Power and insurance – an effective partnership

The damaged dam of the Sayano-Shushenskaya hydroelectric power station near the Siberian village of Cheryomushki Source: Reuters
Experts from the energy division of international reinsurance broker UIB list the ten essential facts that all power company managers and engineers should understand about the world of insurance.

Mark Ritson, UIB, UK

The fields of insurance and power engineering have a long relationship that has developed into a much closer bond over recent years.

The large international insurance companies that offer insurance to power installations have come to understand power risks on a more granular level and offer risk management advice based on their experience of losses and engineering accidents around the world as well as on their experience of seeing best practices in the industry. It is not uncommon for organizations in developing countries to ask reinsurance brokers how insurance is purchased in developed countries.

But the relationship is in continuous flux: new techniques from the power industry and premium price changes from the insurer can lead to misunderstandings on either side. It is the insurance broker’s role to bring the sides together whenever there is a stalemate. The following ten points outline the current landscape of power industry insurance.

Why engineers need an effective dialogue with insurers or insurance brokers

There are several advantages for an engineer in knowing when, why and how to communicate with an insurance company or broker. The first and most obvious advantage is that open dialogue can keep insurance costs to a minimum. Another advantage is that insurers can provide valuable advice on risk management and improved efficiency, via brokers.

So how and when do power engineers interact with the world of insurance? When a power station needs a new insurance contract, it will usually be done via a broker company which will send its own engineer to meet the station managers and speak with engineers and everyone concerned in risk mitigation. The broker’s engineer will carry out a risk assessment and compile a risk report. The visit might last up to three days, concluded by a wrap-up meeting. Subsequent annual visits need not take so long, but it is essential that a strong link continues between the insurance broker and power engineers ” they have to keep each other informed of any changes in procedures or risk management techniques.

Any change that is not disclosed by the client might make an insurance policy invalid. Alternatively, any change that reduces the likelihood of a loss could result in improved insurance terms for the client by way of reduced deductibles or reduced premium. Many international (re)insurers will not look at an account if it does not have a recent survey report.

In most cases the plant manager and his team will know more about their plant than any outside engineer would ever know. That is why a good insurance engineer will never tell a plant manager how to run his plant.

How insurers and brokers have helped reduce power station risks

The fact that insurance brokers, such as UIB, now employ engineers has prompted a significant step forward in the overall management of risks in the power and energy industries. International insurers involved in the power industry also employ their own engineers and many underwriters come from an engineering background.

Officials check children from the evacuation area near the Fukushima Daini nuclear plant Source: Reuters

In today’s world there are more conferences and seminars regarding power generation than ever before. Some of the major turbine manufacturers such as GE and Siemens also hold regular conference calls with the insurance market to discuss technological matters. There is a greater information flow today than at any other time in history. Brokers and insurers have much greater understanding of risk so not only provide balance sheet protection from a fiscal aspect but also can assist in providing a form of enterprise risk management in conjunction with the client’s plant engineers.

Risk reports now look much different from just 15 years ago, when only a handful of insurers and brokers employed engineers. Reports are now more detailed and extensive, and they also reference international standards much more keenly. In addition, these reports contain far more details generated by questions from the broker and insurer rather than offered by the owners of the power facility.

The loss record in downstream energy, power and refining has improved in recent years and many people, including those in the power industry itself, credit the greater involvement and risk management advice of the insurance industry for this change. It was no one moment that brought in this change, but a general increase in the professionalism of the insurance market in tandem with a heightened awareness on risk management and loss mitigation. This shift was triggered initially by hurricane losses in the US ” especially Hurricane Andrew ” although it took several years to take hold.

How insurers insure power stations

To understand the needs of an insurer or insurance broker, it is useful to look at the structure of that part of the international insurance market that serves the power industry.

Insurers pride themselves on making risky corporate ventures possible by softening the blow of any potential accident or loss. The scale of potential losses in power is so huge that insurers naturally have a large role to play. However, this scale usually means that a power facility cannot be managed by a single insurer.

Smaller power facilities can be written by one insurer on their own, but this would generally be when there is insufficient premium to be shared between numerous insurers. Most power facilities will be written by more than one insurer. Either way, the potentially large losses that could arise from a power station claim would be absorbed in a manageable way without the risk of sinking an entire insurance company. Depending on the territory, insurance policies can be placed on either a direct basis or on a reinsurance basis. The territory and local insurance law will dictate the basis on which the policy is placed.

Most developed countries will have a direct policy because they will have a local insurance market capable of writing the risk. Countries that do not have a strong enough local insurance market will often use a local company to manage the risk but this insurer will then spread the risk into the international market with reinsurers through a facultative reinsurance programme.

The nuclear insurance market operates separately from the rest of the power generation insurance markets and consists of a network of country risk ‘pools’ which are overseen by international agreements and the International Atomic Energy Agency, which requires that insurance and risk management operations are adequate. Nuclear insurance capacity from the global reinsurance markets stands at €2-3 billion ($3-4.5 billion).

