Turbine Manufacturer LTSA’s

Turbine Manufacturer LTSA’sTurbine Manufacturer LTSA’s

Hidden Risks…Hidden Risks…

Presented By: Rex Andrews & Associates, Inc.Donato, Minx & Brown, P.C.

M.G. Thomas & Associates, Inc.

What is an LTSA?What is an LTSA?In short, a long-term service agreement (“LTSA”) is In short, a long-term service agreement (“LTSA”) is a contractual agreement between a customer and a contractual agreement between a customer and a manufacturer under which the manufacturer is a manufacturer under which the manufacturer is responsible for operations, maintenance and responsible for operations, maintenance and repairs of the product purchased by the customer repairs of the product purchased by the customer and offered by the manufacturer, for a fee. and offered by the manufacturer, for a fee.

An LTSA is like an insurance policy or extended An LTSA is like an insurance policy or extended warranty on the product purchased.warranty on the product purchased.

How Prevalent are LTSA’s?How Prevalent are LTSA’s?Long-term service agreements - a.k.a. maintenance agreements, Long-term service agreements - a.k.a. maintenance agreements, maintenance service agreements, service contracts, maintenance maintenance service agreements, service contracts, maintenance programs, and various other designations - are gaining favor as a risk programs, and various other designations - are gaining favor as a risk management tool for the growing fleet of installed gas turbines, management tool for the growing fleet of installed gas turbines, especially in the large power generation market. especially in the large power generation market.

Siemens-Westinghouse, for example, expects a 2,070 percent increase in Siemens-Westinghouse, for example, expects a 2,070 percent increase in the number of units covered by long-term service programs, from 10 in the number of units covered by long-term service programs, from 10 in 1998-99 to 217 by 2004. 1998-99 to 217 by 2004.

Power EngineeringPower EngineeringAugust, 2001August, 2001

Who Gains From an LTSA?Who Gains From an LTSA?Benefits of LTSAs for the Turbine Owner:

The Owner knows in advance how much maintenance and parts will cost, The Owner knows in advance how much maintenance and parts will cost, eliminating uncertainty; eliminating uncertainty;

The cost of maintenance can be linked exclusively to the annual The cost of maintenance can be linked exclusively to the annual production level (kWh for power generation plants, cubic meters of gas production level (kWh for power generation plants, cubic meters of gas handled for gas compression stations, etc.); handled for gas compression stations, etc.);

Maximizing production is the common objective of both Owner and Maximizing production is the common objective of both Owner and Manufacturer, and both are recompensed in proportion to the production Manufacturer, and both are recompensed in proportion to the production level; consequently, the plant will be maintained at highest efficiency and level; consequently, the plant will be maintained at highest efficiency and constantly updated technologically, eliminating the risk of obsolescence . . constantly updated technologically, eliminating the risk of obsolescence . . . often the Manufacturer shares risks and rewards with the Owner; . often the Manufacturer shares risks and rewards with the Owner;

The Owner’s personnel are kept constantly informed of new technologies The Owner’s personnel are kept constantly informed of new technologies introduced into the plant and trained about the equipment and its introduced into the plant and trained about the equipment and its operation and maintenance; operation and maintenance;

The Owner is not obliged to keep and manage a spare parts warehouse 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 with the locking up of capital this implies, and the Manufacturer can benefit by sharing its warehouse and inventory with more than one Owner; benefit by sharing its warehouse and inventory with more than one Owner;

The Owner has reassurance that people and parts will be available on The Owner has reassurance that people and parts will be available on relatively short notice for repair and/or service of the machinery. relatively short notice for repair and/or service of the machinery.

