A hard act to follow
A confluence of challenges across segments signals a continued hardening in the power market, says Travelers
Blame it on 2020 if you like; the power insurance market has experienced its fair share of uncertainty and volatility this year.
Challenges with integrating conventional generation and a fast-growing renewable energy sector, severe weather events in areas that hadn’t experienced them previously, growing cyber exposures, and a long period of reduced rates have set the industry on course for hardening rates for the remainder of this year and into 2021.
Granted, power market clients have benefited from low rates in recent years, and this natural upwards trend shouldn’t come as a great shock – particularly as the industry adapts to the evolution of power resources and increasingly extreme weather.
An unsteady mix of old and new
For decades, baseload power has comprised conventional energy sources like coal, natural gas and nuclear. Renewable energy has been a minority intermittent power source, comparatively easy to integrate with traditional baseload power.
But last year, renewables generation (including hydro power) outpaced coal for the first time in the US. And data from the Federal Energy Regulatory Commission (FERC) suggests that the proportion of generating capacity produced by renewals is likely to increase significantly over the next three years, with FERC's June Energy Infrastructure Update indicating that renewable energy sources accounted for over 57% of new generating capacity in the US in the first six months of this year.
When it comes to forecasting, it looks like wind and solar may represent more than three-quarters of new power generation in coming years…
But as renewable energy has become more widely adopted around the world, it hasn’t integrated seamlessly with the conventional energy sources it complements.
Increasingly, for example, coal is being used as a cyclical energy source even though the equipment used for coal generation wasn’t designed to handle regular starts and stops. As a result, the equipment sustains more wear and tear, and its owners don’t feel inclined to repair and replace that equipment at a time when coal’s future is uncertain.
Older gas-fired combustion turbines are also cycling more than planned, often requiring expensive upgrades to cope. This has resulted in increased forced outages for conventional generation.
Wind and solar, conversely, rely on expensive and still-developing battery storage technology to support them. Until those resources become safer, more affordable and more efficient, the reliability of renewables as baseload power sources will be unsteady.
“California, one of the world’s largest user of renewables, has been experiencing rolling blackouts and brownouts recently because the intermittent renewable power generation and intermittent conventional power generation aren’t meshing,” says Louis Scott, head of power and utilities at Travelers Europe. “The balance of the power sources is not in harmony.”
At the same time, the demand for ongoing renewables development remains high – construction of new projects has rebounded after Covid-19 stalled development temporarily – but the locations with the best wind and solar resources have already been developed.
“After all of the most attractive sites are developed, you have to build in areas that are more challenging,” says Charlie Richardson, senior underwriter and head of renewable energy at Travelers Europe. “This could be because the wind or solar irradiation resource is not as strong, the site might have been polluted or have some other detrimental prior use, or it may be more prone to flooding, hailstorms, tornadoes or some other form of adverse weather.
“Those not so-good-quality sites have ultimately seen a higher level of attritional losses for insurers, as well as an increase in weather-related losses, the latter of which have been proving challenging to model and have regularly resulted in far higher quantum losses than the industry expected previously.”
A changing forecast
In fact, weather-driven events such as hailstorms, tornadoes and wildfires have generated insurance losses that have been growing exponentially in size. Richardson said a hail-related loss in the industry two years ago cost $75mn, while the biggest hail loss prior to that totalled just $5mn-$10mn.
The bigger insurers in the market tend to write approximately $100mn of gross premium, so a $75mn loss will consume most of that premium - along with insurer profits – in one go.
Compounding the problem is that these losses are occurring in areas that catastrophe modelling tools hadn’t previously considered to be high-risk.
Flooding outside of FEMA flood zones, tornadoes hitting in unexpected areas, and expanded wildfire activity in not only in California, but also in other parts of the US west coast, Europe and Australia, are generating new losses and with increased frequency.
Returning an underwriting profit in renewables has become increasingly difficult as losses that had been more attritional of nature historically have become much more substantial in recent times. Some insurers have left the space altogether, while many others are looking for ways to reduce their exposures through pricing, terms and conditions, and line size.
Digital investment increases cyber exposures
New technology is helping the power industry monitor and manage these expanding risks. Like all industries, the power industry has been making greater investments in technology to enhance its ability to operate its own equipment and manage environmental risks and other exposures. But as digital investments climb for both conventional and renewable energy developers, so do cyber exposures. Aon reports that cyber incidents are expected to cost the power market $6tn annually by 2021.
In a recent Aon Global Power webinar, Joe Salazar, assistant vice president of cyber at Aon, advised companies to act now to ensure cybersecurity stakeholders including risk, finance, information security and legal are in sync about cyber security, since they will be involved if and when a cyber incident occurs.
He said organisations should then manage their risk by re-evaluating their multifactor authentication and security of their VPN (particularly as the pandemic has made remote work more widespread), to conduct employee awareness training to combat phishing emails, and to not only have an incident response plan but to test it and ensure it coordinates with their insurance policy.
Managing the message
How will this convergence of risks affect business in the power industry? Even clients who buy insurance year after year, with minimal claims activity, will still see a minimum double-digit escalation in premium rate, simply because of how the insurance pool works.
They should also expect to see changes to deductibles, as well as terms and conditions, as underwriters look to bring profitability back to the segment. Brokers will have to continue to educate clients about the market conditions so premium spikes don’t come as a surprise – particularly considering the low rates they have paid in recent years.
“If I were a broker, I would put together monthly or quarterly reports of loss trends to help illustrate what’s happening in the market and why, in order to help my clients understand the changing landscape in which we all operate,” says Richardson.
“Clients with conventional generation, particularly combustion turbines, also need to proactively address the maintenance challenges posed by Covid-19 as deferred outages start to back up into early 2021,” Scott adds.
On the positive side, the businesses that can push through this temporary hardening of the market will likely see greater stability in the long term.
“Clients need to appreciate the benefits they have seen from a long soft cycle,” Scott said. “While this is a time of uncertainty with underwriting difficult to do profitably, and risk managers experiencing tough renewals, we should end up with a much more sustainable environment and insurance market”