New and emerging technologies in renewable energy also demand so called ‘expert capacity’ from insurers and reinsurers which have developed specific skills and products in this area.

Power facilities owned by governments ” usually in developing countries ” will often be insured partly or entirely by the government or by a government-backed insurer. In this case, the facility might lose the benefits brought by the risk management requirements of the international power insurance markets. In the event of a large loss, the government would be in the same position as a company in that if they do not have sufficient insurance then the cost of repair or replacement of a facility would have to come from raising funds by different means.

How insurers and brokers bring international expertise to power engineering

The broker’s main role in power insurance is to represent the customer and place a power facility’s insurance contract in the insurance market. But when this is not possible or when an insurer poses questions before agreeing to provide insurance, it is the broker’s role to reach a solution with the owners of the facility.

A broker can thus help to find the best solution at the minimum cost to the policyholder. For example, if an insurer calls for a $2 million investment in staff, hardware or procedures before insurance can be granted, the customer cannot always expect a $2 million saving in insurance premium.

Many times, an insurer’s demands or questions can be satisfied by a full explanation of current procedures. An insurer will understand that not all power facilities look the same, but a broker’s insight is required to prevent an insurer becoming nervous about a risk and withdrawing an offer of cover. If an insurer has gone so far as to make demands, it often shows that the insurer is interested in the risk. But it is worth remembering that a power insurer has many more risks to choose from and does not need to insure a risk for which the risk report is inadequate or out of date.

The power sector and the insurance sector have been closely aligned for many years. In the past, insurers such as National Vulcan and British Engine had very close ties to the power generators and many of their staff were formerly in the power industry. Later, the ties became even greater. At a global level, the Merrett Syndicate at Lloyd’s of London provided coverage for power companies around the world alongside and often in conjunction with larger insurers such as Swiss Re, Munich Re and Hartford Steam Boiler. Then there was the emergence of Cox Power, another Lloyd’s insurer whose aim was to work in tandem with the power industry in order to respond to its insurance needs.

When the insurance industry was unable to satisfy the needs of the power sector, insurance mutuals came into play, such as AEGIS, USICO and others. These mutuals were and are owned by the power sector.

How power station premiums are calculated

A dizzying number of financial factors contribute to an insurer’s calculations on premium pricing.

The size of the facility and the power company’s risk management and claims record will be the obvious first steps. The insurer will also consider the previous year’s premium, the industry norms and the administration costs of providing the insurance policy.

Power and energy risks are computer-modelled by specialist teams within insurance companies to assess the likelihood and potential cost of a loss. The exposure to natural catastrophes such as earthquakes, tsunamis and windstorms are also taken into account.

Then, insurance company managers will ask their pricing, reserving and actuarial teams to decide on whether their prices should go up or down in certain lines of business or certain geographical zones. When business interruption insurance is calculated, the insurer must evaluate the revenues of the power facility and the expected duration for bringing the facility back to working order.

The insurer will also consider its own capital position and risk appetite and whether certain power facility risks provide good ‘risk diversification’ for the company. The role of actuaries ” the back office mathematicians of insurance companies ” has become more central in the pricing process for all lines of insurance business and not just power, thus moving the pricing process away from the individual decision-making of insurance underwriters. Of course, all of this is gauged and adjusted on a rolling basis by all the interlinked ‘cogs’ in the machinery of an insurance company.

Therefore, when a broker approaches an insurer for a premium quote, the broker will know from experience whether the quote represents a margin of error, as well as how the price compares to other companies and whether an insurer is financially robust enough to pay the claim without complications or delays.

However, power industry professionals might be disturbed to know that the price of their premium is dictated by the claims history of the rest of the power industry, which is why there is a need for differentiation between clients. Facilities with a clean loss record and good risk management will earn credits in their insurance compared with the rest of the industry but the underlying foundation of a price will be influenced by the loss record and catastrophe exposures as a whole.

In addition, the pricing of power industry premiums is also dictated by major insurance losses around the world such as the earthquakes in Chile and Japan. A significant claim in one part of the world may inflate premiums in another part of the world, if not straight away then within 12 to 18 months when the insurers and reinsurers have had a chance to reconsider their costs, capacity and terms. It might seem unfair, but if insurance capacity ” the amount of money held in reserve by insurers and reinsurers ” is squeezed by losses, there is naturally a higher demand for the capacity that remains and insurers can set their prices higher.

In the past few years most power risks will have benefited from this system and should have received years of premium reductions and improved coverage. The current market has a surplus of capacity in power insurance. While ‘soft’ market conditions are still in evidence there is a gradual tightening in premiums, terms and conditions as losses bite into profitability.

Why an insurance broker can be a power engineer’s best friend

A broker can be instrumental in securing a favourable deal for a power company. As a result, the strength, leverage and expertise of a broker are important. An effective broker will demonstrate to the insurer the merits of a customer’s equipment and standards and will do so in an efficient way for all parties concerned, saving time and costs.

