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Ep327: Market Dynamics in Tax Credit Insurance
00:20:03
Dan Berger, managing director at Lockton Companies, discusses recent trends, challenges and developments in the tax credit insurance market.
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Foreign.
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Welcome to Currents and Norm Rose Fulbright podcast. Today we're recording with Daniel Berger, head of Tax insurance at Lockton Companies, where Dan brokers tax credit insurance policies. Dan, thanks for recording with us today.
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No, it's great to be here and thank you for having me on. I'm a big fan of the podcast and view this is one of the foremost. Certainly helped me when big beautiful bill was enacted. This is one of the first things I listened to. So appreciate you having me on today.
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All right, well, thanks for listening and hopefully I don't cause you any dismay or take some of the luster off of it by you getting to see how the sausage is made here. All right, so let's talk why I asked you to be on. We were working on a deal recently and it seemed to me that the market was moving quite a bit. I've done maybe this probably the third or fourth time I've had somebody on talking about the market, but this market keeps evolving, very dynamic. And the last time I had somebody on has got to be a year ago and a lot's happened in the last year. So what is the overall state of the tax credit insurance market? And we can get into some of the details, but just generally how healthy is it and how big is it?
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So the market is definitely dynamic. I think that's a really good word to describe it. And in many ways that's been a positive thing. As the tax credit world has evolved, the tax insurance market has adapted accordingly. Right. So as the credits were modified or enhanced, created a new pursuance to the ira, the tax insurance market reacted accordingly. And we're seeing similarly following the one big beautiful bill that the tax insurance market is certainly adapting. What we're also seeing is the market evolving in terms of a shifting appetite. Right. And that's, I think, causing some concerns amongst clients, developers, tax equity investors, tax credit buyers, and various parties who play in the space that they're seeing the market tighten up a little bit. And that includes with regards to appetite, we're seeing some upward pressure on pricing. So the market certainly is dynamic. All that being said, the market is very much open for business, so there's about a billion or so of capacity available in the market. We're seeing all different types of transactions being insured, whether it be tax equity, straight tax credit transfers, hybrid deals, everything and anything in between, as well as a very wide range of tax credits being insured by the market. So certainly traditional ITCs, we're seeing PTCs 45Z45Q. Really all letters of the Alphabet comprising the tax credit universe. So it is a healthy market, but certainly one that is evolving very much in real time.
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So you said a few things there. Some I think I knew, some surprised me. So did you say that the size of the market so far is only about a billion dollars?
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It's about a billion or so capacity on a single transaction.
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Oh, I see.
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The market has ensured, you know, billions of these credits, but on a single transaction there's about a billion or so of capacity available in the market and that is down a little bit from last year. Last year there's about a billion and a half or so capacity available on a single transaction. This year that that's contracted a little bit to about a billion. But it really only impacts policies and programs that are of very significant size.
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Is that because some carriers have left the market or because carriers are trying to reduce their concentration risk or why would that be?
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It's related to a couple of different things. Mostly related to carriers reducing their maximum limit that they're willing to put out. There have been, you know, really just one or two that have left the market entirely. That is being replaced by new carriers that are now entering the space. So there are a variety of factors impacting that. But again, there are carriers that are also looking to monitor the concentration they have to tax credits. But overall we really haven't seen that impacting the broader tax insurance market to any significant degree.
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And you mentioned there's upward pressure on pricing. One, how much upward pressure? And two, what do you attribute the pressure to?
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So for a long time the pricing for tax credit insurance was relatively stable, typically between 2 to 3%. We saw that really for probably a three to four year period where it was pretty stable within that range. And of course there are some that deals that were less than that, some more, but the vast majority were somewhere in that 2 to 3% range over, I would call it, the past six months or so. We've seen a shift where now deals are pricing, let's say around 3% and sometimes north of that. Again, a couple of different reasons for that. Part of it is really just supply and demand, right? There's a tremendous amount of volume and a lot of deals that are in the market where people are looking for insurance and there is a bit of a limited supply in terms of underwriters being able to service those deals. That has led to some carriers really increasing their pricing to reflect that and say we're willing to insure this, but we're going to charge more for it. And just being more selective on the types of deals that they're insuring. So that has impacted some of the pricing. Again, we've been able to mitigate some of that impact, especially for larger programs where you're able to push down the cost on a percentage basis as you get more insurance, as you get further away from the first dollars of risk. But it is something that we're see particularly on smaller deals impact the cost of the insurance.
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Does it have anything to do with claims history and what is the claims history in the market?
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There have been some claims in the tax credit insurance market, not a lot. There's definitely been a highly profitable line of insurance for the carriers. There are some claims that are out there. And the biggest impact that's had in terms of claims has been on the appetite for Step Ups to date, most of the IRS audit activity. And again, there is not a lot. And I say that both from experience as well as just from conversations with various players who are in this universe, there have not been a lot of irslr activity in this area. But when there has been IRS alert activity, it has typically been focused on basis step ups. I think that's sort of viewed as the lowest hanging fruit for the IRS to challenge. And some of those deals have insurance. Right. So the insurers have seen the IRS challenge basis step ups. To be clear, there isn't any type of IRS campaign to challenge basis step ups. There's no IRS initiative to challenge step ups over a certain threshold. I think the IRS has made it very clear that they're unwilling to issue any specific guidance as to what type of threshold will or not be respected because it is something that is highly dependent upon the fair market value, which again is going to depend on the nature of the specific project involved. Because of the audit activity that has taken place. Even though it has been limited, the insurers have paid out some claims or with regards to basis step ups. And that has also impacted their appetite to cover basis step ups, especially over where we are about 25% in the current market.
