Over the last three years, the Energy Construction market has undergone a drastic change, transitioning firmly out of a very soft market. The previous fifteen years of reductions in insurance premiums and broadening coverage has now made way for restricted and regularly challenged policy coverage, together with increased rates and deductibles/excesses, as the markets seek to alleviate their exposures.
While the full extent of COVID-19 is not yet known, the pandemic and continuing natural catastrophe losses have accelerated the market’s transition. Insurers’ behavior has suggested that conditions will remain in transition into 2021, as the global market assesses the impact on its Energy Construction portfolio. Most insurers are requesting to impose COVID-19/pandemic exclusions, often as a direct result of treaty restrictions and regardless of whether a real exposure is expected.
Insurers began to show a significant change in underwriting appetite and approach during 2020, noticeably evidenced by a more centralised control authority exercised by Global Line of Business Chief Underwriting Officers. Product line underwriters showed more hesitation in agreeing new opportunities without referral to senior management, engineers, or both. This trend of referral has continued into the first quarter of 2021 and it seems clear that losses in 2018/2019 and the beginning of 2020 caused many insurers to evaluate their guidelines on projects and in regions that could be exposed to major perils.
Globally, one of the most noticeable changes was the reduction in active participation and capacity provision in the key regions of Dubai, Miami, Singapore and, for domestic risks, Australia. Even domestic markets previously considered strong, such as in South Africa, Turkey, Germany and Brazil, showed signs of reduced capacity.
There were no new Lloyd’s withdrawals, although the Construction Consortium that represented a viable alternative to the major leaders was heavily affected; while these syndicates still lead risks, they now do so only for small to middle-market projects.
The 2020 reinsurance treaty renewals produced a further shake up in capacity, resulting in global PML capacity reducing to approximately US$3.8-4 billion on a best risk basis. It should be noted that insurers are not using their full capacity for the vast majority of risks; on the contrary, they are only using a percentage of their “best risk” capacity, thereby reducing the global availability by a considerable margin.
In 2020 rates increased on average by 10% to 15% across the Energy sector globally, although higher increases were seen for risks in areas where underwriters have concerns over supply chain and risk management. Deductibles also increased, often by 20% to 30% for the critical areas of technology risks, commissioning and natural perils.
As a result of the transitioning market conditions, insurers are imposing stricter coverage conditions, more aligned with those seen as “standard” for many years rather than the wider/higher sub-limit extensions negotiated in recent years. Each risk is considered on its own merits and pricing is being influenced by type of project and geography.
We are also seeing much reduced line sizes being offered on major projects by some key markets; these insurers are now basing their line sizes on the programme’s Total Insured Values (TIVs) rather than its Probable Maximum Loss (PML). This generally results in much reduced line sizes being offered.
With insurer capacity reducing at the same time as project sizes are increasing, there is potentially a serious problem on the horizon. This is highlighted in the oil, gas and petrochemical sectors, where high project values and high losses are resulting in a cautious approach being generally taken by insurers. This is leading to capacity-driven placements, with a corresponding impact on coverage and premium, and/or first-loss limit placements at MPL or MFL levels which do not incorporate full reinstatement values.
Some of the claims in the LNG sector in particular have resulted from a common set of causes that underwriters are seeing consistently at present. It will therefore be vital for Sponsors/Projects to evidence to the market the specific risk management initiatives that have been initiated to differentiate each risk. There is no doubt that whilst construction premium levels will ultimately plateau, the quest for the perfect cover designed and tailored for each project should be continued. Financing parties who are committing significant funds to projects will continue to insist that the insurance market plays a meaningful part in risk mitigation and protection.
Highlighted by the issues surrounding the events at the Ichthys LNG plant and other process areas of hydrocarbon inclusion plants, the market is focusing heavily on and applying strict conditions to the Passive Fire Protection, particularly on the quality controls on the supply of fire proofing practices. Going forward, we expect this to continue to receive attention, with coverage being provided in accordance with what the markets feel each Sponsor/Project is dealing with this matter.
With all market cycles, changes in terms become a gradual process and to address adverse claims experience, insurers use three main levers: premium levels, deductible levels and coverage. Since the market started to “become less commercial, premiums rates have risen by significant levels, deductibles have increased (depending upon the type of risk) and coverage has been restricted, especially with relevant conditions that insurers feel they are vulnerable to in the event of a claim.
Fundamentally, this means that in respect of Defects cover (i.e. design, faulty workmanship or defects in materials), the emphasis now is on a far stricter approach in terms of providing post-completion risks during the Maintenance, Warranty or Defects Liability period. The widest form of Guarantee Maintenance has and will continue to be very hard to obtain and will only be achieved with information and technical details that shows a compelling and justifiable reason for this level of Maintenance cover.
Of course, most insurers feel that providing Guarantee Maintenance seeks to replace or substitute a Contractors obligation to repair or a manufactures warranty, which is why it has always been selectively provided, more so of course in softer market climates. We feel the same issue applies (and will continue to do so) to coverage in respect of the widest form of Defects (commonly LEG 3 or DE5). Similarly to the Maintenance cover, it will only be achieved when supporting evidence can be provided that this coverage is a justifiable requirement.
When it comes to the Energy Construction sector, large losses are, of course, not unusual; LNG project pipeline defects (Australia), hydro-electric power collapse (Colombia and Georgia), thermal power plant filter failure (Middle East), refinery flood (Middle East) and many others are well documented and certainly caused global insurance markets to take notice of what could happen. Natural Catastrophe events such as earthquakes, hurricanes and typhoons have always existed and are increasing in frequency and severity as climate change affects weather patterns. Official Nat Cat zones are increasing in size (Bangkok is a good example) while flooding and forest fires across several continents have produced hundreds of millions of dollars of damage. Away from natural disasters, 2020 also saw several other high profile/high-value insured loss events in the Energy Construction sector.
To conclude on a more positive note, major insurers in the Construction market such as AIG, Allianz, Axa XL, Axis, Generali, Munich Re, SCOR and Swiss Re have confirmed their continuing commitment to provide coverage and capacity. With continued investment and development in the key sectors of oil and gas, infrastructure, property development and power globally, the capacity from all construction and engineering insurance markets remains critical in facilitating global economic growth.
Furthermore, the Chinese insurance market has emerged as a major player in Construction; this development initially originated from the extensive funding and construction activities of Chinese contractors in many parts of the world, especially in Asia and Africa, although this capacity is greatly reduced where there is no Chinese interest. Conversely however, if a project has Chinese involvement, the capacity that can be obtained from this market can be very significant. The actual amount available varies depending on the project profile but with an overall capacity of around US$1 billion, it’s clear that this is a market that cannot be ignored.
Finally, we not only have new entrants to the Energy Construction market but also existing markets returning to the sector, with capacity now being provided by the likes of Axa XL, Berkshire Hathaway, Castel, Hollard’s Mirabilis and TMHCC.
Michael Venables is Executive Director, Construction at Willis Towers Watson London. Michael.Venables@WillisTowersWatson.com