There are frequent stalemates in insurance contract negotiations, but an effective broker will provide its power industry customer with a complete checklist of what the insurer requires, as well as any recent updates to regulations. The broker should also highlight for the customer any new concerns among insurers resulting from recent claims elsewhere in the power industry.

An insurer’s questions over standards do not usually need a major investment in equipment or procedures as might appear at first inspection. Insurers’ questions can often be satisfied by a thorough explanation of procedures and service history of the power facility. It is the role of a good broker to explain all of this.

A reliable broker will also be open with power industry managers with no fear of causing offence about their internal communication standards. It is essential that a broker can speak to a power industry customer honestly on this subject, because it is such an essential part of a risk report. This is where the clarity of information between grassroots power engineers and power company managers is important. When staff and managers at a power facility can prove they are responsive to risk and implement change, it will go in their favour. The best risks for brokers to deal with are those where you have faith that engineers, managers and financial controllers all operate in unison.

An effective broker will also call customers proactively whenever a change in insurance pricing is predicted. If a rise in industry-wide insurance pricing is anticipated ” e.g. after a major insurance industry loss such as an earthquake or hurricane ” securing contracts early can save money.

Emerging risks in power engineering

New technologies inevitably present new risks for insurers, developers and engineers to tackle jointly. But there are also a number of developing risks which continually change the risk landscape when insurers are evaluating power industry risks.

Debris at the scene of an accident at Russia’s biggest hydroelectric plant Source: EPA

These can be political risks that prevent the power company from recruiting the correct staff or place pressure on company finances. Terrorism and war are often excluded from standard insurance contracts and would require additional coverage which has to be purchased through specialist insurers.

Another interesting emerging risk ” the risk of cyber attack ” has already impacted power stations, particularly in Iran. The Stuxnet computer virus is thought to have temporarily disabled nuclear processing plants in Iran. Although this was fairly isolated, it shows the danger to power plants from malicious software.

At present computer controls at power plants are involved in the monitoring rather than the functioning of hardware. But power machinery will soon be automated and computerized to improve efficiency, potentially putting power generation at risk from computer viruses.

At present, insurers do not cover damage or losses caused by computer viruses because all policies have what is known as a ‘cyber exclusion’. This exclusion began life as the Y2K clause in the 1990s, in which insurers said they would not pay claims related to losses caused by software malfunction.

In most cases cyber risks insurance is just not available, which is understandable because at present the risk cannot be controlled or monitored. In many cases, it is also difficult to prove as a genuine risk.

Insurers have no reason to insure against this risk and at present there is little or no demand, but I would expect that in the future, as technology advances, it will become a more relevant issue. The big insurance and reinsurance companies will have already explored the possibility of providing this type of insurance.

Self-insurance for power companies ” how it works

Power companies often self-insure by forming their own insurance company, known as a ‘captive’. The benefits of creating a captive can include cost savings, the ability to tailor insurance placement, greater control, increased cash flow and a competitive advantage. In addition, establishing a captive can improve a company’s claims service, help build up a capacity surplus, create a new profit centre and ensure access to new risk financing options.

By establishing a captive, a power company will reduce its exposure to premium rate fluctuations. As mentioned previously, insurers and reinsurers are looking for rate increases at the moment to recoup underwriting losses from the previous year and group investment losses. None of these were caused by the power industry, but its insurance costs will be influenced by them. When we are experiencing a ‘hardening’ market like this, power companies could insure more of their assets or perils through their captives, thus reducing their exposure to the rate increases. Under a ‘soft’ facultative market where premium rates were falling power companies could do the opposite, if it were more cost effective than using the captive.

By utilizing a captive in this way power companies can control their insurance costs more effectively, which could aid budgeting and cost controls on a group basis, as the premium cost year-on-year would be more constant. Rather than declare what is to be insured and then negotiate the price for these assets, power companies could declare what price they want to pay and then move the assets and perils accordingly between the facultative market and captive to achieve the desired price.

How insurers and brokers are facilitating the rise of renewable energy

The next few years will see twice as many gas powered energy installations built than anything else ” there are more resources available in this area of energy generation and it is cleaner. Politics and the need for governments to pursue greener power sources are also greatly influencing the power market. Twenty per cent of power in the EU must come from green power sources by 2020 ” and insurers and brokers have risen to this challenge.

Insurers are working with technology developers, power and energy companies and governments in multi-party negotiations to develop renewable energy facilities. The ability of power companies to develop and use new technologies depends upon the involvement and understanding of insurers to support these risks. In addition, international insurers and brokers have also been active in providing loss data, weather information and indications of climate change to persuade politicians to take action.

Why ‘new’ is not always ‘best’ for power station insurers

Insurers are often intimidated by unproven equipment or technology. This is understandable ” in order to provide insurance on a piece of power industry hardware they need extensive documentation on operational history and safety. Even when a known piece of hardware is being used, underwriters will say they wish to see it running for a couple of years before they are prepared to insure the risk at an optimal price.

The latest technologies and trends in power generation and power station engineering not only come under the purview of insurers but also require the participation and input of insurers at the development stage.

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