power market review 2016 - willis towers watson

Power market review 2016

IntroductionGraham Knight, Global Head of Power, Willis Towers Watson 3

Part one – power industry issuesBrexit: possible implications for the UK power industry 6

Risk-based design for critical facilities 15

Employee Value Proposition and Total Rewards: modernize or risk being irrelevant 20

The rush to renewables in Australia 26

Energy storage & batteries – the energy revolution continues 31

The Asia power paradox 34

Advanced condition monitoring & diagnostic technology 39

Part two – risk transfer issuesRisk and resilience: engineering a sustainable financial system 44

The 2015 UK Insurance Act 48

Power sector Business Interruption claims 52

Alternative Risk Transfer solutions revisited 54

Part three – insurance market round-upProperty Damage / Business Interruption 60

Liability 64

Construction 66

Terrorism & Political Violence 68

Political Risks 70

Regional perspectives 72

Front cover image – aerial view of Godafoss waterfalls, Iceland, in the winter (Photo credit – Arctic-Images/Getty Images)

Power market review 2016 3

IntroductionWelcome to our latest Power Market Review, our first as Willis Towers Watson. In our last edition in December 2014, we noted that although companies in the power sector were facing a seemingly unprecedented range of business challenges, they could take comfort from the fact that the insurance market was relatively stable and benign, experiencing a lengthy ‘soft’ phase for most of the main insurance types typically bought by companies in the sector. To the casual observer, it may appear that not much has changed in the months since.

Power sector companies continue to face challenges, including (but not limited to) low energy prices, decentralised generation, emissions reduction targets, the viability of aging plant, power stations designed for baseload operation having to fit around the intermittencies inherent in renewable generation, and the continuing risks of climate change, political/regulatory intervention and financial instability.

Meanwhile the insurance market is still soft, buoyed by the record amounts of capital that have flowed into the industry and a relatively benign claims environment. Such has been the sustained nature of these conditions that some commentators have suggested that we should stop referring to the insurance market as soft and instead start considering current conditions as normal. It is difficult to find any observers who are expecting any broad market hardening in the near future.

However, change continues apace. One of the biggest political events of 2016 was the referendum vote by the British people to leave the European Union, a process widely referred to as Brexit. As Joseph Dutton of the University of Exeter Energy Policy Group notes in an examination of the possible Brexit scenarios, which we are pleased to include as one of three external contributions to this Review, energy has been at the heart of the European project but received very little coverage in the referendum campaign. He looks at the implications of the vote for power and energy policy and interdependence.

Of course, most people will probably not see Brexit as the biggest political event of 2016. This prize surely goes to the stunning victory of Donald Trump in the US presidential election, which happened as this Review was going to press. As a supporter of free markets and an avowed climate change sceptic, Mr Trump is expected to relax regulations that constrain the use of fossil fuels. However, as we note in our North American regional update, this does not necessarily signal a significant slowdown in the growth of renewable energy generation in the US, as renewables have become more competitive relative to other sources of generation.

A less well-publicised but also significant development in 2016 has been the implementation of the 2015 UK Insurance Act, the first major shake-up of insurance law in the UK for over 100 years. The Act’s provisions apply to all non-consumer insurance and reinsurance contracts that are governed by English law, regardless of where they are underwritten or where the parties to the contract happen to be located. Since many international insurance and reinsurance contracts are subject to English law, the Act therefore has global interest and application. Chris Dunn, Head of Kennedys Marine, outlines the key changes and issues.

Our third external contributor is Bob Bailey of Exponent, who looks at the importance of risk-based design for critical facilities exposed to coastal windstorm, as we come to the end of this year’s Atlantic hurricane season. This has been more active than in recent years, with a hurricane making landfall in Florida for the first time in 11 years, and then Hurricane Matthew causing devastation in parts of the Caribbean before skirting Florida and making landfall in South Carolina as a Category 1 cyclone.

Although the worst fears of widespread flooding and damage in Florida were not realised, Hurricane Matthew is still expected to present insurers with billions of dollars of claims. The way that the global insurance market has strengthened its resilience over time to cope not only with losses of this size but also with ‘one in 200 year’ loss events is explained in an article in these pages by Rowan Douglas, CEO of Willis Towers Watson’s Capital Science & Policy Practice.

We are particularly pleased that this year’s Review contains, for the first time, a contribution from our Human Capital Benefits segment. This describes the fascinating findings of our 2016 Global Talent Management & Rewards and Global Workforce Studies, which among other things reveal that employers and employees tend to have differing views on the key elements of job attractiveness and employee retention. We also take a fresh look at Alternative Risk Transfer (ART) in this Review, examining how parametric solutions in particular might become more familiar tools in the armoury of the modern power and utility sector risk manager.

And of course our Review would not be complete without the usual analysis by our in-house specialists of the state of the markets for the principal property and casualty classes of insurance as they affect companies in the power and utility sectors, regional commentaries from our industry leaders around the world, and technical insight into some of the hot topics affecting the industry. We are grateful to all our contributors, and hope that you enjoy this edition of our Review. As ever, we welcome any feedback you may have. Graham Knight Global Head of Power, Willis Towers Watson

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Part onePower industry issues


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Brexit: possible implications for the UK power industryEnergy has been at the heart of the European project since the European Union (EU) was originally conceived as the European Coal and Steel Community in 1951. Although the organisation has evolved considerably since, energy remains a key policy area, alongside the broader policies of climate change and environmental protection/quality. Despite this, energy received little coverage in the run- up to the UK’s EU membership referendum; most of the debate focused on immigration, the financial contributions of membership and the wider but the less-well defined notion of sovereignty.

Still no certaintyDespite the resulting vote to leave the EU (universally referred to as ‘Brexit’), it is unclear what form this will take, in terms of both how the process will be carried out once the mechanism for leaving – Article 50 of the Lisbon Treaty – has been invoked and which areas of policy the UK may wish to retain.

On the day after the referendum, the Prime Minister David Cameron resigned. He decided not to invoke Article 50 before stepping down, arguing that it should be for a new government to decide when to do so. His successor, Theresa May, initially said it would not be invoked until 2017 at the earliest, but in early October she offered more detail, saying that it would occur by March 2017 at the latest. Yet this timetable was thrown into further doubt after the High Court ruled in early November that the government must consult parliament before invoking Article 50. Although the government has said the ruling will not affect the timetable of Brexit, it is likely to appeal the decision which could lead to delays. And ultimately it still remains unclear what the UK’s official negotiating position will be and what the actual nature of the UK-EU relationship will be after Brexit.

Repeal of the ECA inevitableAlongside the announcement regarding Article 50, Mrs May also confirmed that the 1972 European Communities Act would be repealed. The Act gives direct effect of EU law over that of UK, and also recognises the role of the European Court of Justice (ECJ) in interpreting and applying laws and court judgments. Once the Act has been repealed, new European legislation will no longer

legally apply to the UK, but it is unclear what will happen to the existing legislation on UK statute books. As the ECJ is the court that upholds legislation of the Single Market, this has been interpreted by some commentators that the UK intends to end its membership of the single market. However, the government has not outlined its official position; although the comments on the ‘Great Repeal Bill’ were viewed by some as a watershed, repealing the European Communities Act is the only legislative means by which the UK can leave the EU and was therefore inevitable.

The general uncertainty extends to energy as much as other sectors of the economy, and it is not possible to say with full confidence exactly how it will be affected going forward. The UK’s Energy and Climate Change Select Committee opened two inquiries following the referendum looking specifically at the implications for energy and climate policy.

Various options availableThere are various existing options the UK could pursue for its future relationship with the EU. The cases of Norway and Switzerland are useful but not definitive examples of third party country relations with the EU; indeed, the UK could press for a more bespoke relationship than the ones Norway and Switzerland currently have. The eventual nature of UK-EU relations will have a strong bearing on the future of energy in the UK as the two parties are strongly linked in energy supply and policy terms.

Energy interdependence

UK now a net energy importer…While many sectors of the economy benefit from access to the European single market, in the energy arena the UK and EU have physical interconnection as well as being intertwined in policy. The UK has been a net importer of energy since 2004, following the peak in North Sea gas production in 1999 (see chart below). There are four high-voltage electricity interconnectors between the GB system and the EU, and there are five natural gas pipelines running to other countries - three to the EU and two to Norway. Oil and gas production from some North Sea fields is also delivered directly to non-UK facilities.

As well as being dependent on coal and oil imports from Europe and further afield, imports make up a substantial amount of the gas the UK uses for electricity generation and domestic heating. In 2015 imports accounted for 40% of gas supply, with nearly 70% of this coming from mainly Norway, and also from the Netherlands and Belgium.


…but also an important EU energy supplierHowever, the UK is also important for EU energy supply because of these connections. Gas from North Sea fields and that arriving on LNG tankers (liquefied natural gas) at UK terminals can be sent to the EU via the pipelines. Ireland is almost entirely dependent on gas from the UK via the Moffatt pipeline for its supply, and it also imports 4% of its electricity demand from the GB system. The electricity interconnectors between the GB system and the EU also export electricity depending on demand and wholesale prices.

EU policy influence on UK energy so far

Considerable EU influence on UK policy…The EU has had considerable influence over UK energy policy, and this can be most keenly observed in the area of electricity supply: for example, policies on the growth of electricity generation from renewable sources (Renewable Energy Directive, 2009) and the phase out of coal fired power generation (Large Combustion Plant Directive, 2001, and Industrial Emissions Directive, 2010). These high-level energy policies sit alongside directives on environmental habit protection, water quality, and air quality.

…while the UK has also driven EU energy policyBut at the same time the UK has also been a driver of energy policy at the EU level. The market liberalisation and ownership restructuring policies of the 2009 Third Energy Package drew on the UK’s own experience of privatisation and market opening in the late 1980s and 1990s. Similarly, during the UK’s 2005 EU presidency the then Prime Minister Tony Blair pushed for deeper market integration, harmonisation, and a collective approach to tackling climate change.

A weakened UK negotiating position?This move to a more internationalised approach on energy via the EU coincided with the UK becoming a net energy importer in the mid-2000s. The UK’s Climate Change Act (2008) was also regarded as front runner to the EU’s own Climate and Energy Package of 2014, which includes a binding 40% reduction in greenhouse gas emissions from the EU by 2030. Because of the UK’s global and interventionist role, climate change continues to be viewed through the lens of foreign security policy as much as environmental protection. Whether the UK maintains this type of diplomacy as an independent country remains to be seen, but its negotiating position on the international stage could be weakened through leaving the collective EU bloc.

1970

0

10

20

30

40

50

60

-10

-20

-30

1975 1980 1985 1990 1995 2000 2005 2010 2015

Net importer Net exporter

Per

cent

age

UK became a net exporter of energy in 1981 due to North Sea oil and gas development

North Sea production peaked in 1999

UK became a net imported again for a shortperiod after the 1988 Piper Alpha disaster

Reliance on imported energyhas grown in recent times

UK Energy Import Dependency 1970-2015

Source: Office for National Statistics (2016)


Electricity generation and energy supply after Brexit

UK Renewables target met…Under the EU’s 2009 Renewable Energy Directive the UK adopted a non-binding target of a 15% share of total energy consumption in power generation, transport and heating to be from renewable sources by 2020, with 30% of electricity demand to be sourced from renewables by 2020. The UK was one of the most proactive countries in developing its renewables sector, and generated 19.1% of total electricity from renewables in 2015 compared to just 6.7% in 2009. In the years following the directive, installed renewable capacity more than doubled to 27.2GW by the start of 2015 from 9.2GW in 2010.

...and sector may increase still furtherThe EU directive may no longer apply to the UK after Brexit, but the government will still be legally bound by its own Climate Change Act (2008) which requires an 80% reduction in carbon emissions by 2050. Because of this the UK renewables sector may continue to grow, despite leaving the EU. And as energy sourced from indigenous coal mines and the North Sea falls further, the government could push for more renewables. In the run up to the referendum it was reported that as part of the political restructuring after Brexit the government could remove the so-called green taxes and subsidies put in place by the EU to support renewables. However, although there is an EU-wide target for renewable energy that is binding, member states’ targets for renewable energy were set by themselves, along with the means of achieving it. This means that existing support schemes for renewable energy in the UK could also remain.

Cross-border supply

In 2015 around 6% of UK electricity demand was covered by imports through high-voltage interconnectors with other EU countries. There is currently 4GW of interconnection capacity and a further 2GW of capacity to Belgium and France is currently under development; furthermore there are plans to add at least another 5.8GW by 2022. Planned interconnectors to Norway and Iceland would deliver electricity from hydro and geothermal sources – something considered low-carbon and baseload supply for the GB market – while further connection to Ireland and northwest Europe would allow the import and export of electricity and also help balance the system in case of wind power intermittency.

Legal arrangements for interconnectors?Leaving the EU is unlikely to prevent the building of new interconnectors, but it is uncertain what legal arrangement would need to be in place for both these and the existing ones. Although Ofgem’s regulatory regime for interconnectors differs in some respects from other European countries’ own, GB interconnectors are regulated in accordance with EU rules on the single market. A situation could arise after Brexit whereby the current EU regulations and network codes that govern cross-border electricity market transactions and system operation must remain in place to ensure the GB electricity market remains operationally integrated with that of the EU.

Existing interconnectors

In development

Proposed

0 500 1,000 1,500 2,000

0 500 1,000 1,500 2,000

NorthConnect

NorthConnect

NSNNSN

Viking Link

Viking Link

BritNed

BritNed

Nemo

Nemo

Eleclink

Eleclink

IFA

IFA

IFA 2

IFA 2

FAB

FAB

EWIC

EWIC

Moyle

Moyle

GB Electricity Interconnectors (n.b. does not include planned Greenlink to Ireland or IceLink to Iceland)

Source: Reuters, 2015


Possible scarcity of supply scenarioHowever, in a worst-case scenario where the new interconnection capacity does not get built the UK could face electricity supply issues. In the last 12 months coal plants equivalent to 9% of the total electricity generating capacity have come offline, while the seven remaining coal plants in the UK are set to come offline by 2025. Though some plants are being shut down because of unfavourable market conditions and the cost of maintaining old facilities, some closures can also be attributed to the EU’s Large Combustion Plant Directive (2001) and Industrial Emissions Directive (2010). These introduced a choice for the highest polluting industrial units – including coal-fired power stations – of either restricted operating hours followed by eventual shut down or the installation of emission-reducing technology. The government pledged earlier this year that it will ensure the phase out of unabated coal by 2025, but an electricity supply crunch (partly because of no new interconnection) could see this delayed or the policy reversed.

New EU co-operation agreements required?The incorporation of existing EU policy post-Brexit could also arise with cooperation arrangements for oil and gas in the North Sea. For example, the UK and Norway are signatories of a framework agreement relating to cross-border cooperation that includes fields that may straddle the border between the two countries and the pipelines that deliver gas to the UK – which in 2015 accounted for 61% of total UK gas imports. Although signed bilaterally, the terms and conditions for access to pipelines – including the setting of entry and exit tariffs – are set out in accordance with EU law on the single market. Therefore if the UK did not maintain its membership of the single market, it is likely the agreement would need to be renegotiated or replaced.

“ Although signed bilaterally, the terms and conditions for access to pipelines – including the setting of entry and exit tariffs – are set out in accordance with EU law on the single market.”

Cost of energy and investment

Higher investment costs the real riskIn the run up to referendum the then Secretary of State for Energy Amber Rudd argued that Brexit could lead to a ‘£500m shock’ to the energy system which would eventually work its way on to consumer bills. The report to which Rudd was referring, commissioned by National Grid, looked at a wide range of risks posed by Brexit to the energy sector.

The report concluded that threats to physical supply of energy were of a lower risk, but higher costs of investment in energy infrastructure pose the more significant risk to the energy sector after Brexit. Equally any sustained period of uncertainty could lead to a deferral of investment in the sector.

Increased costs were expected because of a devaluation of sterling. This would raise the cost of imported equipment and services that are needed to upgrade networks and infrastructure for more renewables, replace closing electricity generation plants and develop a decentralised energy system. Any delay in critical energy investment could reduce energy supply security further ahead. The report also suggested that if the UK is excluded from the single market for energy it could lose the financial benefits that market integration offers.

Sterling has already fallen…Although the UK has not left the EU, the referendum result made an immediate impact on currency. The value of sterling fell by as much as 11% on a trade weighted basis between 23 June and September, with a 15% fall against the US dollar. Against the Euro it fell by 8% in the week following the referendum. The impact of this can be seen, for example, on wholesale gas prices at the UK’s National Balancing Point (NBP) trading hub.

…with gas prices increasingTrade at the NBP is priced in sterling but European hubs such as those in the Netherlands and Germany are priced in euros. Contracts for longer-term supply and those delivering in the winter months are typically priced in Euros, as the UK imports gas from the continent though winter. As such following the vote and sterling’s fall against the Euro gas prices at the NBP increased. This price-rise fed into the UK power market because of the high volume of electricity generated from gas-fired power stations. This also has the potential to feed in to domestic energy costs and consumer bills in if the price rise is sustained, and already some utility bills have increased on rising wholesale costs. Following Theresa May’s announcement that Article 50 would be invoked by March 2017 sterling fell further, to its lowest level against the dollar for 31 years.


Post-Brexit single market access

Hard or soft Brexit?Retaining access to the European single market is of concern to many sectors of the UK economy. In the run up to the referendum some Leave campaigners sought to assure voters and businesses alike that leaving the EU would not remove the country’s access to the single market. Although ‘Brexit means Brexit’ is the position Theresa May has reinforced, the ambiguity of Article 50 – some say deliberate – and a lack of clarity so far on the plan for the future relationship mean access to the single market could yet be maintained, as leaving the EU does not necessarily mean leaving the single market.

The confirmation by Theresa May that repealing the European Communities Act would mean that ECJ decisions would no longer be binding on UK law suggests that the UK would also leave the single market and pursue a so-called ‘hard Brexit’, though this remains unconfirmed. Given (a) the condition of membership of the single market that requires members to allow free movement of people from other member states, and (b) the role that control of immigration played in the referendum campaign, many find it difficult to see how the UK can maintain its membership status.

Before and after the referendum businesses sought clarification from the government on remaining in the single market. For example in July the British Insurance Brokers Association (BIBA) wrote to the government seeking assurance that the UK would remain in the single market, highlighting how the best interests of its members would be served through retaining tariff free cross-border trade with EU and EEA countries.

“Access to” or “membership of”?There is a fundamental difference between ‘access to’ and ‘membership of’ the single market, with the former being an option available to any World Trade Organisation (WTO) member. And though financial tariff free access to the single market could well be agreed between the UK and EU in the years ahead, it is unclear which non-tariff barriers, such as product standardisation, would remain in place.

Membership of the single market on par with existing obligations of a member of the EU would, as the legal framework stands, require the UK to be a member of the European Economic Area (EEA), like Norway (dubbed the ‘soft’ Brexit option). The UK also has the option of being a part of EFTA, with single market access secured via bilateral treaty negotiations, like Switzerland, which is a member of the European Free Trade Association (EFTA). There is also the so-called ‘hard’ Brexit option, where a free trade agreement along WTO terms would be negotiated between the UK and the EU that would secure access to the single market.

Norway option: EEA

The EEA is a group formed of the EU member states and Norway, Iceland and Lichtenstein. It was set up to extend the single market into the three non-EU EEA countries. The agreement that underpins the organisation ensures EU legislation covering the so-called ‘four freedoms’— free movement of goods, services, persons and capital – are applied equally to EEA and EU members, and guarantees equal rights and obligations within the single market for citizens and economic operators of EEA members. All relevant laws on the single market, except those dealing with agriculture and fisheries, apply to Norway. There is also cooperation on other policy areas, including the environment, known as ‘flanking and horizontal’ policies.

Not really Brexit?But UK membership of the EEA would arguably not be consistent with the ‘Brexit means Brexit’ mantra, especially in terms of financial contributions, free movement of labour and regulations. And to gain membership of the EEA the UK would first have to re-join EFTA, and then seek to join the EEA – something all members would need to agree on.

Norway maintains a mission to the EU to exert considerable lobbying pressure on EU decision makers as, under the terms of the EEA agreement, it is bound by EU legislation but does not have a vote or representation in the European Commission, Parliament or Council of Ministers. Norway has around 60 diplomatic staff in Brussels, with four people specifically focussed on energy and environment issues, and its mission shares a building with four energy companies, together with the trade body that represents some 270 electricity companies. In comparison, the UK has 84 people with diplomatic accreditation at its representation in Brussels, with just the one person designated to energy matters.

Strategic co-operation on energy policy likelyAs a ‘third party’ country Norway relies predominantly on soft power rather than the hard negotiations that member states have with EU policy makers. Because of Norway’s importance to EU energy supply – and indeed, the EU’s economic and political importance to Norway – the two have strategic cooperation on a range of energy issues, including policy developments and the implementation of EU energy rules in Norway. The UK’s importance in petroleum products and gas supply means it is likely the UK and EU would have an enhanced relationship in this area after Brexit.


Switzerland option: EFTA

No automatic EU regulation enforcementSwitzerland is a member of EFTA, along with Norway, Iceland and Lichtenstein, but unlike these countries it is not a member of the EEA. EFTA is an intergovernmental organisation that promotes economic integration and free trade between its four members, but it does not include political integration nor the automatic enforcement and application of EU single market regulations. EFTA is the EU’s third largest trading partner in manufactured goods and the second largest in services. The UK was originally a member of EFTA until 1973 when it left to join the EU.

Limited bi-lateral agreementsSwiss-EU relations are underpinned by more than a hundred bilateral agreements that have been negotiated on a wide-range of policy areas, the first of which was an agreement in 1972 regarding free trade. However, bilateral agreements in energy and environment are limited. In 2006 a treaty on Switzerland’s participation in the European Environment Agency – which undertakes environmental data collection and advises the Commission on policy – came into force following more than four years of negotiations.

The country is integral for electricity transport in central Europe and the functioning of the EU’s single energy market. But negotiations on establishing a legal framework for Switzerland’s participation in the European electricity market which started in 2007 are unfinished, and they had to be extended in 2010 as no solution was reached, despite the framework being a central part of the Swiss Federal government’s 2050 energy strategy.

“ CETA took seven years to negotiate and its scope is far more limited than a UK-EU agreement would need to be. It prioritised the trade of commodities, minerals and agricultural products, and made scant reference to the service sector – the UK’s largest.”

‘Canada option: “hard” Brexit

The UK would still have access to the single market as a WTO member. In the event of no agreement being reached by the end of the 2-year Article 50 period, UK-EU relations would revert to a WTO rules-only basis for trade. Such a situation would not allow the UK preferential access to the single market or to the 53 countries which have free trade agreements with the EU.

But some WTO-only countries do have agreements with the EU – such as Canada. A free trade agreement between the EU and Canada, the Comprehensive Economic and Trade Agreement (CETA), was signed in July 2016. It is referred to by some as an example of a successful agreement the UK could reach with the EU without needing to be a member of either the EEA or EFTA; however this ignores the specific focus of the agreement.

