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Q4 2021

State of the Market Update

The fourth quarter of 2021 was relatively stable for both customers and insurers within the downstream energy segment. Blended physical damage and business interruption (BI) renewal rates were close to flat, and there was modest large loss activity.
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By John Cooper , 

Global Chief Client Officer, Energy & Power, Marsh Specialty

20/01/2022 · 16 minute read

  1. Downstream energy

The fourth quarter of 2021 was relatively stable for both customers and insurers within the downstream energy segment. Blended physical damage and business interruption (BI) renewal rates were close to flat, and there was modest large loss activity. Relaxed global travel restrictions in many regions meant customers were able to meet with insurers and re-establish relationships that had inevitably weakened after 18 months of virtual interaction. At the time of writing it seems engagement will be disrupted again as many countries seek to control outbreaks of the Omicron variant.

Besides rating, the energy transition and environmental, social, and governance (ESG) issues have been focus areas through the quarter. Clients have increasingly put sustainability front and center in their discussions with markets, showing proactive responses to the changing dynamics. There is an understanding that being able to demonstrate a clear pathway through the energy transition is important, and engagement allows insurers and clients to work together through the process. Further, insurers will have an opportunity to diversify their portfolios as downstream refining companies make the transition.

Longstanding wordings should be reconsidered in order to address potential claims settlement challenges around the non-replacement of traditional hydrocarbon assets that are either no longer commercially attractive or have become strategically redundant. Where a loss culminates in the non-replacement of an asset by the client, policies are well established in defining asset value settlement, but not the BI loss. We expect this will become more of a focus for insurers.

Overall market losses in 2021, for the second consecutive year, look to be below USD2 billion. Some deterioration of losses impacted heavily on both 2021 and 2020 claims figures. There has been focus from clients around coverage for contingency expenses and preservation of property. Some of these claims will be complex and are likely to require intense negotiation. The impact has seen a number of insurers reconsidering policy coverage extensions and sub-limits. BI volatility clauses have found favour with insurers; a great number of customers have re-declared their earnings projections through the policy period to avoid cap limitations. Much of this activity has depended on customers’ initial projections over the preceding 12 months, which inevitably spanned between bear and bull depending on future recovery projections for regional economies. We expect that this approach will need to be maintained into 2022.

Currently there is no lack of capacity for traditional downstream risks, in fact insurers are again deploying full capacity as rates are at a high. However, there is often inconsistency of approach between markets. Oversupply continues to come almost solely from incumbent insurers, and a few new entrants are expected to provide additional capacity in the near future. It appears that rates reached their upper limit in the fourth quarter and are now set to decline. However, there are complexities within this dynamic. The insurer perspective is that rates are still shy of technical adequacy levels and there is little headroom to accommodate the anticipated one-in-five year exceptional impact of natural catastrophe (NatCat) losses. Additionally, there is lack of certainty regarding potential treaty reinsurance cost increases. As such, insurers may take a soft approach towards a downward rating trend.

There is, however, a pragmatic view that market forces inevitably prevail. Creativity around long-term agreements (LTA) to allow for smoothing of declining rates, the impact of ESG constraints, and managing potential pricing volatility is being implemented. A concern for insurers is that a fast rating decline may result in similar market issues to those experienced at the beginning of 2018. While clients will welcome cost savings, particularly after three years of rate increases, a sustainable market brings greater value. As such, a partial LTA hedge can be an attractive option. The immediate potential dividend for customers can be the removal of expensive insurer outliers, and the greater concurrency of policy terms. The pricing difference on many policies is expected to apply across the program, which translates to a greater blended premium saving than the headline market rate movement. This may benefit clients and those insurers who applied year-on-year rate increases in a more sustainable way. As such, pandemic implications aside, 2022 could potentially, deliver a relatively stable market for insureds.

2. Upstream energy

COVID-19 and its variants notwithstanding, a benign upstream insurance market is developing for 2022. The business models of many oil and gas companies have improved. With better commodity pricing, insured physical damage values have stabilised, and BI values are increasing substantially. The International Union of Marine Insurance (IUMI) reported that their members had seen an 8.6% year-on-year increase in overall upstream energy premiums for 2020; further increases are expected in both 2021 and 2022 as oil and gas activity increases, buoyed by higher commodity prices.

