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Q1 2022

State of the market overview Q1 2022

Market conditions in the upstream sector continue to improve for clients as the capacity surplus drives competition among insurers.

Person's name and title

By John Cooper , 

Global Chief Client Officer, Energy & Power, Marsh Specialty

05/04/2022 · 14 minute read

  1. Upstream Energy

Market conditions in the upstream sector continue to improve for clients as the capacity surplus drives competition among insurers. This positive trend for insureds will likely continue, at least in the short term, as the sanctions imposed as a result of the Russia-Ukraine crisis have removed about US$100 million of potential revenue for a profitable upstream premium from the market. While insurers may still seek small level rises, the market dynamics are not in their favor. 

The much-improved commodity prices, and political pressure to increase oil and gas production, may see an increase in premium levels for insurers. Loss of production declared amounts have gone up, values have finally stopped dropping, and there are signs that operators are now keen to begin drilling programs. For insureds, however, the increase in loss of production declared amounts could put pressure on the available capacity for some large assets.

Inflation, and increased activity across the upstream sector, may at some point exacerbate claims, but this factor is not currently impacting negotiations.

An exception to the above is coverage for offshore Gulf of Mexico assets, where capacity remains very tight and upstream insurers continue to compete (internally) with other classes for the US named windstorm aggregate capacity. 

Other exceptions include subsectors where the loss record is poor, such as onshore exploration and production, or for low premium accounts. In these cases, quoted rate rises can often be in double digits.

While the market will likely continue to improve, a large loss or a series of losses could change market dynamics quickly due to the very high vertical limits bought by this sector.

2. Downstream Energy

The first quarter fundamentals are good for both customers and insurers. Although there has been limited new capacity into the market, increased insurer appetite is creating a positive effect. Rates have flattened and the momentum has now moved from leveraging expensive capacity downwards to focus on genuine pressure for rate reductions. At the end of the quarter, there is a clear oversupply of capacity with rates broadly flat to dipping, premium pricing deltas closing, and more alignment in policy terms. Large loss activity for the quarter has been minimal, which has set a positive foundation for the year. A more sustainable trading environment with reduced uncertainty will benefit both insureds and insurers.

More broadly, geopolitical factors and interests are acerbating the supply chain issues caused by the COVID-19 pandemic and this is leading to severe inflationary pressures across the world. Spiking commodity prices will significantly impact asset replacement cost values. There is considerable variability in how those values are currently being declared to the market, and the trend for corrections may go from 2% or 3% to as much as 20%.

While insurers are tolerating some lag on valuation movement, operators should review and assess how inflationary pressures may affect their estimated worst-case loss scenarios and the policy limits they require. Consideration should also be given to how sustained inflation may affect rebuild timeframes, and where applicable, the upward trajectory of earnings and business interruption exposures. Although this may have an impact on upfront insurance costs, as increased costs are factored into sums insured, the cost of underinsurance can be significant in the event of a loss.

Having a robust risk transfer strategy that considers the total cost of risk and tests the pricing models of different options will help operators make an informed decision. Most lead insurers have the breadth of portfolios and engineering capabilities to understand how a customer’s declared valuations benchmark. However, where declared values are outside of a conservative margin of tolerance, insurers will likely request an independent valuation. Insurers’ terms may make the capacity conditional on independent valuation and/or include a subjectivity for retroactive premium adjustment.  Having current valuations that reflect the cost of repair or replace materials in the current market environment can minimize any potential uncertainty.

In the context of the Russia-Ukraine crisis, many insurers are reconsidering their property damage cyber buyback wordings to ensure that the coverage provided is aligned to that which has been modelled. Generally, as markets are considering restrictive language, operators should consider their direct exposure, as well as across their supply chain, and discuss the impact of any proposed wording change with their broker prior to placement.

Market focus also has moved towards addressing potential ambiguities surrounding coverage scope for non-replaced or repurposed assets. Insurer interest in this topic in part correlates to energy transition as it is not the intention of insurers to fund customers’ transition plans, or pay for income loss on time element extensions where no practical pre-loss indemnity basis exists. However, we have experienced examples where, on an individual basis, customers, advisors, and insurers have worked on bespoke solutions that allow for replacement of assets on a non-like-for-like basis, including time element extensions where the indemnity tracks the repurposing of those assets and related earnings.