Limited scope of Canadian agreementCETA took seven years to negotiate and its scope is far more limited than a UK-EU agreement would need to be. It prioritised the trade of commodities, minerals and agricultural products, and made scant reference to the service sector – the UK’s largest. The focus of the agreement reflects the EU’s dependence on imported energy and minerals, and Canada’s desire to sell them. There is also no common agreement in CETA on setting standards and regulation, and therefore it does not offer the same degree of access to the single market that the UK enjoys now or would have under EEA or EFTA membership. Ironically, if the UK leaves the EU after CETA has been ratified it could end up having to subsequently renegotiate an agreement with Canada, even to secure what had previously been agreed under CETA.

CETA ratificationCETA has now been signed by Canadian Prime Minister Justin Trudeau, but has still to be finally ratified. Under the Lisbon Treaty the European Parliament technically has to ratify trade deals, but the European Commission has partially deferred CETA ratification to member states. The process hit a substantial block in November as the Wallonian regional parliament in Belgium initially blocked the treaty. The Belgian government is required to consult and gain approval from its regional parliaments, but there had been hostility to CETA in Wallonia because of fears of further deindustrialisation and job losses because of Canadian imports. Any future trade deals between an independent UK and the EU could also have to be approved by member state governments, leaving the process open for delay and potential collapse.


Conclusion: post-referendum policy change is already underway

UK energy regulations to be watered down?Although the exiting process has yet to formally begin, separately the UK government has already made changes to its energy policy. The Department of Energy and Climate Change (DECC) that was established in 2008 was disbanded following the referendum. Its successor, the department for Business, Innovation and Industrial Strategy (BEIS), has signalled the government’s intent to incorporate energy within a wider set of industrial policies. But with the climate change element removed – at least in name – and a lack of clarity regarding the future of EU environmental quality and climate change policies in the UK, there are fears from environmental groups that the government could water down the scope and requirements if it introduces new legislation to replace that of the EU.

Even before the referendum, UK energy policy was diverging from that of the EU in a number of areas. For example, the push to develop shale gas in the UK puts it at odds with a number of EU member states – such as Germany, Denmark, France and Spain – that are in the process of or have already adopted bans or moratoria on fracking. The new UK government has promised to reinvigorate the nascent shale sector, and in August it set out plans to distribute a share of tax revenues from producing areas to local communities, and even directly to households. This was followed by a decision in October by the government to overrule Lancashire County Council planning authority’s previous decision and give the go-ahead for shale gas exploration to take place.

New policy decisions requiredSerious policy decisions will need to be taken on energy by the new government in the years between now and the eventual exit from the EU, but resources are likely to be dedicated to Brexit above most other areas. Long-term challenges include adapting the energy system to growing levels of intermittent renewable electricity sources, ensuring power supply despite the closure of aging coal and gas fired power stations, declining output from North Sea fields and their eventual decommissioning, and large infrastructure investment decisions – including on new nuclear power plants. All of these would be present regardless of the referendum, but government now has to contend with the prospect of potentially unpicking and rewriting many decades of legislation while simultaneously ensuring that the UK energy system is fit for the future.

Joseph Dutton Research Fellow, Energy Policy Group, University of Exeter

Sources

British Insurance Brokers’ Association (2016): ‘BIBA asks government to consider 11 points affecting brokers and their customers during brexit negotiations’ https://www.biba.org.uk/press-releases/biba-asks-government-consider-11-brexit-points/

CapX (2016): ‘The Canda-EU trade deal is no model for Brexit’ http://capx.co/the-canada-eu-trade-deal-is-no-model-for-brexit/

Digest of UK Energy Statistics, 2015 (2016): https://www.gov.uk/government/statistics/digest-of-united-kingdom-energy-statistics-dukes-2015-printed-version

HM Government (2015): ‘Alternatives to membership: possible models for the United Kingdom outside of the European Union’ https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/504604/Alternatives_to_membership_-_possible_models_for_the_UK_outside_the_EU.pdf

House of Commons Library (2013): ‘Leaving the EU’ (Research Paper 13/42)

House of Commons Library (2014): ‘European Union (Referendum) Bill’ (Research Paper 14/55)

Office for National Statistics (2016): http://visual.ons.gov.uk/uk-energy-how-much-what-type-and-where-from/

Reuters (2015): ‘Britain banks on electricity imports to keep lights on’ http://www.reuters.com/article/britain-power-interconnectors-idUSL5N11V1LO20150925

Vivid Economics (2016): ‘The impact of Brexit on the UK Energy Sector’ http://www.vivideconomics.com/wp-content/uploads/2016/03/VE-note-on-impact-of-Brexit-on-the-UK-energy-system.pdf

“ The new UK government has promised to reinvigorate the nascent shale sector, and in August it set out plans to distribute a share of tax revenues from producing areas to local communities, and even directly to households.”


Risk-based design for critical facilitiesThe problem with process facilitiesTropical storms are capable of causing unprecedented levels of damage to coastal developments throughout the world. Process facilities residing in these coastal developments are a critical part of the world economy. Damage and prolonged outages have proven particularly disruptive to manufacturers, agriculture, airlines, and motorists. Not only can floodwaters and extreme winds from tropical storms damage numerous types of assets at these facilities, but they can also cause prolonged power outages, supply disruptions, and widespread employee dislocations, all major contributors to both property and business interruption losses.

Process facilities such as power plants typically have some of the following basic components: process structures, process towers, tanks of various sizes, compressors, drums, exchangers, furnaces, pumps, reactors, pipe racks, cooling towers, storage warehouses, control rooms, maintenance buildings and an administration building. Most process facilities were built during a period (pre-1982) that preceded more modern standards for minimum design loads for buildings and other structures with regard to extreme wind events.

Historically, most components of process plants impacted by tropical storms sustain nominal, if any, wind damage. Thick-walled steel process towers, pipe racks, smaller process vessels, larger tanks, control rooms, and fully engineered buildings designed to support administrative and operations functions perform relatively well. However, it is also a historical fact that a majority of process facilities located along tropical coastlines have not experienced a design-level wind event. A direct hit by a stronger storm could therefore result in major damage to a substantially larger portion of the components within these plants.

Process building risk characteristicsIn general, process buildings are fully engineered, heavy steel buildings with average to weak cladding strengths that are designed for heavy equipment and operating loads. Storage warehouse buildings are usually large span, pre-engineered metal buildings with average to weaker cladding strengths. A large percentage of both of these types of buildings are open frame structures, with damage thus comprised mainly of roof cladding damage and debris impact damage. Most control rooms are either constructed of reinforced cast-in-place concrete or reinforced concrete block, or are fully engineered steel buildings with metal cladding. Administration buildings are usually either pre-engineered metal buildings, or are constructed of un-reinforced masonry. Maintenance buildings are typically large span, pre-engineered, metal buildings.

Collapsed storage tanks

Storage tanksStorage tanks vary significantly in size. Larger tanks tend to fail due to inward collapse of the tank wall caused by lateral wind pressures, while smaller tanks tend to fail due to local buckling of the tank wall cause by wind-borne debris impacts, or in some instances simply toppling over. Large empty tanks either without a roof, or with floating roofs that rested at the bottom of an empty tank, are usually more vulnerable to extreme wind effects due to the absence of sufficient lateral support. By contrast, tanks that have wall stiffeners, fixed roofs, product inside, or a combination of these features, fare better given the added lateral stiffness provided in each case.


Cooling towersOf all the components of a process facility, cooling towers typically sustain the greatest amount of damage. Often constructed of wood with thin-wall shrouds on top, these structures exhibited various forms of damage, from broken slats to collapsed frames. In recent years designers of cooling towers have sought to comply with the performance-based criteria of ASCE/SEI 7 which establishes a minimum design load for buildings and other structures.

However, in many instances cooling towers are often older structures (30+ years) that have experienced notable material degradation of their wooden members over time, particularly when exposed to coastal environments. Although considered a less costly part of a process plant, successful operation of these towers is crucial to the ongoing operation of a facility.

Process towers Dislodged or torn insulation is a common form of wind damage to process towers. Failures of straps and fasteners result in the loss of metal coverings, allowing exposure of insulating materials to the environment and thus allowing high winds to pull insulating materials, some made of asbestos, away from vessel surfaces. However, given their weight and supporting foundations, rarely do process towers experience structure distress in the form of collapse or tilt due to high winds.

Wooden pole failuresWooden pole failures are prominent throughout areas stricken by tropical storm winds. Lines on hundreds of these damage poles have to be restrung and pulled. Prolonged power outages can be attributable, in large part, to the time it takes to repair downed poles. Experience shows that metal or reinforced concrete poles well anchored into the ground are more likely to withstand extreme wind loadings than their wooden counterparts.

The time required to replace these structures, including lines and transformers, depends on the extent of utility crew mobilization and on the priority given to a particular area or site. Emphasis is often placed on repairing downed transmission lines first, followed by distribution lines serving areas with critical functions like hospitals, then to other areas of a community. Emphasis may also be placed on restoration of a facility if its function is deemed to be critical to recovery efforts like a gasoline refinery.

Other forms of plant damage observed following hurricanes include flare tower collapse, telecommunication tower collapse, and construction crane failure. Among the greater concerns regarding tower structures is the threat they pose to nearby structures in the event that they topple over.

Collapsed cooling towers Wooden pole failure


Calculating wind loads and loss probabilitiesCurrent codes and standards do not address all aspects of defining wind loads for process facilities. Therefore, many engineers and companies involved in the industry have developed procedures and techniques for calculating wind loads on such structures. This lack of standardization in the industry can lead to inconsistent structural reliability. As documented in a publication (ASCE 2011) issued by the Task Committee on Wind-Induced Forces of the Petrochemical Committee of the Energy Division of the American Society of Civil Engineers, the variation in wind load estimation techniques was extremely large. The publication Wind Loads for Petrochemical and Other Industrial Facilities was subsequently issued to provide designers guidance for determination of wind loads on common types of plant components.

Knowing the chances that a certain type of event (e.g., a 100-yr event) will occur during the expected or planned operating life of a plant can be beneficial toward understanding the risk exposure of a facility to an extreme event like a hurricane.

The table below shows the probability that a particular type of event, for example a hurricane, will occur at a site during a certain time period. The calculation is based on a Poisson distribution where the probability Pn that an event associated with an annual probability Pa (in decimal form) will be equalled or exceeded at least once during an exposure period of n years is given by:

Pn = 1 – (1 – Pa)n

Occurrence Probability, Pn (%)

Annual Probability, Pa (%)

Return Period (years)

Exposure Period, n (years)

10 15 20 25 30 50 100

10 10 65 79 88 93 96 99 99.9

4 25 34 46 56 64 71 87 98

2 50 18 26 33 40 45 64 87

1.3 75 13 18 24 29 33 49 74

1 100 10 14 18 22 26 39 63

0.4 250 4 6 8 10 11 18 33

0.2 500 2 3 4 5 6 10 18

0.1 1000 1 1 2 2 3 5 10


Assume that the annual probability of a moderate Category 3 storm striking an existing plant is one percent (1%, or 0.01, i.e., the 100-yr event), and that the plant is scheduled to operate for 30 more years. Therefore, the probability is 26 percent, or about 1 in 4, that the plant will experience a moderate Category 3 (or greater) storm during the next 30 years. When considering applicable design standards and associated factors of safety at the time of construction, such an event represents a reasonable threshold of major damage for many process facilities.

Adopting the practice of risk-based designIn recognition of these levels of natural hazard exposures, companies of all types are more readily adopting the practice of risk-based design in recognition that some facilities are more critical than other facilities in terms of their overall contribution to company or agency operations. Examples include structures that contain control systems, unique equipment, or a major hazard to life safety. Such critical facilities require designs that are significantly stronger than conventional facilities. However, unless specified otherwise by the operator of a process facility, the designer will typically use the minimum required value, which often reflects an un-factored load associated with a 50-year return period event (2% annual probability of exceedance).

Coastal plant operators with catastrophic exposure have been known to experience notable increases in their insurance premiums and restrictions in coverage following the occurrence of a major tropical cyclone. For example, after Hurricanes Katrina and Rita in 2005 some Gulf Coast operators saw deductibles increase from two to five percent, wind sub-limits of US$150m or less imposed, and business interruption coverage withdrawn, even though most power and petrochemical facilities did not experience a design-level wind event. However, the damage sustained and associated costs, particularly with respect to business interruption, underscored the apparent uncertainty associated with exposures of these facilities to an extreme wind event.

Adopting a design beyond the required code levelIn addition to traditional insurance, plant operators have other options to- mitigate their risk exposures to hurricanes. For a new design, one option is to adopt performance-based design where the design-level event selected for the new facility is beyond the required code level. For example, critical plant components can be designed for a 250-yr return period event instead of a 50-yr event. The steps taken to determine the best approach for implementing a mitigation plan are:

1. Determine the occurrence probability for the event. In the case of extreme wind, the gust wind is determined as a function of exceedance probability (or return period).

2. Determine the level of damage associated with a given wind speed. This effort may require separating the components of a facility into categories of structures and equipment, then determining the associated vulnerabilities based on historical experience, published data, or engineering analyses.

3. Create a loss hazard curve showing the level of damage as a function of exceedance probability for an associated wind speed.

4. Identify mitigation options for the categories of structures and equipment, where deemed reasonable, the associated cost for each option, and the resulting reduction in estimated losses.

5. Create another loss hazard curve showing the reduced level of damage given the implementation of mitigation measures as a function of exceedance probability.

6. Integrate the two loss curves (i.e. calculate the area underneath each curve) and subtract the two values to get an estimate of the expected annual loss reduction. Once this value is known, a determination can be made about the economic feasibility of the proposed mitigation measures for the operating life of the plant.

“ For a new design, one option is to adopt performance-based design where the design-level event selected for the new facility is beyond the required code level.”


Conclusion: risk of 100 year storm impact can now be definedIn summary, process facilities as a whole have performed relatively well in terms of wind damage to plant components during tropical storm events. However, most process facilities have not experienced a design-level wind event. Most of the direct damage has been to cooling towers, utility poles, supply/storage (metal) buildings, and insulation on process vessels. Major business interruption losses were incurred primarily due to prolonged power outages, to displaced employees, and also to the effects of flood damage. Loss of cooling water capacity due to damage sustained by cooling towers also contributed to downtime at some facilities. A direct hit by a stronger storm could result in major damage to a substantially larger portion of the components within these plants.

The chances that a specific mean recurrence interval wind event (e.g., a 100-year storm) will occur during the expected or planned operating life of a plant can be determined, and is beneficial toward understanding the risk exposure of a facility to an extreme event like a hurricane. Heightened awareness of natural hazard exposures has led companies of all types to more readily adopt risk-based design practices in recognition that some facilities are more critical than other facilities in terms of their overall contribution to company operations.

Bob Bailey Houston Office Director and Senior Managing Engineer, Exponent

Further reading:Minimum Design Loads for Buildings and Other Structures, ASCE Standard ASCE/SEI 7-10, published by the American Society of Civil Engineers, 2010.

Wind Loads for Petrochemical and Other Industrial Facilities, Task Committee for Wind Load Design for Petrochemical Facilities, published by the American Society of Civil Engineers, 2011.

20

00 0.1

0 10 100 1,000 10,000 100,000

0.01 0.001 0.0001 0.00001

40

60

80

100

120

140

160

180

200

Loss

($M

)

Exceedance Probabillity

Return Period (Years)

With mitigation

Without mitigation

Annual Benefit: $780,000B/C Ratio: 2.0Annual expenditure: $390,000Discount rate: 5.0%Operating life: 25yrs

Present value cost: $5,496,638


Employee Value Proposition and Total Rewards: modernize or risk being irrelevant

Findings from Willis Towers Watson’s 2016 Global Talent Management & Rewards and Global Workforce Studies

Attraction, retention and sustainable engagement drivers in 2016

During the second quarter of 2016, Willis Towers Watson’s Human Capital Practice conducted two parallel studies:

�� Global Talent Management & Rewards Study (TM&R), involving 2,004 employer respondents representing over 21 million employees

�� Global Workforce Study (GWS), which involved over 31,000 employee respondents

Of these participants, 66 in the TM&R and 463 in the GWS came from the Utilities sector, with companies and employees around the world.

The main purpose of the studies was to provide employers with an understanding of the drivers of attraction, retention and sustainable engagement in a world in which workforces are facing increasing pressures and stress.

Each study looked at areas specifically relevant to their respondents, such as talent mobility and challenges, total rewards and pay for performance (TM&R) and drivers of sustainable engagement, health, stress, wellness and communication (GWS).

2016 Global Talent Management & Rewards Study

Asia Pacific

EMEA

Latin America

North America

35%

21%

18%

26%



The Modernization AgendaAccording to the studies, an increase in labor market activity is translating into a myriad of attraction and retention challenges for all companies, including those in the Utilities sector. And our research indicates that organizations that are modernizing in certain key talent areas are faring better than those that are not. Key dynamics that are shaping the need to modernize include:

�� The workplace and market environment are changing more rapidly than ever before, putting pressure on companies to respond swiftly, decisively and nimbly. This is as true for the Utilities sectors as any other, with issues such as grid optimization, cyber security, and the impact on the wider sector of the growth of renewable energy.

�� Fast-changing energy technologies, like smart grids, continue to redesign the work performed, creating many new jobs, while eliminating obsolete roles and creating skill gaps, for example meter readers.

�� There are more generations employed in the workforce than ever before with pre-retirement baby boomers needing to transfer knowledge.

�� Employees, including millennials, have an expectation of choice, flexibility and recognition of individual preferences.

The need to build a modern talent agendaFor these reasons, employers need to understand how to build a modern talent agenda that will support employee retention, attraction and engagement to stay relevant in the market.

The challenges of attracting employees in key workforce segments remain high overall; nearly half (48%) of the employers surveyed reported increased hiring activity. At the same time, human capital costs continue to rise for all companies, in particular for Utilities, often attributed to rising benefit and retirement costs for a higher tenured workforce.

Additionally, retaining key employee groups remains difficult, especially for roles that are sought after and key to the changing dynamics of the industry – for cyber security, nuclear, and green technology roles. Almost three quarters of employers reported having trouble retaining high-potential staff, with more than a third (35%) reporting an increase in employee turnover.

This turnover for Utilities tends to be lower than the general norm. However, early retirements and the departure of high-performers can translate into a significant financial burden, putting a significant part of a company’s value at risk:

Job level Financial cost of turnover (% of annual

compensation)1

% of employee’s at high risk of turnover2

Financial cost at risk3

Senior Manager/Executive 74% 31% 23%

Professional 59% 25% 15%

Sales and Customer/Client Management 59% 27% 16%

Business Support 48 27% 13%

1 FCOT measured in our proprietary benchmark database2 % at risk of turnover from 2016 Global Workforce Study3 Financial cost at risk=FCOT*% at risk of turnover

Market trend/reality

Fast-changing Market

Fast-changing Technology

Demographic shift –It’s really happening

Expectations of transparencyand individualization


Modernizing your EVP should be accomplished in the context of an overarching human capital framework

Leadership

Measurement, Change Management, Communication and HR Technology

EVPEmployee Value

Proposition

Desired Culture

HumanCapital

Strategy

almost 3x as likely to report theiremployees are highly engaged

93% more likely to report significantlyoutperforming their industry peersfinancially

27% fewer regrettable new hires in the first year

More than 10% less likely to reportdifficulty attracting and retaining keyemployees segments

OutcomesHuman capital dimensionsBusiness strategy

17% lower voluntary turnover

Best practice EVP companies achieve better outcomes

© 2016 Willis Towers Watson. All rights reserved. Proprietary and Confidential. For Willis Towers Watson and Willis Towers Watson client use only. 4

GLOBAL

As part of the modernization agenda, companies need to be agile and nimbly respond to changes in business strategy and talent markets. Some primary practices of forward-thinking companies include:

�� Introducing flexible practices into talent and reward plan design/delivery – innovation as a driving force

�� Improving transparency in talent and reward programs – facilitated with open and honest communication

�� Tailoring programs to key segments of the workforce – one size does not “fit” all

�� Leveraging technology to digitally engage employees – the right technology is your “friend”

�� Transitioning from job security to relevance or career security – employees are “consumers” of your programs

�� Address work place stress – happy and healthy employees are more engaged.

The organizations that implement forward-thinking strategies to address the key human capital challenges such as early and/or delayed retirements, attraction of the millennial workforce, reduced training budgets, and minimal base salary increase, will be the ones that successfully modernize and address the challenges of today’s workplace and will remain relevant.

Getting Your EVP Right

Part of any modernization agenda needs to include defining and implementing a well thought out Employee Value Proposition (EVP). The EVP is the “deal” between the employee and employer which differentiates a utility from its talent competitors. The Utility industry has not traditionally been viewed as a leading-edge industry to work in, and today may be competing for talent within the broader technology and energy markets – therefore it needs to learn from these sectors as it vies for talent. As such, best practice EVP companies have:

�� A formally articulated talent differentiation strategy that is clearly aligned with what they stand for in the marketplace

�� As good an understanding of their employees and potential candidates needs as their external customers.

�� A customized EVP for high-potential employees, as well as those with critical skills

�� An effective communication plan that leverages technology to better understand employees’ preferences and delivers differentiated messages by employee segment

Best practice EVP companies achieve better outcomes


Understanding the top down driversWhen considering updating an EVP, a good place to start is to gain an understanding of the top drivers of employee attraction and retention. Employers need to know that what they regard as the top drivers may not be the same as those of the employees they are trying to attract.

For example, our studies indicate that base pay/salary was the number one attraction driver by employers. In contrast, employees ranked career advancement opportunities as the main attraction criterion, with employers considering this to be a less important driver. This is particularly the case for millennials who desire and expect progression at a quicker rate than other age employees and who may feel “held back” due to delayed retirements of older colleagues. Similarly, employers placed job security as the number two attraction driver, but for employees this was much less important, at number five.

This disparity also revealed itself in the top drivers of retention, or the reasons employees choose to remain with or leave an organization. Base pay/salary and career advancement opportunities were cited as the two most important criteria by both employers and employees, but in the opposite order. Interestingly, while employees ranked base pay/salary as the number two attraction driver, it was their number one retention criterion.

Employees also cited job security as an important retention factor, but this does not even appear in the employers’ view of top retention drivers. Additionally, this picture can get clouded by the fact that job security can mean different things to different people. For some their sense of job security may be defined by whether or not they are fearful of losing their job, whereas for others it may be defined by apprehension that their job will change and take them outside their comfort area. A number of jobs in the power and utilities sector have changed over the last few years as a result of renewable energy reliance and the security focus.

As part of the modernization agenda, companies need to acknowledge key differences in perspective and utilize this data to better tailor their talent and reward offerings to their specific employees’ concerns.

Effective Leadership Drives Engagement Having effective leaders is a critical foundational element to delivering a compelling EVP. Employers that are looking to or have already modernized their Talent and Reward agenda have recognized and acknowledged the important role leadership plays.

Feedback indicates that 61% of global respondents and 68% of Utilities agree or strongly agree that they develop leaders who will be able to meet changing business needs today and in the future – however this means that 32% of utility companies do not share this confidence.

For employees, there is also a strong desire to have authentic leaders who are honest to employees and can think ahead. An idea being utilized at some companies in the Utility sector is hiring back some of these seasoned, high-performing employees as contractors to help provide mentorship and skill-growth.

