a swift transition to a truly hard market
2019 saw a retrenchment of available capacity and the creation of deliberately centralised underwriting strategies in the International Power market, as it turned from being a market that had begun to harden from a soft base into a truly hard and challenging business environment from a buyer perspective. Previous losses caused only temporary hardening phases For the last two decades, Power market pricing had been on a softening trajectory year on year, punctuated occasionally with brief periods of hardening, such as the global financial crisis in 2008/9, the natural disasters in New Zealand and Japan in 2011 and the US hurricanes in 2017. However, these losses never entirely changed the Power market dynamic. The resultant hardening phases proved to be temporary and were quickly erased, due to the oversupply of capacity and the global freedom to access it. Apart from these short-term hardening periods, the market had experienced years of double-digit reductions; while this may be sustainable in a loss free environment, the sector has seen year on year deterioration in global losses, often surpassing or equalling the global premium available for the sector (see Figure 1 overleaf). This has left insurers with a dwindling pool of premium to counter loss reserves; while the fluctuations of loss quantum has also increased in that time, the loss development pattern continues to bring more sustained challenges to the Power sector. The hard market has lift-off Market pricing for non-loss making, low catastrophe exposed business therefore accelerated from flat renewals during the last quarter of 2018 to mid-single digit percentage increases by mid-2019; by the end of the year the pace and variance of these rating increases had increased significantly. Insurers were able to close their new business budgets; in some cases, even their renewal portfolios managed to hit and surpass their premium income targets for the year, as a result of the rate increases far surpassing what they had originally projected and agreed with management. Consequently, this provided further encouragement and momentum to the drive to increase rates still further at the beginning of 2020, as the available supply of capacity continued to reduce.
Capacity retrenchment across the market Global capacity for Power business has reduced in two different ways; firstly, some insurers have
withdrawn from the sector entirely (the Hartford syndicate at Lloyd’s being the most recent example) and secondly, we have seen a reduction in the capacity that the remaining insurers are agreeing to deploy. Lloyd’s review prompts syndicate reassessment In line with the Lloyd’s review into the sector, there has been a retrenchment of those syndicates that are able to insure this class. The General Property Lloyd’s syndicates that have previously provided capacity to the Power sector have had their existing capacities largely reduced; in addition, more specialist underwriters that continue to support the sector have also reduced their deployable capacity. The overall global theoretical capacity has always been at a far higher number than the actual “realistically” deployed capacity, and as the Lloyd’s review has pushed this figure lower, London market composite insurer appetite has also tempered the realistic capacity available to buyers.
15% reduction in global capacity at a stroke During the past ten years, an average year would generally see a theoretical global capacity total of approximately US$3.5 billion, with a realistic capacity figure of approximately US$2 billion. Now in 2020, the total global capacity is approximately US$3 billion, with a realistic capacity figure of approximately US$1.5 billion. Insurers such as Axis, Mapfre Re, Neon, Hartford and Argo have closed their Power portfolios entirely in London, following the trend set by Pioneer, Priority and Aviva from previous years.
As can be seen from Figure 2 to the right, the sector continues to have a broad range of losses that are not solely down to risk management failures.
Hydro losses cause concern In particular, the hydroelectric loss record has caused insurer concerns (see Figure 3 to the left). Hydroelectric power projects have been in the spotlight due to large claims, which have come both in the construction and operational phases with natural catastrophe perils being the common denominator. The locations and landscape for a large proportion of these projects has high catastrophe risk exposure, so the importance of structural integrity, stability, maintenance and inspection regimes, as well as adhering to international codes and protocols, are critical to insurers. Insurers’ willingness to deploy their natural catastrophe aggregates on hydroelectric plants in high risk catastrophe territories has reduced significantly, with carriers preferring to use these aggregates for risks they deem less volatile.
Machinery Breakdown losses While not unaffected by natural catastrophe perils, a major risk for gas turbines in particular and the associated power trains is Machinery Breakdown (see Figure 4 above). Generally speaking, for gas turbines there are fewer vertical losses from natural catastrophe perils, but attritional losses have significantly concerned insurers over the years. The variety of the root causes for these losses has produced significant technical and underwriting challenges for insurers; the technology suppliers are of considerable importance and much attention is paid to contracts in place between buyers and their suppliers, including factors such as shared sparing or onsite sparings. The increase in the turbine MW unit size now available, together with the unproven nature of certain technologies or technologies with known fleet issues, has seen a restriction in cover and higher deductibles required. Capacity will also be further restricted for technologies with known issues where OEM recommended upgrades/Technical Information Letters (TILSs) have not been acted upon.