As 2021 unfolded, the previous standard application of a 5% increase weakened, and signing pressures (where oversubscription of a risk reduces the amount signed to each insurer from the amount they offered to write) intensified. The surplus capacity has seen more markets willing to compete for business and quote aggressive lead terms to secure maximum market share and increase their premium volumes in 2022. Increased competition should have a positive pricing impact for clients.

As reported at the IUMI conference (September 2021, Seoul Online) only two prominent losses impacted 2021 — the deterioration in an LNG loss from 2019, and the loss of a jack-up rig in Malaysia. Losses from Hurricane Ida were not as significant as initially thought; however, smaller, attrition-type losses have continued to increase. Rising inflation, global logistics challenges, and an undersupply of labour means that any claims occurring in 2022 may be inflated. This has the potential to impact insurers’ margins.

There are signs that “blind” following capacity may become increasingly prevalent, especially as Lloyd’s have approved a much higher premium income amount for syndicates whose business plans are to follow specific leaders.

In 2022, we expect to see increased competition for those clients that are aligned to insurers’ risk appetite —those with demonstrable risk management processes, good claims record, the ability to articulate their ESG journey, and no/low exposure to NatCat risk. While clients and brokers will be pushing hard to break the ‘‘reduction barrier’’ on incumbent led accounts, insurers may struggle to provide reductions as syndicate plans agreed by Lloyd’s do not allow for them.

3. Power

Traditional Power

The final quarter saw continued slowing of rate rises for straightforward renewals with clean loss records and no NatCat exposures. An increasing number of clients experienced premium increases of less than 10%, and rate reductions were achieved on a few placements. This stabilizing of rate increases was underpinned by:

  • Engagement of global insurance markets to increase access to capacity and reduce local market control.
  • Tightening of terms and conditions by insurers resulting in companies retaining higher levels of risk.
  • Emerging managing general agents (MGAs) adding capacity to the market.

This has resulted in the return of over-placement and signing issues (where oversubscription or more than 100% capacity leads to markets being signed to a lower amount than their written line) on some sought after accounts. Additionally, regional insurance markets are re-emerging as hubs, having witnessed a return to profitability of the London market over the past 18 months.

There has not been a change in the rating trend despite the number of large losses hitting the market earlier in the year, and the storms experienced in the US during the third quarter.

Standalone coal placements continued to experience challenges. As an increasing number of insurers have no appetite for such placements, regardless of risk quality or loss history, larger retentions and further rate increases are expected to persist. Insurers, and Lloyd’s, are re-aligning underwriting in support of revised ESG policies, further reducing capacity, in some cases earlier than anticipated. With demand for capacity exceeding supply, rates are often considerably higher than expiring policies, and are felt more acutely by companies without an established relationship with the insurer. In our experience, restructuring of programs and a strategic approach using global insurance markets has become commonplace.

Renewable Energy

The renewable energy market continues to grow as we see traditional oil and gas and other energy insurance markets entering the sector. These insurers are looking to diversify their book of business to align to the opportunities offered by the energy transition. Generally, these markets enter the market conservatively, looking to provide a small amount of follow capacity as opposed to providing lead terms. As such, the increased capacity has not had a significant impact on terms or pricing in the third quarter. However, as these carriers grow their technical expertise, experience, and book size, the changing market dynamics and increased competition could provide greater benefits to clients. Specifically, we have seen continued stabilisation in deductibles and terms for loss-free, operational risks with lead markets focused on rating adjustments as they continue to seek profitability. In the fourth quarter, this resulted in rating increases of about 10% to 15% on loss-free accounts, with further increases reserved for risks that are exposed to NatCat, assets coming out of warranty, or those that have incurred losses or experienced issues during the previous year.

