Transcript Document

Turbine Manufacturer LTSA’s
Hidden Risks…
Presented By:
Rex Andrews & Associates, Inc.
Donato, Minx & Brown, P.C.
M.G. Thomas & Associates, Inc.
What is an LTSA?
In short, a long-term service agreement (“LTSA”) is a
contractual agreement between a customer and a
manufacturer under which the manufacturer is
responsible for operations, maintenance and repairs
of the product purchased by the customer and
offered by the manufacturer, for a fee.
An LTSA is like an insurance policy or extended
warranty on the product purchased.
How Prevalent are LTSA’s?
Long-term service agreements - a.k.a. maintenance agreements, maintenance
service agreements, service contracts, maintenance programs, and various other
designations - are gaining favor as a risk management tool for the growing fleet of
installed gas turbines, especially in the large power generation market.
Siemens-Westinghouse, for example, expects a 2,070 percent increase in the
number of units covered by long-term service programs, from 10 in 1998-99 to 217
by 2004.
Power Engineering
August, 2001
Who Gains From an LTSA?
Benefits of LTSAs for the Turbine Owner:
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The Owner knows in advance how much maintenance and parts will cost,
eliminating uncertainty;
The cost of maintenance can be linked exclusively to the annual production level
(kWh for power generation plants, cubic meters of gas handled for gas
compression stations, etc.);
Maximizing production is the common objective of both Owner and Manufacturer,
and both are recompensed in proportion to the production level; consequently,
the plant will be maintained at highest efficiency and constantly updated
technologically, eliminating the risk of obsolescence . . . often the Manufacturer
shares risks and rewards with the Owner;
The Owner’s personnel are kept constantly informed of new technologies
introduced into the plant and trained about the equipment and its operation and
maintenance;
The Owner is not obliged to keep and manage a spare parts warehouse with the
locking up of capital this implies, and the Manufacturer can benefit by sharing its
warehouse and inventory with more than one Owner;
The Owner has reassurance that people and parts will be available on relatively
short notice for repair and/or service of the machinery.
Who Gains From an LTSA?
Benefits of LTSAs for the Manufacturer
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Guaranteed market for repair work and service. Maintenance and
payments are scheduled at regular intervals;
Guaranteed prices that are determined and negotiated by the
Manufacturer;
Limitation of Liability clauses that protect the Manufacturer for repair
work and services they provide as a part of the LTSA;
Essentially eliminates the competition. The parts must be provided by,
purchased from and replaced by the Manufacturer;
The parts replaced are the property of the Manufacturer…which protects
the design specs and other features of the parts making it hard for other
companies to produce similar parts.
This is all good news for Insurers,
right?
Not necessarily…the bad news arrives
when a claim occurs.
LTSA – Problems for Insurers
Issue #1: The Agreement is Secret!
The disclosing Party shall indemnify and hold the nondisclosing Party harmless for any liability
suffered by the nondisclosing Party as a result of the disclosing Party's improper disclosure to
third parties or improper use of Seller's Confidential Information.
Any unauthorized disclosure of Confidential Information or other violation of the provisions of
this Contract shall be deemed a material breach of this Contract. The Parties agree that
monetary damages for any breach of the provisions of this Contract are inadequate and that
the non-breaching Party is entitled to appropriate equitable relief (including without limitation,
injunctive relief or specific performance) for any breach of such provisions.
Disclosure of LTSA details (to Insurers or Adjusters) can be
problematic for the Assured.
More Problems…
Issue #2: Any Damaged Parts Are the Property of the
Manufacturer!
When the Program Parts and Miscellaneous Hardware are replaced, the parts “shall
be deemed to have a scrap value of $0 and, if Seller so requests, shall be returned
by Buyer to Seller along with free and clear title thereto.” These parts include items
down to the pins, springs, studs, gaskets, tie wires, fasteners, screws, washers,
nuts and bolts.
The OEM “performs” a Root Cause Analysis on Failed Parts
Is an Independent Root Cause analysis necessary?
RCA’s are essentially impossible without access to the broken part.