Lloyd’s Incurred Ratios tell their own story The reduction in available capacity for the sector and the continued volatility of the loss record across all the occupancies has amplified scrutiny on insurers supporting the sector.
The statistics for Figure 5 above come from Lloyd’s of London and show overall Incurred Ratios (i.e. received premiums versus paid and outstanding claims) for the Power Gen portfolio. As most readers will quickly deduce, an Incurred Ratio in excess of 100% (and probably in excess of 80%) guarantees portfolio unprofitability; however, due to the reduced premium income pool and the gradual escalation of operating costs, we now think that any Incurred Ratio within the shaded area of the chart (50-80%) is also likely to produce an overall underwriting loss. From this chart we can see that while the 2015 and 2016 ratios are just underneath the shaded area, the ratios for both 2017 and 2018 strongly suggest overall portfolio unprofitability. Furthermore, although the ratio for 2019 currently sits below the shaded area, history suggests that the final 2019 ratio will almost certainly be excess of 50%. History suggests an unprofitable portfolio for several years Indeed, the percentage loss ratios for the majority of the lead insurers has been consistently in excess of 50% for the last decade, and during the soft market these high ratios were often due to the continual downward rating levels. With the rates annually falling anywhere from 10-20% up to 2018, albeit the brief periods of hardening, with average global annual losses being approximately US$2.5 billion, we can conclude that the global premium for the Power sector has been below the average annual loss amount for some time (see Figure 1 shown previously in this article). This has simply made it unsustainable for carriers to continue the downward curve on rating and to continue insuring the class. Moving further into 2020, insurers are therefore under less pressure to insure all the business presented to them and are more selective than when there was a premium push in the soft cycle environment.
The sector has, as discussed in the introduction, hit a hard cycle after years of downward pressure. Below is a summary quarter by quarter where rating expectancy has been on loss free business:
Centralisation of underwriting authority As we discussed in the 2019 Review, last year there was a push by insurers to synergise their offering globally in the sector. This has become more evident in recent months, with Power leaders becoming more consistent in their underwriting philosophy across their global offices. AIG has multi-tier approval levels set in place, while Zurich has a committee to review referrals from their global hubs, with the message shared and analysed between the various committees. Liberty has closed their US Power portfolio in the region and responsibility now sits solely in London, as it does for the MENA region. In previous years there has been a fragmented approach from insurers in different global hubs; while this didn’t exactly duplicate available capacity, it has previously led to differing products being available due to the simple geometrics of a market dynamic and was endemic of a soft market cycle. The requirement for underwriters based in local hubs to be responsible for insuring the risks in their territory has reduced; in certain cases, these hubs have been closed to limit these insurers to one point of contact for the sector. Review of coverages and contracts During the soft market, terms and conditions remained relatively stable. A notable development, first evident towards the end of 2019 and at the start of 2020, has been the changes to the coverages offered by the market. Sub-limits and extensions are being reviewed more carefully and reduced or removed where they are considered too high or where insufficient underwriting information has been provided to support previous levels. It is therefore recommended that buyers carry out a review of key sub-limit levels ahead of renewal to ensure a better understanding of their actual needs. Data protection coverages have reduced, with Lloyd’s introducing the LMA 5401 (a total cyber exclusion) and a general restriction from the wider market of writebacks such as Machinery Breakdown on the NMA 2915 clause. There is an overall increased desire from lead markets for claims authority, with Claims Control clauses being demanded as opposed to the Claims Co-Operation clauses more often accepted during the softer part of the market cycle. With regards to contracts, with a number of claims arising from avoidable man-made losses, more prevalence is given to the other third-party contracts, for example the contracts in place with original equipment manufacturers. Insurers are scrutinizing and requesting details of any onward agreements in place between the Insured and the manufacturer, with particular focus on warranties and indemnity levels. In certain instances, they are restricting the cover for third parties to onsite activities only and challenging ‘subrogation waivers’. Business Interruption waiting periods Business Interruption coverage has always been a perilous component for insurers, with large portions of claims submitted arising from this exposure. Whilst the demand for the full split of values and the associated data is relatively unchanged, for buyers with more complex revenue streams (including exposure to spot market fluctuations) there has been a demand from insurers to increase the waiting period deductible where information is insufficient or to limit the daily amount or amount per MWh of lost generation that a buyer can claim. Machinery Breakdown retentions For self-insured retentions, Machinery Breakdown retentions remain relatively consistent compared to previous years, but all-risk and natural catastrophe deductibles have begun to be more scrutinised. Historically, increases in Machinery Breakdown