the effect on the Power insurance market
The previous two articles have described very clearly why, throughout 2019, global headlines have been dominated by climate change and how this has driven the growing focus on ESG by major investment funds. The global power sector is in the eye of this storm, with many major portfolio generators and investors having for some years been responding, at varying rates and levels of success, to the increasing reality of the physical, transition and liability risks outlined earlier. But now in 2020, the eyes of the world were diverted to a completely unprecedented and unprepared for disaster, COVID -19, that in a matter of weeks has brought a devastating socio-economic impact on a global scale, the shockwaves of which will be felt by individuals, businesses and economies for years to come. Despite COVID-19, climate change risk still paramount However, this is not expected to deviate spending away from climate change initiatives. On the contrary, the pandemic has highlighted to the world the huge and very real impact that man-made disasters can have on our planet and its communities, as well as the need to take action now to mitigate future damage. Economic stimulus packages being put in place now, to regenerate economies in the virus’ wake, are likely therefore to reinforce the importance of sustainable investment strategies as economies and investors continue to pursue the greater growth opportunities presented by companies that are investing in solving what continues to be the world’s greatest challenge. The insurance industry is also having to not only live with the consequences of the changing climate but also develop future strategies for operating in an ever-changing environment.
Swiss Re’s 2020 Sigma analysis of global losses since 1970 demonstrates the steady rise over time in the frequency and severity of catastrophe losses over this period1. The classification of ‘catastrophe’ is generally accepted across the insurance industry as one that exceeds US$25 million and impacts a certain number of policy holders. Over the past 20 years the increasing number and size of the losses has led to the financial threshold being increased from US$5 million to US$25 million. The study identifies natural and man-made catastrophes and further splits the natural events between earthquake/tsunamis and weather-related events. The contrast between weather related and other losses is stark, as evidenced by Figure 1 to the right.
Mega-losses and the rise in ‘Secondary Perils’ In terms of their value, there has also been a notable increase in the frequency of “mega-catastrophes” which run to the billions of dollars. 8 out of the 10 most destructive losses in US history (on a cost adjusted basis) have occurred within the last 20 years and 10 have occurred since Hurricane Andrew in 1992, with losses ranging from US$9-12 billion for Hurricane Michael in 2018 to US$53 billion for Hurricane Katrina in 2005. Swiss Re also noted in their 2020/2 Sigma study that losses associated with “Secondary” (nat cat) perils have been rising. Secondary perils are the secondary effects of a primary peril such as heavy rainfall and flood following a monsoon, a tsunami following an earthquake, or wildfires. Over the past three years, such events have been increasing in impact and have made up the majority of each year’s total insured losses, something they expect to continue to see on the increase. Munich Re’s analysis of natural catastrophe events over the period 1980 to 2018 found similar trends in causes2. While earthquake frequencies have remained relatively flat at approximately 50 per year, hydrological and meteorological events have risen steadily from around 100 per year to between 300 to 400. The total of global natural catastrophe events has increased from approximately 250 per year to 820 in 2018 (see Figure 2 right).
Prevalence of losses in built-up areas Another feature of the insured losses that insurers are focused on is that they arise in built up urbanized areas where there are heavy concentrations of people and assets. In the case of the US and Asia where most of the climate related losses occur, these urban locations are often coastal and in the path of storms or related events. This build up has been accelerating, as people are increasingly drawn away from more remote rural areas by the economic growth and greater opportunities offered by the cities. The 2018 Revision of World Urbanization Prospects estimated that between 2050 and 2018 the proportion of the globe’s population living in urban areas increased from 751m to 4.2bn (55%). By 2050, this is expected to increase to 68% which, together with population growth, could add a further 2.5bn3.
However, the impact is felt not only in terms of increases in concentration of values but also in terms of the urban sprawl that follows onto flood plains or onto the more exposed land not previously used. Change of land use from clearance of woodland to agricultural often exacerbates the issues, with greater and faster run-off of heavy rainfall into inadequate infrastructure.
Power sector natural catastrophe loss experience Whilst there has been high profile weather related mega-losses that have impacted the Power market, a number of the standout events been:
These losses have been substantially uninsured. So, while there have been catastrophic operational Power sector losses running to hundreds of millions of dollars from windstorm and earthquake events, the performance of the global Power underwriting portfolio has been more substantially driven by “man-made” and technology related losses rather than weather-related losses - contrary to the overall global insurance market experience. In view of the nature of the sector’s loss experience, the Power market’s underwriting focus therefore predominantly remains on the quality of the engineering risk.
