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Gas combustion turbines are often exposed to damage and ultimately failure due to the necessary heavy stress they are put under. Although breakdowns are inevitable, Marcus Alcock ask if there are any business interruption measures that can help to ensure a smooth continuation of operations following a mishap

The energy sector has traditionally been viewed as one of the most volatile insurance markets and this viewpoint has been roundly affirmed over the past couple of years. Hurricane Katrina caused havoc in the offshore energy market towards the end of 2005, and last summer a significant area of the onshore market was hit by millions of pounds worth of business interruption claims after cracks were discovered in at least a dozen General Electric 7FA and 9FA gas combustion turbines with a repair bill of some $200m (£102m).

But, for all the press coverage circulated regarding the difficulties with GE's turbines, this is not the first occasion the sector had experienced a rough patch. Indeed, according to a report by Swiss Re, troubles with such turbines have been common since orders peaked in the late 1990s, including turbine blade failures and compressor discs cracking.

Hitting profits hard

Unsurprisingly, such material failures have translated into significant losses for insurers - losses that appeared to resurface last year. Energy insurance disputes expert Peter Hirst, a partner at law firm Clyde and Co, recognises it "as a problem that has been going on for 10 years or so".

As he explains: "The 7FA was developed 20 years ago, so consequently there has been a desire to develop an improved version that could work at a hotter temperature and have an increase in steam; so it came up with the 9FA. But the development of the 9FA has had all sorts of unintended results. The main change has been in harmonics - which has meant that the blades can start vibrating, fracture, and then snap off - causing significant physical damage to the motors; you're talking many millions of dollars."

Despite what appears to be shocking material problems with gas turbines, the industry should not be too harsh on the various manufacturers, stresses Philip Veale, power and utility practice leader at Aon.

"Recently, some machines have seen problems and the failures have had a variety of causes, but it should be appreciated that the technical challenge facing these machines is unlike any other," he says. "An industrial gas turbine rotor spins at 3,000 revolutions per minute and holds both the compressor blading and the power turbine 'buckets'. Unlike an aircraft engine, which is only at maximum thrust for a short period, these machines have to maintain their output constantly for 8000 hours or more without a planned maintenance interval.

"Running at high temperatures of around 1500 degC means this machine will suffer from stresses that may result in cracks and failures in the blades and buckets, and a small imperfection in the metallic integrity of the component could lead to failure in such arduous conditions. Many of the individual buckets produce more power than a top-class F1 racing car engine and they have to operate for the equivalent of a racing car running at full speed for 1300 hours non-stop."

But even though manufacturers can be excused for some of the operating difficulties faced by gas turbines, this does not let the insurance market off the hook, Mr Veale adds, with most claims resulting from business interruption and the series of losses actually challenging "the economics and viability of the sector for some". The major cost is in the business interruption where the claim, in periods of high demand, may exceed £500,000 per day, while on other claims the material damage and repair cost can frequently exceed £10m, he continues.

As such, Mr Veale states that major power producers have selected higher retentions and captive vehicles and in doing so have reduced the capital contributions to the market sector over the last few years.

But, as Mr Hirst points out, with BI claims the main concern here, the question is whether there are any spares plants that can be used while repairs are carried out.

Finding a replacement

"In the old days, there used to be strategic spares so there was no consequential revenue loss but with so many companies nowadays, spares are much harder to obtain," he explains. "So, when something blows up you have to go to the manufacturer and ask for a spare to be made and the manufacturer will give you an order time. Now that can be quite a long period: up to 24 months. I had a client that had a broken Alstom machine and they had to wait 15 months."

With such long waiting periods, costs can mount for insurers, making this a very niche sector with fewer companies prepared to write it. As one London market broker says: "This all used to be placed into the property market. Now it has to be the specialist energy sector, and underwriters increasingly require really detailed info before they'll look at these risks at all. What turbine is it, what's the operating regime, what service agreement is in place?"

"Other underwriters have used fairly blunt tools to protect themselves, such as insisting that cover is only provided for gas turbines used for thousands of hours already and have, therefore, hopefully 'proved' themselves," adds Mr Hirst. For others he says that the mechanism of control is through higher premiums and deductibles - again, fairly crude and blunt instruments - "but the market is definitely softening, so the ability of underwriters to protect themselves in this way is limited".

He adds that subrogation is extremely difficult as, generally, turbines have 24 month warranties, which exclude consequential losses, though there are one or two countries around the world where it is not possible to contract out of business interruption losses where negligence is concerned, such as Portugal.

"But it's very difficult to prove the manufacturer is negligent," he explains. "What we've had to engage in previously is a process of reverse engineering, which can cost thousands."

And with the money involved so large, this is a market where reinsurance is a necessity rather than a luxury, with most risks going into the facultative rather than the treaty market. But the question must surely be how much reinsurers will be willing to support this sector with such a soft market in 2008, let alone what the primary market will do?

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