Two numbers decide whether a fire during construction becomes a debt default: the indemnity period and the basis of the sum insured.
Size delay in start-up (DSU) insurance in two steps: set the indemnity period at or above the longest delay a single insured loss could cause, then set the monthly amount at the income the project loses less the costs it saves. On an illustrative wind farm with $48.0m of annual revenue, a transformer that takes 15 months to replace calls for an 18-month indemnity period and a $66.6m sum insured on the gross profit basis, against $51.3m if only debt service and fixed costs are covered.
Worked in full in The Project Finance Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
DSU, also called advance loss of profits, sits alongside the construction all risks policy. It pays when insured physical damage during construction pushes back the commercial operation date (COD). It is the cover lenders read most carefully, because a delayed project has debt service falling due and no revenue to meet it, and liquidated damages from the contractor pay only when the contractor is responsible for the delay. A fire or a storm usually is not the contractor's fault.
| Input | Value |
|---|---|
| Contracted revenue at P50 | 48.0 |
| Variable costs saved while the project is not running | 3.6 |
| Scheduled senior debt service | 30.0 |
| Fixed costs that continue through a delay | 4.2 |
| Time excess (deductible) | 60 days, treated as 2 months |
| Main transformer: manufacturing lead time / transport, installation and testing | 12 / 3 months |
| Illustrative premium rate on the sum insured | 0.8% |
The indemnity period is the longest delay the policy will pay for, counted from the scheduled COD. It should cover the worst single loss on the critical path, which on most power projects is not the turbines but a long-lead item with one or two qualified suppliers: here the main transformer.
Transformer lead time + transport, installation and testing = 12 + 3 = 15 months
A gearbox or blade set, by comparison, might cost 8 months. The period is set on the longest item, then rounded up to a standard term with some margin for a slow claims process and recommissioning: 18 months.
There are two common bases. The gross profit basis insures revenue less the costs that stop when the project is not running. The narrower basis insures only what must be paid regardless: debt service and fixed costs. Equity's margin is the difference.
Gross profit basis = revenue − saved variable costs = 48.0 − 3.6 = 44.4, or 3.70 a month
Debt service and fixed costs basis = 30.0 + 4.2 = 34.2, or 2.85 a month, 77.0 per cent of the gross profit basis
Sum insured = annual insured amount × indemnity period ÷ 12
Gross profit basis: 44.4 × 18 ÷ 12 = 66.6; premium at 0.8% = 0.533
Debt service and fixed costs: 34.2 × 18 ÷ 12 = 51.3; premium = 0.410
Excel: =(Revenue-VarSaved)*IP/12 and =SI*Rate
| Indemnity period, months | Sum insured, gross profit | Premium | Sum insured, DS + fixed | Premium |
|---|---|---|---|---|
| 12 | 44.4 | 0.355 | 34.2 | 0.274 |
| 18 | 66.6 | 0.533 | 51.3 | 0.410 |
| 24 | 88.8 | 0.710 | 68.4 | 0.547 |
Suppose a fire destroys the main transformer shortly before completion and COD slips by 13 months. The policy pays for the delay inside the indemnity period, less the time excess.
Months paid = min(delay, indemnity period) − excess = min(13, 18) − 2 = 11
Lost gross profit = 13 × 3.70 = 48.10
Claim, gross profit basis = 11 × 3.70 = 40.70; uninsured 7.40, all of it the excess
Claim, debt service and fixed costs basis = 11 × 2.85 = 31.35; uninsured 16.75
On the gross profit basis the project receives 40.70 against 37.05 of debt service and fixed costs falling due over the 13 months, so the lenders are paid with 3.65 to spare, as long as the claim is paid on time. On the narrow basis the claim covers only 11 of the 13 months of obligations, leaving 5.70 to find, and equity loses its entire 0.85 a month of margin, 11.05 over the delay. That 5.70 has to come from a contingency or the sponsor: a debt service reserve account is commonly funded at or after COD, so it may not yet exist.
| Delay, months | 12-month period | 18-month period | 24-month period |
|---|---|---|---|
| 6 | 2 / 7.4 | 2 / 7.4 | 2 / 7.4 |
| 10 | 2 / 7.4 | 2 / 7.4 | 2 / 7.4 |
| 13 | 3 / 11.1 | 2 / 7.4 | 2 / 7.4 |
| 16 | 6 / 22.2 | 2 / 7.4 | 2 / 7.4 |
| 20 | 10 / 37.0 | 4 / 14.8 | 2 / 7.4 |
Below the indemnity period, the only uninsured loss is the excess. Above it, every extra month is lost in full. A 16-month delay under a 12-month period leaves 22.2 uninsured; the six extra months of cover that would have prevented it cost 0.178 of premium at the illustrative rate. That asymmetry is why lenders' insurance advisers push the period out to the longest lead time rather than the expected one.
Indemnity period = the longest critical-path replacement, rounded up; monthly amount = revenue less saved costs; claim = (min(delay, period) − excess) × monthly amount. On this project, 18 months on the gross profit basis, a 66.6 sum insured, covers a 13-month delay with only the excess uninsured. The cash flow waterfall the claim feeds into is built in the free workbook for this case; for the delays the contractor does owe for, see whether liquidated damages cover a late week, and for what protects debt service after COD, how to size a DSRA.
DSU covers loss from a delay to the commercial operation date caused by insured damage during construction, under the construction all risks programme. Business interruption covers lost income after operations have started. On the illustrative wind project the DSU claim for a 13-month delay is 40.70 million on the gross profit basis; once the project is running, the same damage would fall under the operating business interruption policy.
The time excess is the first part of the delay the insurer does not pay for, expressed in days. With a 60-day excess, treated here as two months, a 13-month delay is paid for 11 months. At 3.70 million a month of gross profit the excess alone leaves 7.40 million uninsured, which the funding plan has to carry through contingency or sponsor support.
Some do, provided the cover at least matches scheduled debt service and fixed costs for the indemnity period. On the illustrative project that is 34.2 million a year, 77.0 per cent of the gross profit basis. Equity bears the difference: in a 13-month delay it loses 11.05 million of margin and must find 5.70 million of obligations the excess leaves unpaid.
This article is one calculation from The Project Finance Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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