Notwithstanding the above, the rising influence of ESG, together with the combination of the global insurance industry loss data and the significant body of ‘climate change’ evidence that has built up against the thermal generation sector, has led insurers and investors to have to view the Power portfolio through a different lens. This has led to the question increasingly being asked: why would the very insurers paying these claims continue to support businesses that actually increase the risk of future climate-related losses? Preliminary focus is on coal as withdrawals increase Bearing this issue in mind, as well as the glare of investor and climate activist attention, many insurers have considered their position in relation to fossil fuel power stations over the past three years. At this stage the focus has been firmly on coal, the largest polluter both in terms of air quality and global warming CO2 emissions. As a result, the momentum to retreat from coal has continued to build; what started as a trickle in 2017 with the Axa, SCOR and Zurich withdrawals, has now turned into a much more consistent retreat, with as many insurers declaring their intention to withdraw in 2019 as in the previous two years combined. Chubb and Axis join European insurers Of particular significance in 2019 was the withdrawal of two major US insurers, Chubb and Axis, who were key markets for the sector. Although in Axis’s case they took a broader view and withdrew from the thermal power sector as a whole rather than specifically coal, it does set a precedent and the hope among lobbyists is that they will serve to put pressure on other US insurers to follow suit. Equally notable is the continued absence from the market of Asian insurers, particularly any of the key Chinese insurers such as PICC, CPIC and PingAn. Withdrawal more gradual than it appears A closer study of the most up to date statements from insurers who have clear exit strategies shows a slightly more gradual withdrawal than may be immediately apparent from press headlines. All 18 are still writing business for existing clients, subject to varying conditions and end dates. It is clear though that for those that are more heavily dependent on coal the restrictions will already be biting and for the rest this is little more than temporary respite, unless they have a clear plan to reduce dependency on coal. In Figure 3 on the previous page we outline the current position taken by the major insurers in the Power market, according to releases on their own company websites. Premium volume considerations not the issue A review of these latest insurer statements makes clear that, for those that have a more staggered position between the commencement of restrictions and the final exit dates, insurers are not driven by a reluctance to lose revenue. Most of the insurers have clarified that the premium volume derived from the sector as a proportion of their overall portfolio is not something that would in itself prevent them from exiting sooner.
However, there is a recognition that the transition from coal is not something that can be done easily; having been close partners of many of their Insureds for a number of years, part of these insurers’ obligation is to play an active part in encouraging and helping these companies through the technical challenges of the transition period. Regional awareness and understanding limits withdrawal momentum There is also a very clear awareness and sympathy for the greater challenges faced by buyers in certain regions of the world, where socio-economic factors and the reality of local circumstances mean that transition from coal may simply not be a reality over the medium or even longer term. It is this dynamic that is also delaying many other insurers who have not yet taken a firmer stance; while this would appear to be substantially at odds with their respective governments’ commitments under the Paris Agreement, they have at least all committed to withdrawing capacity for new coal power construction. The insurance market therefore continues to struggle to find the right balance between their own ESG commitments and helping governments to deliver on their decarbonization commitments, while ensuring a reliable and affordable energy supply.
For those insurers remaining in the Power market, the challenge remains around returning to a more sustainable and profitable underwriting environment in which the portfolio can be returned to profitability. While driving the majority of the losses, the risks arising from engineering/technology related losses are those that insurers are better placed to manage, through the combination of their own engineering-based expertise, rating corrections and coverage adjustments that have become a feature of the current market conditions. Past experience will be no guide for the future However, the climate-related exposure is one that, for all the reasons discussed in the earlier sections, is a significantly harder one to forecast; with a complex and constantly changing climate and population risk landscape, past experience cannot be taken as an indication of what is to come. More sophisticated ‘Cat’ modelling techniques, fed by better quality weather and climate change data, will therefore be essential for insurers to develop the confidence they need in their rating strategy to be able to continue to offer cover to the levels that will be needed. Good quality information will be critical as models improve In an increasingly uncertain world, good quality information will be key to successful outcomes for insurers and buyers alike. More sophisticated modelling not only gives insurers the ability to predict the frequency and severity of future events more accurately but will also enable them to feed in risk management features of insured locations, including that which is site-specific, as well as overall regional nat cat protection. It is also important for buyers to work with their risk advisors to be able to run their own models, which will inform their risk management spend, minimize losses and ultimately, through lower costs and enhanced coverage, lower their total cost of risk.
Carlos Wilkinson is GB Head of Power, Natural Resources, Willis Towers Watson London. carlos.wilkinson@WillisTowersWatson.com
1 All statistics for this section are taken from Swiss Re’s Sigma 2020 report: https://www.swissre.com/institute/research/sigma-research/sigma-2020-02.html 2 All statistics for this section and the subsequent chart are taken from the Munch Re website page “Risks posed by natural disasters: economic losses caused by natural catastrophes are trending upwards”: https://www.munichre.com/en/risks/natural-disasters-losses-are-trending-upwards.html 3 https://population.un.org/wup/Publications/Files/WUP2018-KeyFacts.pdf
