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Insurance for Projects
Project finance transactions have certain risks associated with them that traditional credit-based transactions do not. These risks previously made it impossible to approach whole classes of investors due to regulatory reasons. Many pension funds and so forth are limited in their ability to invest in such projects without an investment grade rating or support the transaction with NAIC 5 levels of equity leading to prohibitive pricing. By using various insurance products now available in the market, many project finance developers have been able to change previously sub'investment-grade risks into more highly rated transactions, thus opening them up to classes of lenders that otherwise would not be able to provide the debt for such transactions.
Turning an uninsured transaction into an insured transaction can lengthen both the term and amount of debt for the transaction while at the same time lowering the interest rate of the debt, which implies less equity and overall capital cost for the transaction.
In a nutshell, the project developer pays an insurance premium to an insurance company willing to take on certain risks that a credit based investor is not. This mechanism accomplishes two benefits for the developer. First, because the lender is now taking on a highly rated risk, the range of potential lenders is significantly greater than it otherwise would have been both in terms of quantity of investors and length of the loan. Second, because the transaction has been changed in terms of risk the interest rate will be lower than it would be without the insurance policy.
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