Conditions in the Energy Liability insurance markets all around the globe are suddenly the toughest for decades from a buyer’s perspective. With capacity in short supply, and awards going through the roof, buyers and their brokers face many challenges ahead to secure appropriate coverage at a realistic price. Willis Towers Watson’s Michael Newsom Davis (MN-D) and Jo Stroud (JS) recently met with one of the most respected leading specialist Liability underwriters in London, Zurich’s Ben Kinder (BK), to gain a more detailed insight into underwriters’ mindset at a time when the industry’s Liability risk landscape is in a state of flux.
MN-D Ben, let me start by asking you why you think the Liability market capacity is contracting quite so rapidly in 2020?
BK From my perspective I don’t think it’s contracting too rapidly - we still see significant capacity in the marketplace, but what we are now witnessing is underwriters being held accountable for the capacity that they have. They are having to fight harder for the capacity provided by their management, who will allocate that capital where they feel they are going to get the best return to enable them to hit their long-term strategic targets. Historically the Liability market hasn’t been good at selling the long-term capital returns that they provide internally, and managers tend to view long tail liability as capital intensive and capital eroding over a long-term period. So in general terms they have been moving their capital away from long tail business to other lines that are hardening at a quicker rate and can give better returns on capital in a shorter amount of time.
JS What’s different this time about today’s hardening insurance market? We’ve had spikes before, most notably after 9/11.
BK I see that this hard market is very different. Comparing the current situation to hard markets from previous eras, this one has not been the result of a huge catastrophic event. Leading into 9/11 we had rumblings of hardening; the Independent had gone bust, facultative reinsurance had dried up, but the trigger was the huge withdrawal of capital off the balance sheets of the big insurers where they were having to conduct share calls to prop up their balance sheets; the big insurers were just shutting their doors trying to work out exactly what was going on. Previously, following catastrophes such as Piper Alpha in 1988, underwriters often didn’t know what their aggregates were, which resulted in a shrinkage of capacity; this time it’s a death by a thousand cuts. No one has had their legs chopped off; rates have just been shaved again and again. We are now seeing a correction and a need to gradually rebuild capital because so many people have emptied the Incurred But Not Reported (IBNR) pool; I think IBNR has been masking the true situation for too long, so there will be no more raiding the savings accounts to mask the results. Meanwhile there has been significant social inflation around the world; we are now in a world where claims are inflating at around 9%, so we can’t stand still.
MN-D We have seen London-based insurers leading the charge on terms but there has been a bit of a disconnect with local markets in the past – do you see the dynamic changing, so that some of the regional markets begin to harden as well?
BK I can only comment on Zurich’s perspective here, as other insurers work very differently. We do have a global energy casualty strategy - we allow our customers to access the Zurich network, wherever they are located, and we will give them all the same price for the same product, the same proposition - at least, as much as possible. In a softer market place, you see the way in which companies conduct themselves is much more decentralised; when they are looking for growth, they are pushing empowerment out to all the offices and it is very hard to control that. In a hardening market you tend to see a recentralisation; we need to bring it back to the skill sets and only empower those people who we think can implement the strategy.
JS Are there any lines of business which are coming under particular scrutiny?
BK We are seeing a significant shift in litigation in a number of Liability lines where management are looking back and realising that these lines have never actually delivered any significant returns to the business. It’s coming to an epiphany whereby they are thinking: can we turn this around, is this a viable product we can go forward with to the market? In areas such as Directors & Officers (D&O) and Professional Indemnity (PI), the legal environment is changing very significantly and insurers can’t change the product swiftly enough to respond. The Liability portfolio is sitting at the very precipice of that and there’s still a lot more to come in terms of changing legislation.
MN-D In these more challenging market conditions from a buyer’s perspective, how will specialist Energy Liability insurers like you differentiate your client base?