When asked to rate their senior leadership on the below statements, fewer than 50% of employee respondents gave their senior leadership a favorable rating.

�� I believe the information I receive from senior leadership

�� I have trust and confidence in the job being done by the senior leadership of my organization

�� Senior leadership at my organization has a sincere interest in employees’ well-being.

It is noticeable that the favorable percentages among Utilities employees were lower than the global average.

My organization makes effective use of a leadership competency model

Leadership development

61%

46%35%20%

Agree/Strongly Agree

Currently have

Plan to add in the next year or two

No plans


Highly Engaged

Unsupported

Detached

Disengaged67%

5%

17%

11%

33%

25%

24%

18% 23%

20%

32%

26%

9%

11%

26%

54%

Both e�ective

E�ective seniorleaders and ine�ectivemanager

E�ective managerand ine�ectivesenior leaders

Both ine�ective

When asked how they would rate the job that their senior leadership was doing to grow the business, manage costs and develop future leaders, again only a minority of employees gave a favorable rating, particularly when it came to developing the next generation of leaders. Since succession management is a key enabler of developing future leaders, there is a significant opportunity for a majority of employers to do more.

In terms of leaders enabling employees to perform at the highest levels possible, under 20% think their employers are providing development opportunities to top talent by removing or redeploying “blockers.”

Interestingly, employees give their immediate managers better marks than senior leaders, with favorable ratings consistently above 50% – with the exception of the sensitive issue of making fair decisions about how the employee’s performance links to pay decisions.

Lastly, our research indicates that it is not enough to have either highly effective leaders or highly effective managers. Both must be fully invested in supporting the EVP for employers to see significant increases in employee engagement levels.

My line manager/supervisor has the necessary skills

The People manager role is highly respected in my organization

Lack of effective feedback is the #1 barrier to the performance management experience

42%

45%

45%

49%

Global

Global

Utilities

Utilities

Employees with effective senior leaders and managers are much more likely to be highly engaged


Creating a Culture of Well Being

Stress the top workforce health issueTwo-thirds of employers globally identify stress as the top workforce health risk issue, with 75% in the U.S. indicating it is a top issue and 64% globally drawing the same conclusion. Not surprisingly, the other top wellness concerns are heavily influenced by stress and include: overweight/obesity (identified by 70% of U.S. respondents, 46% globally), lack of physical activity (61% U.S., 53% globally), poor nutrition (50% U.S., 31% globally) and lack of sleep (31% U.S., 30% globally).

Tackling the causes of stressTo combat this, employers need to focus on workplace stress and wellness, which requires identifying and tackling the main causes of stress. In this area, there are again disconnects between employers’ views and those of employees. As far as employers are concerned, lack of work/life balance is the main cause of stress, but employees report the key issues are inadequate staffing leading to employees being stretched thin due to fewer resources, followed by low pay and company culture. Yet at the same time millennials are reported to desire a greater work/life balance, with a focus on “working to live” versus a “live to work” mentality.

Reducing workplace stress and increasing wellness will involve addressing staffing issues, rethinking pay and changing an organization’s culture. Steps learned from fully optimized companies to ensure a work environment that is conducive to healthy employees includes understanding the following:

�� Moving from a “pull” (encouragement) to a “push” (driving change) for wellness must happen gradually, building employee permission along the way

�� There is a strong connection between health engagement and the broader employment “deal”

�� Leveraging worksites and supporting interactions/competitions between employees around health can be critical drivers of changed behavior

�� It is important for leaders and managers to be effective advocates of employer programs

�� Use technology, peer groups and personal communication to motivate action

In closing: the 5 steps to modernisationMany companies, including those in the Utility sector, appear to be at a crossroad of either modernizing or being left behind when it comes to attracting and retaining the brightest and the best. These organizations have everything to gain by enacting a modernization agenda that will support the creation of a more equal employee-employer relationship and value exchange. If you are an employer who has yet to implement steps towards modernization, you can start by enacting the following measures:

1. Have your leadership team role model transparency, trust and relationship building with the next generation of leaders – the leaders of the future need to be trained by the leaders of today

2. Make room for supervisors and managers to have the time needed to provide effective people management beyond their current operational roles – place importance on the skill of motivating and empowering the workforce

3. Redefine what your talent and reward programs look like – redefine what performance management is, how performance is measured and differentiate pay

4. Create flexible career paths and embrace flexible work arrangements – adaptable programs will often thrive

5. Make technology work for you by leveraging digital media to drive engagement – utilize all of the technology levers at your disposal

Utilities that want to thrive in an environment that is evolving at an unprecedented pace – regulatory changes, green energy initiatives, focused risk management and security needs – need to keep up with an ever changing market place for employee talent, and modernize. Future success requires companies to challenge conventional thinking and re-invent themselves.

Catherine Hartmann Talent and Rewards Senior Consultant, Willis Towers Watson


The rush to renewables in AustraliaDoes Australia need to make haste more slowly?

September storm cast doubt over capacity

In late September 2016, a “once-in-50-years” storm blacked out the entire state of South Australia, thrusting the energy risk debate back into the spotlight.

It was, perhaps, a little unfair to blame the state’s heavy reliance on renewable energy for that particular crisis, which affected Adelaide for days – and much longer in regional areas. South Australia takes 40 percent of its power from wind turbines, which could not operate in high winds, but the main problem came from power distribution infrastructure being knocked out by the storms, including an interconnector linking the state with neighbouring Victoria.

But the emphasis on renewable sources of electricity in South Australia raises significant questions about capacity – not just in that state but for Australia as a whole. This is not the first time South Australia’s energy grid has been found to be fragile and there have also been other documented instances across the country where capacity and security issues have led to soaring costs and intense pressure on supply.

Political debate too simplistic?

In the political context, the debate all too often comes down to a simple equation:

Renewables = good

Fossil-fuelled power = bad

Like many countries, Australia has relied heavily on coal or gas-fired electricity which historically was owned and operated by state-run institutions. The privatisation of energy supply has led to a dichotomy; while governments push energy companies to develop and bring renewable technologies on line, they face a backlash if baseload capacity is diminished.

That capacity has traditionally been provided by environmentally unpopular power plants using fossil fuels. The storms in South Australia put the electricity grid in total shutdown but there have been other occasions where lack of capacity has seen prices spike – another issue one July night saw wholesale prices hit A$9000 per megawatt hour (MWh), where the yearly average was A$60. Essentially, Australia energy prices are free-flowing, up to a $14,000 MWh ceiling mandated by Australia’s Energy Market Operator (EMO).


The role of the RET in the price spike

The causes of that spike were described at the time as “complex” but there is little doubt that Australia’s Renewable Energy Target (RET) is playing a role. The RET mandates that 23.5 percent of electricity must be drawn from renewable sources by 2020. The issue with South Australia is that it has gone further down the renewables path – and faster – than any other state or territory in the country and many other jurisdictions around the world.

In the September storm’s immediate aftermath, there was a shift in political rhetoric. The independent senator from South Australia, Nick Xenophon was quoted in media as saying the state’s energy arrangements were “a textbook case of how not to transition to renewable energy”.

A wake-up callSouth Australia is a wake-up call that has reverberated around Australia. In the rush to take up renewable technologies, the full impacts on the community at large have not been adequately considered. The EMO must be seen as the major culprit here, having failed to ensure that appropriate redundancies are in place, not only for uninterrupted supply but price stability.

Tasmanian exampleLet’s take another example. Tasmania has a long history of generating hydro-electricity. In the quest for much-needed revenues, the state supplied energy to mainland Australia during the period of the federal Labor government’s carbon pricing scheme, using the Basslink undersea power cable.

While hydro-electricity is an efficient way of generating power, it has one major caveat – it needs water. Tasmania made a lot of money in that period, but ran its dams to low points and seasonal rains were disappointing. When it could no longer use its hydro system to generate enough power, Tasmania found itself having to import 40 percent of its electricity needs. Then, in December 2015, the state was hamstrung by a fault in Basslink. As a result, a gas-fired power station in the Tamar Valley had to be brought back online.

So if water doesn’t flow, the sun doesn’t shine and there’s too little (or too much) wind, where does that leave Australia in terms of energy security and how can organisations manage energy risk?

The Basslink problems took more than six months to resolve with industry sources putting the economic cost of its failure at more than A$560 million. That figure apparently did not include an estimate of lost production from major manufacturers and miners in Tasmania who were required to cut back on their energy use. The Tasmanian government also had to contend with greatly reduced revenues from Tasmanian Hydro, while wholesale power prices in the island state increased four-fold to A$177 MWh in the March quarter 2016.

A reactive rather than measured approachSimply, there is no reason why outrageous price spikes should occur, but the aggressive removal of fossil fuel power generation and the maintenance of the facilities that remain to ensure that infrastructure can cope with whatever challenges are thrown at it, are resulting in enormous risks.

Many of the older facilities throughout Australia require significant capital expenditure but the push to renewables makes energy companies think twice about making that level of investment. How they run their plants, and their businesses, is done in a reactionary rather than a measured way.

Energy market systemAnd that’s the problem. Australia has developed an energy market system, not a capacity system. Energy companies are not paid for their power plants – only if they’re operating.

This is not the same as some other jurisdictions such as the UK, where a capacity market was introduced in 2014 to meet the twin challenges of a loss of capacity due to the impending closure of a large number of power plants and the need to accommodate the variability in output of the growing amount of renewable generation.

The UK schemeThe UK scheme awards payments, allocated following an annual auction, to power generation companies in exchange for an undertaking to be available when required. Its purpose (as stated by the UK government) was to “ensure security of electricity supply by providing a payment for reliable sources of capacity, alongside their electricity revenues” and to “encourage the investment we need to replace older power stations and provide backup for more intermittent and inflexible low-carbon generation sources” (source: https://www.gov.uk/government/collections/capacity-market-2016).

(It should be noted, however, that the design of the UK capacity market has attracted criticism, for example for the unintended consequence of acting contrary to the UK’s decarbonisation goals by rewarding coal- and diesel-fired generation, and earlier this year the government conducted a formal consultation on possible reforms to the capacity market.)

In Australia by contrast, the EMO and its predecessor has slowly taken a more authoritarian position within the marketplace over the past 20 years or so. Simply put, given oversight of the industry it gained more and more power to make instructions to energy companies. That seemed to work until the carbon pricing scheme was introduced in 2012 and renewables were heavily promoted.

28 willistowerswatson.com28 willistowerswatson.com


Victoria example – energy generators frozen in their seatsFrom there, quite frankly, it all became quite bizarre. Let’s take as an example a power station located in Victoria, which burns environmentally unfriendly brown coal. In 2012 their short-run costs to generate power were below A$5 per MWh, while the market wholesale price was around A$35 per MWh. Carbon was priced at A$20 per tonne under the scheme, which, due to their use of brown coal, equated to an increase in their fuel costs of approximately A$30 per MWh. This meant that their total generating costs were now only marginally less than the market wholesale price, almost completely eroding their profit.

But then federal government compensation to fossil fuel generators kicked in, to the tune of billions of dollars. Energy companies found themselves sitting on a pile of cash and many dropped their coal-fired production substantially – but 18 months after the scheme took effect, it was repealed.

The idea was to force companies to make the case for renewables but this was also a period of political turmoil. It was hardly surprising then, that some energy generators were effectively frozen to their seats.

The rise and rise of battery power

Australia is seeing a more moderated approach to renewables, thanks mainly to the funding and input of the Australian Renewable Energy Agency (ARENA).

Technology is also starting to help make better use of what can be generated through renewable sources, especially solar energy. The coupling of storage to photo-voltaic cells is seeing solar being taken up at a rapid rate. For the first time, users have been able to get their power generated during the day and use it at night rather than merely feeding back into the electricity grid. It has overcome one of the major issues with solar – the need for very expensive equipment on the roof that doesn’t necessarily give a return on investment.

Indeed, battery technology has transformed the renewable energy landscape. Developers are now factoring in renewable technologies to communities where battery storage can offer a round-the-clock solution. Many communities have the distinct possibility of living off the grid as a result. It’s also an attractive solution for energy companies and their need to invest in infrastructure such as high voltage lines, particularly in more remote areas.

Where to from here?

Australia has just over three years remaining to meet the RET of 23.5 percent renewable energy by 2020. With statements like that, business has to respond, irrespective of whether the goal is achievable.

The confluence of events at the moment shows our uptake of renewables needs to be done in a considered and sustainable manner. Technology needs to develop and mature and become economic – that will happen through commercialisation of products like battery storage.

The Australian advantageAustralia is an ideal country for that to happen. Our population is widely dispersed and the infrastructure cost of putting lines into regional or remote centres, as well as the associated maintenance, is prohibitive. That too is a key upward pressure on energy costs.

The renewable technologies themselves must be able to maximise their output. Wind technology is looking at what it can generate in mega-wattage per turbine but that is happening at a far slower rate than solar. Indeed, while solar efficiency is increasing exponentially, there is only so much that can be generated from a single wind turbine unless they are made bigger.

Getting the mix rightThere’s no need for governments to “sell” renewables to the public any longer. Everyone accepts they are sensible technologies, but we must ensure the mix is right. The aggressive moves by South Australia to take away fossil-fuel generation can have disastrous consequences.

Energy management and risk is a real balancing act and we’re seeing the strain of putting all our energy “in one basket.” This is a transition period and, without balance, we will continue to see impacts on pricing, business and households.

No off-grid incentivesOne of the major issues we will confront at some stage is that there is no real incentive to go off grid and certainly the energy generators are not going to promote that. Australia still needs its energy infrastructure; if people go off the grid in a significant way, the cost of providing and maintaining other electrical infrastructure will be borne by an ever-decreasing pool of users.

This also leads to revenue risk for energy companies; while they are looking at options in renewable technologies (and these are usually the companies that are also electricity retailers), they still need to manage this process in terms of shareholder return.



What will success look like?

We need to see some “stickiness” in the energy sector; energy companies should take a life-cycle view of their customers in terms of being able to manage the use and need for power. It will take a move away from the traditional relationship with customers and that will reduce a lot of churn.

At the moment, churn is probably running at around 20 percent per year – that is, a typical power company loses a fifth of its customers to a competitor each year. That may well be related to price at the moment but, in future, customers may be swayed by obtaining their energy from a renewable source. Some energy companies are already offering ‘green’ options.

Government and regulators need to up their gameRenewables are more than embryonic in the Australian market but it has been too politicised. Government and regulators are slow to respond to changes and business has had to sit on the fence trying to work through the political will of the time. And, we still have an energy market rather than a capacity market; if business can’t get a guaranteed return on the investment needed to implement these technologies, it’s hard to see them moving ahead at any great speed.

Energy companies to reinvent as technology businesses?There is probably a need for energy companies to reinvent themselves as technology businesses. Typically their workforces have been dominated by engineers whose thinking was locked into managing assets and plant; getting them to take up new technologies is a challenge.

We have seen energy companies become behemoths; for many of them their processes aren’t as nimble as, say, Tesla. How they respond and transition is a major risk.

Indeed, in the Willis Towers Watson Natural Resources Risk Index published in July, one of the biggest concerns for executives was technological change. The megatrends identified in the index were all centred around digitalisation and new technologies.

The challenge of evolving business modelsIn the face of rapid technological innovation and the arrival of new entrants redefining the competitive landscape, companies face real challenges around evolving business models. Those companies that are able to maintain cost discipline, drive efficiencies and adapt to change, will have many opportunities to grow market share and build competitive advantage.

Digitalisation and new technologies was ranked the second highest risk overall (after geopolitical instability and regulatory change) and the senior executives polled for the Index also put it second highest when asked to evaluate which will continue to have an impact in the next five years. Indeed, in the Asia-Pacific region, 47.5 percent of respondents to the Index survey agreed it was their number one risk.1

Ultimately, governments need to have a very clear plan about how the industry will transition and it must support all businesses – whether they’re legacy players or disruptors in the renewable space. A key plank of that will be to provide a framework that achieves the right mix but also to change the way we approach the sale of electricity from an energy market to a capacity market.

Martyn Thompson Regional Industry Leader, Natural Resources, Australasia

Source

1 The View from the Boardroom: Willis Towers Watson Natural Resources Risk Index 2016


Energy storage & batteries – the energy revolution continues Using batteries on a large scaleThere are many different types of electrochemical energy storage systems - otherwise known as batteries - which have been with us for many years and are an essential component of our daily lives. Broadly speaking, batteries can be distinguished between:

�� sealed portable batteries

�� batteries designed for industrial or professional uses or used in any type of electric vehicle

�� automotive batteries, which are used for vehicle starting and ignition systems.

Industrial batteries in the EU tend to be lead-acid batteries (96%), NiCd batteries (2%) and others (2%). However, batteries in the sense of large-scale electricity storage systems are something new and different, but offer the same opportunity to revolutionise our lives as the batteries with which we are all familiar.

Slow acceptance of technological changeDespite the commonplace role of batteries in our lives and the desirability of clean, smart technology and greater security of supply, there has been a surprisingly slow reaction to embracing and supporting energy storage technologies that can be used to control the electric grid. This has especially been the case for many governments who could foster accelerated research and development or provide fiscal mechanisms to support commercial enterprises. It is perhaps not surprising that some of the more traditional power and utility companies, who are being challenged to move away from a centralised ‘’bicycle wheel spoke’’ model to distributed generation, have moved on from the intermittent and decentralised renewable energy sector to embrace the next disrupter technology.

“ New battery technology will permit excess power to be stored for later times when generation slows or consumption peaks, or the smoothing of export fluctuations over short time-frames.”

Now the time is right…Now that renewable sources of energy have firmly established their place in today’s world energy mix, the development of new storage technologies couldn’t have come at a better time. It looks a racing certainty that we will now see energy storage technology quickly adapt to help control energy costs and improve grid efficiency worldwide.

…batteries can assist the supply/demand matchHistorically, when electricity was generated and exported to the transmission system, it needed to be the equivalent of the variable demand requirements. Transmission system operators had to ensure that supply and demand always matched in order to support the frequency of the grid. This was rather crudely achieved through variable peak demand generation, such as pumped hydro schemes, demand management (‘load shedding’) agreements and importing electricity from neighbours with surplus generation capacity. A considerable downside of the new age of renewable technologies is that a substantial intermittent power supply can potentially jeopardise the whole system stability. New battery technology will permit excess power to be stored for later times when generation slows or consumption peaks, or the smoothing of export fluctuations over short time-frames, allowing more wind and solar capacity to be added to a country’s power mix without the stability of the grid being put at risk from short term power output fluctuations.

The storage technology, whilst differing in chemistry, is a concept evolution from what we have readily accepted into our daily lives for so many years.

Energy storage a godsend for renewablesAt their core, renewable energy technologies are themselves disrupters as the power sector transforms itself to decarbonisation helping drive the energy revolution. Driving innovation in technology, cost efficiency and challenging the long established centralised base load system are essential to a decentralised generation and distribution model. However, the intermittency of generation peaks and troughs coupled to resource availability, rather than demand, has always dogged the industry. So energy storage is a godsend for the renewable energy sector, where wind and solar technologies and distribution systems have been unable to address these surges of excess power – which can now be stored for later use at times when the sun sets and consumption peaks in the early evening. Removal of this intermittency will also remove risk to the stability of the grid which would otherwise be the result of increased usage of renewable technologies.



An end to baseload capacity requirements?A number of energy experts have indicated that once storage costs approach USD 100 per kilowatt hour, the economic argument to build large scale and costly nuclear ‘baseload’ power plants, which can’t be regulated with power demands, becomes questionable. Renewables generated 18% of the UK’s total power output in 2015 and this is expected to double by the late 2020s as installed wind and solar capacity reaches 50GW. Once that power can be stored, potentially overnight, there is potential for extended periods in the summer where no baseload capacity may be needed at all. Batteries have the real potential to alter the global energy sector as we know it by enabling the integration of increasing higher volumes of intermittent wind and power supplies on a distributed and grid-scale level.

Grid digitalisationEnergy storage has the ability to digitalise the grid, making the evolutionary leap from analogue to digital. This potential to elegantly manage the ebb and flow of electricity supply and demand as an alternative to the brute forces of peaking generation must be embraced as we move to smart grids. Energy storage systems are able to instantaneously respond to signals from controlling software to manage critical grid needs such as voltage variation, frequency regulation, absorbing excess generation, and shifting peak demand to off-peak periods. This is the future.

More companies to enter the marketDespite the overall energy storage capacity in the UK hitting 3.23GW in October 2016, the industry is still regarded as immature. The presence of large and well-established companies appears to support the expectations many have for it to grow significantly. Given the huge disruptive potential and opportunity in the next few years we can expect a greater number of companies to enter the market. Falling costs, a sense that energy storage’s time is here, coupled with many governments’ review of their support and desire to potentially be considered technology leaders in a developing sector will additionally drive new entrants in this sector.

Battery varietiesThere are many battery chemistries, with each manufacturer pushing its own specifications that offer the right performance characteristics for specific applications and products to support renewable integration and other grid services. Some provide short bursts of high power output, while others can discharge a steady stream of electricity over many hours.


Lithium-ion batteriesLithium-ion chemistry batteries appear to be the focus of current and near term commercial scale deployment, due to the technology’s multi-functionality that allows vendors to tap into markets ranging from consumer electronics to grid-level storage. These batteries are flammable (unlike Vanadium Redox Flow batteries) and present challenges to insurers in terms of risk management and fire prevention or suppression. In their early days there were a number of headline market claims, as insurers struggled to understand how the technology was being integrated and managed. Developers, owners and insurers alike appear to have settled recently in the support of new opportunities.

Vanadium Redox Flow batteriesHowever, other technologies such as Vanadium Redox Flow (VRF) will become an attractive storage option in isolated and/or unreliable power systems where they will be well positioned to tap the multi-hour (four hours or more) storage market due to their ability to store and supply substantial volumes of energy over longer timeframes. This technology is easily scalable and able to sustain thousands of deep discharge cycles without degradation and is operable within a broad temperature range. Accordingly, systems in developing countries with challenging climatic conditions for battery technology such as Sub-Saharan Africa (SSA), South Asia and isolated power systems (such as islands) offer vast potential to develop. Recently we saw the shipping container sized (VRF) battery installed by RedT on the Scottish Hebridean island of Gigha for a set of community-owned wind turbines. Output previously had to be limited because of a shortage of grid capacity and no way of storing the excess generation.

Supporting intermittent wind and solar power generationThis technology can help displace the need for expensive diesel-fired power and support intermittent wind and solar power generation. Sodium Metal Halide, Sodium-Sulphur, Nickle-Cadmium, Nickle-Metal Hybrid, Lead-Acid and Zinc-Bromine Flow are all technology types with differing levels of maturity, application and support. The market is now expected to boom, with cutting-edge research leading to a cheap, reliable and clean form of electricity storage.

Navigant Research recently placed AES and RES top of its annual leader-board of utility-scale Energy Storage Systems Integrators (ESSI’s).rated on a dozen criteria. Very few companies have the same four skill-sets of technology and engineering, construction, and development and asset management that allow their customers to benefit from a one-stop-shop experience. Other contenders on the Navigant leader-board include Greensmith, Invenergy, General Electric, ABB, Younicos, NextEra, Leclanche and Doosan Grid Tech.

