Energy & power industry: 5 ways to manage risk cost-effectively

Across Asia, energy and power businesses are facing insurability challenges such as capacity constraints and premium increases, which contribute to rising risk-related expenses and liabilities to the balance sheet — also known as total cost of risk (TCOR), which consists of three components — insurance premiums, retained losses, and risk control expenses.

Both traditional and renewable energy businesses face pressures

Traditional fossil fuel businesses find themselves increasingly uninsurable due to insurers’ decarbonisation commitments and climate change obligations, which have resulted in exit policies and a growing list of exclusions relating to oil and gas, in addition to coal. These actions lead to an increase in retained losses (i.e. self-insured losses and liabilities undertaken by businesses), driving up TCOR.

At the same time, renewable energy businesses, such as wind and solar, may face insurance capacity constraints owing to the lack of historical loss data for emerging and prototypical technologies. Where capacity is available, macroeconomic factors — such as inflation — exert cost pressures on both insurance premiums and retained losses.

Across both traditional and renewable energy businesses, natural catastrophe (NatCat) risk is also significant. In NatCat-prone locations, rising losses due to increasingly severe and frequent extreme weather events are prompting insurers to pull back capacity and tighten terms and conditions, leading to significant coverage gaps and an increase in both insurance premiums and retained losses.

Factors driving rising total cost of risk

To ensure their projects are financially sustainable and profitable, energy and power developers and operators need to optimise TCOR by strategising their risk management and transfer approach. What actions can they take to unlock insurance capacity and lower their TCOR? Here are five solutions to consider:

#1: Update insurance declared values and indemnity period

With inflation leading to higher costs of reinstatement following a loss event, many energy and power businesses may be exposed to uninsured losses. Additionally, supply chain constraints are also resulting in longer lead times, potentially delaying the restart of operations, and incurring significant losses and liabilities due to prolonged business interruption.

Amid rising NatCat losses and reinstatement costs, insurers require accurate declared values and indemnity periods from energy and power businesses for underwriting. As failing to do so may result in underinsurance and activation of the payout-reducing average clause, energy and power businesses should work with valuation and business interruption experts ahead of renewals to ensure they remain sufficiently insured.

#2: Conduct natural catastrophe and climate risk modelling

Facing escalating extreme weather losses, developers and operators need to precisely diagnose and price NatCat risks, including how climate change is impacting the frequency of severe events.

NatCat models use sets of thousands of different extreme events to capture the range of potential loss scenarios in combination with detailed engineering information on the vulnerability of specific assets. Traditionally, risk modelling has focused on earthquakes and typhoons, but increasingly businesses see the need to quantify the impact of floods, wildfires, and hail as well. The modelling process can help energy and power businesses prioritise and make informed risk mitigation investments and risk transfer decisions by considering how these extreme weather risks are increasing due to climate change.

Choosing the right modelling tool, whether for current day exposures or future projections, is also critical. For instance, Marsh works only with leading model providers to create a suite of up-to-date and comprehensive physical climate risk models to ensure highly accurate and relevant outcome data.

#3: Conduct risk engineering on at-risk assets

The key to improving energy and power businesses’ risk profile is by conducting risk engineering surveys on at-risk assets. This involves site surveys by experts to better understand site-specific vulnerabilities, uncover opportunities for improvement, and validate physical climate change modelling outcome data.

The findings from risk engineering surveys not only help energy and power businesses improve their risk profiles, unlock insurance capacity, lower retained losses and reduce the cost of risk, but may also improve the bankability of projects.

#4: Conduct Risk Finance Optimisation

Amid the need to contain insurance premium costs while ensuring optimal coverage against key energy and power risks such as extreme weather and cyber risks, business often face difficulty when having to make an unbiased assessment of different program structures offered by their insurers, such as determining whether the proposed policy limits are sufficient, if the deductible structure is within risk tolerance, and if the quoted premium is fair.

With Risk Finance Optimisation (RFO), businesses can uncover the most cost-competitive program structure by leveraging an experienced team of actuaries and data analysts to conduct simulation modelling. This enables businesses to estimate retained losses and opt for the program structure with the lowest TCOR.

#5: Consider alternative risk transfer solutions

Insurance capacity constraints may make alternative risk transfer solutions — such as parametric insurance and captives — worth exploring for energy and power businesses.

Parametric insurance has particularly proven to be a valuable and customisable complement to traditional property insurance and business interruption (PDBI) insurance coverage. Payouts are dependent on triggering a predefined threshold based on an independent third-party index (e.g. Japan Meteorological Agency). A unique benefit for renewable energy businesses is that parametric insurance can also insure power generation capacity, such as performance guarantees based on wind speed.

Another option for energy and power developers and operators is setting up a captive insurance company — which allows a company to fund and formally insure itself against future losses, especially for unique and emerging risks that may be unavailable or costly in a traditional insurance arrangement. Surpluses from the captive can also be used to fund vital investments.

Lower total cost of risk and improve insurance outcomes with Marsh

As the global leader in risk management and insurance broking, Marsh is a trusted advisor in the energy and power sector. Our in-depth industry knowledge, diverse areas of expertise, and local presence enable us to provide tailored business interruption reviews, insurance valuation, physical climate change risk modelling, risk engineering, risk finance optimisation, and alternative risk transfer solutions that help you effectively lower your TCOR and optimise insurance outcomes.