BK For my team, the biggest focus now is on customer buying behaviours. What we have found for a long time is that some customers have been very transactional, tendering every year; their brokers have not been trying to differentiate their product, they have tended to just walk into the market and obtain the cheapest price. Those clients who have used us to pick up their additional losses, to take all their risk off the balance sheet and to push for low deductibles - they are really going to struggle to access capacity in this market because firstly, they have used the insurance market to prop up their lack of maintenance and secondly, their balance sheets have failed to look after their assets. In my view, those customers are now in trouble; we will walk away from customers who think our capital is cheaper to use than their own. In contrast, there are customers that have bought sophisticated products to protect their balance sheet, who haven’t looked to us to subsidize maintenance cost, who haven’t been willing to let their assets go into a poor state of repair and who haven’t compromised on the quality of metal they use in their well casings or the quality of their contractors. Those customers are going to be fine.
JS Turning to the issue of climate risk and sustainability, do you think the insurance industry should be helping clients move more towards more sustainable business models?
BK I think sustainability is becoming a massive factor, particularly on Energy and Casualty lines. But on this issue, there’s also a very important message to put out - at Zurich, we are not going to stop providing insurance to fossil fuel companies. Furthermore, we can’t expect coal-fired power stations to suddenly stop being who they are – we can’t turn around and say we won’t insure you anymore. Because if they want to convert that power station to the biomass or a gas fired station that is going to cost them money; they are going to need to go to the banking markets to find it and they are going to need insurance to cover it while that process is going on. That again goes back to behaviours. What we have said is that if a company falls into one of these categories over the next two years, we want to engage with you and share our knowledge within our risk engineering team with you - we want to understand how we can help you achieve your ESG targets. I think the insurance industry as a whole has a massive part to play in this; we have significant data, we have property and risk engineering skills, and that is the sort of offering we should be bringing to clients to help them achieve these goals. We are very strong around that engagement piece; we have shared data, analytics and technology to support these industries in achieving their targets. We developed this approach in a softening market; now the market is changing, and we have seen another group of significant insurers taking the same position; so the pressure on buyers is only going to increase. Meanwhile we are seeing increased climate change litigation so we need to be in a situation where we can defend how we are transacting business with these clients, how we are enabling them to meet their long term ESG targets. That’s where companies such as Zurich can differentiate ourselves from the General Liability providers.
MN-D What other ways do you see the insurance industry adding value in terms of managing climate risk?
BK Well, here in the UK the Bank of England has now built climate change into capital stress testing. They are looking at financial institutions in the city and saying: if you are investing in XYZ infrastructure, how are you differentiating that infrastructure around what we call stranded asset exposure? To illustrate, if a bank lends 25 billion dollars to an energy company to build the biggest coal-fired power station in the world, and then the legislation changes in three years’ time and coal-fired power stations are banned, the bank is left with a stranded asset - it’s worth zero. And the bank has a debt on their balance sheet to the tune of 25 billion dollars; that’s enough to potentially bring down a significant financial institution. The reason why the financial institutions are doing this is they cannot risk a suite of debt on their portfolio that is highly exposed to stranded assets – especially after the 2008 crisis. That’s why they are careful about what they are lending and who they are lending to. So those companies that need to transition to more sustainable sources, cleaner fuel and output along the whole ESG journey are going to require investment; they are going to need to go to the banking markets and insurance markets and will require finance, liquidity and insurance.
JS In what other ways are specialist Energy Liability carriers such as Zurich differentiating themselves from other Liability carriers?
BK Over the course of the previous ten years, risk analysis and selection had become ignored and eroded, together with exposure analyses; underwriting had just become a process of churning quotes across the desk. The General Liability teams generally consist of underwriters; they don’t include specialist risk engineers, so I think that those teams don’t have the breadth of knowledge to really differentiate on risk selection, whereas Zurich has a large team of risk engineers who have worked in the industry for 20-30 years and sit within the underwriting teams. And if an enquiry comes in on an energy risk in these new market conditions, the first question we ask our engineers is quite simple: would you work for this company? Would you want to work in one of their refineries? If they say no, we won’t quote it. But if instead the engineers think it’s a decent company, that’s when we take the process further.