According to market research firm HIS, the energy storage market is set to ‘’explode’’ to annual installation size of over 40GW by 2022, from an initial base of only 0.34GW installed in 2012 and 2013.

The UK’s National Grid has accepted eight bids of a combined 201MW from battery storage providers in its first (EFR) Enhanced Frequency Response service tender. In June 2016 it also awarded RES a parallel deal for 20MW of sub-second frequency response. The RES lithium-ion battery storage facility, expected to be live towards the end of 2017, will be the UK’s first sub-second grid balancing system. It is understood that there are over 1600+ BESS (Battery Energy Storage System) projects worldwide, including over 700+ in USA.

Willis Towers Watson are at the forefront of Renewable Energy generation. The Global Renewable Energy team have been leading the field in supporting the development and de-risking through risk mitigation techniques and creating innovative risk transfer products which include insurance backed guarantees for both integrated and isolated energy storage solutions.

Steve Munday acii Global Renewable Energy Leader, Wills Towers Watson

“ Recently we saw the shipping container sized (VRF) battery installed by RedT on the Scottish Hebridean island of Gigha for a set of community-owned wind turbines.”


The Asia power paradox The power generation gap

There are many countries in Asia, perhaps more particularly South East, where the division between the need for growth in the power generation sector and the rate of projects under development shows an alarming gap. Yet, at the same time, the number of global and regional power companies looking to expand and invest into the power sector remains strong. What are the reasons for this investment gap and what can be done to accelerate the implementation of reliable and cost effective power generation?

The development of the power industry in any territory is a complex issue involving domestic economics; country specific resource availability; social pressures and a balance of cost per megawatt hour versus the benefits to the overall development of the country’s economy. How governments respond to this in Asia varies dramatically, presenting investors with a heady mix of consideration on the potential returns for any investment. How do power investors address these challenges and how are some of these risks managed, mitigated or transferred to an acceptable level? This article seeks to review some of the major challenges seen in Asia and offers a view on best practice to support of project viability.

Geopolitical instability

The 2016 Willis Towers Watson Natural Resources Index study titled The View from the Boardroom contained the results of interviews with executives from 350 Global Power, Energy and Mining companies. Geopolitical instability and regulatory change was cited as the number one risk that can impact their business.

The study’s risk index score, a combined total of the potential impact rating (severity) and the rating on the ease of managing the exposures, topped the WTW risk ranking table. Interestingly, further analysis of this global mega-trend showed that here in Asia not only was geopolitical instability and regulatory change top of the risk ranking but also the risk score of 72 was almost 50% higher than the equivalent global risk score.


Inconsistent energy policiesWhat is driving this heightened level of concern and perceived difficulty in managing risks is not too hard to see for anyone who operates in Asia - particularly in South Asia, where developing economies such as Indonesia, Myanmar, Cambodia and Vietnam lack a track record of consistent transparent energy policies offering investors acceptable certainty on their capital. In many locations the government’s energy policy is unclear and/or there are challenges in working across multiple government departments whose approvals are required to progress a development site.

Examples of these risks are numerous in the region with challenges evident in Indonesia, such as access to a reliable infrastructure supporting coal of or gas fuel supplies, Myanmar, where land availability and land usage policy lacks definition and Vietnam, where currency convertibility presents a risk to projects seen often as unacceptable. These issues are just a few examples of government policy and regulations that lack a comfortable level of certainly.

Renewables no exceptionAdded to this mix of challenges facing the power investor in Asia is the government’s approach to renewables, where growing social pressures for clean energy butts heads with the need for cheap reliable baseload power generation. Inconsistency on feed-in tariffs policies, grid stability issues, and land use, particularly for large hydro and solar projects, challenge policy-makers still further on implementing a balanced energy policy. Overarching energy policies across Asia are a little hazy and the region’s response to the Paris Accord remains a work in progress. Coal-fired facilities delivered cheaply and funded by China’s state-owned power companies presents a convenient solution to baseload power needs - but at what longer term cost to the environment and Asia’s seat on the world stage?

Call for greater regulatory certainty and fairer risk allocationThe consistent message across South East Asia among the power generation community is a call for greater regulatory certainty - to allow projects to correctly price risk and allocate these risks fairly between the government authority and the private sector. Independent Power Projects in Asia have had a distinctly mixed track record with investors’ memories still tainted by past failures partly triggered by the 1997 Asia financial crisis, which forced a number of IPP contracts to be renegotiated. Conflicting interests within Asia remain evident and it remains to be seen how countries will address these issues in the coming years. This uncertainty drives up the cost of power development projects where developers need to factor risks against a project’s projected rewards.

Geopolitical instability and regulatory change

Geopolitical instability and regulatory change

Risks resulting from digitalisation and new technologies

Complex operating models in a global business landscape

Complex operating models in a global business landscape

Risks resulting from digitalisation and new technologies

Business model and strategy challenges

Workforce management and talent optimization

Workforce management and talent optimization

Business model and strategy challenges

Rank RankMegatrend MegatrendCombined Risk Score

Combined Risk Score

Global Ranking Asia Ranking

1 12 23 34 45 5

51 72

49 49

42 48

39 48

34 42


Philippines leading the way?Despite this, there are examples in the region of positive collaboration between the government and the private sector. The Philippines is perhaps leading the way in South East Asia with its Public-Private Partnership (PPP) Centre championing the model and acting as a positive negotiator between the private investor community and the Philippine government.

The Philippines PPP Centre is mandated to facilitate the implementation of the country’s PPP programme and projects. It serves as the central coordinating and monitoring agency, supporting the country’s PPP programme by enabling various implementing government agencies in all areas of project preparation, managing the project development, providing projects advisory and facilitation services.

Importantly, the Philippines PPP Centre is also advocating policy reforms to improve the legal and regulatory frameworks governing PPPs in order to maximize the potential of these infrastructure and development projects.

Indonesia PPPsIn Indonesia, the government has made a clear commitment to meeting its significant power needs in partnership with the private sector. Of the 35,000 MW growth target a substantial number of projects will be delivered by private power developers, and although there remain numerous challenges on the road to closing, deals are happening and private developers are broadly comfortable with the country specific risks.

Volatile political risk landscapeHowever, country-specific political risks can be relatively high in Asia and are subject to sudden movement and changes in policy. Regulatory approvals are often time-consuming and costly, with project companies having to negotiate with multiple government agencies. Tension or inconsistency between central and regional authorities creates a further minefield for the developer to navigate. Challenges are evident in obtaining consistency between agreement terms and, in advancing the various agreements at a consistent and timely pace. This makes the journey to financial close a long and uncertain one. All too often projects are delayed by one of more authorisations needed by a local or regional authority, driving up the cost of project implementation.

“ Coal-fired facilities delivered cheaply and funded by China’s state-owned power companies presents a convenient solution to baseload power needs – but at what longer term cost to the environment and Asia’s seat on the world stage?”

Increasing interconnection – but more disputes?The region is also becoming increasingly interconnected in both energy policy and the cross-border trading of power. Although this offers some positive news with greater collaboration in resolving Asia’s power needs, it also highlights the potential for increased cross-border disputes as development projects in one country impact life and economic activity in neighbouring countries.

Nowhere is this more evident in Asia than the Greater Mekong region, where the damming of the Mekong River in Laos has potential to create social unrest in the Lower Mekong Basin where almost 60 million people make their home. According to some estimates, as many as 80% of the population rely on the river system for food, drinking water and their livelihoods. The river is also home to one of the most diverse ecosystems in the world, supporting over 1,000 animal species including over 500 endemic fish species.

Receiving country gains most from new power projectsA large power project development will drive some short term economic benefit for the host country, mainly in terms of jobs in the construction industry and a small number of skilled and unskilled employment opportunities for the local community. However, for projects where the power generated is exported across borders, the longer term and more significant benefit resides in the country receiving the power, as this will be put to use to support economic growth and power homes. All power projects have a negative environmental impact so in circumstances where this unwanted impact is felt by a community in the absence of an economic beneficial offset, there is potential for unrest.


Risk Management for Power Development Projects

The benefits of a “life cycle” risk management approachThe complexities and risks highlighted above should be included in the basket of issues that a developer should consider as part of his investment approvals. Best practice risk management requires that these issues are considered early and monitored not only during the feasibility phase but also during the subsequent construction and operational phases of the plant. A ‘Life Cycle’ risk management approach is therefore called for; however, how companies assess, quantify and set risk management strategies can be challenging when, typically, responsibility for development, construction and operations will be the remit of three different internal departments. Where there is no central risk management function these roles will fall initially with the development team and transition to construction project management and then again to plant operations. Decisions made during the development phase will inevitably have an impact on subsequent phases as, for example, the site location choice may embed a heightened exposure to flooding or earthquake or impact the logistical ease on fuel supply or generation dispatch. A project ‘Life Cycle’ risk register is needed to best consider, assess and allocate responsibility for ongoing review and management of recorded risks.

Implement your risk strategy earlyA robust insurance strategy should be put in place early, in which coverage options are consistently reviewed as the project develops and decisions are made. Use of technology, site location, terms of the PPA and O&M agreements will all contain embedded risk, indemnity and insurance requirements. A project-specific insurance programme will need to adapt in line with the project programme and allow the developer to build into his financial model the cost of comprehensive risk transfer. It is better to have considered the exposure, priced the risk and subsequently made a conscious decision to absorb the risk in the light of other commercial factors. The alternative of having to retrofit a new risk cost into a budget already signed off by the Board - and inevitably under pressure from other project elements - is always unpalatable.

Use of insurance-backed solutions to secure investment/debt financingInsurance today has the ability to protect projects from more than just loss or damage to physical assets and increasingly insurance-backed solutions are utilised by developers to help enable a project to obtain investment approvals or secure debt financing. Early consultation with a professional risk and insurance adviser can increase awareness of these options and help bridge gaps that might otherwise place an unacceptable strain on the project’s financials or present unacceptable volatility in the project’s projected return on investment.

Some examples of projects and solutions beyond some of the better known Property & Casualty products are:

�� Contract Frustration, Expropriation and Trade Credit: the risks to be considered range from those of a physical, tangible nature such as damage to property or machinery to those inherent in the project fundamentals such as delays under, or complete cancellation of, a major contract (whether that be an off-take contract or a fuel supply agreement). Prudent risk management will involve the former and cater for small or large failures of machinery or damage to assets; however, debt and equity providers will also be concerned with low frequency but high severity possibilities such as licence cancellation, illegal actions by a host government or seizure of assets (known as expropriation).

The potential for political tension in Asia using Laos and the unique dilemma apparent in the energy policy adopted as an example has already been highlighted earlier. The Mekong River presents huge hydro power opportunities to the extent that power sales to neighbouring Thailand, Cambodia and Vietnam are the country’s biggest export and a significant source of revenue. However, the social and environmental implications are far-reaching, not just in the vicinity of the dam but also the estimated 60 million people that live downstream in the delta. The political ramifications are therefore similarly local and international.

�� Currency Inconvertibility: investment in Vietnam has a particular challenge - the government of Vietnam will only guarantee certain percentage of local currency that can be converted into hard currency. A project that sells power to the national grid and therefore generates revenue in Vietnamese Dong but has to service debt in US Dollars will require a solution to this potential shortfall. Furthermore, the “bankability” of such projects may be questioned, which will impact the cost of debt finance. The insurance market can offer a means of mitigation: Currency Inconvertibility and Exchange Transfer will indemnify an Insured for both the inability to convert Vietnamese Dong into US Dollars and the inability to extract US Dollars from Vietnam if the government were to impose currency controls.

In Indonesia, the state utility company Perusahaan Listrik Negara (PLN) monopolises the grid and is the sole buyer of electricity generated by independent power providers. President Jokowi has set ambitious new power targets, aiming for 35 GW by 20251 Investors are circling and with support from institutional investors and multilaterals such as the World Bank and Asia Development Bank the possibilities are looking healthy. However, PLN has not had a perfect track record; during the Asia financial crisis in 1997, arbitrators found that PLN had breached a fixed tariff off-take contract signed with two US geothermal energy companies, and the company was required to pay out.


Non-payment under a contract by a state owned entity is a risk that the Political Risk Insurance market is familiar with, a typical insurance policy will, following a cure period, cover the cash shortfall created when such a state entity fails to pay. This protects balance sheets and debt service and helps investors to manage low frequency but high severity risk.

�� Political Violence: factors outside the control of a power project developer in emerging markets also include delays or full cessation of construction or operation of a plant as a result of hostile actions by armed forces, civil war, revolution, terrorism and sabotage. The speed and impact of such events can vary, from the wildfire spread of the Arab Spring through social media to the unpredictable nature of Russian intervention in Eastern Europe.

The root cause of all three of these issues can be attributed to local politics; whether that is a dispute between ethnic minorities or political groups; national politics, such as a coup, resource nationalism or currency controls; or global politics, such as disputes between nations over the South China Sea.

The supply of basic power to the population is too emotive, too linked to social progress and too fundamental to the growth of GDP not to be affected by micro and macro political change in South East Asia. The opportunities and risks associated with investing in such a region and sector therefore need to be balanced. The Political Risk insurance market offers partnership in such scenarios; there are now in excess of fifty private insurers in Lloyd’s of London and company insurers that offer cover on a range of perils.

Source

1 http://www.google.co.uk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0ahUKEwiWyb3Bu4XQAhWGF8AKHSS1Ar4QFggcMAA&url=http%3A%2F%2Fwww.pwc.com%2Fgx%2Fen%2Fissues%2Fhigh-growth-markets%2Fpublications%2Fghost%2Fpower-in-indonesia---investment-and-taxation-guide-3rd-edition.html&usg=AFQjCNEScrDYloWzUQE4WaT83p2JWGFTig&bvm=bv.137132246,d.d24).



Advanced Condition Monitoring and Diagnostic TechnologyWhat is Condition Monitoring?

Condition Monitoring (CM) is a method of monitoring the condition of a machine or a process whilst in operation, using various parameters such as vibration, noise and temperature. A well-integrated CM programme will help identify and predict wear rates and abnormal operating conditions as they develop, helping to reduce the likelihood of expensive unplanned equipment failure.

CM essential for the power industryThere are few things more important in the power and other process industries than accurate condition-based maintenance information for improving safety, reliability, performance, productivity and overall profitability. Nevertheless, even with a track record of proven economic justification and benefits to industry, some companies do not take full advantage of the latest technologies and developments in the fields of sensor engineering, condition monitoring and diagnostic technology.

Experience and familiarity with tried and tested CM technology is of great importance for maintaining accurate and meaningful results. However, this does not remove the need for change, or indeed the adoption of new or complementary CM technology.

The fundamental questionThe power industry needs to ask itself this fundamental question:

“How do the plant engineers identify the machines or processes to be monitored and what considerations should be given to ensure the maximum Return on Investment and the most cost effective use of time and money resources?”

Unfortunately the answer is not straightforward, and is particular to each facility. However, what is certain is that a reactive maintenance organisation can rapidly erode the benefits and ROI of a CM programme. The most cost-effective aspect of condition monitoring is that maintenance can be planned and scheduled before an unplanned failure occurs; the control and stability of maintenance practices are therefore essential to achieve the maximum ROI. A review of the performance of the maintenance organisation to ensure that the planning and scheduling of corrective actions are carried out on time and in the most cost-efficient manner is an essential step in providing a well-integrated CM programme.

RBMI programmeIn addition, a Risk-Based Maintenance and Inspection (RBMI) programme will identify the critical machinery that could present a significant exposure to the business. This should be based on risk experience and should encompass the following points:

�� the criticality of the plant

�� sensitivity to failure

�� machine speed and/or power

�� accessibility and environmental conditions

�� asset value and potential loss value taking into account the asset value, loss of production and reactive maintenance costs.

Single outage programmeOpportunities also exist in taking a holistic view of plant condition by combining planned maintenance tasks into a single outage programme. CM is at its least powerful when used as a stand-alone maintenance tool and it is often the case that other stand-alone maintenance data is held in different information formats and systems which are rarely brought together to identify an optimal maintenance programme. A holistic programme can be achieved by the effective integration of stand-alone maintenance information such as condition monitoring data, visual inspection records, preventive maintenance programmes and operational performance data.

New mindsets needed!CM technology is continually and rapidly advancing, and so too must the mindset of plant managers, CM practitioners and users. They should not simply disregard new technologies on the basis of cost and unfamiliarity, in favour of existing tried and tested technology. The increasing power and speed of electromechanical equipment, and the ever-increasing complexity of process control and automation, demand that the most advanced CM technology is used to prevent costly plant downtime.



CAD advancementsFurthermore, the use of increasingly sophisticated equipment where materials are used ever closer to their material property limits and geometries are continually optimised by advancements in Computer Aided Design (CAD), can contribute to a decrease in safety margins, reduced margins of operational error and incomplete field experience. Placing the power of CM into the hands of every maintenance engineer means that informed decisions can be taken quickly and confidently, which can ultimately lead to significant improvement in a company’s bottom line.

Removing “expert skill”Newer, more advanced technologies often reduce the complex science of measurement and diagnostics, thereby removing the need for sophisticated and often costly knowledge of in-house or external specialists. Removing some of the ‘expert’ skill from CM technology brings about further advantages of cost, speed, flexibility, ease of field application, analysis and diagnosis.

Maintenance personnel are responsible for keeping the plant running, and the adoption of new advanced CM technology enables them to monitor the plant condition themselves, identify where action is needed and check that the action taken has solved the problem.

Benefits of advanced CM technology

The value of a comprehensive suite of CM technology may seem obvious to the engineer, but the tangible and intangible benefits are often difficult to quantify in monetary terms.

Although the actual value of each will differ, the following potential benefits should be evaluated when preparing or considering a financial justification for additional CM technology.

1. Reduced Inspection Outage Frequency Periodic inspection outages are often used to allow a detailed inspection of the plant equipment. However, a plant condition monitoring system can reduce or eliminate the need for periodic inspection outages, or shorten the inspection period by providing an enhanced in-service analysis of running condition. The tangible benefits include a direct cost saving on the inspection outage and the associated loss of revenue. Intangible benefits include the reduced risk associated with shutdown, inspection and restart.

2. Reduced Maintenance Outage FrequencyTime-based maintenance work can often be found to be unnecessary. A CM system can enable condition-based maintenance which can reduce the maintenance outage frequency by providing information that helps to determine whether maintenance work is in fact necessary.

3. Reduced Maintenance Outage Repair TimeCM systems can help forward-plan maintenance work by providing information to help determine what further off-line testing may be required and what component parts are required to effect the repair.


4. Reduced Maintenance HoursThe above reductions can result in reduced maintenance hours for the equipment being monitored. This can reduce overtime costs, enable a limited resource to be utilised elsewhere or, in some cases, actually reduce the number of maintenance personnel required.

5. Increased Operating EfficiencyCM technology can provide valuable data to allow personnel to maximise the operating efficiency of equipment. By comparing actual consumption or throughput with design or theoretical values, the operations and maintenance team may be able to adjust for maximum efficiency.

6. Increased Service LifeAs mentioned, plant equipment that is monitored can be adjusted for optimum performance, which can help avoid aggressive operating conditions and reduce equipment wear rates. This can help eliminate or extend the time between costly and intrusive inspection outages, thereby increasing the service life of equipment.

7. Safe Operation of PlantPlant equipment that is operating at its optimum point is operating in the safest manner possible, reducing the hazard to operation and maintenance personnel of catastrophic failure.

Further to this, with a focus on cost, many power and utility companies make cost savings by installing advanced control and automation, which allows unattended or remote operation of plant equipment. Plant condition can deteriorate rapidly if unchecked, which can jeopardise the safety of people and equipment. The real-time trending and diagnostics of plant equipment enables accurate and up-to-date decisions regarding the continued operation of the plant until the next planned or next optimal unplanned outage period.

8. Reduced Spare Parts InventorySpare parts, particularly consumables and day to day spares, can be reduced to a minimum. CM of plant allows data trending and prediction of equipment failure, allowing advanced planning and additional time to procure components.

9. Improve Maintenance SkillsPlacing the power of CM into the hands of every maintenance engineer allows them to make informed decisions quickly and confidently, and take corrective action sooner. This proactive approach can significantly improve a company’s performance.

“ Investing in new CM technology or extending the CM programme to cover more of the plant can be expensive, but this should not be seen as a cost which has little or no return.”

Conclusion: the vital role of CM

CM plays an important role in industrial loss prevention, which is why great emphasis is put on the adoption and promotion of new advanced CM technologies by the insurance industry. The hope is that CM brings about reduced risk and financial benefits to both the insurer and the insured. Whilst tried and tested CM technology may have yielded beneficial results in the past, it is important to recognise that the increasing complexity of equipment, complicated geometries and requirements for the detection of ever smaller flaws often merit two or more complementary or advanced CM techniques to provide the most detailed picture of the equipment condition.

It is clear that limitations in time and money restrict the opportunity to make use of every single possible diagnostic method. However, great effort must be made to understand the needs of the maintenance engineer and to periodically evaluate the components or machines in order to identify the latest CM technology that can help yield both the tangible and intangible benefits.

Investing in new CM technology or extending the CM programme to cover more of the plant can be expensive, but this should not be seen as a cost which has little or no return. The value is not necessarily in preventing catastrophic failure, but in the recurrent savings from timely parts ordering, optimised scheduling of manpower and the benefit of planning other maintenance tasks during the outage, as well as enabling the field engineer to rapidly diagnose and mitigate a developing problem.

Paul Watson Power Risk Engineer, Willis Towers Watson

Part twoRisk transfer issues



Risk and resilience: engineering a sustainable financial systemA Brief History

In the last quarter of a century, engineering based methodologies, metrics and models have transformed the world’s insurance market from a state of precariousness to one of much greater resilience. As the wider economy now confronts the risks ahead and aligns itself with delivery of the UN’s Sustainable Development Goals (SDGs), engineers and engineering led expertise will play a central role in the design, regulation and operation of the wider financial system to reframe our development and reshape our environment.

1992 – the insurance market’s “Annus Horribilis”In the autumn of 1992 the world’s insurance and reinsurance market stood at the edge of an abyss. A six year run of unprecedented losses from US liabilities, natural disasters (notably Hurricanes Gilbert and Hugo, the San Francisco–Oakland earthquake, and the 1987 and 1990 North European storms), the Exxon Valdez tanker grounding and the destruction of the Piper Alpha North Sea oil platform, culminated on 24 August 1992 when Hurricane Andrew slammed into the coast of Florida and Louisiana, unleashing $20 billion of insurance losses. Andrew propelled 11 property and casualty insurance companies into insolvency, while some other companies became technically insolvent and needed the transfer of funds from their parent companies to meet their policy liabilities. [Source: Catastrophes: Insurance Issues: Insurance Information Institute, July 2016]

These misfortunes were compounded by outdated underwriting practices, unmanaged risk accumulations and, in some cases, professional incompetence. The survival of Lloyd’s was threatened by the LMX reinsurance “spiral”, in which risks were reinsured several times, with underwriters miscalculating, under-pricing and failing to measure or manage their retained exposures.

“ In the late 1980s, three engineering consultancies emerged in the United States that realised that this profession had the expertise to transform the underwriting of natural disasters.”