Who Gains From an LTSA?Who Gains From an LTSA?Benefits of LTSAs for the Manufacturer

Guaranteed market for repair work and service. Maintenance Guaranteed market for repair work and service. Maintenance and payments are scheduled at regular intervals; and payments are scheduled at regular intervals;

Guaranteed prices that are determined and negotiated by the Guaranteed prices that are determined and negotiated by the Manufacturer; Manufacturer;

Limitation of Liability clauses that protect the Manufacturer for Limitation of Liability clauses that protect the Manufacturer for repair work and services they provide as a part of the LTSA;repair work and services they provide as a part of the LTSA;

Essentially eliminates the competition. The parts must be Essentially eliminates the competition. The parts must be provided by, purchased from and replaced by the Manufacturer;provided by, purchased from and replaced by the Manufacturer;

The parts replaced are the property of the Manufacturer…which The parts replaced are the property of the Manufacturer…which protects the design specs and other features of the parts protects the design specs and other features of the parts making it hard for other companies to produce similar parts. making it hard for other companies to produce similar parts.

This is all good news for This is all good news for Insurers, right?Insurers, right?

Not necessarily…the bad news Not necessarily…the bad news arrives when a claim occurs.arrives when a claim occurs.

LTSA – Problems for InsurersLTSA – Problems for Insurers

Issue #1: The Agreement is Secret!Issue #1: The Agreement is Secret!The disclosing Party shall indemnify and hold the nondisclosing Party harmless for 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 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 improper disclosure to third parties or improper use of Seller's Confidential Information. Information.

Any unauthorized disclosure of Confidential Information or other violation of the 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 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 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 Contract are inadequate and that the non-breaching Party is entitled to appropriate equitable relief (including without limitation, injunctive relief or specific equitable relief (including without limitation, injunctive relief or specific performance) for any breach of such provisions. performance) for any breach of such provisions.

Disclosure of LTSA details (to Insurers or Adjusters) can Disclosure of LTSA details (to Insurers or Adjusters) can be problematic for the Assured.be problematic for the Assured.

More Problems…More Problems…

Issue #2: Any Damaged Parts Are the Property of Issue #2: Any Damaged Parts Are the Property of the Manufacturer!the Manufacturer!When the Program Parts and Miscellaneous Hardware are replaced, the 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 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 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, title thereto.” These parts include items down to the pins, springs, studs, gaskets, tie wires, fasteners, screws, washers, nuts and bolts.gaskets, tie wires, fasteners, screws, washers, nuts and bolts.

The OEM “performs” a Root Cause Analysis on Failed PartsThe OEM “performs” a Root Cause Analysis on Failed Parts

Is anIs an Independent Root Cause analysis necessary? Independent Root Cause analysis necessary?

RCA’s are essentially impossible without access to the broken part.RCA’s are essentially impossible without access to the broken part.

What if the problem is the What if the problem is the Manufacturer’s Fault?Manufacturer’s Fault?

Issue #3: Limitation of Manufacturer’s LiabilityIssue #3: Limitation of Manufacturer’s Liability

The LTSA limits the Owner’s causes of action against the Manufacturer The LTSA limits the Owner’s causes of action against the Manufacturer and also limits the amount of recoverable damages that the Owner can and also limits the amount of recoverable damages that the Owner can recover from the Manufacturer. The provision states that the recover from the Manufacturer. The provision states that the Manufacturer will not be liable under any theory of recovery, whether Manufacturer will not be liable under any theory of recovery, whether based in contract, in tort, under warranty or otherwise. based in contract, in tort, under warranty or otherwise.

The LTSA also restricts recoverable damages and excludes any recovery The LTSA also restricts recoverable damages and excludes any recovery for any “indirect, special, incidental or consequential loss or damage . . . for any “indirect, special, incidental or consequential loss or damage . . . damage or loss to property or equipment.”damage or loss to property or equipment.”

Was a Waiver of Subrogation Insurers’ Intent?Was a Waiver of Subrogation Insurers’ Intent?

