While the Upstream market had the good fortune to experience a benign loss year, the same cannot be said for the Downstream market. With rating levels consistently at the bottom of the spectrum for several years now, a difficult situation for insurers has been exacerbated by one of the worst loss years in recent times. No wonder the pressure on underwriters to increase rates in this section of the market is even more intense than for their counterparts in the Upstream market.
Be that as it may however, insurers still find themselves having to work in an environment characterised by an oversupply of capacity, which continues to be as much a fact of life in this market as it is in others in the Energy sector and indeed the wider global insurance market.
So how will market conditions play out as we move further into 2018? Will this be the year that some insurers decide that enough is enough and withdraw from this market, or will the competitive pressures of over-capitalisation continue to ensure that prices remain at the record low levels enjoyed by buyers for at least the last five years?
Notwithstanding the Gulf of Mexico hurricane season and the rising tide of Downstream energy losses around the world, the macroeconomic forces that have been in play since the onset of the global financial crisis continue to feed capital into the insurance and reinsurance markets. As Figure 1 on the previous page shows, any hopes that insurers in the Downstream sector might have entertained of a change in this dynamic at the start of 2018 have generally been dashed. Our chart shows another rise in overall capacity levels, this time to nearly US$7 billion for International markets and a very slight reduction to US$4.1 billion for North American markets.
These figures should, of course, be treated with some caution. They represent only what the insurers themselves state that they can theoretically offer, not what they will actually deploy in practice. So the figure is only useful in terms of measuring the year-on-year change, rather than as a guide to what might be achievable for any given piece of business. What we can say is that if there is more supply available within the market, underwriters’ ambitions for meaningful rate increase are likely to crash up against the harsh economic laws of supply and demand - no matter what the conditions in the market are and no matter what the prospects are for writing this portfolio on a profitable basis.
In Figure 1 we have also provided an estimate of the maximum realistic capacity available, taking into account our own experience of what each individual insurer has actually deployed during the last 12 months. On this basis, we have estimated that our 2017 figures of US$4.5 billion for International markets and US$2.3 billion for North American markets should be maintained this year.
Even these figures, however, should not be viewed by all buyers as necessarily indicative of the programme limit that can be achieved for their own programme. The Downstream market is very regionally diverse and there is no doubt that buyers in some regions are likely to have the advantage of significant local insurance capacity to increase the options available to them. On the other hand, those programmes that have assets featuring a concentration of exposure at a single site, significant natural catastrophe exposures, or a relatively negative risk profile or loss history, will inevitably attract less interest and underwriting capacity than others. In some instances, programme limits of as little as 50% of our stated maximum figure may be a struggle to achieve.
Some buyers who need very high insured limits, and/or need to insure their assets to their full reinstatement value, may purchase additional capacity (at a price) from outside the conventional Downstream insurance market to ensure they have access to sufficient capacity.
Therefore, the amount of capacity actually available to buyers will vary considerably, depending on a variety of factors. However, there is certainly just as much capacity available to buyers as there was last year – something that is likely to frustrate attempts by insurers to raise prices by more than a modest degree during 2018.
Click on the table to expand
The statistics for Figure 2 on the previous page have been collated from our Energy Loss Database as of February of this year and make depressing reading for Downstream insurers. No fewer than 13 losses in excess of US$100 million were recorded for 2017, more than in 2016 (9) and considerably more than in 2015 (3). It can be seen that four were Gulf of Mexico windstorm losses, although Hurricanes Harvey, Irma and Maria (HIM) caused much less damage to the Downstream portfolio than Hurricane Ike in 2008 or Hurricane Katrina in 2005.
Of far greater significance to the Downstream market has been the degree of non-natural catastrophe claims made against the market. We understand that some of these losses (including the major ones listed in Figure 2) have the potential to deteriorate significantly so the final statistics for 2017 may eventually be even worse for the Downstream market than they are at the time of writing.
Furthermore, we understand from market feedback that in the case of at least one of these major losses the overall gross loss total was significantly in excess of the insurance limits purchased. This illustrates the importance of ensuring that asset values are regularly reviewed and updated, and the correct values reflected in the Estimated Maximum Loss (EML) calculation on which an insured limit is likely to be based. (Since the risk engineers who calculate the EMLs are not infallible, it will usually be prudent to allow a margin above the EML when deciding on the limit of coverage to buy.)
If we shift our focus from the major losses to the overall loss picture for the Downstream portfolio (Figure 3 on the previous page), we can see the full impact of the 2017 loss year on this sector of the market. It can be seen that 2017 was the worst overall year for Downstream losses this century, apart from the hurricane-affected years of 2008 (the year of Hurricane Ike) and 2005 (Katrina, Rita, Wilma).
Meanwhile the estimated global premium income for the Downstream sector is still at approximately US$2.1 billion; although not all of the 2017 losses will result in claims to the insurance market, this premium income stream still represents less than 50% of the overall current 2017 loss total.
Given the recent loss record, it is little wonder that the market softening of the last four years or so appears now to have finally bottomed out. Almost without exception, during the January 1 renewal season underwriters were under instruction from senior management not to provide any reductions in rating levels. As a result, notwithstanding any increases in underwriting capacity, modest rate increases were the norm, as well as some limitations on the amount of sub-limited cover available for coverages such as Contingent Business Interruption.
