Stiff competition results in softening energy market challenges

by Artemis on July 31, 2015

The energy insurance and reinsurance market has witnessed increasingly intense competition in recent times, as traditional and insurance-linked securities (ILS) participants look to the space, negatively impacting rates.

Much discussion over the past 12 months concerning pricing pressures and competition in the global insurance and reinsurance sector has circulated around property catastrophe reinsurance business lines, as the influx of alternative capital and a lack of major losses persisted.

But during recent second-quarter earnings calls, executives in the international insurance, reinsurance and ILS space have noted significant pressure on rates and intense competition in primary energy insurance lines.

One company that highlighted the trend was Aspen Insurance Holdings, which declared it had maintained discipline during 2015 by pulling back on writing energy lines, as “the rates offered did not adequately reflect underlying risks.”

The firm highlighted that energy physical damage lines were down by as much as 14%, while rates in the Gulf of Mexico, a key region for onshore and offshore energy exposures, decreased by up to 20%.

Mario Vitale, CEO of Insurance at Aspen, commented; “In our International platform, we maintained discipline and chose not to renew a meaningful amount of business in the Energy sector. This market is experiencing intense competition and in our assessment the rates offered did not adequately reflect the underlying risks.”

Vitale explained that Aspen has diverted some of its capacity away from the energy insurance space, in search of better returns in other lines of business where the risks still command a reasonable level of reward.

Aspen Chief Executive Officer (CEO), Chris O’Kane, highlighted the energy insurance market at Lloyd’s as one particularly under pressure, saying; “We reduced our exposure in certain Energy-related Lloyd’s lines where rates were under pressure and competition was intense and as a result our level of Insurance premiums declined.”

O’Kane also said during the firms earnings call; “A few years ago, with pricing at its peak, we had over $300 million of exposure to Gulf of Mexico windstorm. With rates declining, we reduced that to $100 million at the beginning of this year, as the competition further intensified we withdrew capital, but now our exposure is only $18 million.”

That’s a significant amount of exposure to stop writing in the region, considering the location’s substantial energy exposures which are exacerbated by the potential threat of windstorms and the fact it was a very profitable area of the market for some years.

O’Kane described the current energy insurance market environment as an “ugly experience.”

“We are moving our capital to other regions within this line of the business such as the North Sea and Southeast Asia where we are seeing better prospects, rates are under less pressure and less volatile,” continued O’Kane.

Traditional and increasingly alternative reinsurance capital providers, including ILS players are deploying capacity into the primary energy sector and, coupled with the overspill of catastrophe reinsurance that is also focused on Gulf of Mexico wind, the sector has witnessed a sharp rise in competition and decline in pricing.

As capital has spilled over, or sought out new lines to allocate to, it has affected other areas of the insurance and reinsurance market. The commercial property insurance space is one sector that has been negatively affected and is now seeing softening, it seems the energy insurance market, particularly Gulf of Mexico, is too.

Insurance-linked securities (ILS) players have always had some participation in Gulf of Mexico wind renewals, as it’s a risk they can diversify against their Florida and East Coast hurricane exposures, to a degree.

It’s also an area where cat-in-a-box structures and industry loss warrants (ILW’s) have historically been used for risk transfer, resulting in ILS and alternative markets gaining an appreciation for the class.

ILS fund managers have increasingly also been taking on some energy specialty business, such as physical damage covers and other offshore oil and energy industry re/insurance contracts.

As other regions of U.S. wind risk have become increasingly competitive, it stands to reason that the Gulf would face a new capacity crunch on pricing. The growing focus on specialty and commercial risks in the ILS space is also likely to apply further and ongoing pressure in energy insurance and reinsurance markets.

The pressures in the energy sector, globally and particularly with the Gulf of Mexico were also stressed by Lancashire Holdings during its recent earnings call, with Paul Gregory, Group Chief Underwriting Officer (CUO) and Chief Executive Officer (CEO) stating that energy had “undoubtedly witnessed the most severe declines” at recent reinsurance renewals.

Lancashire, like Aspen, also reduced its amount of exposure to the energy space during Q2, and despite noting that part of this was due to a series of multi-year deals signed last year, it also stressed significant rate declines amidst fierce competition.

Looking to the future of the energy re/insurance sector, Gregory said; “Without losses the sector will see further reductions going into 2016, albeit not at the same levels as this year, but there will be further pressures.”

In fact, Lancashire’s Renewal Price Index for major classes, which tracks premium trends for each sector from year-to-year, notes that YTD 2015, for energy offshore worldwide, 88% of contracts achieved similar pricing as the previous year. For Gulf of Mexico energy this was 95%.

The continued softening reinsurance market environment has seen traditional reinsurance players and more commonly now, alternative or ILS players, search for profit and diversification in specialty classes and also primary segments, with energy seemingly falling victim to the trend.

And as the ILS and alternative capital market continues to grow it’s possible that more of it will find its way into the energy sector, while traditional players become ever more competitive, depressing rates further, at least in the absence of a large loss event.

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