The insurance market on the brink…The result was that, for the first time in 300 years, the international insurance market, with Lloyd’s at its symbolic and economic epicentre, faced ruin and, with it, an essential economic and social foundation was at risk. Without insurance, many things stop: airlines, mortgages, power plants, professional practice, healthcare, shipping and construction, to name just a few. Without insurance to protect their investment, banks will not lend money for new infrastructure or other projects.

Amid the chaos of the insurance markets of the mid-1990s, three forces converged to drive a structural transformation in this market place:

�� a new breed of ‘smart capital’ that demanded a new approach to underwriting risk;

�� an analytical and scientific awakening;

�� a regulatory revolution.

The rise of the modellersIn the late 1980s, three engineering consultancies emerged in the United States that realised that this profession had the expertise to transform the underwriting of natural disasters. These firms were called catastrophe risk modeling companies or ‘cat modelers’ for short. Rather than relying on past events in historical claims files as a guide, they contended that that the probability distributions of seismic and extreme weather events could be described at underwriting locations, and the vulnerabilities of exposed assets, structures and population to those forces could be evaluated. From the resulting combination of hazard probability, exposure attributes and vulnerability functions, an estimate of annual risk could be derived.

Such a formula is of course bread and butter to engineers designing structures or other systems, but it was novel to the insurance world, requiring new data and underwriting tools. The models and the usage were quite rudimentary at the beginning but they slowly and steadily improved as each subsequent natural disaster highlighted the differences between the real world and the modeled world.


A New Regulatory Approach

Regulation in Lloyd’s was fundamentally changed by the creation of Equitas as a way of centralising liabilities, but something even more profound happened to the overall regulation of the insurance market.

People concerned with the protection of policyholders asked a fundamental question that had never been asked before: if an insurance contract is a promise to pay if something bad happens, what should be the tolerance level of that insurance contract? In other words, how much loss should it be able to handle?

While at one extreme, an insurance contract cannot be expected to cope with the level of losses that would come from the type of meteorite strike that doomed the dinosaurs 65 million years ago, insurance is society’s backstop. In the 300 years since Edward Lloyd opened his coffee shop this question had never been asked; indeed, the sector did not have a lexicon or metric for answering it.

Once again, the engineers came to the rescue. During the mid-1990s a regulatory convention emerged in the UK and across much of the world that insurance contracts should be able to cope with the maximum probable annual losses expected once every 200 years: the “one in 200 year” return period. This was not just from natural disasters, but all risks – from financial market shocks to mass tort liabilities. That meant that insurance companies needed to have financial resilience to that level.

Proof of the Pudding - Hurricane KatrinaEngineering metrics have become the bedrock of insurance and reinsurance pricing and of risk management; they have transformed the industry from understanding risk by looking backwards at the history, allied to a bit of luck, to a far greater understanding of risk through data and analysis. A major landmark came in 2005, when Hurricane Katrina became the biggest insured catastrophe loss in history, but did not result in the level of insurance market failures that had followed Andrew 13 years previously (although one large personal lines insurer in Florida collapsed following Katrina).

Indeed, while a major catastrophe can be the visible event that tips an insurer into insolvency, research has shown that this is more likely to be the trigger than the underlying cause. The presence of factors such as weak controls and poor management is likely to be an essential pre-condition of insurer failure. The 2002 report “Managing Risk: Practical lessons from recent “failures” of EU insurers” published by the UK’s Financial Services Authority, concluded that “Management or governance issues were at the root of every case” of insurer failure analysed.

A.M. Best Co came to a similar conclusion in its 2004 report into failures of Property and Casualty insurers in the United States over a 34 year period.1 The leading causes of financial impairment were found to be deficient loss reserves, inadequate pricing and rapid growth.

It has therefore become clear that greater understanding of potential insurer liabilities and exercising discipline in managing these liabilities are key to the financial resilience of the global insurance industry.

(Re)Insurer Actions to Bolster Resilience

Withdrawal of terrorism coverThis discipline can sometimes manifest itself in what may appear to the insurance buyer to be a self-interested and ruthless cutting of cover, which can suddenly leave buyers with unprotected exposures. Before 11 September 2001 terrorism insurance in the US was provided under property policies as standard and essentially free of charge, since, to the extent that they had thought about it at all, underwriters considered the risk of a terrorism loss in the US to be too remote and insignificant to warrant a specific consideration in the premium. Following the 9/11 attacks, insurers and reinsurers immediately excluded terrorism losses from all US property policies issued thereafter.

Insurance buyers in the UK had already gone through the experience of seeing their insurers suddenly exclude the risk of terrorism from commercial property policies, following a series of attacks on the UK mainland by the IRA in the early 1990s. In both cases, after the initial across-the-board withdrawal of terrorism cover, alternative solutions emerged – in the US the government became the insurer of last resort, through the Terrorism Risk Insurance Act (TRIA), while in the UK the mutual reinsurer Pool Re was established – but not immediately, and not without teething problems. The initially inflexible Pool Re rating scheme, whereby prescribed rates, which were much higher in London and other major city centres than in smaller towns and rural areas, were applied to total insured values, could produce perverse outcomes; for a utility company such as London Electricity, which had high-value accumulations of property in the highest rated locations, the terrorism insurance premium churned out by the strict application of the Pool Re rates was a multiple of its “All Risks” property premium.

It would be incorrect to see these withdrawals of cover as knee-jerk reactions by underwriters to unforeseen events. Apart from the fact that the underwriting options of direct insurers were severely limited when they found themselves without reinsurance protection, the terrorist attacks in the US and UK highlighted not only the potential financial severity of such losses, but also the lack of reliable information that would enable insurers to assess the probability and severity of future losses, and therefore to set loss limits and price the risk.


Continuing to provide cover on the same basis as before would have run counter to the need for underwriting discipline, understanding the risks being insured and management of insured exposures, which we have seen to be essential components of a resilient market. It could certainly be argued that insurers should have recognized this reality and taken action before the catastrophic events that actually triggered the withdrawal of cover.

Transmission & Distribution linesInsurance buyers in the power sector are familiar with a specific industry risk exposure which shares the same insurability limitations as the risk of terrorism, namely the risk of damage to overhead transmission and distribution networks, usually referred to as “T&D”. The absence of a bank of historical loss data and relative shortage of similar exposure units that would allow insurers to benefit from the law of large numbers represent a barrier to anyone wishing to underwrite T&D assets on a scientific basis. As a result, T&D cover is excluded from reinsurance treaties and therefore also from standard property policies, other than in respect of assets within a small distance from generating locations.

The history of the T&D exclusion is similar to that of terrorism insurance, insofar as cover used to be included as standard under an “All Risks” property policy (by dint of not being excluded), until catastrophic events occurred to change market practice. Again, the UK was ahead of the US. The storm which struck the south-east of England in October 1987, reported to be the worst to hit the country since 1703, was at first considered to be such an unusual event that some brokers were able to persuade underwriters that losses sustained in this storm should be discounted from an Insured’s claims experience for the purpose of setting the following year’s renewal terms.

Little more than two years later the “Burns Day” storm of January 1990 struck the UK, causing millions of pounds of damage to the distribution assets of some regional electricity companies (which as entities recently created under Margaret Thatcher’s liberalisation of the UK electricity sector were relative newcomers to the commercial insurance market), and underwriters have given short shrift to brokers’ arguments about discounting “one-off” events from their clients’ loss records ever since.

If the Burns Day storm marked the end of readily available T&D coverage in the UK, the sea-change event in the US was the aforementioned Hurricane Andrew in 1992. One utility company suffered a US$270m loss to its T&D network, having paid a premium of US$3.5m for coverage with an unaggregated “per occurrence” loss limit of US$350m; at its next renewal it was offered terms which consisted of an aggregate T&D loss limit of US$100m, at a premium of around US$23m – which, in the absence of any alternatives, the company had to accept.

A criticism sometimes made of blanket T&D exclusions is that they do not differentiate between transmission and distribution assets. Distribution networks are more vulnerable to damage than the higher voltage transmission networks; the support structures are less robust and the lines are closer to the ground and therefore at much greater risk from flying debris and falling trees. Surely underwriters would be exercising their underwriting judgment if they were to decline to insure distribution risks but provided cover for transmission assets? However, the Lothar and Martin storms at the end of 1999, which toppled nearly 300 high voltage towers in France, causing around US$3bn of damage to EDF’s power network, demonstrated that transmission assets can also be vulnerable to severe damage, with devastating impact. Any insurer that had decided, notwithstanding the absence of underwriting data, to insure these assets on the grounds that they were more resilient than distribution assets would have incurred potentially ruinous losses.

Conclusion - market resilience now proven

2011 was the world’s worst insured natural disaster year on record with US$121 billion in claims.2 Despite this unprecedented figure, the global insurance market proved resilient, given that this level of losses was considered as a “one in 12.5 year” event, well within the “one in 200 year” return period which the industry now aims to withstand. The global re/insurance sector is stronger and more resilient and sustainable than it has ever been, despite a massive growth of risk over that time, greater penetration of insurance into parts of the world where insurance purchase was previously uncommon, an increase in insured property and business interruption values in areas prone to natural disaster, and the inevitable disruptive effects of climate change.

The introduction of engineering-based risk assessment and disclosure will play a key part in achieving sustainable development, by ensuring that our investments and the financial systems of the future are resilient, stress tested and the architects of a risk-sensitive future. Such strong systems will provide the foundation for meeting all the targets set out by the UN’s Sustainable Development Goals (SDGs), as outlined by the Insurance Development Forum’s mission:

“Understanding risk to create resilient platforms for sustainable growth and human dignity.”

Rowan Douglas CBE CEO Capital Science & Policy Practice, Willis Towers Watson

Sources

1 http://www.businesswire.com/news/home/20040524005620/en/A.M.-Publishes-34-Year-PropertyCasualty-Insolvency-Study.

2 http://www.swissre.com/clients/Sigma_22012_Natural_catastrophes_and_manmade_disasters_in_2011.html


The UK 2015 Insurance Act – why it mattersA new landscape for insurance contract law

The Insurance Act 2015 came into force on 12 August 2016. It applies only to contracts of insurance entered into on or after 12 August 2016, but also to contract variations entered into on or after 12 August 2016, regardless of when the original contract was entered into.

Previously, the most significant piece of UK insurance legislation was the Marine Insurance Act 1906 (“MIA”), which after over 100 years was considered to have become outdated and no longer fit for purpose. Although the MIA has not been formally repealed, the 2015 Act has set out a new landscape for insurance contract law. Fundamental changes have been made in respect of the negotiation of the contract of insurance, with a greater onus upon insurers to ask key questions of the Insured and its business before the policy incepts or renews.

The 2015 Act affects the way in which business is underwritten and placed, and also changes insurers’ remedies for non-disclosure and misrepresentation, breach of warranty and fraudulent claims. The 2015 Act has particular ramifications for key aspects of insurance law, including critical policy provisions such as Warranty and Due Diligence Clauses.

The Insured and its brokers are now required to make a fair presentation of the risk. This represents a fundamental shift from the doctrine of “utmost good faith” (enshrined in Section 17 of the MIA). That is not a new concept – in fact, there is an element of going “back to the future”. Nearly 250 years ago Lord Mansfield (Carter v Boehm (1766) 3 Burr 1905 at 1909) stated:

“Insurance is a contract based upon speculation. The special facts upon which the contingent chance is to be computed, lie most commonly in the knowledge of the insured only; the underwriter trusts to his representation and proceeds upon the confidence that he does not keep back any circumstance in his knowledge, to mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risk as if it did not exist.”

What does this mean in practice, against the backdrop of statements of practice, FCA rules, FOS discretions and industry guidance?

First, these changes apply only to business insurance (consumer insurance having already been clarified by the Consumer Insurance (Disclosure and Representations) Act 2012). The 2015 Act applies to non-consumer insurance and reinsurance contracts that are governed by the laws of England and Wales, Scotland or Northern Ireland, wherever they are underwritten or wherever the parties to the contract are located themselves. It does not apply to policies governed by the law of another country, even when those policies are placed in the London insurance market.


“ The most important aspect of the 2015 Act is the requirement of a fair presentation of the risk.”

Fair Presentation

The most important aspect of the 2015 Act is the requirement of a fair presentation of the risk. The 2015 Act places a duty on the Insured’s senior management (including the board of directors and others such as risk managers, amongst others, who have actual knowledge of the Insured’s business) to make a fair presentation of the risk.

The Law Commissioners criticised the perceived practice of overly complicated presentations and “data dumping” by Insureds and their agents, whereby a mass of information is provided that may not be particularly relevant to insurers in determining whether to accept the risk. Accordingly, disclosure must be “in a manner which would be reasonably clear and accessible to a prudent underwriter” (Section 3(3) (b) of the 2015 Act). The Insured must now carry out a reasonable search for information; with what is “reasonable” depending on the size, nature and complexity of the business.

The Insured will be deemed to know what “should reasonably have been revealed by a reasonable search”.

Positive duty of inquiry for the insurer

Unlike the MIA, which did not require the insurer to ask questions or indicate what it wished to know, the 2015 Act creates a positive duty of inquiry for the insurer. Furthermore, an Insured is not required to disclose information that an insurer already knows (Section 5 (1)); or information that it ought to know (Section 5 (2)); or information that it is presumed to know (Section 5 (3)). As was previously the case, an insurer will also be presumed to know things which are common knowledge.

Examples of “material circumstances” for the purposes of a “fair presentation” are set out in the 2015 Act for guidance. They include “special or unusual circumstances” relating to the risk; any particular concerns that led the Insured to seek insurance in the first place; or anything which those concerned with the class of insurance and field of activity would generally regard as being required to be dealt with in a “fair presentation”. Insurers and brokers have been tasked with developing protocols setting out their agreed procedures.

The fundamental change is that insurers are required to raise queries if they are put “on notice” of information that requires further clarification. No defence of non-disclosure will be available to insurers who do not raise enquiries in those circumstances.

Furthermore, the application of the MIA had “evolved” in the Courts, where if an insurer had been put fairly on enquiry about the existence of other material facts which an enquiry would have revealed, then if the insurer does not pursue those enquiries he will have been held to have waived the disclosure of those material facts. The test is objective while the insurer need not be “….a detective on one hand nor lacking in common sense on the other”, notwithstanding that mere possibilities would not put the insurer on enquiry (per L.J. Rix – WISE (Underwriting Agency) Ltd v Grupo Nacional Provincial SA [2004] 2 All ER 613 at [64]).

Remedies

The 2015 Act also changes the remedies that are available to parties to the policy. The test for reliance on the “nuclear” remedy of contract avoidance in the event of nondisclosure or misrepresentation has changed significantly. Furthermore, the ability of either party to avoid the policy for a breach of good faith has been abolished.

It will now be possible to avoid a policy only where the misrepresentation or nondisclosure was deliberate or reckless, which, depending on the facts of the case, may prove to be an extremely difficult test for an insurer to overcome. In all other cases, the following proportionate remedies will apply, depending on what the insurer would have done if a fair presentation had been made:

1. If the insurer would not have entered the contract at all, it can avoid the contract but return the premium

2. If the insurer would have entered the contract on different terms, the contract is treated as if those different terms were applicable

3. If the insurer would have charged higher premium then the amount paid on a claim may be reduced proportionately

The test of what the insurer would have done had it known the true facts remains entirely subjective, while the burden of proof for avoidance is also unchanged. It remains to be seen whether the courts will be more willing to conclude that the insurer has met this burden, with proportionate remedies being on the menu as opposed to the one option (avoidance of the policy) that was previously available.

The level of egregious behaviours – in terms of what constitutes an unfair presentation – will no doubt be developed by case law. The increased options available to insurers should assist commercial relationships, as opposed to having only the one previous “nuclear” option.


Warranties

The MIA provided that a warranty had to be strictly complied with, whether it was material to the risk or not (Section 33 (3)). If not complied with, the insurer was discharged from liability from the date of the breach.

The effect of the breach was actually automatic rather than being dependent upon the Insured’s acceptance or election of the breach (per Lord Goff – Bank of Nova Scotia -v- Hellenic Mutual War Risks Association (Bermuda) Ltd (The Good Luck); HL 1992).

The 2015 Act mirrors the position in consumer contracts of insurance by doing away with “basis of the contract” clauses of this nature. Long lists of answers to questions in a proposal form being “converted” into individual warranties are now a thing of the past. Instead, all warranties become “suspensive conditions”, so that an insurer will now be liable for losses that take place after a breach of warranty has been remedied, assuming this is possible.

For example, if a policy for a power company contains a warranty that generation equipment shall not be operated in excess of the manufacturer’s safety tolerances, that company may be without cover for a machinery breakdown loss during any period in which these tolerances are exceeded (should they be minded to ignore the manufacturer’s instructions in this regard), but will be “back on cover” when operation returns to within the manufacturer’s safety tolerances.

Alternatively, if the Insured breaches a warranty that an alarm system will be inspected every six months, that breach will be “remedied” if the system is inspected after seven months, with coverage being deemed to have been suspended for one month in such circumstances. If a claim arises during that one month period, then insurers can potentially rely upon the breach of warranty.

The Act makes it clear that breaches of warranty that are irrelevant to a loss that is the subject of a claim will no longer discharge insurers from liability. If the Insured can show that failure to comply with any term in the contract (including warranties) could not have increased the risk of the loss which actually occurred in the circumstances in which it occurred, insurers will no longer be able to rely on the breach to exclude liability.

In order to limit the scope for dispute, it would be advisable for the parties to clearly set out their requirements and the consequences for non-compliance. Warranties are still “live” but clear wording is required for them to bite. The usage of detailed protocols has been encouraged and should include specific reference to warranties.


Fraudulent claims

An insurer is not of course liable to pay a fraudulent claim. Under the 2015 Act an insurer will have the option of terminating the contract from the date of the fraudulent act – not the discovery of it – or, if it does not treat the contract as having been terminated, refuse all liability to the Insured in respect of a relevant event after the time of the fraudulent act without any return of premium.

The Law Commissioners believed that insurers would welcome this option as it would allow greater commercial flexibility. The insurer can then refuse to pay any claims from that point onwards (but will remain liable for legitimate losses before the fraud), whereas previously under the MIA an insurer may be able to cancel the policy from inception regardless of when the fraudulent act occurred, enabling them to recover any sums already paid prior to the fraudulent act.

Contracting out

The changes are intended to be a “default regime” for business (non-consumer) insurance. The Law Commissioners anticipated that “in sophisticated markets, including the marine insurance market, we expect contracting out will be more widespread”. In other words, an Insured and an insurer can opt to contract out of the requirements of the 2015 Act, which presents a potential business opportunity to insurers and brokers who wish to provide and negotiate a bespoke product.

That said, if insurers seek to proceed arbitrarily during the placing negotiations they will be required to identify every change which they do not intend to apply and specify the opt-out for that change separately in the policy. The changes need to be transparent.

Where insurers intend to include a more disadvantageous term than in the default position, they must take sufficient steps to draw that to the Insured’s attention before the policy incepts, and the disadvantageous term must be “clear and unambiguous as to its effect“. Particular attention in that regard should be given to small businesses (especially when purchasing via online platforms).

However it is not possible to contract out of “basis of contract” clauses (see Warranties above).

“ In order to limit the scope for dispute, it would be advisable for the parties to clearly set out their requirements and the consequences for non-compliance.”

The Enterprise Act

The Enterprise Bill was introduced to Parliament on 16 September 2015. It proposed an amendment to the 2015 Act by introducing a legal obligation for insurance claims to be paid within a reasonable timeframe.

How long is ”reasonable”? I do not know - as with all claims, the facts will differ from case to case. Where the insurer is in breach the remedy is damages, which will be awarded in addition to and distinct from any right to enforce payment of the sums due under the policy and any right to interest on those sums.

Again, the amount will be case specific and will vary. This implied term can be “contracted out” - provided the transparency requirements are complied with, and the insurer does not deliberately nor recklessly fail to pay the claim.

A limitation period is deemed to be of one year from the date when the insurer actually makes payment (if it does) or the last payment if in tranches or if earlier 6 years from the date on which the cause of action for the breach of the implied term occurred.

The bill became law on 4 May 2016 when it received Royal Assent on 4 May 2016, becoming the Enterprise Act.

A final word

The 2015 Act has in parts codified modern case law (as did the MIA in its day). However, the introduction of proportionate remedies in cases on nondisclosure and warranties are startling and the effects on the insurance market will be far–reaching.

Since the Act has now come into effect, any insurers, brokers or affected Insureds who are not yet up to speed with the new framework would be well advised to make sure that they are prepared for the “new normal”.

Chris Dunn Partner, Head of Kennedys Marine


Power sector Business Interruption claimsWhy focus on Business Interruption?

The Business Interruption (BI) and Contingent Business Interruption (CBI) component of Property Damage (PD) insurance claims now makes up a significant value of the losses incurred within the Power insurance market.

In comparison, PD claims are in most cases relatively straightforward, but an increasing amount of time is now spent discussing the BI element, which is not only frequently more difficult to calculate but also tends to take longer to settle than the corresponding claim for PD.

Increased complexity and global connectivityThe main reason for the rise in the significance of BI (which is not unique to the power sector) lies in the fact that businesses are increasing in complexity with globally connectivity. Furthermore, calculating BI indemnification requires measuring the ‘but for’ position in terms of production, cost and sales. This is often highly subjective, and needs far more investigation and support than simply presenting an invoice for PD.

Differing opinionsAs a result of this subjectivity, each party involved (the Insured, insurer, forensic accountants and loss adjusters) will frequently have a different opinion, which can result in the prolongation of the claim process. This can be compounded in the event of CBI by the shortage of information, with the cause and location of the physical loss which gives rise to the CBI claim being made at a point removed from the point of measurement of the claim (i.e. loss of sales by the Insured).

Poor policy wordingAlthough the very nature of BI claims leads to complexity and disagreements, a poor policy wording is sometimes the major reason for claims not to settle in a timely manner. Preparation is key; having a clear and up-to-date policy wording, together with the correct sum insured, can help address and minimise ambiguity and disagreements.

Ageing equipmentWhen it comes to power sector claims, many power plants are working with ageing equipment and infrastructure, and this can potentially lead to more frequent wear and tear losses and pose increasing risk for BI exposure for the plant. The Insured could experience a delay in replacing equipment, a task which in many cases may be subcontracted to third parties, which could provide a slower response, impacting any BI claim.

Meeting the BI challenge

Use of forensic accountants and claims preparation specialistsThe use of forensic accountants and claims preparation specialists is now commonplace, especially for losses which are sizeable or complex; these experts are not just appointed by Insurers but are now increasing becoming involved on behalf of the Insured to support them in the preparation of their BI claim. Businesses typically do not have in-house claims expertise and need assistance to prepare a complex claim.

Use of claims preparation clauseBrokers and Insurers have recognised the additional work and costs associated with collating information and have started to introduce a ‘Claims Preparation Clause’ within the insurance policy to cover these additional costs. This is to the benefit the Insured in order to prepare their claim and for Insurers to progress the claim.

Knowledge of PPAsIt used to be thought that measuring the BI loss of a power generator that had a Power Purchase Agreement (PPA) represented one of the biggest challenges to face forensic accountants and loss adjusters. Wading through mathematical formulas and preparing a financial model based on them can be daunting. However, in recent years understanding merchant power plants, selling generation ahead on the open market and unwinding forward contracts, require the skills of a particularly experienced insurance professional.