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How much has the change in the administration altered carriers appetite to insure and also the types of risk that they're willing to ensure?
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It's a great question because I think you really have two competing factors at work here. The first is you see on the one hand regular announcements coming out of the IRS and Treasury that IRS employees are leaving the IRS voluntarily or involuntarily. And you're seeing that impact the number of audits that are taking place. So clearly the number of audits are down. And it seems like the administration is taking a view that they would like to shrink the IRS and perhaps limit the amount of significant controversy that were to occur going forward in terms of the audit activity, which on the one hand would seem to be in favor of insurance companies wanting to insure more tax risks. Right. And wanting to take on more risk because they have less to be fearful of. I think that is one factor. On the other hand, you also see the administration and particularly the executive order that was issued following the enactment of the one big beautiful bill, which where there was very negative rhetoric towards the renewable energy industry and a directive towards the IRS and Treasury to strictly interpret and enforce the tax rules relating to these renewable energy tax credits. And that's something that the insurance companies have also very much taken note of and seen. Overall, I would say between those two things, it's been relatively neutral. I'm not sure that either one has had a significant impact or measurable impact on the tax insurance market or pricing. It is something that certainly everyone is monitoring very closely. The other thing to point out is that these policies are typically seven to 10 years in length, which is a very long period of time. They will cross different administrations. Right. Policies that were written during the Biden administration are now certainly still live here today. And that's something that I think that the tax insurance market also takes into account that there is going to be various ups and downs when it comes to administrations, and the market is really looking to underwrite these for the long term without regard to the specific administration that might be in power today.
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In addition to step ups, is there anything changing with respect to domestic content or beginning of construction?
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So beginning construction, there was significant concern and hesitation, especially following the one big beautiful billboard before we got the IRS guidance that came out. There was a lot of uncertainty following the executive order as to how begun construction would be defined and what the impact of that executive order would be. So that definitely led to a bit of a pause in the tax insurance market as people were looking to digest that and really wait for the guidance to come out. I think that the guidance that was released was viewed as highly favorable and really provided the stability that's needed from the insurance markets to underwrite begun construction. Right. Tax insurance has been around for over 20 years and it's been insuring these types of tax credits for about a decade now. And one of the areas that's been insured over that time quite often has been the begun construction threshold. So it is something that the market is very familiar with and very comfortable ensuring. And I think that the guidance that came out ultimately has provided a path forward for the insurance to remain active and willing to insure that area as well.
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How about Fiat and fiat impacts on the eligibility for credits?
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That is a very popular question right now. We continue to get a lot of those questions. I would say for right now, the insurance market is ready and willing to ensure that products don't have to satisfy the fiat requirements because they began construction by a certain date. That type of coverage is readily available in the market. And as the calendar continues to roll on, we're going to see few and fewer projects that will be able to rely upon that exception. And we're continually getting questions about projects that are actually going to have to satisfy the fiat requirements and what that's going to mean and whether there is insurance available to cover it. I would say the short of it is tax insurance will adapt. I think, as we talked about at the outset, the market is very much evolving, and I think it will adapt to be able to cover fiac. But one of the things that it's going to be dependent upon is guidance. We're going to need some guidance to come out of treasury in order for the insurance market to really be able to cover it in earnest. I think any discussions or conversations you might be hearing about insurance covering fiat today, that that type of coverage is really going to be so highly conditional that I'm not sure it's going to be that valuable. There are going to be so many conditions and exceptions to it. It's going to be dependent ultimately on guidance. They're not sure how valuable any type of fiat coverage is going to be today, but it is something that we're working with very closely with underwriters individually and collectively, as well as advisors. Right. Because this isn't something that is going to be solely dependent upon the insurance markets. The insurance markets are only going to be willing to provide fiat coverage if there is proper diligence being performed. Right. And that's going to be probably a combination of different parties. Right. There is going to be law firms who are going to be involved, accounting firms, other diligence advisors who are going to be necessary to put together various diligence reports and summaries regarding how the fiat rules are being complied with. Those are conversations we're having with all of the above in order to be able to develop a market and an environment where fiat will be able to be covered by these policies. And, you know, one of the things I just wanted to point out Right. You're going to see some sensitivities around fiat, let's say, related to ownership requirements, who the various parties are and disclosures there. And there may be some sensitivities there as to how that information is going to be disclosed. That's something that we've dealt with in the insurance market, whether it be for domestic content or in other areas of tax insurance. So again, there will be a path there. What exactly that's going to look like is still a little bit up in the air at this moment.