This has generally been a disappointment to most Downstream insurers, as during the last quarter of 2017 several were suggesting that the market turn in 2018 would be more pronounced. However, as reported elsewhere in this Review, the abundance of capacity in the reinsurance market has kept underwriters’ rating ambitions in check and ensured that the upturn in the Downstream market has been modest.
It is difficult to forecast how long underwriters’ rating discipline will last. Experienced market observers can point to similar circumstances in the past where initial underwriting discipline has faltered in the face of competitive pressures brought about by the continued existence of excess underwriting capacity; it remains to be seen whether the pain of recent underwriting losses can strengthen insurers’ determination to hold the line.
At the moment, there is no sign of any other insurer following the lead of Axis some 12 months ago and announcing a withdrawal from the market. Instead, we can report a relatively stable underwriting dynamic in the market, with leadership positions still taken by virtually same insurers as last year and with their capacity augmented by new underwriting teams at Axa and Zurich. These insurers are likely to prefer to build up their portfolio gradually over the next 12 months or so rather than to challenge existing leadership positions during 2018.
During the first quarter of this year we have seen most of the smaller Downstream insurers taking a distinctly cautious approach; most are waiting for the larger more established leaders to show their own underwriting stances. It is likely that following the April 1 renewal season we will be able to determine how the overall market position has changed (if at all) from January.
In the meantime, it has become clear that optimum terms and conditions can only be delivered to buyers in most instances if “vertical marketing” strategies are deployed. Given the choices on offer to most buyers, as well as the variety of underwriting philosophies currently being deployed in the market, the best way for clients to benefit is to distil an optimal blended price from a variety of different markets rather than for brokers to simply obtain ground-up Quota share terms from a recognised leader and persuade other insurers to follow the lead (as would be more common in a classic subscription market such as Upstream). While these separate blocks of cover from insurers tend to have their own set of terms and conditions, there is generally little difference in the actual coverage provided, thereby avoiding the potential headache of a claim that is covered by one part of the programme and not by another.
2018 is also likely to be a year where long term relationships between buyers and insurers will be tested. With most major insurers currently committed to securing improved terms (from their perspective), some buyers are likely to put pressure on brokers to look for alternatives, the objective of course being improved terms from the buyer’s perspective, compared to those on offer from the incumbent leader. At the same time, some insurers are now offering to renew existing Long Term Agreements (LTAs) with a built-in price increase in the second policy year, regardless of risk profile changes or a clean loss record. Perhaps it’s not surprising that to date we are not aware of any buyer who has actually entered into such an arrangement.
We have reported for several years now on the variety of underwriting philosophies adopted by the largest global carriers with regard to underwriting this portfolio from various regional hubs. Now we are finding that, with very few exceptions, any attempt by these major global carriers to maintain consistent underwriting stances across these various regional hubs has to all intents and purposes been abandoned.
Instead, we are finding wide varieties in underwriting approaches from the major hubs, which include Miami, Houston, London, Dubai and Singapore. Indeed, we have seen several renewals recently where terms have been offered by a global carrier from their regional hub office that would have been anathema to their London market counterpart. There can be little doubt that most regional markets tend to offer more competitive terms than the international market, although most major Downstream programmes will almost certainly need the participation of the London market if they are to be completed successfully at optimal terms and conditions.
Furthermore, several significant Downstream insurers that might previously have been labelled “local capacity” have now set up a base in London and/or expanded their remit to write a truly global portfolio. The existing London market will therefore continue to come under pressure, not only from their own regional hub offices but also from regional insurers investing in the London market.
The Downstream market has experienced many twists and turns of the underwriting cycle during the 25 years that we have recorded the data for the chart in Figure 5 above. It can be seen that year-on-year capacity increases have been the norm ever since the tragic 9/11 events of 2001, apart from one year (2012) following the Japanese earthquake and tsunami and Thai floods. This momentarily brought a pause in the injection of fresh capital into the market, but since then the tale has been a simple one – a remorseless increase in capacity that has stifled attempts by Downstream insurers to move rating levels into more profitable territory.
So will it be any different this time? It’s true that the pressure to underwrite to meet increased premium income targets, so typical of a softening market, has eased, at least in the short term. But as underwriters and brokers look around the market, things are still very much the same – no-one has withdrawn, every carrier has mouths to feed.
Nevertheless, some leaders are saying that conditions are now unsustainable, given the rapid deterioration of the loss record in 2017. That may well be the case; however, until more insurers decide, as Axis before them has done, that it is time to withdraw, then it seems that little can be done to stop rating levels continuing to be suppressed – regardless of whether 2018 continues in the same vein as 2017 and produces a similar level of losses.
What will it take to prompt a more widespread market withdrawal? We have asked this question several times in this Review over the last few years, and to date the only answer has been that it will not be underwriting results alone. It is of course possible that another loss year on the scale of 2017 may be enough to convince some insurers that enough is enough, but only time will tell.
In the meantime, we have alluded to how brokers’ expertise in vertical marketing will help buyers find their way to optimum terms in a market where prices are inching upwards, but still depressed by historical standards, and where over-capitalisation is almost bound to keep a lid on significant rating increases and minimise the impact of any individual market withdrawals.
Graham Knight is Head of Downstream Natural Resources and Head of Risk Management & Engineering, P&C, Willis Towers Watson.