retentions have mainly been due to the increase in MW output of the units being produced, prototypical units being produced and/or if there are any defects associated with the unit or fleet. However, natural catastrophe (nat cat) deductibles, which are often a percentage of declared values with a financial minimum and maximum, have seen both these minimum and maximum amounts increase. The all-risk retentions for non-nat cat or main plant equipment Machinery Breakdown that were previously available to buyers are now also being increased. More selective underwriting Considering the increased rating levels evident in the sector, insurers have been able to be more selective in the risk exposure of their individual portfolios. Diverse multilocation portfolios will be analysed based on the catastrophe exposure and a given buyer’s variance in occupancy. There has been a reduction in the overall capacity available to write risks spread over multi-locations, geographically in high nat cat exposed territories, as insurers can achieve better return from less exposed risks. Insurers continue to insure assets located in heavily nat-cat exposed territories, but their preference will be to do it on an individual site basis and/or where buyers have significant self-insured retentions and/or limitations on nat cat coverage. Greater modelling by buyers of their portfolio’s for nat cat exposure is recommended to ensure a better understanding of exposures and limits required and to support renewal negotiations. Less appetite for complex risks With regards to diverse portfolios, the market’s appetite for the more complex risks has decreased accordingly. Buyers that have a portfolio of differing power plants, for example hydroelectric plants, coal fired plants, combined cycle gas turbines and power barges, will have access only to a more restricted pool of insurers. This will also apply to a diverse portfolio of manufacturers utilised by a given buyer, as insurers tighten down on their risk volatility. The coverage of operations such as Transmission and Distribution, which has in the main had a standard market limitation in place of one thousand meters from the generating site, will also be more heavily scrutinised for those buyers that have extended cover for this risk.
Hardening trend to continue through 2020 With further global economic pressures apparent, especially from COVID-19, the reality is that the hardening market is set to continue for the remainder of 2020. While the back end of 2019 saw insurers expose the lack of capacity available due to their closing portfolios early by increasing rates exponentially, going forward there should be a more consistent market ‘norm’. Anticipated rate increases will have been mainly set through the January 1 treaty renewals and the extent to which increased reinsurance costs are passed on to the direct buyer. Double digit rate increases will continue as a starting point on loss free, well risk managed business; coverages currently in place will receive further scrutiny than in 2019, and third-party agreements with original manufacturers will also come under the spotlight.
Buyers to focus on lender agreements Furthermore, buyers need to revisit agreements in place with lenders and the extent of the minimal requirements they have in place; for example, they should know which limits are ‘nice to have’ and which are non-negotiable. When entering into contracts with third party suppliers, buyers need to engage with their insurers to obtain agreement in advance of entering into any agreements to enable a seamless process.
It should also be noted that while the global Power market has hardened and underwriters will scrutinize risks still further, there still is a strong pool of insurers underwriting the sector who continue to support the industry and the clients within it. That being said, perhaps the most important piece of advice we can give buyers at the moment is that you should work very closely in partnership with your risk intermediary to ensure you are driving an optimum risk management strategy. That means not only working with your broking team to enable them to negotiate optimum terms in the market, but also to engage with your risk intermediary’s risk engineers, forensic accountants and analytics experts to ensure that every dimension of your strategy has been worked through thoroughly in advance of any negotiations with the market. Furthermore, it is hugely important for buyers and their brokers to engage with their insurers as early as possible regarding the placement of their Power risk and provide risk management protocols and up to date underwriting information such as survey reports and detailed Business Interruption breakdowns. In these challenging conditions, we think that buyers should also think very carefully about which market relationships they value as we think a relentless focus on price above any other factor may run the risk of backfiring – especially if a loss is incurred. This means engaging early in the entire process. Especially under these unprecedented conditions, everything is going to take a lot longer than in previous years. We suggest that buyers use this time to develop more detailed underwriting submissions, ensuring that accurate values both for physical assets and business interruption are presented to insurers. And finally, the work to maintain a healthy, optimal risk transfer program should really continue all the year round. Keep in touch with your broker and ensure that the market is kept abreast of all significant developments within your organisation. Only in this way will buyers offset the worst effects of the current hardening market conditions.
Ed Cooper is an Executive Director, Natural Resources, Willis Towers Watson London. ed.cooper@WillisTowersWatson.com
Michael Buckle is Head of Downstream, Natural Resources, Willis Towers Watson London. michael.buckle@WillisTowersWatson.com
