Re/insurance, ILS key for energy sector extreme weather risks

The energy sector is increasingly vulnerable to the impacts of extreme weather events around the globe, highlighting a need for greater innovation and adoption of reinsurance & risk transfer solutions to mitigate potential losses and build sector resilience.

According to the World Energy Council (WEC), energy systems around the world are now more connected than ever before, and as the planet continues to experience an increase in the severity and frequency of extreme weather events, the exposure to energy systems has risen also.

“The frequency, severity and exposure of energy systems to extreme weather events are increasing. The number of extreme weather events increased more than four times from 38 in 1980 to 174 events in 2014. Severe convective storms contribution to overall insured losses (last 5 years compared to last 20 years) alone has increased to over 40%,” explains the WEC.

Made up from an “impartial network of leaders and practitioners promoting an affordable, stable and environmentally sensitive energy system for the greatest benefit of all,” the WEC has collaborated with Marsh & McLennan Companies and Swiss Re Corporate Solutions, to address the growing risks and challenges facing the global energy sector, underlining the need for public and private sector involvement.

“The energy industry and financing sector should work with regulators and governments to adapt regulations to make it more viable for a greater variety of long term investors, in particular large institutional investors such as insurers, reinsurers and pension funds to invest in energy assets,” says the WEC in its new report ‘World Energy Perspective, The road to resilience – managing and financing extreme weather risks.’

The WEC report stresses the need for secure, reliable global energy systems that can meet current and future needs, highlighting the need for private investor inclusion as the rising costs of energy risks, and potential losses to energy produce, systems and infrastructure from weather events simply can’t be borne solely by governments, and therefore tax-payers.

“The energy system of the future needs to integrate concepts such as soft resilience, local empowerment to ensure quick disaster response, weather risk coverage as part of financing, and must consider the downsides of lengthy public procurement in relation to disaster response,” explains the WEC.

In an ideal world local and international energy systems, providers and energy related businesses would be sufficiently capitalised, prepared and resilient to the impacts of extreme weather events, ensuring rapid rebuilding and a speedy return-to-normal following an event.

However, as the threat of extreme weather events continue to grow and heightened interconnectedness threatens substantial business interruption and financial implications, weather risk financing products and solutions become a necessity in protecting the energy sector and those that operate within it.

The WEC said; “With greater transparency, insurance companies and banks could take advantage of extreme weather risks to create unique financial vehicles that help fill project financing gaps.”

An inherent problem with creating adequate and affordable risk finance solutions for the energy sector is with the modelling of the risks, as a lack of historical data and the complexity of threats, limits underwriting expertise.

“Improving modelling would help to make a cost-benefit analysis of resilience measures and create the foundation for mechanisms, such as insurance products, that can reduce the risk of exposure,” said the WEC.

However, the wide knowledge of the insurance, reinsurance and wider risk transfer landscape of the frequency and severity of a range of perils that are a threat to the energy space can and should be utilised to improve the understanding of how extreme weather can impact the energy market.

Furthermore, benefits of alternative risk transfer solutions such as catastrophe bonds, weather derivatives, reinsurance and insurance risk financing pools, and importantly parametric focused products are a perfect fit for building sustainability and resilience in the sector.

The WEC report highlights this point; “There is a role for insurers, reinsurers and the ILS market to make available the products and capacity required to help offset the growing exposure, providing a significant opportunity to the market in new capacity.”

Reinsurance, insurance and ILS products such as catastrophe bonds and fully-collateralized reinsurance ventures are highly suitable to protecting the energy sector from extreme weather events. The ability to tailor the products to individual needs presents an opportunity to innovate and better serve the energy sector.

One mechanism certainly worthy of note is the use of a parametric trigger within a risk transfer solution, as by design this ensures rapid payout due to the trigger being based on pre-defined parameters, such as failure to produce a certain amount of energy within a specific time due to a convective storm, for example.

Building regional and international energy sector resilience against extreme weather events will require a public and private sector effort, innovation and dedication. But once the adoption of improved modelling capabilities and the wider acknowledgement and acceptance of ILS-type solutions in the sector grows, so to will investor and sponsor appetite for the risk.

Insurers, reinsurers and ILS players are always looking for new ways to grow, diversify and earn yield, and the reinsurance market certainly has the capital to start seriously looking at how best to protect the energy space against adverse weather events.

The WEC notes the following as ways the public and private sector can help achieve the goal of energy sector resilience and sustainability in light of a rise of extreme weather events:

1. Insurance and brokers can assess extreme weather risk.
2. Insurance and banks can provide risk transfer instruments, including new ones such as green bonds, catastrophe bonds, weather and weather-triggered commodity price options and swaps.
3. Insurers, banks, pension funds, and new sources of capital can provide investment.

“The energy industry and financing sector should work with regulators and governments to adapt regulation to make it more viable for a greater variety of long term investors, in particular large institutional investors such as insurers, reinsurers and pension funds to invest in energy assets,” concludes the WEC.