3. Midstream Energy

The midstream energy class covers a very broad spectrum of operations including gas processing plants, pipelines, and terminal operations. Insurances for businesses that fall in this class are written across the upstream, downstream, and marine insurance sectors (for ports and terminals). The more benign exposures of pipeline physical damage or gas plants can be written in either the downstream or upstream sectors. More hazardous exposures such as the onshore US named windstorm, hydrocarbon blending or processing (excluding refining), and complex business interruption exposures, are written by a limited group of upstream underwriters, or directed to the downstream market. The diverse scope of the class means it is difficult to pinpoint specific trends in pricing or coverages however, it tends to follow the upstream and downstream sector tends. In general, the class does not have the large premium volumes seen in the upstream and downstream sectors, resulting in more volatile loss ratios. An example of this is a recent incident in the US where a pipeline pigging operation burst through a pipeline end valve causing severe damage to a gas plant. The associated business interruption, written predominantly in the upstream market, is likely to wipe out several years of premium for this class. This is likely to result in an upward rating pressure from markets, along with more focus on terms and conditions, especially for business interruption exposures.

4. Traditional Power

We continued to see single-digit rate increases during the first quarter for straightforward renewals with clean loss records and no natural catastrophe (NatCat) exposures. We have also seen a number of flat rates and, in some specific cases, rate reductions. This stabilizing was aided by wider marketing to global insurers and restructuring of coverage, with some clients choosing to accept higher retention levels as insurers shift their pricing focus to tightening terms and conditions. For the first time in two years, we have had an oversubscription of some risks resulting in a reduction of some markets’ desired line on those placements. Markets are now accepting that the rate cycle has changed, and they are no longer feeling the need to constrain their line sizes, while at the same time local and regional markets are looking to maintain their lines on expiring business.

Standalone coal placements are continuing to see increased retentions and further rate increases, regardless of their loss record. As previously reported, there is a continuing trend by insurers to withdraw from any coal participation as they re-align to environmental, social, and governance (ESG) guidelines.

AIG announced its new climate change commitment to achieve net zero carbon emissions by 2050. As a result, AIG will no longer insure the construction of new coal-fired power generation risks, and will gradually phase out insuring existing coal-fired power assets. This will continue to increase pressure on this challenging sector as capacity continues to diminish. Given the remaining shallow pool of insurers, the restructuring of programs is now commonplace, alongside the need for a more global placement approach and a re-evaluation of the risk transfer strategy of clients.

5. Renewable Energy

Similar to the conventional power market, single-digit rate increases were the norm in the first quarter for accounts with a clean loss history; some accounts achieved coverage terms and premium rates as expiring. Accounts with key components nearing the end of their warranty periods, or those with historic loss activity, have experienced more significant rate increases. Terms and deductible levels continue to remain stable on operational renewal business following significant changes imposed during the last 12-24 months.

Existing renewable energy insurers have ambitious premium growth targets for 2022, and we have continued to see markets diversify into the renewable energy sector (both onshore and offshore), principally from the conventional power and upstream oil and gas sectors. Importantly, the majority of new markets have entered as follow-on participants rather than providing lead capacity. However, we have seen increased interest from existing insurers to expand their capabilities as a lead market as they grow their expertise and resource.

The key placement challenges are primarily related to construction business (as opposed to operational projects) and many insurers continue to take a cautious approach. This is due to global supply chain disruption leading to inflation pressures on raw materials, as well as increased transportation and labor costs. The result is that insurers are paying greater attention to the accuracy of the declared sums insured, the specific breakdown of the costs for key components, and the availability and lead time of key spare parts. Some markets are seeking to load self-insured retentions and pricing to mitigate these factors, as well as the historic poor performance of the renewable energy construction business. Policy period extensions to existing construction projects are becoming increasingly commonplace as supply chain disruption leads to project delays. Engaging with brokers and advisors early in discussions, for both new projects and extensions to existing programs, is important in mitigating the impact of these market dynamics, and provides an opportunity to build understanding around the risks and opportunities involved.

The only capacity shortfall in the renewable energy market is for battery energy storage projects. The insurance market continues to struggle to keep pace with the evolution and significant global growth of battery storage, and markets continue to take a highly conservative approach as they build their understanding of the range of technologies and related risks. Insurers’ main concerns are related to thermal runaway risk, and scrutiny tends to be aimed at component separation distances as well as fire suppression and protection measures.

In summary, to avoid tougher market conditions, insureds need to leverage roadshows and recent engineering reports to demonstrate commitment to continual risk improvement and management. The Russia-Ukraine crisis has not had a large impact on the power sector, with a majority of the insurance capacity generated within the European market. It is still too early to know if energy sector insurers, who are more likely to be affected financially by the recent sanctions, will turn to the power sector to make up any shortfall of premiums.

6. Terrorism/Political Violence

The Russia-Ukraine crisis has significantly changed the outlook for the terrorism and political violence (PV) market; the market is bracing itself for significant losses. As the conflict continues, it will take time for these to materialize, but with suggested estimates of US$3-5 billion worth of exposure in Ukraine, many markets are expecting sizeable claims from individual policies or assets that form part of a global program.

