My asset values are falling: so why isn’t my insurance premium?
My asset values are falling: so why isn’t my insurance premium?
Introduction: the downward trend in asset price
1 , supply chain competitiveness and the growing experience of manufacturers and developers have all had a major impact on the renewable industry. This has driven a steady decline in asset price for photovoltaic solar (82%), onshore wind (39%) and offshore wind (29%) since 20102 . Why, then are renewable energy insurance premiums increasing?
The hard insurance market and the importance of correct values The primary reason for this is that the Renewables insurance sector is currently experiencing a hard market, impacted by the decline in premium income with several insurers having pulled out of underwriting Renewables business. The market has been unprofitable due to the high frequency and severity of claims, together with tightened reinsurance rates.
With insurance rates still widely predicted to rise again during 2021, it is important to ensure that the values declared to insurers for the application of what is probably an increased rate remains appropriate and correct.
While the insured values will not be the only consideration as insurers assess an appropriate risk rate in a hard insurance market, they are the next most important factor (together with the applied rate) in determining the ultimate premium which must be paid. While insurance buyers and their brokers spend considerable time negotiating to achieve an appropriate rate for the risk, shouldn’t there be similar attention paid to ensuring that the correct values are utilised?
However, while insurers will take any decrease in asset values presented into consideration as part of their overall assessment when fixing their rate, cover, terms and capacity for a given asset, it is still only one factor in a much broader spectrum of considerations which must be analysed.
Insurer EML models When considering the level of impact a reduced reinstatement value and sum insured will have on the ultimate pricing, insurers will pay particular attention to the Estimated Maximum Loss/Probable Maximum Loss (EML/PML) model on any one asset or site. With a renewable energy project often spread out over a wide geographic location, insurers accept that it is unlikely that a loss incident will result in a complete 100% loss to the project. As such, insurers model what they believe to be their estimated maximum loss on a worst-case scenario, based on the material project risk information submitted and the location of the risk, blended with their modelled projections and industry knowledge. Their given project rate will be geared to their assessment of the PML; while they are likely to purchase reinsurance protection for the difference between their modelled PML and the total insured value, the premium applicable to this delta will not be of the same magnitude as that which is applied to the value at risk below the PML. Accordingly, if the overall total sum insured value is reduced by 20% following a devaluation and assessment of correct insured values, there will not be a proportionate reduction in the overall premium until the revaluation impacts the insurers’ assessment of their exposure on a PML basis.
Impact of reduced total sum insureds on insurers’ technical rates If the overall project insured value has reduced by 20%, insurers will also consider that, statistically, they now have a higher frequency exposure to a partial rather than a total loss. As such, they remain equally as exposed to the first 80% of the value at risk, even after a 20% reduction in the full value.
As an example, Company ABC owns an Onshore Windfarm with total reinstatement values of US$100 million:
With good risk measures in place, insurers asses their PML scenario to be 40% of the total insured value.
As a result, insurers calculate a technical rate of 0.30%, based on the premise that their likely maximum loss will not exceed US$40 million in total.
If Company ABC revalued their assets, resulting in a 20% reduction in values, this may not in itself substantially impact the overall premium. This is because insurers would still believe that their primary risk exposure is still US$40 million.
However, the rate will now be applied to the lower total sum insured, producing an overall premium benefit to Company ABC.
With projects that are more heavily exposed to Natural Catastrophe (Nat Cat) losses, there will be an increased reduction relative to the insurers’ assessment of costs to protect against a full value loss. So from a premium perspective, the impact of having the true reinstatement value is more important for programmes with higher Nat Cat-exposed locations.
Importance of current valuations on proportional programmes Having discussed the impact of reduced total sum insureds on the insurers’ technical rates, we must also look at the importance of ensuring that values are accurate and up to date. When initially assessing the risk, insurers need to be confident that the sum insured adequately represents the true reinstatement cost in order to accurately determine a correct PML, to which their deployed capacity will be aligned.
This is especially important in a quota share market where insurers work on a proportional basis, taking an agreed percentage of the overall total insured risk. Insurers must also consider if they are increasing their exposure to higher frequency losses by not charging enough premium, due to a disproportionately low total insured value.
Project financing and Average Most renewable energy projects are subject to project financing which, broadly, does not permit the application of the insurance concept of “Average’’, being the proportional reduction in any claim to the degree of under-insurance. As such, insurers are very sensitive to projects where overall dollar per MW represents a lower ratio than would commonly be seen in the market.
Conclusion: best practice to track fluctuation in asset values at each renewal period Like many other aspects of insuring a renewable energy project, the declaration of correct sums insured after valuation, as well as careful internal diligence, is considered material to the overall risk assessment for which clients have a duty to disclose, inclusive of any changes in valuations. As outlined at the beginning of this article, with the developments in technology within the renewables industry and the cost of such technology reducing, it is important that clients accurately track any fluctuation in asset values at each renewal period. This to ensure that their duty of disclosure is fulfilled, and they do not overpay their insurance costs.