Nevertheless, PPAs still require a good knowledge base and attention to detail in order to decipher them in the event of a Business Interruption claim or even to ensure that the policy wording is appropriate for how a power generator earns its revenues and profit. Furthermore, PPAs evolve along with a country’s power market; in other words, the terms and formulas which incentivise an operator to run their plant in a particular way change as the power market in each country matures. For insurance purposes, it’s important to understand the PPA of an Insured and therefore make sure all revenue streams are covered, as well as to review the contractual relationships and obligations therein.

In the event a claim, the formulas in the PPA provide a basis for the BI loss measurement, as opposed to a normal business where the profit and loss accounts are usually used. This is potentially beneficial, as a model encompassing all the formulas and rates can be prepared and readily agreed early on to avoid fundamental disagreements and wasting time. Both parties can then work on agreeing the key variables, namely expected availability and forced outage rates, outage allowances and efficiencies. Sounds simple and pain free!


“ The Business Interruption (BI) and Contingent Business Interruption (CBI) component of Property Damage (PD) insurance claims now makes up a significant value of the losses incurred within the Power insurance market.”

Meeting the PPA challenge

However, PPAs were designed for operators and the grid, not insurance purposes. Complications therefore can arise and there can be grey areas in the measurement of the loss. The following can be ‘sticking points’ when presenting a claim to insurers:

�� Loss of bonus payments – A bonus may be payable at the end of a period if a certain level of availability is achieved. An outage at the beginning of a contract year for a few months could result in a loss sustained months later. Some BI wordings can be unfavourable in responding to this loss.

�� Rolling average availability – Some PPAs (commonly in Malaysia, for example) have a provision where capacity payments are linked to the historic average availability of the plant. Therefore, an incident can result in the Insured suffering a continued loss of capacity payments even after the property is reinstated, as the historic average will continue to be impacted until many months after. Again, this is important to take into account when deciding on suitable wording, but also useful to make sure insurers are alive to this risk.

�� Availability allowances – PPAs can include an allowable number of days in each contract year for unplanned outages. If an incident occurs, this allowance is quickly used up and the Insured is left with no buffer even after property is reinstated. The result is that once the plant is operating normally again, even a small outage for one day can result in losses due to the original incident, up until the end of the contract period. The question of whether these are a direct result of the incident can be raised.

Despite these issues being known to the insurance market, there are still differences in opinion amongst insurers over their application to a BI claim, which can be compounded by unclear wording. An experienced broker can look to pre-empt this by tailoring the policy to the PPA and then providing high-level technical support to the client in the event of an incident.

Minimising the BI threat

So in general and for all businesses, can any steps be taken to minimise the BI trend? From the Insured’s perspective, it is important to look at their business and see if their BI insurance fits their business requirements. Factors for them to consider include:

�� Do they require an ‘All Risks’ BI insurance or will a bespoke product that provides specific coverage, for example, one which provides coverage for Standing Charges and Debt Service Costs, be best for their business?

�� Will Additional Increased Cost of Working cover, or a specific Replacement Power Costs item, be required to fulfil their contractual supply obligations to their offtaker, or to meet any other additional costs expended in order to mitigate sales losses?

�� Do they require protection against BI triggered by a direct loss on a third party’s property (i.e. a CBI exposure)? For example, a power plant may be dependent on a substation owned by the local transmission or distribution company to get their power onto the grid, and could suffer a financial loss if damage to that substation prevented them from meeting their contractual obligations.

�� Does the Insured need to differentiate between exposures to loss of income and unusual expenses if there is potential for direct and indirect damage to occur concurrently?

�� Has a risk survey has recently been carried out? This should include a current valuation of the Insured’s assets and identification of the BI and CBI exposures.

From both the perspective of all interested parties – Insured, broker and insurer – there is a need to ensure that the policy wording fits the Insured’s business and is suitable to respond to the business interruption losses that the Insured could foreseeably incur. There should be a focus on avoiding any ambiguity which could result in an unnecessary extension of the claims process.

Furthermore a clear claims protocol, perhaps involving a pre-loss claims meeting between the Insured, lead insurer and brokers, is increasingly important. This can provide a clear procedure of what all parties should do and expect, and how they will each communicate in the event of an incident giving rise to a claim under their policy.

Manvinder Phul Claims Advocate, Willis Towers Watson, London

Henry Dumas Forensic Accounting & Complex Claims, Willis Towers Watson, Singapore


Alternative Risk Transfer solutions revisitedThe challenge to the power industry

Insurers and risk management professionals have been talking about so-called ‘Alternative Risk Transfer’ (ART) since the 1990s. Over the years this vaguely-defined term has variously been applied to a wide range of risk management products. During this period some of the more outlandish approaches have been abandoned and their more ‘creative’ interpretations of risk and accounting confined to history. However, ART lives on and we examine in this article how risks facing the power sector may now benefit from the solutions that extend beyond the “plain vanilla”.

What, if anything, has changed?In recent years the volume of capital in the traditional reinsurance market has remained somewhat stable, whereas the volume of alternative capital continues to grow and may now represent as much as 15% of the global total. This influx of new risk bearing capital has resulted from uncertainty in some asset classes and the low interest rate environment, which has created an appetite amongst sophisticated investors to consider alternative investments, thus enhancing the practical availability of ART products to address new risks in today’s market.

The increase in new capital is significant in itself, but it is also instrumental in creating leverage in the offerings of traditional insurers and reinsurers. Insurers in both Europe and the US have responded with investments in ART focussed teams and a willingness to offer more flexible and bespoke solutions to the risk issues of corporate buyers.

New capital is not the only driver of change in this market. The greater availability and sophistication of data which was previously unavailable or effectively so within reasonable time and cost constraints, has created opportunities for innovative investors and (re)insurers to price and underwrite new types of risk business.

A good example is that of open-source satellite-derived imagery which enables the pricing and settlement of contracts in real time which, only a short while ago, would have been inconceivable.

Power industry challengesToday the power sector is confronting challenges from a variety of diverse influences, including volatility in power prices, an increased focus on renewable generation, climate change, increasing global demand for power but reduced or static demand in some developed countries, changing regulatory environments, natural catastrophes and changing technologies.

At the same time, risk managers in the sector are increasingly facing emerging risks that are traditionally difficult, or perceived as impossible, to insure. These include non-damage business interruption, environmental, climate, reputational and cyber risks, the impacts of which can amount to many billions of dollars of cost, but which often remain uninsured creating volatility and risk to the corporate balance sheet.

Today’s ART solutions

Today’s ART market is flexible and far-reaching, providing many ‘types’ of solution which can be tailored to the buyer’s specific risk management objectives and financial circumstances. This creates opportunities for power companies to manage risks which might otherwise be uninsurable, either at all or at economically feasible cost or to more efficiently structure cover for risks which are traditionally insurable.

Many power companies already own their own captive insurer which, whilst being far from ‘alternative’, does enable an interaction with reinsurers and alternative capital providers and more efficient, flexible and creative structuring of self-funding through multi-line, multi-year and risk sharing solutions. Captives also provide opportunities for managing risks which might otherwise be commercially uninsurable, embedding discipline in identifying, recording and minimising such risks and creating opportunities to blend emerging risks with more traditional risks to develop a portfolio which can be more efficiently managed and reinsured.

Reinsurance solutions for captives are becoming more widely utilised as captives seek capital efficiency in response to the higher solvency requirements in many domiciles. Simple stop losses, more complex multi-year and structured solutions and retrospective covers can all improve the solvency of a captive insurance company at economic cost.

Integration of the traditional and the innovativeKey to the growth in the deployment of ART solutions is the ability to integrate capital market techniques and capacity with traditional re/insurance products.

The early 1990s witnessed the introduction of so-called Catastrophe (”Cat”) Bonds, more generically referred to as Insurance-Linked Securities. These highly tailored instruments enabled buyers of protection to access bespoke capital ‘directly’ from investors who were able to evaluate natural catastrophe risks such as windstorms or earthquakes.


At that time, the sophistication of modelling of such risks had, for the first time, reached a point to enable non-expert risk takers to participate in an objective and price-transparent fashion. The providers of the models were – and still are - specialist third parties accessing the most up-to-date perils data and science to evaluate the expected loss to the contract. On the other side of the deal, such products enabled investors for the first time to participate directly in the insurance ‘event’ risk – without either the need to register as an authorised re/insurer or to invest in the general stock of such companies.

Since that time, the base of capital that has become available has grown exponentially in absolute size and broadened in origin. At the outset of the ILS market, investors were confined to a small number of far-sighted institutions (typically pension and specialist funds) with the aptitude and appetite to dip their toe in the water of a new asset class. Investments were individually modest - all deals were rated and little if any reference was made to the process of indemnity. In other words, contracts were typically settled against an index or a modelled version of the risk. The structure of these cat bonds was deliberately set so that pay-outs were indeed at the catastrophe end of occurrence probability – somewhere in the region of 1 in 75-100 years or greater. This remote probability of expected loss enabled the securities to be issued with an investment grade rating or better, this being an essential requisite of the investor community at that stage.

Although the majority of the sponsors of cat bonds were insurance and reinsurance companies seeking to transfer the peak exposure risks from their portfolio, a handful of corporate cat bonds were completed. One of the early examples of a corporate cat bond was Pylon Re, which was completed in December 2003 and provided a limit of $190m to EDF to provide cover against European windstorm damage to their transmission and distribution (T&D) lines.

Moving into traditional territory as appetite broadensDuring the last couple of decades, investors of alternative capital in the re/insurance market have certainly found their stride and made inroads into areas traditionally occupied by insurers and reinsurers. In particular, their appetite has broadened in terms of the type of underlying risk they are prepared to invest in and the forms in which these contracts are drawn. Notably there is some willingness to accept traditional indemnity style (or ultimate net loss) contracts whose pay-outs are the same as traditional insurance or reinsurance contracts. These ultimate net loss contracts have so far been limited to insurance company portfolios and have not yet reached corporate buyers, but in time these might become available.


Parametric risk transfer

At the same time as alternative capital has started to accept traditional reinsurance risks, many traditional insurance and reinsurance companies have moved into the area of parametric risk transfer. The parametric solutions they offer to the corporate buyer provide an alternative way of transferring the revenue or cost impact of natural and man-made catastrophe perils, such as earthquake, windstorm, terrorism, adverse weather and pandemic. These solutions differ from traditional insurance policies in that loss payments respond to the occurrence of a pre-agreed and parameterised event or movement in a reference index rather than the normal principles of indemnity which usually apply. Typically, these solutions are used to manage non-damage business interruption exposures which would otherwise be uninsured. Examples of risks that can be efficiently managed by means of a parametric contract include the cost of evacuating facilities in the event of real or forecast windstorm activity, the impact on demand for power of warm winters or cool summers, the cost uncertainty associated with the construction and maintenance of offshore windfarms in high wind or wave conditions or the variability of power output from renewable energy plants that rely on the availability of wind, water and solar. Parametric solutions are not necessarily a replacement for traditional insurance, but can often provide cover in situations where traditional insurance doesn’t respond. In this way they are used in parallel with traditional insurance rather than as a replacement for it.

Parametric solutions may be structured as what is known as a “cat in a box” or as a “parametric index”. In the case of the first of these, the policy responds if a defined event occurs within an agreed indemnification zone during the agreed coverage period. In the second, the policy responds if the agreed index exceeds or falls below an agreed threshold during the coverage period. The structures are bespoke and reflect the risk exposures, locations and risk management objectives of the insured.

Weather derivativesAn example of a parametric solution utilised extensively in the power sector is the weather derivative. In fact, the power sector has been the dominant buyer of weather-index programmes since the origination of these products in the late 1990s. Typically power companies use these solutions to hedge the energy demand risk, which has been shown to correlate well with temperatures. Indices based upon population-weighted temperature provide a good proxy for the demand for power in certain regions and derivatives of the indices provide an efficient hedging mechanism for companies whose revenues depend upon high power demand. Since the outset of the weather-index market the available solutions have become more sophisticated and, in today’s ART market, index-based solutions can also address

power generation risks such as low rainfall, low wind and low solar as well as power price volatility and power outages not linked to physical damage. The availability of weather data from satellites along with synthetic and reanalysis data sets now allows weather-index solutions to be developed in territories with a limited network of ground stations as well as for offshore locations, which in the past were no-go area for these products.

Speed and simplicity of contract settlementAs well as providing cover against traditionally uninsurable risks, parametric, or index-based, contracts offer many functional and economic advantages over the more conventional indemnity-style contracts. A major benefit is the objective and non-ambiguous nature of the policy trigger which removes the need for loss adjustment which can, in a conventional indemnity-based insurance contract, take months or even years to finalise. This allows claims to be settled very quickly after the event or at the end of the contract period. So long as the underlying index data are available without delay (and it is typically the case that index data are published in real time), then there is no reason why the settlement amount cannot be agreed immediately and payment made within a number of days. Two weeks would be a typical timeframe in which to reach such an agreement.

Consideration of the basis riskThe flipside of the parametric trigger is the concept of ‘basis risk’, that is the risk that the payments under the parametric contract do not precisely match the loss of revenue or increase in costs sustained by the insured. This arises as a result of the parametric solution responding to the occurrence of an event or movements in an index, as opposed to the losses actually sustained by the insured. It is important that this basis risk is properly considered in the design of any index-based contract. It must, wherever possible, be estimated and discussed between buyer and seller to ensure absolute transparency. However, this potential for mismatch between actual loss and contract pay-out is certainly not confined to parametric structures. Conventional contracts of insurance and reinsurance also contain terms and conditions (exclusions, warranties, deductibles, waiting periods and the like) which can significantly limit the insurer’s payment obligations. Some would argue that these conditions of non-payment are far more penal and prone to subjective interpretation than the relatively simple operation of an index.

Although basis risk is a potential disadvantage of parametric contracts, this structural approach remains a more suitable basis for the efficient participation of alternative risk investors, particularly in respect of the risks of corporate buyers. The participation of the capital markets in such structures expands the pool of capital available to support such programmes and the policy limits that can be negotiated.


What makes a suitable index?

Given the importance of designing the triggers or indices which underpin a parametric programme, it is worth considering the features which make a good index. The design of the index itself is open to myriad possibilities so long as there are data available upon which to structure and price the contract and upon which to settle claims. This flexibility allows buyers to develop bespoke coverage to reflect their own specific circumstances.

There are a few prerequisites for good index design and for their underlying data:

�� The data must be independent; and need to be measured and recorded by a third party that is trusted by both buyer and seller

�� There can be no subjectivity or lack of transparency in the way in which the data points are measured or compiled

�� The data should not be subject to historic (or indeed future) discontinuities that cannot reasonably be accounted for

�� The index data must continue to be reported in the same way (and generally by the same agency) during the foreseeable duration of the contract.

Correlation to actual underlying losses is essentialIn general terms, the performance of an index based contract is only as good as the design of the underlying index and the extent to which the index itself provides a good proxy for the actual underlying losses. In general terms this requires that a strong correlation in statistical terms can be shown between the historic performance of the index and the losses that the index based contract is seeking to transfer.

There are two main reasons why this may not be the case:

�� If the measurements for the index data are taken at a time or place which does not accord well with the activity and location of the risk(s) in question

�� A simple single parameter index (say wind speed or rainfall) may not be sufficient to capture all the components of risk that impacts the insured assets or the revenues/costs of the buyer.

It is, of course, possible to design highly complex multi-parameter indices so that these fit the actual loss profile more accurately, but, although an overly complex index design may have scientific merit or mathematical credibility, it may not be sufficiently easy to explain to buyer or seller.

“ The availability of weather data from satellites along with synthetic and reanalysis data sets now allows weather-index solutions to be developed in territories with a limited network of ground stations as well as for offshore locations, which in the past were no-go area for these products.”

Conclusion: ART and the sophisticated buyer

While parametric solutions are one form of ART, the term also encompasses a much broader range of solutions. These can be employed to provide more efficient structuring for traditionally insurable risks, to access deeper pools of risk capital or to provide capacity for otherwise uninsurable exposures, such as supply chain vulnerability, cyber, pandemic, brand and reputational risk.

ART solutions merge the best of capital market techniques with traditional insurance, risk sharing and risk retention structures, all underpinned by sophisticated analytics, to enable companies to select the most efficient form of risk financing for their specific risk profile, risk exposures, risk appetite and cost of capital. Along with parametric solutions, the ART toolkit also encompasses captive programmes, portfolio solutions, structured policies and retrospective covers each of which can be utilised as part of a risk management strategy to more efficiently and effectively manage risk.

ART is becoming increasingly mainstream amongst the more ‘risk management savvy’ corporates and there is evidence of a positive correlation between a company’s general sophistication and the adoption of ART solutions as part of their management of risk.

Claire Wilkinson and Julian Roberts Willis Towers Watson Alternative Risk Transfer Solutions and Global Weather Practice

Part threeInsurance market round-up



Property Damage / Business InterruptionProperty Market backgroundSuch has been the sustained nature of the current soft property market environment that not only is it becoming hard for commentators to find new things to say about it, but several have suggested that we should stop referring to the market as “soft” and instead accept that current conditions represent the “new normal”.

Apart from relatively short-lived hard market phases following 9/11 and the hurricane-hit 2005 year, insurance market conditions have been historically soft for more or less the whole of the 21st century. In particular, the amount of capital that has flowed into the market since the 2007/08 global financial crisis has created a situation whereby reinsurance protection is cheap and plentiful, and supply of insurance and reinsurance greatly exceeds demand, making price competition for business inevitable.

Some now contend that this demand/supply imbalance means that even a series of major catastrophe losses could be comfortably absorbed by the market and would not precipitate a return to its traditional cyclical behaviour. Analysts at Deutsche Bank recently concluded that even a “mega” loss event (a 1-in-200-year hurricane in the USA) might not be enough to scare investors away from the sector in a way that would allow underwriters to push up pricing.1

Is this the new normal?So does the so-called “new normal” signal the end of the traditional market cycle? Or is it, to echo former Chinese premier Zhou Enlai, when thought to have been asked in 1971 about the impact of the French Revolution, “too soon to say”? 2

It seems paradoxical to be referring to a new normality at a time when a number of the factors that traditionally contribute to the financial health of insurers have, in historical terms, been abnormal. One such factor is interest rates, the recent levels of which could be said to support the argument that the market is particularly robust and sustainable; if capacity is still being attracted to the market and if insurers can still be profitable at a time of very low interest rates, this surely bodes well for a future where interest rates return to more normal levels?

Insurers’ results have been boosted by other transient factors, such as the release of prior year claims reserves. Although Lloyd’s reported a 22.4% increase in aggregate market profits for the first six months of 2016, its Chairman and CEO said in a joint statement: “This period’s result… benefited from yield curve movements and the strengthening of the US dollar against sterling post the EU referendum, neither of which represent sustainable profitability.” 3

Natural catastrophe lossesA particular abnormality of current market environment is that the five years since 2011 have been remarkably free of major natural catastrophe events (and even freer of such events in areas of significant insurance penetration). As if to underline this fact, the largest insured catastrophe loss in 2015 was actually a man-made event, in the form of the explosions at the Port of Tianjin.1

Swiss Re reported that insured man-made and natural catastrophe losses in 2015 totalled US$37bn, just a little over 2014’s total of US$36bn, and considerably less than the 10 year average of US$62bn. Therefore while most major insurers’ combined ratios for 2015 were under 100%, the benign global ‘cat’ environment had much to do with it.1

What if there had been normal nat cat losses?At a Bloomberg roundtable in August 2016, featuring some of the largest European insurers and reinsurers, the managing director of international reinsurance at Berkshire Hathaway noted that if 2016 were to see “normal catastrophe claims”, a number of companies’ combined ratios could exceed the 100% threshold, where claims and expenses would exceed premium income.4

Indeed, the first half of 2016 saw higher-then-expected catastrophe losses, with losses from the Fort McMurray fires in Canada, earthquakes in Japan, Taiwan and Ecuador, together with flood losses in Germany and hailstorms in the Netherlands. While none of these events are of comparable magnitude to major historic ‘cat’ losses, in total they represent a significant increase on the equivalent period in 2015, and were enough to send some insurers’ reported combined ratios for Q2 above 100%. (It is worth noting that Q3 is traditionally the costliest quarter for the insurance industry, driven by the Atlantic hurricane season).

Hermine - low urbanisationThe 2016 hurricane season has in fact been more eventful than recent years, although August and September, which historically have been the most active months for hurricane formation, passed without a truly significant loss to the insurance market. In September Hurricane Hermine became the first hurricane to make landfall over Florida since 2005; however, it tracked over an area of relatively low urbanisation, and the resultant damage was estimated at less than US$400m to the insurance industry by Risk Management Solutions (RMS).5


Matthew – no landfallThen at the beginning of October Hurricane Matthew caused devastation in parts of the Caribbean before skirting Florida, but failing to make landfall. By mid-October both RMS and AIR Worldwide were estimating insured losses from Matthew as somewhere between US$2.5bn (RMS) / US$2.8bn (AIR) and US$8bn (RMS) / US$8.8bn (AIR).6

The upper end of the range would make Matthew the most costly hurricane for insurers since Sandy in 2012, but even should the most pessimistic scenario prove correct, it would not put Matthew into the all-time top 10 of claims to the insurance market. Accordingly, its effect on market conditions is unlikely to be significant or lasting.

The impact on the marketOn the one hand, a return to average levels of catastrophe losses (or worse), either this year or in the near future, would seem very likely to lead to 100%+ Combined Ratios for some carriers. On the other, it appears that investors seeking the most favourable return on their capital are not going to desert the insurance sector under any foreseeable circumstances - leading to a continued glut of reinsurance and retrocession capacity, in turn mitigating direct insurers’ exposure to catastrophe loss and thereby continuing the current downward pressure on pricing.

We can expect insurers to navigate this environment in a number of ways:

�� Some may look to withdraw from particular industry sectors or classes of insurance that their analysis shows to be particularly unprofitable (as XL Insurance did, when it withdrew from the downstream energy sector in 2014).

�� Expense management and cost cutting are likely to be seen as a way to maintain profitability in the event of still-falling premiums.

�� One manifestation of this may be in increased M&A activity, as certain carriers struggle to survive on their own.

�� Competition for high-quality risks, which by definition are less prone to losses, or better able to manage them, is likely to continue.


Power market dynamics – yet to hit the bottom…As we have noted in previous reviews, the insurance market arena for risks in the power and utilities sector is a specialist area of the wider market, and has its own dynamics. For example, largely because of its continued experience of attritional machinery breakdown claims, the power market initially lagged behind the general market when it came to succumbing to market pressures on pricing.

However, the power market is not immune from the pressures affecting the wider insurance market. Despite the hope expressed by some underwriters in 2015 that the bottom of the market was around the corner, it seems that we have yet to hit it. Rates have continued to decrease, albeit at a slower pace than the last couple of years; on average, rate reductions range between 5% and 15% for business that is running well (i.e. loss-free or loss–light, with good engineering and management standards).7

Some can afford to walk away…There is evidence that some insurers may now be prepared to “walk away” from business if their competitors quote rate reductions in excess of these levels. Typically, insurers who can afford to take this stance are well-established and write a broad range of business.

