Energy Insurance Newsletter - October 2006 - JLT

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20FOCUS ON:The Impact of Losseson the Power MarketIn the past two years the power and utilitysector has experienced a substantial increasein claims activity, as shown in the chart below.The resulting volatility in the wholesale energymarkets has led to changes in the structureof Business Interruption (BI) coverage and claimshandling procedures, adding to the complexityof loss settlement in the sector and affectingthe future insurance requirements of powerproducers and distributors.Loss events have ranged from combustionturbine failures to transformer malfunctions andhave involved the most proven of technologies.One casual contribution to this increased claimsfrequency emanated from the collapse of Enronin 2002-2003, which resulted in the closureof a number of plants and the subsequentmothballing of power generators. Theintroduction of venture capitalists who boughtout these stations and resumed normal powergeneration led to a rapid reduction in thelifespan of the installed gas powered turbines,consequently compressing losses into ashortened period of time.Some have also pointed to a potential reductionin the quality of workmanship resulting from thePower station mechanical failure claims (USD)160,000,000140,000,000120,000,000100,000,00080,000,00060,000,00040,000,00020,000,000020012002200320042005<strong>2006</strong> to May
21expanding use of subcontractors in thepower and utilities sector, as a further cause forconcern. With increasing amounts of installationand maintenance work now being outsourced,quality checks have begun to suffer andsafeguarding issues such as overuse havebecome a conspicuous problem. Subsequently,the repair resource of major turbine companiesis now stretched beyond capacity, and inconjunction with the further outsourcing ofrepairs it has led to a substantial rise in BI claimsmade by power companies in the last 2 years.So what effect has this had on claimsprocedures and what implications does it posefor the power sector in the future? Within theclaims industry itself there has been a dramaticflight to specialisation in the way claims portfoliosare handled and in the amount of resourcesnow dedicated to power claims. Indeed,the emergence of specialist claims advocacyteams, loss adjusters and accountants coincideswith the growing number of complex and timeconsuming power and utility losses that are nowhandled as a separate and entirely independentelement of the property book.Underwriters are also beginning to approachpower and utility insurance with more scrutinyas the pitfalls of existing policies now becomeapparent. A particular focus has been onthe Long Term Service Agreements (LTSAs) heldbetween companies and the Original EquipmentManufactures (OEMs) of gas turbines. In thepast LTSAs have been used as selling pointsby power companies to drive down premiums,though losses have now highlighted theircontractual weaknesses – not least involvingwaivers of subrogation, the obligation tooutsource repairs to specific locations and afailure to sufficiently cover liquidated damages.Changes in the way claims are managed willobviously have consequences on future insurancepolicies. In a post-loss situation, insurers are nowlooking much more closely at OEMs and howtheir repair resources affect BI timescales. Theyare also becoming less tolerant of where repairsare being outsourced since contractual obligationsin LTSAs can sometimes hinder the speedwith which a turbine is repaired and returnedto its station. Consequently, underwriters maysoon refuse to recognise existing LTSAs infuture insurance policies unless they are partof a negotiated insurance package. This movewould represent the first outright effort by insurersto apply some form of control to the use of suchagreements in a manner that is wholly favourableto OEMs, but it will also impact on the futurepremium rates of power companies.To conclude, increased power losses in thelast two years have thus set in motion a seriesof changes to the way claims are handledin the sector. These developments carryimplications not just for turbine manufacturersbut also for power producers and distributorswho may soon feel the effects of increasinglycomposite claims procedures and more stringentinsurance requirements.
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Energy Insurance Newsletter - October 2006 - JLT

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