What if the problem is the
Manufacturer’s Fault?
Issue #3: Limitation of Manufacturer’s Liability
The LTSA limits the Owner’s causes of action against the Manufacturer and also
limits the amount of recoverable damages that the Owner can recover from the
Manufacturer. The provision states that the Manufacturer will not be liable under
any theory of recovery, whether based in contract, in tort, under warranty or
otherwise.
The LTSA also restricts recoverable damages and excludes any recovery for any
“indirect, special, incidental or consequential loss or damage . . . damage or loss to
property or equipment.”
Was a Waiver of Subrogation Insurers’ Intent?
What if the problem is the
Manufacturer’s Fault? – Part 2
Issue #4: LTSA Insurance Requirements
The Owner is required to maintain property damage insurance, commercial general
liability insurance, umbrella excess liability coverage, workers compensation
insurance and business automobile liability insurance. Further, the Owner is
required to make its policies primary to any of those maintained by the seller. The
Owner is also required to name the Manufacturer as an additional insured on all
types of insurance . . . except the property damage policy.
Most importantly, all policies furnished by the Owner “shall include waivers of
subrogation rights against the Manufacturer.” If the Owner does not obtain a
waiver of subrogation, the Owner is required to “defend, indemnify, and hold the
Manufacturer and its Affiliates harmless in and from any claim or proceeding by
Buyer’s insurer(s) seeking subrogation which should have been waived.”
Doesn’t the LTSA provide a good deal
on Parts and Labor, though?
Issue #5: LTSA Repair Costs for “Unscheduled Events”
Unscheduled Outage –
If, during the Term, an Unscheduled Outage occurs, then Buyer shall, pursuant to a Change
Order, hire Seller to, and Seller shall, supply any additional New Program Parts, Miscellaneous
Hardware, Shop Repairs or Services…
(i) Services will be provided at the prices specified in Seller's then current domestic Price
List(s) in effect at the time… for elements not included in Seller's domestic Price List(s) and (ii)
Program Parts and Miscellaneous Hardware will be supplied at the prices set forth in the
Contract…
Contract pricing benefit is only for “Program Parts”, i.e., normal
replacement items. Everything else priced per “Price List”…
Approximate
Year of
Program
EOH
Outage Type
Sample Costs to
OEM Escalated
Sample Annual
Payment by
Owner
1
8000
Combustion
Inspection
700,000
5,000,000
2
16000
Combustion
Inspection
750,000
5,200,000
3
24000
Hot Gas Path
7,500,000
5,410,000
4
32000
Combustion
Inspection
850,000
5,620,000
5
40000
Combustion
Inspection
900,000
5,850,000
6
48000
Major
12,000,000
6,080,000
7
56000
Combustion
Inspection
1,000,000
6,330,000
8
64000
Combustion
Inspection
1,050,000
6,580,000
9
72000
Hot Gas Path
8,500,000
6,840,000
10
80000
Combustion
Inspection
1,015,000
7,120,000
11
88000
Combustion
Inspection
1,020,000
7,400,000
12
96000
Major
15,000,000
7,700,000
NOTE: The hot gas path parts are good for
only one overhaul. - Two sets of new Hot Gas
Path components come with the unit - One in
the machine and a spare new set for storage. Once the HGP parts are removed, they are
overhauled and ready for the next planned
outage. - This will be discussed later in this
presentation.