What if the problem is the What if the problem is the Manufacturer’s Fault? – Part 2Manufacturer’s Fault? – Part 2

Issue #4: LTSA Insurance RequirementsIssue #4: LTSA Insurance RequirementsThe Owner is required to maintain property damage insurance, The Owner is required to maintain property damage insurance, commercial general liability insurance, umbrella excess liability coverage, commercial general liability insurance, umbrella excess liability coverage, workers compensation insurance and business automobile liability workers compensation insurance and business automobile liability insurance. Further, the Owner is required to make its policies primary to 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 any of those maintained by the seller. The Owner is also required to name the Manufacturer as an additional insured on all types of name the Manufacturer as an additional insured on all types of insurance . . . except the property damage policy.insurance . . . except the property damage policy.

Most importantly, Most importantly, allall policies furnished by the Owner “shall include policies furnished by the Owner “shall include waivers of subrogation rights against the Manufacturer.” If the Owner waivers of subrogation rights against the Manufacturer.” If the Owner does not obtain a waiver of subrogation, the Owner is required to does not obtain a waiver of subrogation, the Owner is required to ““defend, indemnify, and hold the Manufacturer and its Affiliates harmless defend, indemnify, and hold the Manufacturer and its Affiliates harmless in and from any claim or proceeding by Buyer’s insurer(s) seeking in and from any claim or proceeding by Buyer’s insurer(s) seeking subrogation which should have been waived.”subrogation which should have been waived.”

Doesn’t the LTSA provide a good Doesn’t the LTSA provide a good deal on Parts and Labor, though?deal on Parts and Labor, though?

Issue #5: LTSA Repair Costs for “Unscheduled Events”Issue #5: LTSA Repair Costs for “Unscheduled Events”

Unscheduled OutageUnscheduled Outage – – If, during the Term, an Unscheduled Outage occurs, then Buyer shall, pursuant to a 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 Change Order, hire Seller to, and Seller shall, supply any additional New Program Parts, Miscellaneous Hardware, Shop Repairs or Services… Parts, Miscellaneous Hardware, Shop Repairs or Services…

(i) Services will be provided at the prices specified in Seller's then current domestic (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) 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 Price List(s) and (ii) Program Parts and Miscellaneous Hardware will be supplied at the prices set forth in the Contract…the prices set forth in the Contract…

Contract pricing benefit is only for “Program Parts”, i.e., normal Contract pricing benefit is only for “Program Parts”, i.e., normal replacement items. Everything else priced per “Price List”…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


3 24000 Hot Gas Path 7,500,000 5,410,000



6 48000 Major 12,000,000 6,080,000

7 56000 Combustion Inspection 1,000,000 6,330,000


9 72000 Hot Gas Path 8,500,000 6,840,000



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.

12 96000 Major 15,000,000 7,700,000

$

Time, Months

Sample LTSA Cash Flow as Planned(Values for Example Only)

0

5

10

15

20

25

30

35

40

45

50

8 16 24 32 40 48 56 64 72 80 88 96

Hours (X 1000)

$ M

illio

nsPaymentCostsNet to OEM

Sample LTSA Cash Flow Failure at 40K(Values for Example Only)

0

5

10

15

20

25

30

35

40

45

50

8 16 24 32 40 48 56 64 72 80 88 96

Hours (X 1000)

$ M

illio


Sample LTSA Cash Flow - Failure at 40K - $12MM Contribution(Values for Example Only)

0

5

10

15

20

25

30

35

40

45

50

8 16 24 32 40 48 56 64 72 80 88 96

Hours (X 1000)

$ M

illio


Set 1

Set 2

Set 1

Set 2

96000

40000 48000 56000 64000 72000 80000 88000 96000

New Set Required

Resultant Outage Schedules for Parts Changeout of Stage 1 Nozzles

8000 16000 24000 32000

Normal Outage Schedules for Parts Changeout of Stage 1 Nozzles

8000 2400016000 32000 40000 48000 72000 80000 8800056000 64000

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 This means Set 1 lost 23,625 hours of the expected 48,000 hours

Lost Life of Set 1 = 23,625 / 48,000 = 49.22%

49.22% of $1,007,782.61 = $496,018

Summarizing the bad news, the Summarizing the bad news, the manufacturer has:manufacturer has:

