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What Everybody Ought to Know to Insure Energy Risks Cost-Effectively in 2021?

image credit: Fire/explosion accounts for almost half of the value of all claims in the overall energy sector (oil & gas + power industries).

The energy sector ranks 3rd after aviation and property by the value of insurance claims. Energy companies no longer have the capital available to cover their losses - they need insurance to reduce their exposure to risks. But they need to calculate how much cover they can afford to take out and how much risk exposure they are willing to accept. An insurance expert's biggest challenge is to determine the right limit and scope of cover at the right price. How best to balance the cost of premiums against the cost of potential losses today?

Energy claims particularity

Energy insurance claims vary by the nature of causes, equipment, and energy types.

Weather/atmosphere is the main cause (37%) behind losses in the power industry. While turbine failure is the single biggest equipment type loss by value (36%).

Fire/explosion accounts for almost half of the value of all claims in the overall energy sector (oil & gas + power industries).

Eight of the largest ever property damage losses in the global hydrocarbon extraction, transport, and processing occurred in 2018 and 2019. They stemmed from refineries and petrochemical plants, especially the ones built in the 1960s.

Refineries accounted for 50% of new losses. Moreover, the COVID-19 pandemic triggered extra delays to recover from these property damages and even could mark the end for a site.

If a generating, transmitting, or distributing system ceases to function, losses are incurred in terms of repair or replacement of the equipment. Meanwhile, loss of function can also lead to loss of sales revenue. Business interruption insurance indemnifies the energy company against loss of revenue caused by non-functioning equipment. But business interruption insurance is expensive, and it is crucial to ensure that should a claim be made, that it will be paid in full.

The challenge here is calculating potential losses and showing these losses to insurers when a claim is made. So, you need to calculate the cost of cover and achieve a balance in the cost of premiums against the cost of potential losses incurred should operations shut down.

Business interruption insurance is very expensive, but it is very risky to not have it.

A lot of complexities arise when seeking business interruption insurance: you need to calculate the production rate of the asset to know how much to insure against. Therefore, you want to define the role of business interruption insurance in your insurance strategy. How confident are you that you could demonstrate losses to your insurer if/when making a business interruption claim?  

Another distinguishing trend in the energy industry is the construction and repair of offshore wind farms. This type of activity can pose difficulties - securing expert contractors, weather conditions and the laying of submarine cables are particularly problematic. Insurers often hesitate to insure offshore projects or toss costly premiums.

Experts know that majority of successful claims from offshore wind farms are related to subsea cables. Unfortunately, insurance regimes are not improving fast enough for offshore wind farms to keep up with the changes in this dynamic domain.

Call your insurance broker to assess insurers’ areas of specialty to tackle such complications.

Read your policy

Energy technologies are developing. Advances are especially rapid in clean energy in the light of accelerating energy transition triggered by public spending as an economic response to the pandemic.

At times it is difficult to secure insurance for new or prototype technology because insurers are unwilling to take risks on equipment that they do not understand or have no previous experience of. Presenting the risks associated with new technologies to insurers is important in the changing landscape. If you don't explain changing risks within plants, there is a danger that the policy might get invalidated due to changed risks.

And when involved in large projects, the technical knowledge of insurers is not as developed as it would be desired by other stakeholders. How confident are you that you will be able to secure insurance cover for new or untested technology?

 

‘’As projects progress and time goes, the changes occur. So, you should maintain good and long-term relationships with the insurer to nudge policy wording development’’.

 

Imagine a cyber-attack on your critical infrastructure. Your insurance broker or agent should read 40 pages of policy and answer if the policy covers certain financial, safety, operational or IT risks.

In processing claims, disputes over wording lead to lengthy claims processes, especially due to the technical wording used in these insurance policies. Thus, the underwriter's and broker's competence in technical issues is fundamental. Jointly with the energy firm’s risk manager, they structure insurance models to limit the liabilities exposed to and invest in the relevant insurance policies.

Effective management of insurance policies and models results in the reduction of the level of risk, liability, and expenditure on insurance policies.

Profiting from improved communication with insurance parties

The insured, the insurer, the re-insurer, and the broker affect and impact one another. If you establish a clear system of relations, then you are on track to secure an effective and efficient insurance regime.

The effectiveness of the insurance regime is achieved by ensuring that the policy is up to date and appropriate for your needs. As the energy transition advances and the energy sector becomes more complex. The insurance implications grow, particularly for new technology and renewable energy.

