Opportunity for ILS investors in energy & power: Twelve Specialist Risk

There is an opportunity for investors or ILS funds to provide collateralised reinsurance capacity to the energy and power generation sectors, according to specialist MGA Twelve Specialist Risk.

Twelve Specialist Risk Limited (Twelve) is an MGA with a focus on machinery breakdown risks and specialises in Excess of Loss (XoL), particularly in Power Generation (PG), for all types of generating assets.

The MGA believes there is an opportunity for insurance-linked securities (ILS) funds or investors to participate in this market, by partnering with specialists like Twelve that have the ability to originate risk but could use additional capital support from alternative sources.

Twelve believes these risks could be part of a differentiated ILS proposition, something the ILS market is currently very focused on, as ILS funds and investors look increasingly for investment opportunities away from natural catastrophe risks.

They see these machinery breakdown focused risks as uncorrelated to broader financial markets, giving the example of a gas turbine failure, which cannot directly cause fluctuations in financial markets.

Paul Dowling, Director of Underwriting at Twelve Specialist Risk, explained, “We feel this type of business delivers a high return on capital, while the return is also more reliable and consistent, being easier to mathematically model the failure rates of machinery, as opposed to trying to predict expected losses from natural catastrophe events.”

He pointed out that these risks are high returning, but not high risk, adding that this is, “Especially true for Excess of Loss power generation, as the probability of loss is extremely low and substantially drops away depending on how the insurance programme is structured which considerably improves the risk-reward ratio.”

Being short-tail in nature, Dowling and his team feel the risks underwritten in this specialist market segment could be particularly attractive to the ILS market, offering a way for those writing collateralised reinsurance to expand into a new and diversifying class of insurance.

Depending on the structure of the insurance placement any natural catastrophe exposure can be either significantly reduced, or even removed completely by being sub-limited beneath attachment points, adding even more diversification to ILS portfolios.

Kiran Sagoo, Underwriter at Twelve Specialist Risk, explained one way he could foresee investors accessing this type of risk.

“We can develop an Excess of Loss Power Generation proposition specifically for ILS fund or investors to participate in, which would be carefully designed around the loss and exposure profile of international power generation assets insured through the London Market.

“This segment typically sees a higher frequency of relatively smaller losses than other energy sub-class (known as attrition),” he explained.

Twelve would propose setting up a Collateralised Reinsurance (CR) cell structure of $50 million (or more), ideally with a 3 year term, so offering $150 million of limit in all, Sagoo said.

“Twelve’s tailor-made Sandwich Structure would see this Cell Fronted by an A rated re/insurer and reinsured by a specialist in reinsurance, with the liability of the Collateralised Reinsurance cell only on the hook to pay the first loss in any period,” Sagoo continued.

Importantly, Twelve feels that this strategy can also be compliant with ESG policies, as the proposition can have a non-coal conventional power generation focus.

On top of this, if traction is achieved, Sagoo noted that, “Routinely, power utility companies incorporate their renewable energy assets into their main insurance programmes, thus further enhancing the ESG credentials of this proposition.”

The proposition could also be extended to cover renewables as well, or in isolation, for an even more ESG aligned strategy.

Twelve believes there is a specific market opportunity right now to set up such structures and bring collateralised capacity into the market’s it focuses on, and with collateralised reinsurance cells being relatively fast to set up and simple to exit, they benefit investors with an appetite for differentiated risks.

Importantly, the probability of claims on such contracts is seen as very low, meaning there is minimal chance a cell would be completely depleted and a strong chance of returns being attractive, Twelve believes.

Commenting on the opportunity, Dowling said, “We want to partner with ILS capital sources that can benefit from Twelve’s expertise in underwriting and engineering, with our proven risk selection methodology that selects risk by Quality and attachment point via a thorough exposure analysis.

“Because of our specialist risk selection by risk engineers and technical underwriters, this substantially reduces the likelihood of claims and increases profitability for the cell or portfolio.

Due to how contracts are designed, and portfolios constructed, Twelve believes they have a way for ILS markets to access the returns of this class of business while avoiding the attrition, which is the main source of loss and also minimising volatility.

But perhaps most attractively, Twelve believes this type of proposition could deliver a minimum 15% Risk-Adjusted Return on Capital (RAROC), which could prove very attractive to some ILS investors.

Dowling concluded, “Twelve believes its comprehensive underwriting expertise is the USP in delivering this cautious but well-devised strategy.

“This allows Twelve to build a diversified portfolio consistently generating high profit in consecutive underwriting years regardless of market cycle. The proposition is an exciting opportunity to support a highly experienced team in the power generation class of business in a hard market, which looks set to remain so for the foreseeable future.”