…while some discipline remainsNotwithstanding the soft market conditions, the technical leaders continue to show discipline over deductibles, especially around turbines and Business Interruption. Competition for business therefore continues to manifest itself principally around pricing.

Increased “mega” losses – especially the BI elementThere have been a number of “mega losses” in the power sector in the last year. We are used to catastrophic machinery breakdown incidents driving this activity, but other causes such as fire and human error have led to some very significant losses.

“ In a competitive market where organic growth remains a challenge for insurers, inorganic growth through merger and acquisition activity has led to some consolidation of underwriting teams.”


These losses are well spread across the globe, including South America, Russia, and the Pacific regions. As can be expected, the business interruption component of these losses has tended to be the driving factor. This in itself has been due to a number of factors varying from long lead in times needed in order to replace very specific pieces of equipment to the time it has taken to mount large logistical debris removal and reinstatement operations in remote parts of the world.

While the low frequency / high severity “mega losses” may grab most attention, the trend of attritional high frequency / low severity machinery breakdown claims continues to be a feature of the power market. That these losses have failed to put a brake on the softening market conditions is down largely to the amount of capacity available to the sector, and the competition for business that this generates.

Capacity – M&A balanced by arrival of new competitorsIn a competitive market where organic growth remains a challenge for insurers, inorganic growth through merger and acquisition activity has led to some consolidation of underwriting teams. Most noticeably, the Mitsui Sumitomo and Amlin merger has led to a single MS Amlin power and utilities team, while the XL Catlin merger has led to the run-off of the XL Re property team, who were traditionally an excess of loss market who would write power business.

Mergers rarely result in additional capacity, usually reducing competition over time. However, recent merger activity has been balanced by the arrival of new entrants to the market. These have included a new Pioneer power team, acting as an MGA for alternative primary capacity and therefore additional to the already-existing Pioneer capacity. AXIS has also entered the conventional power market.

General property insurers (as opposed to the technical power specialists) still remain active on larger power placements where non-proportional layers often present attractive opportunities. Another relatively benign natural catastrophe year in 2015 encouraged the emergence of new Lloyd’s property capacity, which will occasionally look at participating in the power insurance sector. Examples include new entrants such as Probitas, Berkley Re, Hamilton Re and Skuld.

The net effect of new entrants and leavers is to leave the supply of capacity for power risks more or less unchanged at approximately US$4bn, with supply still exceeding demand for all but the most challenging risks. This leads to power insurance placements often being over-subscribed, allowing buyers to select insurers with track records of good service and claims payments and/or underwriters who do not seek to amend the terms and conditions agreed by the leader.

Notwithstanding the overall levels of power market capacity, some underwriters are looking to increase their capacity on certain risks, as a way of maintaining premium income at a time of falling rates. Inevitably, this focuses on risks that are considered high quality and well managed, increasing the amount of competition for such business. Therefore companies that have a favourable loss record and can demonstrate good risk quality and practice (for example prompt implementation of risk engineers’ risk improvement recommendations) will tend to be the ones that benefit most from the current market environment. Even in a soft market, as in the movie Casablanca, “the fundamental things apply”.

David Reynolds Executive Director, Downstream Natural Resources, Willis Towers Watson

Alex Findlay Divisional Director, Downstream Natural Resources, Willis Towers Watson

Sources

1 www.swissre.com/media/news_releases/Global_insured_losses_from_disasters_reach_USD_37_billion_in_2015.html

2 It is now widely accepted that Zhou was in fact referring to the 1968 students’ riots in Paris rather than events of 1789, but it would be a shame to allow the facts get in the way of a good anecdote.

3 www.lloyds.com/lloyds/investor-relations/financial-performance/financial-results/2016-interim-results/joint-statement

4 www.bloomberg.com/news/articles/2016-08-23/hedge-fund-incursion-weakens-reinsurers-catastrophe-defenses

5 www.artemis.bm/blog/2016/09/19/hurricane-hermine-insured-losses-expected-below-400m-rms/

6 www.air-worldwide.com/Press-Releases/AIR-Worldwide-Estimates-Combined-Insured-Losses-for-Hurricane-Matthew-for-the-United-States-and-the-Caribbean/

www.rms.com/newsroom/press-releases/press-detail/2016-10-21/rms-estimates-hurricane-matthew-insured-losses-for-the-us-will-be-between-15-billion-and-5-billion

7 Willis Towers Watson


Liabilities

CapacityThe Liability market continues its inexorable growth trajectory and has now reached a new peak in 2016 with global capacity at an all-time high of US$3.2 billion.

In practical terms the true available capacity is often considerably less than the theoretical capacity. This is a result of a number of factors. For example, some insurers only focus on specific industries whilst others have reinsurance treaty restrictions or geographic constraints. In addition, some insurers elect to offer less than their published capacity for accounts to which they are new, or where they are not yet totally comfortable with the attachment point or risk profile.

Consequently, the realistic liability capacity available for insureds in the Power sector is approximately US$ 1.5 billion. This level of capacity is still more than adequate for the vast majority of buyers and represents a virtual tripling of available capacity over the past 13 years. Whilst the total limits purchased by Insureds in the Power sector vary greatly depending on their type and size, clients with significant hydropower operations, particularly those based in Europe, continue to purchase significant limits of liability ranging from US$ 500 million to US$ 1.2 billion.

The overabundance in capacity has been driven by a number of macro-economic and industry factors, including:

�� Low interest rates, leading capital to seek a profitable home

�� The relatively profitable results across the Casualty class as a whole over the past few years

�� The desire for insurance investors to spread their risks across a wider portfolio than just short-tail Property insurance

�� The cheap cost of treaty reinsurance

�� The movement of a number of senior and experienced Liability insurers away from some established companies to set up their own Liability operations.

Number of leadership options continues to expandThe result of these factors has not only been a growth in capacity, but also a growth in choice of insurers. In the past two to three years alone we have seen the arrival of a host of new Liability insurers including Ascot, Acappella, Apollo, Dale, Hardy, MCI, WR Berkley and most recently Probitas, all staffed by seasoned veteran underwriters. In addition, we are yet to see any meaningful reduction in capacity following the recent spate of Mergers and Acquisitions.

The increasing emergence of broker facilities (such as the Willis Towers Watson G360 Liability facility which provides up to 20% of additional capacity per risk) has added to the available capacity.

0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

(US

$ B

n)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Global Liability Capacity

Source: Wilis Towers Watson


Regional markets become more aggressive as buyers cut back on activity and expenditureLondon, Dublin, Bermudan and Continental European based Liability insurers are having to compete not only with each other but also with local regional markets that are becoming increasingly aggressive and autonomous.

This market dynamic is overlain by the fact that revenues for clients in the Power sector are being affected by falling energy prices which is in turn translating to increased pressure on their insurance budgets.

Meanwhile, exposures increase…The irony is that while premiums are reducing, Liability exposures are increasing. The growth in environmental regulation, the increasing spread in litigation costs globally and the increase in legal costs and awards have all combined to raise liability exposures. Equally, many companies are reviewing their contractual conditions in an effort to lay off losses and liabilities onto their contractors, suppliers and joint venture partners. Governments are also increasingly willing to impose very significant fines on companies that are involved in events causing damage, injury or pollution.

For Insureds whose operations involve the generation or supply of electricity underwriters continue to see transmission and distribution as the key exposures, with generation assets often benefiting from lower and more favourable rates. The availability of Failure to Supply coverage remains unchanged, with considerable information being required by underwriters in order to consider the provision of Pure Financial Loss cover. This, combined with the additional premium required for Pure Financial Loss cover, means that Injury and/or Damage restrictions to Failure to Supply clauses remain commonplace. Similarly, cover for Electro-Magnetic Fields continues to be written on the market standard ‘claims made’ basis.

A two-tier marketThe net result of the oversupply and reducing demand is a soft liability market. However, there are important variations depending on the profile of the client, resulting in what is essentially a two-tier market. For simple, single territory onshore operations requiring modest limits the considerable over-supply in capacity and aggressive local markets can result in buyers benefiting from significant premium reductions. For the larger energy clients that have a global footprint and/or more complex operations (including offshore exposures for example) the capacity pool is smaller and premium reductions are more measured.

“ The growth in environmental regulation, the increasing spread in litigation costs globally and the increase in legal costs and awards have all combined to raise liability exposures.”

What can buyers expect in the future?As a result of the factors described above, the market conditions are favourable for buyers and are expected to remain so for the foreseeable future. In a news release in September, Swiss Re stated that they expected pressure on liability reinsurance rates to abate, with broad rate increases possible for liability lines in the case of deteriorating reserve adequacy across the industry, but we are yet to see any sign of such rate increases as there is currently simply too much supply chasing limited demand.

Notwithstanding this, the past twelve months have seen underwriters placing a greater focus on risk selection, reducing their line sizes where rates are considered to be too “thin”, and starting to pull back from the unprofitable sectors. Recently four insurers, Axis, Dual, Marketform and Novae have all withdrawn from writing open market Liability business, an indicator that market consolidation is likely to eventually act as a brake on capacity growth, albeit not this year.

A good time to take stockThe net effect for buyers in the Power sector is that the current trading conditions present an excellent opportunity for clients to work with their brokers not only to ensure they get the most competitively priced deal, but also to review their breadth of coverage, enhance their limits and foster their relationships with key strategic carriers. Liability claims are often unforeseeable events capable of presenting themselves whether the market is soft or hard, and the value of a Liability policy lies in how and when it responds to such a loss. With Liability claims becoming more likely and economic challenges continuing, clients can use their Liability policies as valuable balance sheet protection in the event of a major loss. However this is only the case if time and effort is spent to ensure that breadth of coverage is not sacrificed in the race to commoditise and reduce cost.

Mike Newsom Davis Head of Liability, Natural Resources, Willis Towers Watson


ConstructionAs you were...“More of the same” is our main summary remark on the Power Construction insurance market, fuelled by further increases in the capacity of the global construction market, which now exceeds US$5 billion on a PML basis.1 The competitive market conditions continue to dominate both underwriting and broking, but is obviously extremely beneficial to the party who purchases the insurance. Careful monitoring of claims handling and recovery processes remains paramount to ensuring that low premiums do not result in poor claims service.

Capacity up by US$1bnNew capacity from Qatar Re, MENA Re, PEAK Re, plus an increase in capacity from many of the major reinsurers, is the main reason for the US$1 billion year-on-year capacity expansion. Regional markets in areas such as Singapore, Dubai and Miami grow stronger, assisted and strengthened by local insurance markets. Another key feature of the construction power market has been the expansion of the Lloyd’s Construction Consortium from four members to six, with the addition of Travelers and Novae now producing an overall PML capacity of US$340 million.

Power industry a primary focusWith over 50 carriers underwriting construction, most, if not all, consider the power industry as one of their primary focus areas. The leading reinsurers remain the major markets such as AIG, Allianz, Chubb, Munich Re, SCOR, Swiss Re and the Lloyd’s Construction Consortium, but others such as XL Catlin, Starr, Starstone and Zurich have the capacity, the experience and the skill sets to offer significant options.

Furthermore with significant capacity being available from other local and regional markets it is reasonable to suggest that no insurance requirements for any project (other than nuclear and large hydroelectric projects being built in exposed natural catastrophe areas) would exceed the capacity available.

Rate reductions continueThe competition fuelled by this abundance of capacity has resulted in a general reduction in insurance rates within the power construction industry over the last 12 months, of up to 30% in some cases.2 There appears no let-up in the increase in capacity with capital providers using insurance as a method of investment returns – these returns may be small in historical terms, but still superior to the returns that can be achieved in many other financial sectors at present.

Gas fuelled sectorIncreasing power output through revolutionary and evolutionary technology advancements continues to be a priority focus for insurers and reinsurers underwriting this sector. Finance and lender driven security has seen an increase in enhanced warranties being offered from manufacturers such as General Electric, who in the last 12 months have purchased the power operation of Alstom. With these warranties in place, reinsurers are more likely to offer the wider defects cover of LEG 2 in respect of new technology, instead of only offering LEG 1 in the absence of warranties. The development of new gas turbine technology, with the 7HA and 9HA series from GE, H class from Siemens and J class from MHI, leads the way for this increase in power.

In addition, the continuing emergence of Chinese manufactured turbines and boilers is a new underwriting factor under careful scrutiny by the International markets. Concern in quality assurance and indeed quality controls are natural, although Chinese standards are indeed improving.

Other factors will continue to influence underwriters’ rates. Exposure to natural catastrophe perils is a key underwriting consideration for projects located in cat-exposed areas, irrespective of the type of power plant being constructed, or the nature of the technology. Additionally, certain types of projects constructed in mountainous areas give rise to consideration about accessibility, ground conditions and other features, including tunnelling and occasionally the construction of long tunnels using high risk methods such as tunnel boring.

Testing and commissioning deductibles plus Defects risk and Defect liability (maintenance) (particularly with new technology in the gas or coal power fields) remains between US$ 1 – 1.5 million any one occurrence.

Coal sectorThe construction of coal power plants using supercritical and ultra-supercritical boilers has been very evident over the last 12 months, due to their improved efficiency, reduced omissions and lower operator costs, with new plants being constructed in China, Russia, Pakistan and Indonesia dominating the sector. Financing and financiers continue to have a strong influence over the procurement of insurance, particularly with regard to the responsibility being maintained of the owner of the plant and therefore the borrower of the finance. The insurance market continues to monitor the involvement in construction projects by those Chinese manufacturers who are increasingly seeing themselves as the operator and not just the EPC contractor, although this is more relevant to the operational power market than to the construction power market.


Renewables sectorThis has seen significant growth both in terms of new spend (USD 290 billion in 2015) and also insurance capacity. Whilst technology continues to improve the power output of projects such as Biomass, Wind, Solar and Biofuels, projects of these types remain highly desirable to insurers due to their wide spread of risk and relatively low risk exposures. Other renewable technologies such as Waste-to-energy, Geothermal and “mini Hydros” receive slightly lower appetite from the insurance markets, but still enjoy extremely competitive premiums and deductibles.

One feature of the insurance market for the renewables sector is the dominance of GCube, although other key markets such as Starr, AIG, Chubb and others also offer a competitive product. Another particular feature of the renewable industry is that it is driven by lenders providing the financing for new projects, and their need for long term security. This has resulted in a creative response from the market by way of a combined Marine, Construction, Liability, Operational Risks and Financial Loss policy (Delay in Start-up / Business Interruption). Those offering such a product are leading the field of the renewable industry.

Nuclear sectorWell documented rising costs, extremely long construction periods and once again the emergence of Chinese technology makes the nuclear insurance industry extremely significant, especially in the light of the prevailing market conditions. Product enhancement, extending the complex situation regarding coverage towards testing and commissioning, definitions of nuclear risks and the interface with nuclear pools, all coupled with the significant investment being made in China, India and the United Kingdom has created a very active construction insurance industry.

Rates and deductibles have also been reduced in this sector, but carriers underwriting these projects are aware that they may receive additional premiums through rising costs and extensions in period.

Conventional construction coverage expires when the project reaches a certain stage, namely the loading of nuclear fuel, certainly in respect of the high radioactive zone or nuclear island. A noticeable extension, whereby construction insurance will continue beyond fuel loading for the non-nuclear island, will also provide maintenance cover.

Most construction power insurers will underwrite this sector. Indeed, a recent market move has been the formation of a new Nuclear construction underwriter under the direction of Nuclear Risk Insurers (NRI) called “NRI Construction Binder”. This has the backing of key London markets providing capacity and technical support allowing NRI to add construction to the operational risks that they provide cover for within the UK nuclear pool. With a capacity of US$250 million on a PML basis this provides a significant market with advantages to provide combined construction and operational cover.

Conclusion: good underwriting information remains essentialLooking forward, it is difficult to see anything on the horizon that will disrupt the continued market softening. But as always, projects with thorough and timely information will fare more favourably in the underwriting process. This includes the demonstration of quality controls supported by technical information such as manufacturer and supplier details, lead times of critical items, accurate PML reports, progress monitoring control, a detailed breakdown of the value and DSU costs and contractor method statements.

David Warman Deputy CEO International Construction, Willis Towers Watson

Sources




Terrorism & Political Violence Over-capitalisation continues softening process Despite the increased frequency of political violence events worldwide, the over-capitalisation of the global insurance market means that rates for terrorism and political violence insurance continue to soften. Rather than just pocketing the premium savings on offer, many insured companies are acting prudently by reinvesting the savings in broader and more comprehensive insurance coverage, helping them to avoid the potential pitfalls of unforeseen and unpredictable risk.

Terrorism and Police Violence activityThe last three years have recorded steady increments in the number of terror events globally, particularly with the emergence of Islamic State. In reality the majority of the incidents go unnoticed by people who are not immediately impacted or are not otherwise purposefully monitoring their frequency. Numerically, the predominant regions for terror incidents are the Middle East, Africa, and Central Asia, where the legacies of ongoing conflict perpetuate themselves, but 2015 and 2016 have seen an increase in attacks in Europe and North America. Fatalities in the West during the last twelve months are the highest in a single year since the Madrid bombings in 2004, and large-scale attacks such as those in Paris in November 2015 and July 2016, and Brussels in March 2016 keep the threat of terrorism firmly in the public consciousness.

Conflict escalation difficult to predictThe escalation of the conflicts in Syria, Iraq, and Yemen are furthermore a reminder that political violence and the spectrum of risks covered under a conventional Terrorism insurance policy are extremely difficult to predict. Unlike other risks with the potential to cause catastrophic injury, loss or damage, in particular natural phenomena such as earthquakes and hurricanes which tend to be limited geographically to known “cat zones”, patterns of violence cannot be so easily predicted on an empirical basis. Of course, in the case of Yemen, where conflict between the Saudi backed President Hadi and the Houthi rebels is ongoing, there is a well-known precedent for terrorism and the potential for the civil war that developed, but there are other examples of increased political violence that will have caught analysts and risk managers unaware. Events in Ukraine in 2014 are a good example; underwriters’ rates for political violence cover for Ukraine had been low, reflecting the conventional view of the level of risk, until protests in early 2014 resulted in skirmishes between the military and pro-Russian rebels in the summer of 2015.

The Arab Spring is perhaps the perfect example of how an escalation of violence can rapidly transform perceptions of predominant risk exposures, in this case moving from terrorism to full war in relatively short timeframes.


Companies operating in the region today would be well advised to seek insurance against a broader range of political violence perils, as simple terrorism coverage would not have provided adequate indemnification against the civil unrest and rioting that emanated out of the events of December 2010, and certainly the insurgencies and civil wars that erupted in Syria, Libya, and Yemen.

The power industry particularly at riskIn calculating risk, the sum of probability and impact, it is clear that certain companies in the international power and utilities sector are exposed to some of the highest levels of political violence risk. Vulnerability for such companies stems from multiple factors, not least that many are operating in hostile and less permissive environments, where remoteness and spread-out assets can render their interests almost impossible to secure.

The probability of loss is further exacerbated in certain territories due to the role of power plants and other assets as critical national infrastructure, often with state interest and high values, raising the target profile during times of conflict. Islamic State in Syria and Iraq, for example, were quick to target the acquisition of energy installations in their attempted conquest of the region, identifying power generation as key to their establishment of a new state and energy resources as a key economic necessity. Incidental to this, regional instability has contributed to a recent rekindling of hostilities between Turkey and displaced Kurdish fighters, who have a history of targeting unsecured energy installations as a method of economic harassment of the Turkish state.

Contingent Business Interruption and interdependencyOne of the key areas most frequently left unprotected by companies is third party contingent risk. The most obvious example of this risk in recent times was not terrorism-related, but occurred when the Japanese electronics industry virtually shut down as a result of floods in Thailand, from where many components were sourced. In the context of power generation companies, contingent operations are just as significant and should not be overlooked. Gas Pressure Reducing and Metering Stations and pipelines carrying fuel for gas-fired power generation, or substations owned by the local transmission and distribution companies, are usually essential to the continued operation of a power plant, and therefore indemnification against the consequences of a terrorist attack on these third party facilities should always be considered in a suite of coverage options.

Impairment of Access – a new solution offered by the marketAnother area that is often overlooked is the risk of site access being prevented or hindered, with consequent impact on the business. Under conventional property damage and business interruption policies, including those covering terrorism and political violence, the occurrence of an incident of physical loss or damage is usually required in order to trigger the policy coverage. However, as many companies have experienced, even if buildings and other facilities remain unscathed after a security event, the disruption can still lead to a significant loss of earnings. Take, for example, a scenario where roads surrounding a power station are blocked by political protestors (who may not even be demonstrating against the power station itself), restricting access for employees and suppliers, and preventing the plant from operating. The financial ramifications could be serious.

In response, Willis Towers Watson and a leading Lloyd’s Syndicate have recently collaborated to offer a new and exclusive policy wording covering Impairment of Access. This unique product provides cover for losses incurred if an incident, threat, or a hoax means a business cannot function normally due to the total or partial prevention of access to their premises. The policy is a standalone product, uniquely requiring no property damage trigger, and covers business interruption losses not only if caused by a terrorist event or scare, but also if they arise from a government cordon, civil unrest, and strike action, at either the company’s own or adjacent facilities within a given radius or defined route. Because of the relatively short-lived nature of the events being insured against, the time deductible is lower than under a conventional policy.

Even if physical loss or damage occurs, action by third parties could exacerbate the impact. In the event of damage to a pipeline supplying a power plant with gas, for example, which might be easily reparable in normal circumstances, the plant might be unable to rectify the issue due to demonstrations or obstruction by the local populace. Impairment of Access cover would mitigate any concerns over whether insurers will consider the protest to be the proximate cause of the interruption (and therefore not insured under a conventional policy), rather than the original damage (which anyway may not have been due to an insured peril).

Alternatively, a neighbouring company’s actions could generate strikes, riots, or peaceful protest within the proximity of the insured, or at a location vital to their interests. The impact of this could be a severe impairment of access, through no fault of their own.

Brendan Hobbs Senior Broker, Financial Solutions – Terrorism & Political Violence Practice, Willis Towers Watson


Political Risks State of the insurance marketThe last twelve months has witnessed a raft of new entrants into the Political Risks insurance (PRI) market significantly increasing the amount of available capacity. In a continuing low interest environment, PRI is perceived as a class that can still offer decent returns.

Additionally, the fact that this is viewed as an uncorrelated class of business from a Solvency II perspective (in other words, a PRI loss is considered unlikely to materially affect other types of insurance, and vice versa), combined with a reduction in reinsurance costs, has also meant that the barriers to entry have reduced. This has also enabled the more established market participants to broaden their offerings as well as writing increased lines and longer tenors.

The geopolitical landscape – political risks on the increaseThis surfeit of capacity has resulted in a softening of rates generally across the board although arguably this is at complete odds with the current geopolitical landscape, in which political risks exposures are seen to be on the increase. What could upset this trend would be a collapse of oil dependent economies such as Angola, Ghana and Nigeria to whom the PRI market is heavily exposed. The fall in the oil price has had significant ramifications for these economies, resulting in a lack of hard currency with which to meet their debt service obligations. This will undoubtedly result in an uptick in claims notifications, but thus far the market has proven itself to be very resilient.

