In last year’s Power Market Review we stated that the hard market had finally become a reality for the International Power sector. Indeed, we really had very little by way of any comfort to offer buyers as the normal symptoms of a hardening insurance market – reduced capacity, higher rates, tighter conditions, lower sub-limits and increased deductibles – became increasing apparent as the year progressed.
We ended our article by recommending buyers to take more time over the renewal process, and to consider carefully the advantages of maintaining strategic long-term relationships with key insurers. What, if anything, has changed this year? Figure 1 above outlines the various factors that are driving conditions in today’s market. Although there are some positive developments from a buyer’s perspective, there are still too many negative factors in play to prevent a continued market hardening process. Indeed, the existing market leaders continue to require improved pricing, terms and conditions and to strive for the elusive “technical rating adequacy” that often appears to be beyond existing rating levels.
Let’s take each of these factors in turn to determine the latest developments in this market and determine how buyers should now respond as we look towards the January 1 2022 renewal season.
Last year we advised that overall underwriting capacity had reduced to a theoretical total of US$3.5 billion, with a maximum realistic level of capacity of US$1.5 billion. In 2021, we estimate that the global theoretical total has now reduced still further to approximately US$3.25 billion, with the realistic level in the region of US$1.4 billion.
This still leaves buyers with plenty of capacity available to support their insurance programmes. The highest programme limits that we have had to place during the last 12 months have been around US$1 billion, with many programmes featuring overall limits well below this figure. This is in keeping with either EML or PML projections, enabling customers to buy well within their total values declared. Of course, certain programmes are subject to more stringent lender’s agreements whereby the buyer is obliged to purchase an insurance programme for much higher limits, up to and including the overall value of the plant. Under these circumstances, accessing sufficient capacity has certainly become more challenging over the last two years.
Where programmes can demonstrate a verifiable Chinese interest, considerably more capacity is available from the Chinese market, which in theory can offer as much as US$3.5 billion of additional capacity of its own for Chinese risks. In the future, it will be interesting to see if the definition of Chinese interest will be expanded to include additional Power assets around the globe as the strategy of “One Belt, One Road” continues to be rolled out.
It may come as something of a surprise to some buyers, but the reality is that the International Power market is likely to have made an overall profit in 2020. Figure 2 on the previous page shows our best estimate of overall loss totals and premium estimates during the last six years.
In compiling this chart, we have taken the relevant Power losses from our Willis Towers Watson Energy Loss Database and augmented them with additional losses advised to us by various insurers. The record for 2015-18 is one of unremitting gloom for insurers, with overall losses constantly outstripping the five-year annual premium income average.
Despite this, as this Review went to press we were expecting the 2020 final loss total to be modest enough for insurers to record a small margin of profit, although as we look to 2021 we have just been advised of two major incidents, one in Australia and the other in the United States, that are likely to amount to nearly US$500 million. These losses may have a significant impact on rating levels as we move further into 2021.
In Figures 3 to the right and 4 overleaf, we have detailed every loss excess of US$20 million advised to us for both 2019 and 2020.
Given the improved loss record of the last two years, together with the increases in premium rates that we highlighted in last year’s Review, it is now possible for the Power portfolio to have moved back into profitability across the board. While Lloyd’s of London by no means has a monopoly on this sector, their own figures provide good evidence for this. Figure 5 overleaf shows Lloyd’s Incurred Ratios (i.e. overall net premiums versus paid and outstanding claims) for the PG (PowerGen) audit code for the period 2015-2020.
We have shaded the area between Incurred Ratios of 60% and 150% as being the area where overall underwriting profits may not be secured. That is because in addition to claims costs, insurers have to factor in operating and reinsurance costs to arrive at a Combined Ratio (i.e. net premiums received versus all outgoing costs). On this basis, while the four years between 2015 and 2018 show Incurred ratios in excess of 75%, 2019 appears to be almost on the edge of profitability while 2020 is currently looking much better (although there is the potential for this figure to deteriorate). And of course, should the loss levels of the last two years continue to be maintained, the outlook for 2021 is very promising from an insurer perspective, especially given the recent market hardening.
From a buyer perspective, it does seem somewhat ironic that the improved loss record has materialised just as the push for increased rating levels from the market gathers momentum. Indeed, some readers would be forgiven for thinking that these improved market conditions for insurers might now prompt a reversal of the recent hardening dynamic and a return to soft market conditions.
