Evaluation of insurance on generation forced outages

Hedging against financial losses of generation forced outages (GFO) with insurance can be an attractive hedge against one of the risks associated with generating unit operation. It is difficult, however, to provide a satisfactory valuation of such insurance contracts with classical financial pricing methods. This is because the distribution of the receipt of GFO insurance is exceedingly asymmetric due to the discrete nature of the outages and the unique characteristics of the electricity market that makes possible the presence of price spikes. This valuation problem is dealt with herein by decomposing the original asymmetric receipt distribution into two approximating normal distributions. Then, using the approximating distributions, a generalized method of evaluating insurance on GFO is presented. Using the technique, a procedure for determining an optimal insurance structure is illustrated.