The contagion of low oil prices has also spread to Latin America. The Venezuelan economy, whose oil industry accounts for some 95% of the export earnings, is effectively in meltdown. Meanwhile, Brazil continues to reel from the corruption scandals that have brought its economy, and their leaders, to its knees.

“ The impact of the UK’s vote to leave the European Union on 23 June is yet to be fully felt but the wider context in the immediate aftermath was investment flight to safe havens and a strengthening in the dollar, both of which have piled further pressure on emerging market economies.”

The impact of low commodity prices combined with a slowdown in demand from China will continue to have an impact on the global economy for the foreseeable future. When analysed against a backdrop of heightened political instability and civil unrest, for the election year countries such as Gabon, DRC and Zambia, the economic outlook looks increasingly uncertain. The IMF reduced their growth forecast for the region to 3.0%, down from 4.5% in October 2015, but some success stories remain as Kenya, Cote D’Ivoire and Senegal expect growth to be over 6.0% due to strong levels of foreign direct investment.

The impact of the UK’s vote to leave the European Union on 23 June is yet to be fully felt but the wider context in the immediate aftermath was investment flight to safe havens and a strengthening in the dollar, both of which have piled further pressure on emerging market economies. With all this in mind, caution continues to be exercised globally by investors and stakeholders alike and the requirement for PRI protection remains as strong as ever.

Political Risk loss modelling challengesJust as PRI stands apart from other insurance classes from a Solvency II perspective, so political risk differs from many other business risks in that it is inherently difficult to estimate and model exposure and future losses when making overseas investment decisions.

Political risk is the threat posed to businesses by actions or inactions of governments, both foreign and domestic, political upheavals or social change; common examples include expropriation or political violence or sanctions. These events are significantly more difficult to manage than other business risks, such as exchange rate volatility, for two key reasons:

1. they are inherently unpredictable – arising from complex, dynamic human societies;

2. they often have catastrophic consequences – for example, as we have seen in certain Latin American countries, where assets owned by multinational energy companies have been expropriated by national government.

Given this uncertainty over frequency and severity, it is very difficult to put a monetary value on the expected losses arising from international investments over time.


VAPoR - a potential solution?Willis Towers Watson has attempted to overcome these issues by applying a leading edge analytical approach. In partnership with the global qualitative risks analysis of Oxford Analytica, and employing the leading global catastrophe risk modelling capabilities of Willis Towers Watson Analytics, we have developed a web-based political risk modelling platform known as VAPoR (Value at Political Risk).

Although there are a number of risk mapping tools in the market which score risk on a traffic light system, or one-to-ten basis, these tools are largely generic, based on third party information (much of which is in the public domain) and are not forward looking. In contrast, VAPoR is a new platform which, for the first time, allows companies to put a real dollar value on their capital at risk when investing, or seeking to invest, in emerging markets.

The VAPoR system enables businesses to:

�� Estimate dollar-value expected losses and probable maximum losses for political risk events over time

�� Monitor political risk exposures on an ongoing basis in light of changing world conditions

�� Assess the severity of particular political risk contingencies under alternate investment scenarios

Therefore VAPoR now makes it possible for companies to assess their exposures against a suite of political risks, globally, regionally, by sector and over time, allowing companies to make informed investment decisions and better plan their current and future investment strategy.

Andrew van den Born Managing Director, Financial Solutions, Willis Towers Watson

The VAPoR system combines the user’s exposure input with political risk ratings to put a price on political risk


Regional perspectives Asia

To a large degree, the power market in Asia reflects the wider global market, with the same specific issues surrounding machinery breakdown exposures and the attritional claims that these exposures deliver. Despite these losses, the same market dynamics apply: over-supply of capacity continuing to drive premiums down.

Local capacity at an all-time highIn Asia, Singapore is home to the regional offices of the majority of international insurers and European reinsurers, who have full capacity and authority in the region, with minimal referral to their respective home offices. In addition there are various Middle East and Asian regional players represented, together with the Lloyd’s Asia platform. This Singapore-based capacity is further supplemented by indigenous local capacity, principally of a general property insurance nature, but willing and able to provide capacity in the territory in support of a power insurer’s leading terms. Capacity in Asia is as a result at an all-time high, with no sign of any meaningful withdrawal despite the profitability challenges in this business sector. The challenge therefore for insurers is to manage their way to delivering profitable revenue in a market where this abundant capacity is leading to declining premiums, and but where losses continue to be incurred.

Pressure to make budgetInsurers in Asia, like their counterparts in other parts of the world, are coming under intense scrutiny from their global head offices to meet their income budget while delivering a profitable account. The generally accepted way to meet the challenge of profitability and revenue targets is through strict adherence to risk selection, largely focused around positive risk management and a good loss record, noting of course that even the better quality risks can have losses. A key aspect of risk selection continues to be the adequacy of the underwriting information presented; the better the information, the more able insurers are to provide their best terms.

Soft market strategies not always succeeding…Insurers are looking to address those parts of their portfolio that are failing their own risk selection criteria, with strategies that range from standing firm on further premium reductions, and possibly implementing more restrictive terms to mitigate the perceived enhanced risk, to walking away all together. However, any attempt by an insurer to implement this strategy and retain the risk in the process tends to meet with limited success, as there seems always to be another insurer, driven by the same revenue pressures, ready to step in. The overall effect is that the correction in terms that some insurers consider to be necessary is compromised, but at the same time the insured companies involved do not see the degree of premium saving being generally achieved by their better-managed peers.


Easing of softening pressures?There will of course be many risks that sit in the middle ground which should continue to enjoy a degree of premium savings, but perhaps to a lesser degree than they have in recent years. Premium savings look set to continue, but perhaps at a lessening rate of decline overall, and very much on a case by case basis, depending on perceived risk quality and acceptable loss record.

Non-price underwriting discipline remains strongAs many commentators have said over the past few years, this is not a true soft market where insurers throw away their underwriting manuals. Apart from premium rating, underwriting disciplines remain strong, with deductibles, limits and coverage remaining steady. This is true especially with new “unproven” or “prototypical” combined cycle gas turbine technology, which is being used more and more in Asia as operators strive for ever greater efficiency gains, with original equipment manufacturers (OEMs) looking to meet that demand. Insurers will still treat these technologies with a degree of caution, and the deductibles and coverage offered will reflect that approach.

Project delays add to insurer woesOne further downward pressure point on the Asia power insurance market is that whilst the demand in Asia for power continues to grow, with various state-led and internationally financed initiatives across the region to satisfy that demand, in the last couple of years we have witnessed a number of projects which have been delayed or even cancelled due to regulatory, political and financial constraints.

This is certainly so with traditional fossil fuelled projects, with fewer major construction projects reaching commercial operation in 2015 and 2016. Therefore the consequent shortage of new demand for insurance capacity and opportunity for additional premium growth has added to the already significant profit and budget pressures faced by Insurers.

Making do with existing business will not be easyIf a limited number of new projects are coming to the operational insurance market, then insurers have to focus on what already exists. Already facing continued pressure on premium rates, in order to make their budgets insurers need to make up income by writing more accounts. By definition, if some insurers succeed in doing this in a market where demand for their products is relatively static, other insurers are going to find themselves writing less business. If we bring in the drive to protect profitability with disciplined risk selection, we therefore see further downward pressure exerted on pricing for those operational risks with the right risk profile and loss record.

Steve Jenkins Natural Resources Broking Leader, Asia

“ This is not a true soft market where insurers throw away their underwriting manuals. Apart from premium rating, underwriting disciplines remain strong, with deductibles, limits and coverage remaining steady.”

Australasia

Power account renewals in Australia and New Zealand in 2016 reflect the continued market appetite for companies that are well risk-managed, with a focus on loss control and prevention, and have good claims experience. There is sizeable appetite and capacity available in the local insurance market, as well as international market interest, and premium reductions remain available for such companies.

Local market conditions are still competitive, with insurers such as AXA, XL Catlin and HDI driving competition particularly for high-quality risks. However, the limited number of insurers participating on power risks means that the market is not as competitive as the general property market. Traditional lead insurers are reviewing their deployment of capacity and remain committed to line size for those accounts that meet their standard of risk management.

The million dollar question: what the market will do in 2017? Macro factors at this point do not support a market hardening, but a large earthquake loss in New Zealand (which is always possible) can be expected to quickly alter short term pricing and coverage availability.

Martyn Thompson Natural Resources Regional Industry Leader, Australasia


Latin America

The Latin American power outlook remains on the path for growth due to growing demand and commitment from governments to expanding generation, transmission and distribution sectors. Power growth in Latin America is estimated at an average of 3.4% per year over the next decade.1 Brazil and Mexico will continue to be leaders in Latin America in terms of new capacity in MW. Chile and Mexico are expected to outperform in growth percentage for new power investments. Special attention will go to Argentina, where the new government is expected to create a stable environment for power investments.

Renewables on the riseType of generation for new investments remains hydro, gas-fired and (non-hydro) renewables. The share of renewables is on the rise in almost each country in Latin America. A World Wide Fund for Nature study published in late 2014 ranked the top Latin American countries focusing on green power in Latin America as Costa Rica, Uruguay, Brazil, Chile, Mexico, Peru and Nicaragua. In absolute numbers, Brazil and Mexico remain the leaders. Colombia’s first regasification facility near Cartagena is set to start operations before the end of the year. By providing natural gas to thermo-electric power plants in northern and central Colombia, the generation mix will be diversified, which is expected to contribute to the stability of the Colombian Power market.

Brazilian market expandingIn respect of the insurance market, Latin America´s insurance capacity for large power projects continues to come from the international market: principally Miami, London, and Spain. The Brazilian insurance market remains strong for Brazilian power risks and is also expanding internationally - for example Instituto de Resseguros do Brasil (IRB), the largest reinsurance company in Latin America privatized in 2013, now has offices in Buenos Aires, New York and London.

Business Interruption losses increasingLatin America´s power sector has posted significant claims to the international reinsurance market in recent years. As described elsewhere in this Power Market Review, the business interruption aspect increasingly contributes to the complexity of the claims. Companies in the power sector should be looking to ensure that their business interruption insurance cover dovetails with their exposures. This should contribute to better protection against the consequences of property damage / business interruption for investors in power projects and could sustain the willingness to support new developments.

Marc Vermeiren Power & Utilities Regional Industry Leader, Latin America

Middle East

Power generation supply in the Gulf Cooperation Council (GCC) countries and the wider Middle East is set to continue rising, due to a number of recent trends, including increasing demand due to construction of new plants as well as improvements in operating efficiency of existing plants.

Demand for power continues to riseDemand for power in the region continues to rise - in the United Arab Emirates for example, it is estimated that demand for power is growing 9% annually and therefore governments are striving to ensure that a reliable supply of electricity is critical to sustainable growth and continued attractiveness of investment to the region.

BP’s 2016 Energy Outlook for the Middle East forecasts that electricity supply will rise by nearly 125% between now and 2035 and whilst the use of gas as an energy source continues to remain dominant, the renewables sector is set to continue growing.

Solar barriers coming downIt is commonly acknowledged that the Middle East has an incredible opportunity in the potential to harness sunlight as a form of power production, but whilst the World Energy Council reports that renewable energy accounts for over 30% of power generation globally, until recently operational challenges in the Middle East have created barriers to entry to developers. These include economic feasibility and geographic constraints such as inaccessibility, rough terrain and the harsh desert environment. Recent advances in efficiency, solar technology and the declining cost of solar power generation infrastructure will therefore all be contributing factors to the continued growth of solar power generation in the Middle East.

New nuclear power plantsA further contributing factor to the increase in electricity supply in the Middle East is Nuclear Energy. The UAE’s first nuclear power plant is currently under construction and expected to start operations between 2017 and 2020, with capacity in excess of 5000MW. This will bolster the power generating capabilities in the UAE considerably, as well as provide an element of balance in terms of a more sustainable and long term electricity mix, providing a greater degree of energy security, energy diversification and preservation of natural energy resources.

More insurance capacity flows into regionInsurance market capacity for power and utility risks emanating from the Middle East continues to flow towards Middle Eastern reinsurers, many of which are based in the Dubai International Financial Centre (DIFC). This is as a consequence of new entrants to the market (such as Qatar Re and XL Catlin) as well as increases in capacity from existing reinsurers.

1 BMI View - Latin America Q4 2016


In addition to this, and rather crucially, where international reinsurers operate out of Middle Eastern hubs (such as AIG, Chubb, Liberty and Lloyd’s), underwriting authority continues to flow away from traditional hubs such as London and New York towards the region, which is attractive to clients wanting to work closely with their local markets. As this trend has continued during the last 24 months, it has encouraged more capacity and more underwriting authority to be vested in the Middle East.

As many carriers operating out of the DIFC and wider Middle East are subsidiaries of international reinsurers, they have the same ability as their London-based counterparts to participate on insurance programmes whilst satisfying the stringent requirements of lenders, international insureds and their parent companies.

Increased profile of DIFC-based lead reinsurersIn addition, many of the Middle East domiciled power programmes are led by DIFC-based lead reinsurers rather than their London counterparts. Whilst deductibles being levied by London and DIFC reinsurers remain similar, to date the appetite and pricing dynamics have been generally more aggressive in the DIFC than their counterparts in traditional reinsurance hubs.

Focus on risk engineering as losses increaseThe increase in appetite comes at a time where losses to the insurance market in this sector remain significant, particularly when reinsurers align their global portfolio of power and utility clients to analyze trends in the sector. Reinsurers continue to focus on the financial performance of a programme, with a high degree of focus also being centred on risk engineering and risk quality, as evidenced by factors such as implementation of engineers’ risk improvement recommendations. Where there are concerns with particular technology or a particular operator, reinsurers generally choose to limit their participation to excess of loss or abstain from participation entirely.

As a consequence of the increase in capacity and despite the losses prevalent in the market, pressure continues to be applied to premium rates, particularly on well-performing accounts. As a way of preserving their position, reinsurers continue to look at ways of differentiating their approach for clients, including the identification of areas of coverage which other reinsurers struggle with, such as Cyber, and the provision of incentives such as Long Term Agreements and No Claims/Renewal Incentive Bonuses.

Will Peilow Power & Utilities Regional Industry Leader, Middle East


North America

The North American marketplaceKey markets for the power sector in North America remain Associated Electric & Gas Insurance Services (AEGIS), ACE/Chubb (StarrTech), AIG, Liberty International, Munich American, Swiss Re, FM Global, Allianz, Berkshire Hathaway, Scor and Zurich. There is still significant domestic North American capacity available, estimated at over US$3 billion for the right accounts, although this drops off significantly if the risk has extensive loss experience or catastrophe peril exposure.

While the US Property market overall has been soft for some time, power generation markets had, until relatively recently, been able keep rates more stable, offering smaller reductions then the general market. However, the power generation sector has recently been softening as quickly as the rest of the market. This sector has not been particularly profitable for insurers, and in fact many are losing money. However, carriers are hungry for premium, and the overwhelming marketplace capacity is causing carriers to either reduce their price or lose business. Few markets are showing real discipline in striving to maintain their technical pricing.

AIG is a partial exception, being in the process of re-underwriting its overall book, including the power sector, and choosing to exit from approximately 15% of its portfolio. However, AIG remains aggressive on risks it favors, and its competitors – especially AEGIS and FM Global – are usually more than happy to pick up AIG’s discarded business.

Machinery breakdown and associated business interruption claims at power thermal generation plants in North America have continued to be troublesome for some insurers, but competition generated by new capacity in the market the first half of 2016 has been the main factor behind rates decreasing for accounts with nominal loss experience, commonly by 7.5% to 12.5%, and sometimes higher for accounts with clean loss records. Decreases of 20% or more have been seen when new insurers are introduced.

Even accounts with recent loss experience are typically renewing close to flat, with rate increases only given for risks with large losses and/or poor loss history. One account saw its three lead insurers decline to renew their participation, having sustained approximately US$50m in losses over the previous 2 years, only to find a new insurer write 100% of the risk at a 25% premium discount off their expiring premium.

In the renewables space, rates for PV Solar, the fastest growing sector in the solar space, remain very competitive. Partly because it requires less engineering expertise than traditional thermal power generation, PV solar has

attracted new insurance players. At the same time, there are significant differences in the risks associated with utility grade solar farms, many of which are located in the West and Southwest, and distributed energy ground, garage and rooftop- mounted PV projects. In either case, exposure to natural hazards, such as tornadoes, hurricanes, earthquakes and fires, constitute significant risks to these projects. For example, an unexpected tornado in early 2016 ripped through a large wind farm in the West and created an insured loss in excess of US$40m.

Onshore wind also remains very competitive, although machinery breakdown and natural perils losses continue to challenge the current rate and deductible structure. Since wind is a growth area, underwriters still seek to attain and maintain a strong foothold in this sector. Despite the improvement in the reliability of the machines, the combined impact of larger units, low deductibles, low rates and climate change related risks continue to put pressure on the current market. Insurers are increasingly concerned about wind projects coming off their original OEM warranties and their extended warranty programs – five or more years. Insurers also look favorably on projects which have installed or are committed to installing Condition Monitoring Systems. At the same time, manufacturers are offering long term extended turbine service contracts covering both scheduled and unscheduled maintenance for their units (in effect, warranty programs at a price), and insurers, themselves, are beginning to explore offering post warranty protection themselves, when provided with significant engineering details regarding the maintenance and operability of the machines.

Insurer concernsWhile insurers continue to monitor asset valuation, in practice less attention is focused in this area as carriers attempt to protect their expiring lines in the face of significant competition. Overall, values for power generation risks are stagnant and, in some cases, falling. Inflation has minimized increases to replacement costs, while low energy prices, weak power demand and other factors are causing revenues to shrink, resulting in lower business interruption values. Energy prices are expected to remain inexpensive in the intermediate term, with opportunistic shale producers ready to produce quickly should prices rise.

Carriers continue to monitor deductibles closely, particularly the waiting period for business interruption losses; however, whereas there was a trend for waiting periods to rise in past years, they are mainly standing still today.

In the past few years US insurers have tended to be more accommodating with power clients and their brokers in accepting manuscript policy wording on shared programs, even as some large carriers roll out or plan to roll out new company-scripted forms for risks they write on a 100% basis.


Losses associated with power generation facilities are rising. Larger machines and transformers, and even some key parts, require 18-24 months to be replaced, increasing potential business interruption losses. Insurers in particular remain wary of prototypical equipment; new equipment is more expensive, more complex, but also more sensitive to operation deviation. Insurers worry that manufacturers’ testing new machines on test benches rather than in the field does not fully simulate plant environments. Some new prototypical machines in the field have had very poor reliability when installed new, with one model reportedly having insurable events occurring on nearly half of its installed units. (It should be noted that most of these insurable events were covered under the manufacturer’s’ warranty.)

At the other end of their lifecycle, aging plants (including both old coal plants and younger, but also past original expected lifetime, combined cycle plants) also represent a concern to insurers. More attention and maintenance dollars are needed, and typically being provided, to continue to operate these facilities safely.

Natural catastrophe events are probably less of a concern to insurers in the power generation sector, as heavy power turbines and other equipment better withstand the impact of heavy winds and earthquake relative to other industries. However, flood concerns remain a significant concern to insurers.

“ Onshore wind also remains very competitive, although machinery breakdown and natural perils losses continue to challenge the current rate and deductible structure. Since wind is a growth area, underwriters still seek to attain and maintain a strong foothold in this sector.”


North American power landscapeOlder, inefficient coal plants are shutting down in some areas of the country, for reasons both environmental (coal plants produce more CO2 than other thermal plants) and economic (the comparative cost of fuel for other plants, in particular cheap gas). The growth of renewables is not expected to replace all the capacity from these coal plant retirements. Consequently, combined cycle plants are also being built, but often have challenges such as reliable gas supplies to the sites, and the need for grid infrastructure improvements.

However, the renewables space continues to grow, with solar leading the charge in 2015, and wind expected to grow more in 2016 and beyond. Increased renewables availability is crowding out coal and causing baseload plants in some cases to cycle more often. Operating in this manner is harder on baseload plants, and this strain on the machines may be contributing to more breakdowns.

In January 2014, power system operators, power producers and consumers in the Northeast US endured prolonged periods of bitterly cold temperatures that drove up energy use, increased uncertainty for grid operators, and stressed available power supplies. This resulted in significantly higher number of forced generator outages due to mechanical problems and natural gas market inflexibility. In order to encourage efforts to prevent future forced outages, regional transmission organizations such as PJM and ISO New England implemented stricter rules for those collecting capacity payments in their markets under emergency conditions. The rules assess significant payments upon generators that cannot deliver when called upon. These payments are sent to generators that provide the energy that those called upon could not. This approach serves as an insurance policy to ensure the reliability of the system to provide essential electricity to customers. However, while potentially solving the grid operators’ problems, this created significant uninsured risk to generators in the form of these heavy nonperformance assessments, which property insurers view as penalties.

Some clients are taking prudent steps to minimize their risk, by altering how they bid into the grid operators’ capacity markets, and by pooling with other generators to minimize their overall risk.

Special insurance markets, including Swiss Re and Lloyd’s, have developed to insure this “penalty” risk, but pricing is steep and take-up low. Property insurers have little understanding still of the risks their clients face, let alone the ability to offer solutions in their property policies. Traditional insurers continue to exclude penalties, but some are beginning to explore providing vehicles to provide some coverage to their clients. However, potential penalties are severe, and while traditional insurers are hungry for new business, they are also very cautious about providing coverage limits needed.

Stop Press: U.S. Presidential Election ResultThe election of Donald Trump will reverberate throughout the North American power and energy industry in a number of ways. Although to date he has not put forward detailed plans for the sector, Trump’s presidency is likely to be better news for gas and coal than for renewable energy. Trump supports free markets, and can be expected to look to loosen regulation, which historically would be bad news for renewables. However, the overall impact on the growth of renewables in the US will likely be modest; one of the reasons that renewables have thrived in recent years is that they have become more competitive. Indeed, the installed cost of wind and solar power generation is now neck-and-neck with many fossil fuel installations.

Trump is not expected to support renewables in the same way as President Obama has done, and he is likely to curb subsidies and planned tax credits. However, wind and solar will continue to grow on their own economic merits, supported by renewable energy commitments made by utility and state-level regulators. Relaxed environmental regulations appear to be on the horizon, but older, inefficient coal-fired plants are shutting down, with more shutdowns planned. These plants will not reopen; coal’s issues are as much economic as environmental, with gas-fired plants cheaper to run and build (and also more efficient). With or without regulation, the US will continue to become a cleaner energy economy, as investors continue to pressure generators to reduce carbon emissions.

Michael J. Perron Northeast Region Property Placement Leader, Energy & Engineered Risk, North America

ContributorsApart from those featured as article authors, the following Willis Towers Watson personnel also took part in contributing to this Review:

�� Ed Cooper London

�� Alex Irvin London

�� Matt Clissitt London

�� George Guy London

�� Alistair Hill London

�� Jamie Markos New York

�� Dick Merbaum New York

�� Stephen MacDermott Brisbane

�� Craig Buckle Auckland

�� Ken Vogl St Louis

�� Laura Rickey Dallas

�� David Wathen Atlanta

�� Sarah Chandra Raj Chicago

Joint Editors: Robin Somerville and David Reynolds

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