Insurers continue to look for increases in self-insured retentions in the construction sector as wind technology evolves and turbine sizes increase, while retention levels on solar projects remain largely consistent. Project location remains an important factor across all technologies, and as developers invest in more remote regions insurers are becoming more concerned around supply chain lead times, which remain a key factor in driving deductible levels, particularly in respect of delay in start-up (DSU) coverage.

While historically the traditional renewable energy market has comprised mostly wind and solar placements, we have seen significant growth in commercial scale battery energy storage systems (BESS) globally. The technology is relatively immature, and insurers generally take a conservative approach to such prototypical and rapidly evolving technologies, particularly as there have been a spate of recent fire related loss incidents. As a result, there remains relatively few lead markets in the BESS space. Early engagement with a specialist broker throughout the project development process is important to help secure coverage in this challenging market.

Another key challenge is around particular original equipment manufacturers (OEM) on the wind side, driven by recent losses. Similarly, early engagement with your broker will allow them to provide advice early in the development process and help to mitigate the risk.

Challenges around remote working, blended with the rapid growth of the sector, may allow underwriters to more easily dismiss risks that do not fit their core appetite. The quality and quantity of the risk information presented during the placement process is vital. Program optimisation and strategic purchasing are key tools to inform a detailed whole of portfolio strategy in order to optimise coverage and pricing.

4. Terrorism/political violence

The terrorism and political violence insurance lines remains profitable, and there has not been any major withdrawal of capacity over the course of 2021. There was an influx of new capacity at the end of 2020, and we expect that there may be a small number of new entrants at the start of 2022. In addition, some current markets are expected to increase their line sizes and offerings for 2022. This indicates that rates that had been generally flat at renewal (for assets that are loss free and well regarded) may see small reductions. On the other hand, there are and will continue to be localised increases in rates in parts of the world that have experienced losses from riots or looting, particularly those with a retail background.

Thankfully, there have been no severe and catastrophic losses as a result of terrorism. The quantum from incidents in South Africa are being confirmed, and though the claims might be high, it is unlikely that there will be a knock-on effect to the market at large.

The trend of “all risks” property insurers looking to exclude the perils of strikes, riots, civil commotions, and malicious damage (SRCCMD) will likely continue, with such coverage being sought in the terrorism and political violence market.   

With deductibles and retentions already at low levels, we do not anticipate much change to the current structures. Exposure to third parties, and by that nature sub-limits to policies that include contingent BI, might come under more scrutiny, especially in areas where looting and civil disturbance have been issues. The market remains stable, with ample capacity and a willingness to be flexible and accommodative, particularly for longstanding clients. We may start to see more policies with longer-term deals.

5. Energy casualty

During the fourth quarter, average rate increases at renewal of around 15% were experienced on like-for-like upstream/offshore casualty exposures, though the rate of increase declined throughout December 2021.

There have been a couple of new insurance market entrants in the upstream and offshore sector; each is writing cautiously and selectively offering relatively small lines (around USD10 million). In addition, a new managing general agent emerged bringing new capacity from a major carrier not currently in the casualty arena, offering up to USD20 million, written by underwriters with a proven track record in this sector. Staffing movements have resulted in an underwriter with a proven track record joining a insurer looking to start a casualty book, which may add another market. However, these new entrants are unlikely to impact the rate increases being experienced as there is still an overall lack of competition, and capacity remains tight.

Downstream/onshore casualty market renewals through the fourth quarter, on average, experienced rate increases of around 20%, before any change in the risk exposure metrics. As with the upstream sector, there was a lack of competition, and insureds looking to purchase high limits (in excess of USD500 million) were likely to face enforced self-insurance gaps in the program.

Reinsurance treaty renewals at January 1 may be a factor for early 2022 renewals. Insurers are increasingly seeking climate change exclusions, particularly if restrictive wording is imposed on them through their casualty treaty insurance program renewals.

Bermuda casualty

Over the past two years, large Bermuda carriers (offering USD100 million plus of capacity) have either withdrawn from the energy class or dramatically cut back their capacity to no more than USD25 million each. This dramatic reduction in available capacity drove an often top-down increase in rating where the Bermuda markets capacity, usually used at high excess lines, have applied rate increases of 20% to 25% for two consecutive years. In 2021 there was less pressure from the excess Bermuda carriers that were typically supporting rate increases of underlying London/European insurers at a minimum double-digit rate increase level.