Sadly for the buyers, this is not likely to happen in the immediate future. Let us now look at the reasons for why the market will continue to harden in the months (and even possibly years) ahead.
Despite the loss statistics for the past two years, most readers will appreciate that insurers tend to use a much longer timeframe within which to evaluate what they consider to be a “technical rate”, i.e. a rate that will guarantee them an underwriting profit in the long term. Figure 2 showed two years of relatively modest losses; however, it also showed four years where losses significantly outstripped average premium income levels. Insurers are therefore still convinced that they are still some way off achieving technical rating adequacy and are therefore determined to maintain the momentum towards higher rating levels instigated during the last three years or so. And for the moment, they are encouraged by the fact that when they hold out for higher rating increases, they are generally being rewarded with firm orders.
Rating increases for the most well -regarded business are now averaging between 15-20%, depending on a variety of factors, including risk profile, premium income volume, spread of risk, loss record and, increasingly, ESG criteria. This represents a slight easing of the underlying hardening dynamic in this market but is still far removed from any actual turnaround in rating levels.
Of course, it would be very difficult for existing leading insurers to maintain this drive towards technical rating if fresh competitive pressures were to be introduced to provide realistic alternatives to their stance. However, it seems clear that no such new competition is likely to materialise at any time soon; indeed, the leadership panel for this class of business has been relatively static for the last two years.
Interestingly, many programmes that have remained essentially with the same leadership over the last few years are more competitively priced than they would be if the broker concerned sought out fresh leadership options. This is also the case in terms of applicable deductibles – most programmes of this nature are currently receiving the benefit of lower deductibles than would be applied if a new insurer were to quote terms for the same programme.
From a buyer perspective, the situation has not been helped by the continuing centralisation of underwriting authority by global insurers around the world. Whereas in previous underwriting eras buyers and their brokers would be able to obtain a range of underwriter quotes from different composite insurers around the world, the situation now is such that their regional representatives are generally on a much shorter underwriting leash than in the past. Consequently, depending on region, those buyers requiring even moderate programme limits in practice have little option but to refer to London and European leads to secure terms that will guarantee the completion of their programme. Here they have found that the name of the insurer might be the same, but the London-based underwriter is now often looking at the programme through a very different lens. That being said, in certain markets in North America, Asia and Latin America, brokers can indeed still obtain lead quotes and complete placements locally, so regional options are still relevant in certain territories.
In the meantime insurers are being boosted by the rating levels achieved when quoting fresh business, so are keen to resist attempts to renew programmes at existing rates, knowing full well that they can obtain more advantageous terms on new business.
As a result of all this, the “delta” between a programme’s current leadership and any alternative markets is growing wider than ever. An incumbent underwriter tends to take a slower, more measured approach to rate and conditions changes whereas a new insurer - likely to have declined the programme in prior years - puts out what they would require, based on internal rating models for price and internal technology guidance for coverage. The new prospective lead market is likely not to be chasing income, as they are seeing a larger number of new underwriting submissions due to a combination of the hard market cycle and centralisation of underwriting authority; they can therefore hold out for what they require and, if not forthcoming, walk away to the next opportunity.
By now most readers will be aware of the withdrawal of insurance market support for thermal coal-fired power stations that we have referenced in previous editions of this Review. While the position regarding certain European (re)insurers is well known, we must now advise that certain Power market leaders from Lloyd’s and other London operations have now made it clear that they are not looking to increase their Coal portfolio in the future, although there has not as yet been any formal announcements to that effect.
Such has been the cooling appetite for Coal business that we are now finding it challenging to achieve overall programme limits in excess of US$1 billion, and even less for some buyers whose operations are located in areas where alternatives to coal-fired power generation are plentiful; indeed, some buyers are struggling to access even US$250 million of underwriting capacity.
The general exception to the rule is where the buyer is from a country where realistic alternatives to coal to supply the nation’s power are simply not available. For these programmes, insurers can lower the impact of capacity reduction for Coal risks, by virtue of their criticality to the country from a social responsibility perspective. However, even for these companies, we have seen examples recently where the buyer has been forced to cut the overall programme limit by as much as 25%, although in some instances the buyer has been able to fill out their programme on a “horizontal” basis instead. While alternatives to traditional insurance such as increased captive insurance company deployment are available to some buyers, others have not yet developed the capacity for any significant risk retention within their organisation and are therefore facing a significant risk to their balance sheet should a major loss materialise.