If energy companies can maintain good relationships with their insurer and ensure that all necessary information is communicated to them effectively and efficiently, the insurance policy will benefit. And when energy companies and insurers can maintain successful communication, the policy can be kept up to date.

As projects progress and time goes, the changes occur. So, you should maintain good and long-term relationships with the insurer to nudge policy wording development.

Construction vs. operations priority

Often the question of which area should take priority in insurance strategy- operation or construction emerges. Because there are grey areas between the construction and operation phases.

The challenge is to identify which are most pertinent to insure, which areas of insurance should take priority and how much time/money you should allocate.

It is furthermore necessary to remember that the insurance responsibilities of operators and contractors during a project or can be unclear. Success will be defined by knowing how they can assess risks and assign responsibilities effectively between parties; what should be covered, and which party should insure what.

Setting borderline where does construction end and operation begin adds to the complexity. And if there are cross-over then what the insurance implications it may have. At the end of the day, you should decide to what extent does the grey area between construction ending and operation beginning impact on insurance.

The rule of thumb is that operational and constructional insurance must go hand in hand.

Role of insurance in securing investments

Many countries announced investments into the transition from old energies to new energies as an ultimate way to recover stronger from the COVID-19 pandemic’s economic blow. Joe Biden pledges investments in clean energy in the US which draws global investment appetite especially after Democrats won control over Senate.

As a result, a greater emphasis is being placed on renewables as a source of power generation and more companies are beginning renewable energy projects. As projects get bigger or more complicated, public financing becomes more difficult to secure. So, finance must be obtained from banks or other lenders such as private investors who want insurance policies in place to feel reassured that they won’t lose money.

Climate change outlook emphasized by COVID-19 mood sparked interest among banks and private lenders towards clean energy.

But banks and private lenders are conservative in their views and somewhat still reluctant to invest in new and relatively untested technologies.

Private investors want to feel assured that they will gain a profit for their input, that's why insurance plays a big part in securing this investment. Lenders usually look for basic liability and property insurance to be comfortable enough to provide finance.

Limiting the cost of insurance

As insurance is expensive and budget constraints become tighter, energy companies aim to cut cost leakage and are thus looking towards alternatives to traditional insurance.

Particularly the use of captive insurance companies comes in handy. Maximizing the captive’s potential by covering risks independently and cost-effectively is the way forward. Structuring captives to improve self-reliance and reduce expenditure is the main ingredient in this procedure.

And yes, meanwhile you need to be confident that your captive can provide enough insurance cover.

Another way to reduce insurance premiums is by improving safety. It is not always interconnected so you need to analyze to be sure that you could reduce your premiums by reducing accidents. The main insurance classes you need to deal with:

  • reliability;
  • construction;
  • personal.

Liability insurance is a big topic where there is a large risk exposure in this sphere. Because if something goes wrong there can be huge consequences.

Adapting to changing conditions

Climate is changing so the energy industry is changing too. The pandemic has quickened those changes in 2020.

As 2021 gets into the working phase insurance and risk managers have to adapt business models to changing conditions to win the game.

The main question: how to structure insurance strategy in the energy industry to ensure the maximum cover of assets and portfolio?

P.S.:

Carbon-free doesn't mean risk-free. Thus, insuring energy risks in Net Zero World is still essential. At the end of the day, you need to balance risks between self-insurance and external insurance. The decision about which risks to take yourself and which risks to pass to external insurers depends on capacity and price.

 

Rauf Fattakh's picture

Thank Rauf for the Post!

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Discussions

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Randy Long's picture
Randy Long on Jan 19, 2021

Excellent post Rauf! I'd like to add something from a California perspective. When PG&E finally came out of bankruptcy (second time in 20 years) last summer, I think they may have "gotten it." Insurers are going to have to look at past performance and future promise. C-suite personnel at PG&E seem like they are poised to transition to a more sustainable business model and I'd like to see the insurance industry reflect that. This summer and fall should be a good indicator of how well PG&E and their insurers view concrete and actionable steps that the utility has done. "Black Swan" events sure are happening more often now, let's hope they consider this in their operations room.

Matt Chester's picture
Matt Chester on Jan 19, 2021

good insights, Randy-- the PG&E situation certainly has to be a wakeup call, because if it's not then what actually would be? 

That said, do you think it will be enough of a wakeup call to other utilities and stakeholders (like the insurance companies you mention)? Did it scare boardrooms across the country, or will there be any sense of 'well that wasn't me, not my problem'?

Rauf Fattakh's picture
Rauf Fattakh on Jan 21, 2021

Matt, ''it wasn't me, not my problem'' attitude will continue I guess. 

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