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Any other big impacts that you've seen, either because of executive orders or the OBBBA or subsequent directives from the administration that you think have altered the way that the insurance policies are issued or negotiated over the last 12 months?
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That's a good question. I would say that as much of as people have said that the current administration is not necessarily been super friendly to the renewable energy industry. What we do have though is clarity for the first time. And there is what the new legislation, what the executive orders, what the guidance has provided is clarity on a path going forward. Right. And at least certainty for to have a Runway for the next few years. And again, it's a little bit. We'll see what happens after that. But certainly for the next few years there is a Runway for the credits to be available and for companies and developers to plan accordingly. So that Runway, we've seen that play out in terms of the deal activity that's going on. Right. We are a lot busier than we were last year before the current administration was voted into power. So there is a lot of positive deal activity that's happening in this space. And that's something that we're seeing play out in real time across a very wide range of project types. All right.
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I started with kind of the tougher stuff. By the way, you, you answered my first question, just got me going here. And I got a few more general questions for you for people who maybe are less familiar with insurance markets. One is how do the insurance policies vary? We're talking about ITCs, PTCs. Is there a big difference in terms of what is covered? Some of these things that we discussed really are only relevant for ITCs. And does that impact the underwriting process and the cost?
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Sure. So tax insurance, for anyone not familiar with it, is used to provide certainty for any type of ambiguous tax position. So it's been used in a very wide variety of circumstances. As I mentioned earlier, it's been around for over 20 years. And one area where it's been used quite Extensively is in the tax credit space even well before the IRA was enacted. So tax equity investors who use tax insurance to get comfortable investing in tax equity structures. And after the transferability regime was enacted, we're seeing tax insurance used really as a staple to transferability deals as well. One of the things that's been interesting to see is how tax insurance sort of varies between ITC deals versus PTC deals. I would say again, we obviously only see the deals that have insurance based on some of the numbers that are put out there by others. In terms of the market size, I would say tax insurance is probably used more often in the ITC realm than it is for PTCs. Not to say that tax insurance is not used for PTCs. It is, and it's been used probably more often for PTCs over the past 12 months than ever before. But it is used more often for ITCs, I think particularly because ITCs have the risk of recapture. That's just one thing that I think a lot of tax credit investors are concerned about, given that it's a forward looking risk for five years. So that's something that the tax insurance market can certainly protect against. Specifically for ITCs, obviously the risk for PTCs is different because you don't have recapture. So the scope of coverage is going to look a little bit different. But the idea is the same, right? The insurance is there to provide certainty that the credits will ultimately be respected. And for PTCs, the nature of the risks are going to vary depending on the type of ptc, the type of project. You know, pwa, for example, is an example of something that could be relevant for PTCs. And again, that's an area which is often not under the direct control of a developer. Right. You could have some type of subcontractor, contractor or subcontractor that is ultimately directly more responsible for the PWA compliance. So that's something that we've seen for 45Z, that is really sort of a relatively new credit. And as transactions have begun to really develop in earnest, specifically for 45Z, that's something that I think insurance has really stepped up to be able to cover. I believe that for at least for 45Z, even though it's PTCs, that's an area where I think insurance is used again as a staple for all the 45Z deals that are out there. And a lot of that is really also because of a lack of guidance. Right. Some areas, even if we have guidance, there's still some ambiguity. But. But 45Z scenario where we still don't even have regulations. And that's again, a perfect example of how tax insurance can help facilitate a transaction, even if there isn't necessarily perfect guidance that's out there to guide the parties involved.
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All right, let me end it for you. Dealt with all my tough questions upfront. I'll let you end with a softball here, but it's one that's helpful for people who are less familiar with this. So let's say you're somebody who hasn't actually partaken in the tax credit insurance market yet. If somebody wanted to get involved with that one, what does the process look like in terms of when does somebody get in touch with you, how do they get in touch with you, and how long does the process take?
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Definitely would recommend getting in touch with me. We'd be happy to help and assist in any way. Insurance is something that is there to really facilitate the transaction and provide comfort that there is an A rated insurance company that can stand behind the validity of the credit. We've seen it used strategically by both sellers as well as buyers, and sometimes both to help get comfortable and really allow a transaction to move forward. Feel free to reach out to me by email dbergerlockin.com Reach out to me on LinkedIn Locked in helps companies, all types of companies, ensure a very wide range of risks. We're a global company with over 100 offices around the world. I focus exclusively on tax insurance, so I can't speak to other types of insurance. But certainly with regards to tax, it's been a very exciting time to be in this market and would be happy to answer questions that people may have. It typically takes anywhere from two to five weeks to put an insurance policy into place. We've done it faster in urgent deal timelines. So happy. There is something that requires immediate attention to dig in, but the typical process takes somewhere between two to five weeks, depending on the availability of information.
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All right, thanks for joining today, Dan, and very informative.
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Thank you very much, Todd.
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You can find us online at www.projectfinance.law or send us an email at currentsortonrosefullbright.com Please rate, review and subscribe on Apple Podcasts, Spotify or your professional preferred Podcast app. Our show today was produced by Emily Rogers.
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