There have been a few new start-ups in the Bermuda casualty market, but all have been cautious in writing the energy class, to a maximum of USD10 million on selected energy risks.

One Bermuda market (that typically participates in the first layer above London/Europe) is looking to specifically add the emission of greenhouse gases to their pollution exclusion to placements, and excess Bermuda markets are looking to impose the same restrictive language as the underlying polices.

6. Marine exposures

In 2019 and 2020, the marine market capacity reduced worldwide. Most remaining underwriters have adopted a pattern of increased focus and scrutiny on ship owner experience/credentials, reviewing operating standards and previous loss experience; a new, more challenging market has now developed. 

A recent marine market review of 2020 premiums by the International Union of Marine Insurance (IUMI) concluded that global marine premium base has gone up by 6% from 2019.

In the fourth quarter of 2021, the marine market increasingly stabilised. With renewals for well-performing business seeing flat renewals, we expect that clients may start to experience some pricing stability in 2022. This could change quickly should the market suffer one or two large losses.

A 2021 mid-year hull loss trend analysis carried out by IUMI illustrated that the frequency of hull and machinery claims continued its long-term downwards trend, with an extraordinary drop in 2020. This is likely caused by the reduced shipping activity during the pandemic; more pessimistic underwriters are considering the impact once shipping activity returns to more normal levels, particularly the cruise sector.

In 2021, new capacity entered the market. Experienced and respected underwriters employed by established capacity, are looking to grow market share and this is creating improved market conditions and benefits for clients. However, they are likely to remain focused on revenue targets and not allow rates to fall too sharply. 

7. Onshore construction

In January 2021, we suggested that, while portfolio pricing appeared to have improved, underwriting could be considered profitable and the class viable — prior years were still worsening, more losses were expected, and the expected profit levels were not being realised. Since then, rates rose steadily throughout the year, claims were experienced, and reserves on prior year losses worsened; however, three years of upwards pricing trend does not cover 15 years of downwards trend. 

Has the onshore construction market reached its peak? It is unlikely. The rating direction is unlikely to change until more capacity is available to result in competitive tension. While capital is considering (cautiously) entering the class, new capacity is unlikely to arrive with enough scale in the immediate term to create the excess required to give insurance buyers useable alternatives. Clients seeking onshore construction coverage will need to work with a specialist broker to best position their risk to address insurer concerns around issues such as cyber risk, delay in start-up (DSU), exposure to natural hazards and LEG 3 (latent defect) cover. Even then, the market will remain challenging with companies facing coverage restrictions and rating pressure. Extensions of policy periods on existing terms are rarely achievable.

A lack of consensus between underwriters in relation to opinion, or understanding where the losses will come from, is creating extremes. We are seeing some quite varied quotes and offers on coverage, and on occasion there has been 100% variance in lead quote pricing in recent quarters. This makes budgeting for insurance costs difficult for insureds, and there is a correlation between the required market capacity for a project placement and whether the placement is finalised at the best offered terms, the second best set of offered terms, the third best set, and so on.

A relatively common approach is to index link sub-limits and deductibles during a project period — as inflation rises the fear is that deductibles at the end of a project could have a real value significantly lower than at the outset. There is also a school of thought that policy sub-limits need to bear some proportion to the overall project value. But in both of these cases, not enough thought is being given by the underwriters as to what the clients’ actual exposure is, where the contractual risk of loss falls, or how terms of insurance are fixed between owners and EPC parties (or lenders). More importantly, how much consideration is being given to what the client originally requested or requires?

Lastly, we might also see the law and jurisdiction of a construction policy be further scrutinised. Some insurers have concerns about the lack of consistency and the challenge of quantifying exposure under local regulatory regimes, particularly if a dispute may involve multiple regions.

Ultimately, markets will continue to focus on rates, so ensure that you engage with your broker, provide good information, and leave more than enough time for negotiations.

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