Payment
Costs
Net to OEM
Sample LTSA Cash Flow as Planned
(Values for Example Only)
50
45
40
$
$ Millions
35
30
25
20
15
Time, Months
10
5
0
8
16
24
32
40
48
56
Hours (X 1000)
64
72
80
88
96
Payment
Costs
Net to OEM
Sample LTSA Cash Flow Failure at 40K
(Values for Example Only)
50
45
40
$ Millions
35
30
25
20
15
10
5
0
8
16
24
32
40
48
56
Hours (X 1000)
64
72
80
88
96
Sample LTSA Cash Flow - Failure at 40K - $12MM Contribution
(Values for Example Only)
Payment
Costs
Net to OEM
50
45
40
$ Millions
35
30
25
20
15
10
5
0
8
16
24
32
40
48
56
Hours (X 1000)
64
72
80
88
96
Normal Outage Schedules for Parts Changeout of Stage 1 Nozzles
8000
16000
24000
32000
40000
48000
56000
64000
72000
80000
88000
96000
Set 1
Set 2
Resultant Outage Schedules for Parts Changeout of Stage 1 Nozzles
8000
16000
24000
32000
40000
48000
56000
64000
72000
80000
88000
96000
New Set Required
Set 1
Set 2
Value of one set of nozzles = $1.007,782.61 and are intended to last 48,000 hours
Set 1 will use 375 hours + 24,000 hours = 24,375 hours total
Lost Life of Set 1 = 23,625 / 48,000 = 49.22%
49.22% of $1,007,782.61 = $496,018
This means Set 1 lost 23,625 hours of the expected 48,000 hours
Summarizing the bad news, the
manufacturer has:
Capitalized on the owner’s insecurity and uncertainty
about the manufacturer’s product by:
1. “Locking in” a favorable parts/service pricing agreement
that
2. Guarantees the manufacturer’s market and eliminates
his competition, but
3. Excludes any “unscheduled” problem from the favorable
price schedule, knowing that Insurers will pay for this type
of event, and
4. Guarantees that the manufacturer can’t be held
liable for his own mistakes.
OK, the situation isn’t good for
Insurers. What options exist?
1.
Get More Information?
Underwriters could require that the potential insured provide the
Underwriter with all contracts that the potential insured has entered into
that have waived subrogation. This will allow underwriters to better
assess the potential exposure that they may have and adjust the
premium and deductible accordingly.
2.
Modify the Policy to only Pay the Cost of the Parts and for any
Covered Loss and not for the Total Cost Including Profits?
Underwriters could also modify the insurance policy to pay a different
amount of damages for any losses where the insured has waived
subrogation rights. A clause could be included in the policy that states
that for any loss where the insured has waived the insurer’s right of
subrogation, the insurer will only pay the costs not including the third
party’s profits built into the third party’s quote. Effectively, this allows
the insured to only pay the wholesale cost of the damages which would
not include any profits
OK, the situation isn’t good for
Insurers. What options exist?
3. Tell the potential insured that underwriters will not waive
subrogation?
Underwriters could tell the insured that they will not agree to waive their
subrogation rights on any new contract entered into by the insured. If the
insured still wishes to still obtain insurance given this fact, then
Underwriters can now issue the policy. Under the LTSA, if the insured
(buyer) does not obtain a waiver of subrogation, the insured (buyer) will
be required to “defend, indemnify, and hold Seller and its Affiliates
harmless in and from any claim or proceeding by Buyer’s insurer(s) seeking
subrogation which should have been waived.” Then, the insurer could still
pursue subrogation. As a result, the insurer would make a claim against
the seller (OEM) and the seller (OEM) will go back to the insured (buyer)
for defense and indemnification. As a result, the insured (buyer) would
then have to submit this claim to their CGL carrier for defense.
Extreme Measures
4.
Increase the Premium?
Underwriters could increase the premiums of any insured that has agreed
to provide an OEM with a waiver of subrogation. This will guarantee
more upfront profit in exchange for the risk of not being able to pursue
subrogation in the event of a loss. The downside to this is the possible
loss of insured’s that go elsewhere to find insurance.
5.
Require Prior Written Consent to Waive Subrogation on any New
Contracts or Renewed Contracts?
Underwriters could place a clause in their insurance policy that requires
prior written consent with the insurer to waiver the rights of subrogation
on any new contract or any contract that is to be renewed during the
policy period. This makes the insured get consent from the insurer to
waive subrogation on any new or renewed contract that is entered. If
the insured does not get prior written consent, the policy will not pay for
the loss because there was no prior written consent to waive the
insurer’s subrogation rights.
Presented by:
DONATO, MINX & BROWN, P.C.
