insurance was being offered, and the participating states would collectively contribute an equal amount. The total contribution of the federal and state government thus would be $50 million.

This does not mean that the governments necessarily would have spent $50 million at the end of the program. Their contribution would be contingent on the insurance companies actually insuring the agreed amount of capacity. If the insured capacity fell short of the agreed amount, the federal and state commitment would be reduced accordingly. For instance, if the companies agreed to insure 1,000 megawatts of capacity but only 500 MW were actually insured, the commitment would be reduced by $25 million.

In addition, part of their contribution would be subject to potential refund. The governments’ contribution would be divided into two parts. One would be a non-refundable fee paid to the participating insurance companies to cover part of the cost of setting up and administering the insurance. This probably would be a relatively small part of the total. For the analysis in this paper, it is assumed to be $5–10 million.

The remainder — $40–45 million — would be available to meet insurance claims. Depending on the magnitude of those claims, some or all of this part of the federal and state contribution might be refunded at the end of the program.

The total funds available for meeting claims would consist of three layers:

• The first would be the insurance premiums paid by marketers. At a premium of 0.05¢ per kWh, these premiums might total some $25 million over the life of the program — comparable to the contribution of the federal government or the aggregate contribution of the participating states.²⁵

• The second layer would consist of $40–45 million from the funds that had been paid in by the federal and state governments. This would be drawn on to the extent that claims could not be satisfied from insurance premiums. To the extent it had not been drawn on by the end of the program, it would be refunded to the federal and state governments.

• The third layer would be the capital of the participating insurance companies. This would be used to satisfy claims that could not be satisfied from the first two layers. The insurance companies’ theoretical exposure for claims runs to hundreds of millions of dollars.²⁶ The likelihood that they would be required to pay more than a small fraction of that amount is very small. However, an insurance policy must be backed by funds sufficient to pay unlikely claims as well as likely ones. The insurance companies’ capital would provide the funds needed for this purpose and would make it possible to place a strict upper limit on the contribution of the federal and state governments.

Half of the $50 million would be committed by several states. In return for its commitment, a state would have a preferential claim on a pro rata share of the insurance. If the agreed capacity to be insured was 1,000 megawatts, a state that com-mitted $5 million to the program — $1 million annually — would have a preferential claim to insurance on 100 megawatts of green power capacity located within its borders.

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