Capitalized on the owner’s insecurity and uncertainty about the manufacturer’s product by:1.1. “Locking in” a favorable parts/service pricing “Locking in” a favorable parts/service pricing agreement agreement thatthat2. 2. Guarantees the manufacturer’s market and Guarantees the manufacturer’s market and eliminates eliminates his competition, buthis competition, but3. 3. Excludes any “unscheduled” problem from the Excludes any “unscheduled” problem from the favorable favorable price schedule, knowing that Insurers will pay price schedule, knowing that Insurers will pay for this type for this type of event, andof event, and4.4. Guarantees that the manufacturer can’t be held Guarantees that the manufacturer can’t be held liable for his own mistakes.liable for his own mistakes.

OK, the situation isn’t good for OK, the situation isn’t good for Insurers. What options exist?Insurers. What options exist?

1. Get More Information? Underwriters could require that the potential insured provide the Underwriters could require that the potential insured provide the Underwriter with all contracts that the potential insured has Underwriter with all contracts that the potential insured has entered into that have waived subrogation. This will allow entered into that have waived subrogation. This will allow underwriters to better assess the potential exposure that they may underwriters to better assess the potential exposure that they may have and adjust the premium and deductible accordingly.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 Underwriters could also modify the insurance policy to pay a different amount of damages for any losses where the insured has different amount of damages for any losses where the insured has waived subrogation rights. A clause could be included in the policy waived subrogation rights. A clause could be included in the policy that states that for any loss where the insured has waived the 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 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. 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 Effectively, this allows the insured to only pay the wholesale cost of the damages which would not include any profitsthe damages which would not include any profits


3. Tell the potential insured that underwriters will not waive subrogation?

Underwriters could tell the insured that they will not agree to waive Underwriters could tell the insured that they will not agree to waive their subrogation rights on any new contract entered into by the their subrogation rights on any new contract entered into by the insured. If the insured still wishes to still obtain insurance given this insured. If the insured still wishes to still obtain insurance given this fact, then Underwriters can now issue the policy. Under the LTSA, if fact, then Underwriters can now issue the policy. Under the LTSA, if the insured (buyer) does not obtain a waiver of subrogation, the the insured (buyer) does not obtain a waiver of subrogation, the insured (buyer) will be required to “defend, indemnify, and hold insured (buyer) will be required to “defend, indemnify, and hold Seller and its Affiliates harmless in and from any claim or proceeding Seller and its Affiliates harmless in and from any claim or proceeding by Buyer’s insurer(s) seeking subrogation which should have been by Buyer’s insurer(s) seeking subrogation which should have been waived.” Then, the insurer could still pursue subrogation. As a waived.” Then, the insurer could still pursue subrogation. As a result, the insurer would make a claim against the seller (OEM) and 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 the seller (OEM) will go back to the insured (buyer) for defense and indemnification. As a result, the insured (buyer) would then have to indemnification. As a result, the insured (buyer) would then have to submit this claim to their CGL carrier for defense.submit this claim to their CGL carrier for defense.

Extreme MeasuresExtreme Measures4. Increase the Premium?

Underwriters could increase the premiums of any insured that has Underwriters could increase the premiums of any insured that has agreed to provide an OEM with a waiver of subrogation. This will agreed to provide an OEM with a waiver of subrogation. This will guarantee more upfront profit in exchange for the risk of not guarantee more upfront profit in exchange for the risk of not being able to pursue subrogation in the event of a loss. The 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 downside to this is the possible loss of insured’s that go elsewhere to find insurance. 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 Underwriters could place a clause in their insurance policy that requires prior written consent with the insurer to waiver the rights requires prior written consent with the insurer to waiver the rights of subrogation on any new contract or any contract that is to be of subrogation on any new contract or any contract that is to be renewed during the policy period. This makes the insured get renewed during the policy period. This makes the insured get consent from the insurer to waive subrogation on any new or consent from the insurer to waive subrogation on any new or renewed contract that is entered. If the insured does not get prior renewed contract that is entered. If the insured does not get prior written consent, the policy will not pay for the loss because there written consent, the policy will not pay for the loss because there was no prior written consent to waive the insurer’s subrogation was no prior written consent to waive the insurer’s subrogation rights. rights.