ATTORNEYS AT LAW
3200 Southwest Freeway, Suite 2300
Houston, Texas 77027-7525
www.donatominxbrown.com
M.G. THOMAS & ASSOCIATES, INC.
Payment Schedule
Continuing the bad news, by entering
the LTSA, the Owner has:
Seriously limited the opportunity for equitable treatment of his
Insurers by:
1. Engaging a third party who arguably has insurable
interest in the turbine, but has no responsibility to
Insurers, which
2. Allows the principle of indemnity to be violated by the
third party’s direct enrichment in the event of a
claim (even when the claim is the responsibility of the
third party), and
3. Allows the third party to avoid accountability at any level
Doesn’t the LTSA provide a good deal on
Parts and Labor, though?
Part 2
OK, the situation isn’t good for
Insurers. What options exist?
3.
Require Prior Written Consent to Waive Subrogation on any New Contracts or
Renewed Contracts?
Underwriters could place a clause in their insurance policy that requires prior written consent
with the insurer to waiver the rights of subrogation on any new contract or any contract that
is to be renewed during the policy period. This makes the insured get consent from the
insurer to waive subrogation on any new or renewed contract that is entered. If the insured
does not get prior written consent, the policy will not pay for the loss because there was no
prior written consent to waive the insurer’s subrogation rights.
4.
Modify the Policy to only Pay the Cost of the Parts and for any Covered Loss and
not for the Total Cost Including Profits?
Underwriters could also modify the insurance policy to pay a different amount of damages for
any losses where the insured has waived subrogation rights. A clause could be included in the
policy that states that for any loss where the insured has waived the insurer’s right of
subrogation, the insurer will only pay the costs not including the third party’s profits built into
the third party’s quote. Effectively, this allows the insured to only pay the wholesale cost of
the damages which would not include any profits.
OK, the situation isn’t good for
Insurers. What options exist?
3.
Require Prior Written Consent to Waive Subrogation on any New Contracts or
Renewed Contracts?
Underwriters could place a clause in their insurance policy that requires prior written consent
with the insurer to waiver the rights of subrogation on any new contract or any contract that
is to be renewed during the policy period. This makes the insured get consent from the
insurer to waive subrogation on any new or renewed contract that is entered. If the insured
does not get prior written consent, the policy will not pay for the loss because there was no
prior written consent to waive the insurer’s subrogation rights.
4.
Modify the Policy to only Pay the Cost of the Parts and for any Covered Loss and
not for the Total Cost Including Profits?
Underwriters could also modify the insurance policy to pay a different amount of damages for
any losses where the insured has waived subrogation rights. A clause could be included in the
policy that states that for any loss where the insured has waived the insurer’s right of
subrogation, the insurer will only pay the costs not including the third party’s profits built into
the third party’s quote. Effectively, this allows the insured to only pay the wholesale cost of
the damages which would not include any profits.
OK, the situation isn’t good for
Insurers. What options exist?
2. Modify the Policy to only Pay the Cost of the Parts and
for any Covered Loss and not for the Total Cost
Including Profits?
Underwriters could also modify the insurance policy to pay a
different amount of damages for any losses where the insured
has waived subrogation rights. A clause could be included in
the policy that states that for any loss where the insured has
waived the insurer’s right of subrogation, the insurer will only
pay the costs not including the third party’s profits built into
the third party’s quote. Effectively, this allows the insured to
only pay the wholesale cost of the damages which would not
include any profits.
OK, the situation isn’t good for
Insurers. What options exist?
1.
Increase the Premium?
Underwriters could increase the premiums of any insured that has agreed
to provide an OEM with a waiver of subrogation. This will guarantee
more upfront profit in exchange for the risk of not being able to pursue
subrogation in the event of a loss. The downside to this is the possible
loss of insured’s that go elsewhere to find insurance.
2.
Get More Information?
Underwriters could require that the potential insured provide the
Underwriter with all contracts that the potential insured has entered into
that have waived subrogation. This will allow underwriters to better
assess the potential exposure that they may have and adjust the
premium and deductible accordingly.