If eventual losses amount to the upper-end of this estimate, they would be the equivalent to several years’ worth of premium. In that case, and on the basis that the exposure is written across both Lloyd’s and the London company market, it would be a significant and market changing event.

The terrorism and PV market has historically been a profitable class of insurance and for the time being there remains an abundance of capacity for most countries globally. But it will be important to keep an eye on any tightening of terms and conditions, in particular for war and civil war perils. As ever, rates, coverage, and capacity will come down to the asset location, perils sought, and previous loss history.

7. Energy Casualty

The energy casualty market is still pushing for increased rates, albeit the momentum of increases has slowed down in comparison to 2021. Social inflation and growing jury judgements have continued to play a significant role in market rate dynamics.

Upstream/offshore classes continue to experience rate increases of 10% to more than 15% on like-for-like exposures. Downstream/onshore casualty classes are slightly higher at 15% to more than 20% for static exposures.

The January treaty renewal season showed limited impact on the early 2022 renewals, with flat to low single-digit increases.

Capacity has generally remained stable over the quarter, as some new carriers have entered the market and there is improved appetite from existing insurers. However, these factors have not yet directly influenced current rate levels.

ESG continues to be a hot topic in the energy casualty market. Many insurers believe climate change is not covered by their existing wordings, whereas others are seeking to include language that specifically excludes all liability going forward. We expect further developments on this over the coming year.

Markets are continuing to seek exclusions for poly fluoro alkyl substances (PFAS), which are often referred to as “forever chemicals”. These are a group of synthetic chemicals used in a variety of industries such as firefighting foam and oil and gas fracking.

8. Bermuda Casualty

While there was a reduction of capacity in 2020 and 2021 from the insurers who had typically produced line sizes of US$50 million or more, the emergence of five new insurers during that time bolstered the marketplace by adding up to US$125 million of new capacity. In 2022, we expect the more established Bermuda markets to continue limiting their energy offerings to US$25 million, while the newer markets are deploying an average of US$12.5 million on select energy risks. In general, it appears that improved combined ratios, in conjunction with the capacity entering the market, have had a positive effect on mitigating rate increases, and in some cases resulted in overall rate reductions for towers.

The heightened focus on ESG considerations continues to be a key factor in risk analysis, with Bermuda markets following the trend to impose pollution exclusions designed to target the emission of greenhouse gases across all program layers. Chemicals continue to be an area of significant interest, especially as multiple geographies seek to add exclusions for substances like methyl tertiary butyl ether (MTBE) and PFAS.

9. Marine Exposures

From the end of 2021 and into the first quarter of 2022, the market continued to stabilize following years of hardening that resulted in rate increases, higher self-insured retentions, and narrowing coverage. Capacity has stabilized following an uncertain few years of disruption caused by withdrawals and new entrants. Renewal rates for good-performing accounts have improved to single digits in some cases.

However, there were a number of large losses in the first quarter that may affect the outlook for marine insurers’ over the coming year. One example involved a car carrier that caught fire in the Atlantic and subsequently sank. The estimated loss for this incident alone is US$150-200 million and is expected to significantly impact the market.

As well as losses, insurers are also trying to manage the uncertainty caused by the Russia-Ukraine crisis. An attempt to reduce the longstanding market practice of seven days’ notice of cancellation for war risks to 48 hours was successfully resisted by brokers. However, the expanding territories subject to sanctions continue to be closely monitored. 

10. Onshore Construction

The onshore construction market remained inconsistent during the first quarter. The outlook for the year ahead will likely see a focus on rates, deductibles, continued scrutiny of information, restriction of particular coverages, and longer turnaround times.

  • Rates: Although the pace of rate increases may be slowing down, the direction is unlikely to change until more capacity is available to drive competition. While capital is cautiously considering entry, the scale of new capacity is unlikely to create the excess required to give insurance buyers viable alternatives.
  • Cover: The market remains challenging with very limited flexibility. Insureds are experiencing coverage restrictions in general but more specifically in relation to design defect cover and NatCat restrictions and sub-limits in susceptible regions.
  • Capacity: During the hard cycle of the last few years, the construction market saw the withdrawal of about 25% of its global market capacity, which resulted in higher rates. Additional withdrawals are not expected in 2022, though new capacity at scale is highly unlikely. This will maintain the challenging market conditions for the short term.
  • Adequacy of underwriting information: There is greater focus and scrutiny on the quality of information during underwriting assessments. Detailed submissions that clearly articulate the exposure and address insurer concerns will ultimately drive improved pricing and coverage results.
  • Emerging trends: ESG considerations are increasingly in focus and gaining traction across the industry. Capacity restraint is accelerating for projects or insureds that cannot demonstrate the required credentials.

Early engagement with brokers and underwriters is key to achieving optimal pricing and coverage results. A focus on supplying quality and extensive information, and involving underwriters at the information gathering stage, is equally essential.

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