MN-D Do you think the product that the Liability market has offered during the last ten years or so is now in need of modification?
BK In some cases, the product been used was written 20 or more years ago when the legal environment was a very different place. The litigation, legal and business environment has changed and the shareholder pressure that our clients are under has shifted dramatically. So we have to improve the product to meet the needs of our clients.
Furthermore, customers have been willing to sign contracts that impose significant liabilities on their business, because they know they have full contractual liability within their policy wording that will back up the contracts that they are signing. Over the years you have seen this - Liability insurers have become the dumping ground for customers who can’t find any other home for the cover. Now we are seeing even more of this with the Downstream Property market hardening. For example, a customer might want to cover their product in a particular tank or other receptacle. Now that’s Care Custody & Control coverage, but because the Downstream Property market has hardened, they might want to attempt to insure their product under their Liability programme. If this was presented to us, we would simply walk over to our Downstream Property colleagues and say: this is the sum insured, the amount of product in the tank, so how much would you charge for that? But curiously, as soon as we say we’ve talked to our Downstream Property colleagues, that demand suddenly disappears.
Similarly, what we saw after the Deepwater Horizon tragedy in 2010 was customers trying to blur the lines between Operators Extra Expense (OEE) coverage and Sudden & Accidental (S&A) pollution. The clients did not want to buy the OEE limits they really needed to buy, and they thought that if they could blur the lines, they could use both lines of cover. But that just won’t work in this market. What we have been quite good at has been to say: this is our product – we know what it is, what it does and doesn’t do, and we are not going to blur the lines any more.
JS Finally Ben, in light of the new market dynamics now in play, what advice would you give clients in terms of optimising their Liability programme terms and conditions?
BK Let me put it this way: if you go to the dentist once a year, that doesn’t guarantee that you will have the best set of teeth – we all know we need to maintain our teeth throughout the year! A client that just comes to the market once a year is not going to have the best experience. What we want are professional customers who engage with the market regularly and update us properly with what is going on in their business. Some brokers come in to us with a lame story: “it’s the same risk as last year”. Now if I was a shareholder of that company, and I went to the CEO to ask what had happened to the company over the last 12 months, only to be told by the CEO that “nothing has changed”, I would want to know why - it just doesn’t sound right. A $20 billion energy company, and we are being told that the exposure is exactly the same? We need more visibility from the company on a regular basis. Customers such as these should understand that insurers’ main focus at the moment is risk quality information. They need to be transparent about the risk and to differentiate themselves from their peers. Underwriting is a professional skill and underwriters need to fully understand a client’s exposures. We can then provide our capacity based on that, especially for those wanting to but the bigger limits. The danger has been certain clients who have produced a lack of information and who then wanted and/or demanded certain coverages; this will no longer be accepted by insurers. These customers must also realise that this process is not a one-day transaction - if you look at the way these same companies deal with the capital markets, they have monthly meetings with their bankers, they have quarterly capital market days, because these people lend them money. We are putting our capital at risk – I appreciate that in the first instance we get to keep our capital, we don’t give it to them initially. But we are still risking our capital, just as the capital markets are, and we get treated very differently. In contrast, for customers that have been with us for a long period of time, we will show where we think their exposure has gone, where their premium has gone and where their claims have gone, using the data that we have compiled. We will overlay that and highlight the gap that has been created which we have to close.
MN-D Ben, many thanks indeed for your time.
Ben Kinder is Global Head of Energy Casualty at Zurich Insurance Company Ltd.
Mike Newsom-Davis is Head of Liability, Natural Resources at Willis Towers Watson London.
Jo Stroud is Head of Energy Liability at Willis Towers Watson London.