Throughout the period of the last soft market, deductibles continued to be maintained at specific, generally agreed levels. As the hardening dynamic began to apply itself, these levels continued to be successfully maintained by brokers on existing business. However, as brokers sought to achieve alternative (and preferably more competitive) terms from other insurers, they soon realised that the minimum deductible levels required by these new markets were sometimes significantly higher than those agreed on the existing programme. This perhaps explains why many buyers have had little option in recent months but to stick with their existing leaders – particularly if they are contractually obliged by Lenders’ agreements to insure their assets at existing deductible levels. It is therefore becoming increasingly challenging for brokers to access new capacity for their clients without their existing terms and conditions being affected.
Meanwhile insurers continue to focus on reducing sub-limits for coverages that were given during the soft market cycle and imposing Communicable Disease and Electronic Data exclusions. In some cases, sub-limits have been reduced by nearly 50% as insurers are now looking acutely at limits imposed during the soft cycle. The only way they can mitigate against this development is to supply the data to prove why the original sub-limits have been required in the past, as well as advising insurers of any additional exposures outside their standard agreements. Furthermore, insurers continue to focus on the nature of their clients’ contracts with their OEM contractors, as they are increasingly reluctant to waive their rights to such contactors and allow possible subrogation targets to be included as Named Insureds under the policy.
One other major area of concern for the market are the challenges posed by the Combined Cycle Gas Turbine (CCGT) fleet in terms of proven versus unproven technology. This has been evidenced by a large-scale reluctance of major leaders to participate in the first year of operations post-construction - even if these insurers had formed part of the original Construction programme.
However, the various requirements currently being demanded by the market do tend to differ. For example, one major insurer insists on say 20,000 effective operating hours from the lead unit in question, while another is happy to accept 12,000 hours on the same basis, while generally a figure of 8,000 hours has been the benchmark for when a unit is deemed proven. The difference between proven and unproven technology can also lead to huge differentials between the buyers’ (and often lenders’) coverage requirements and those insisted on by insurers. Furthermore, the size of some of the units being produced and the subsequent losses impacting the insurance market again significantly adds to the size of the gap between buyer needs and what the market is prepared to offer.
Indeed, there are so many different units being produced by such a variety of technology suppliers that buyers need to be very clear, when conducting upgrades, as to the implications for their existing cover – they could mean additional restrictions such as high deductibles or LEG clauses imposed until the technology has been satisfactorily proven.
Another major impediment to the easing of the current hardening rating environment has been the continuing unprofitability of several significant lines of business within the overall Property & Casualty (P&C) portfolio, as evidenced by Figure 6 above, which shows overall underwriting results for 2020 at Lloyd’s of London. Although some areas (including Powergen, as we have seen in Figure 5 earlier) to have secured an underwriting profit, it can be seen that the same can hardly be said for either general Property or general Casualty, while Lloyd’s Reinsurance portfolio has also made an apparent underwriting loss for the first half of the year. Our final negative factor is therefore the continued management scrutiny of the Power portfolio, whether within Lloyd’s or from the major composite insurance companies. Often operating at some considerable distance from the Power portfolio itself, these managers are generally taking an overall Property & Casualty portfolio approach to their business strategy; while currently profitable, Power is only one cog in a much wider business wheel.
We saw from Figure 1 that the balance of power between buyer and insurer remains firmly in favour of the International Power market. For all the positive factors that we have indicated, the impact of the multiple negative factors that we have outlined has been to enable the hardening dynamic within the market to continue, albeit at a slightly decreased rate. And with the market determined to maintain its journey towards “technical adequacy”, and without the emergence of fresh competition to challenge the existing status quo, buyers should generally expect conditions to continue to harden still further.
As we move closer to the January 1 2022 renewal season, we therefore think it will be imperative for buyers and their brokers to deliver clarity, transparency, a focus on risk management and a renewed engagement with their leading insurers. Only then will they minimise the impact of this challenging market.
So to sum up, our advice to clients is basically three-fold:
Ed Cooper is Associate Director, Natural Resources, Willis Towers Watson London. ed.cooper@WillisTowersWatson.com
Carlos Wilkinson is Head of Power & Utilities, Natural Resources, Willis Towers Watson London. carlos.wilkinson@WillisTowersWatson.com
Michael Buckle is Head of Downstream, Natural Resources, Willis Towers Watson London. michael.buckle@WillisTowersWatson.com