DONATO, MINX & BROWN, P.C.ATTORNEYS AT LAW

3200 Southwest Freeway, Suite 2300Houston, Texas 77027-7525

www.donatominxbrown.com

M.G. THOMAS & ASSOCIATES, INC.

Presented by:

Payment SchedulePayment Schedule

Continuing the bad news, by Continuing the bad news, by entering the LTSA, the Owner entering the LTSA, the Owner

has:has:Seriously limited the opportunity for equitable Seriously limited the opportunity for equitable treatment of his Insurers by:treatment of his Insurers by:

1. 1. Engaging a third party who arguably has Engaging a third party who arguably has insurable insurable interest in the turbine, but has no interest in the turbine, but has no responsibility to responsibility to Insurers, whichInsurers, which2. 2. Allows the principle of indemnity to be violated Allows the principle of indemnity to be violated by the by the third party’s direct enrichment in the event third party’s direct enrichment in the event of a of a claim (even when the claim is the responsibility claim (even when the claim is the responsibility of the of the third party), andthird party), and3. 3. Allows the third party to avoid accountability at Allows the third party to avoid accountability at any level any level

Doesn’t the LTSA provide a good deal Doesn’t the LTSA provide a good deal on Parts and Labor, though?on Parts and Labor, though?

Part 2Part 2


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 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 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 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 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 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, the policy will not pay for the loss because there was no prior written consent to waive the insurer’s subrogation rights. 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 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 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 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 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 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 allows the insured to only pay the wholesale cost of the damages which would not include any profits.include any profits.


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 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 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 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 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 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, the policy will not pay for the loss because there was no prior written consent to waive the insurer’s subrogation rights. consent to waive the insurer’s subrogation rights.


Underwriters could also modify the insurance policy to pay a different amount of 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 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 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 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 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 allows the insured to only pay the wholesale cost of the damages which would not include any profits.include any profits.



Underwriters could also modify the insurance policy to Underwriters could also modify the insurance policy to pay a different amount of damages for any losses where pay a different amount of damages for any losses where the insured has waived subrogation rights. A clause the insured has waived subrogation rights. A clause could be included in the policy that states that for any could be included in the policy that states that for any loss where the insured has waived the insurer’s right of loss where the insured has waived the insurer’s right of subrogation, the insurer will only pay the costs not subrogation, the insurer will only pay the costs not including the third party’s profits built into the third including the third party’s profits built into the third party’s quote. Effectively, this allows the insured to party’s quote. Effectively, this allows the insured to only pay the wholesale cost of the damages which only pay the wholesale cost of the damages which would not include any profits.would not include any profits.


1. Increase the Premium?

Underwriters could increase the premiums of any insured that Underwriters could increase the premiums of any insured that has agreed to provide an OEM with a waiver of subrogation. has agreed to provide an OEM with a waiver of subrogation. This will guarantee more upfront profit in exchange for the risk This will guarantee more upfront profit in exchange for the risk of not being able to pursue subrogation in the event of a loss. 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 The downside to this is the possible loss of insured’s that go elsewhere to find insurance. elsewhere to find insurance.

2. Get More Information?

Underwriters could require that the potential insured provide Underwriters could require that the potential insured provide the Underwriter with all contracts that the potential insured has the Underwriter with all contracts that the potential insured has entered into that have waived subrogation. This will allow entered into that have waived subrogation. This will allow underwriters to better assess the potential exposure that they underwriters to better assess the potential exposure that they may have and adjust the premium and deductible accordingly.may have and adjust the premium and deductible accordingly.

Documents

Turbine Manufacturer LTSA’s