According to the book of Ecclesiastes, “What has been will be again, what has been done will be done again; there is nothing new under the sun”. Yet every generation tends to think that the challenges it faces have never been encountered before, and therefore require new approaches and solutions.
While a few challenges will be new, it is always useful to remember that most of what comes around will have gone around before – and this is applies as much to the power and utilities market as anything else.
Catastrophic? Maybe. But not New
The world currently stands seemingly on the brink of economic meltdown. Respectable scientists such as Lord Rees consider that climate change gives civilization only a 50/50 chance of making it to the next century. Pundits are waiting for the next hotspot to emerge from the Arab Spring. In the insurance industry, 2011 is already the worst year ever for natural catastrophe claims. These are all very serious issues, but probably only the catastrophic potential of climate change is truly unprecedented, at least since the end of the last Ice Age.
The power insurance sector is experiencing its own hardships:
- Underwriters’ attempts to move their books into profit have so far been largely frustrated and soft (or relatively soft) market conditions have persisted since around 2003
- Losses – particularly machinery breakdowns affecting gas turbine and generators, with the occasional ‘mega claim’ such as the explosion at the Vassilikou power station in Cyprus in July – continue to devour their premium income
- The insurers’ promised land of a hard market is nowhere on the horizon.
This has led some people to speculate that the hard-market cycles of the past may not be replicated in the future, but this is probably to make the mistake of thinking that it is primarily insurers’ financial results that drive the underwriting cycles.
You Can’t Buck the Market
In our 2010 Power Market Review we said that the main reason the 2009 hard market that many observers expected failed to materialize was insurance market forces. “Surplus capacity and reduced customer demand… and an unusually quiet year for insured losses, largely prevented underwriters from increasing rates to the level that many thought appropriate.”
As Sam said, the fundamental things apply – which is that market forces driven by excess market capacity will trump underwriters’ attempts to increase rates in the wake of poor results. But sooner or later underwriting capital will depart from the market, changing the dynamics between demand and supply in underwriters’ favour.
History suggests that this may be triggered by an external “shock” event occurring at a time when the market has been stretched to breaking point by losses and over-competition – which is what happened when the industry was last hurled into a hard market by the events of 9/11.
Then, as now, the power market had been incurring unsustainable underwriting losses, largely due to the rush of unproven Combined Cycle Gas Turbine (CCGT) models into commercial operation. This ensured that the hardening of the power market post-9/11 was more severe than many other sectors.
With loss ratios today that are similarly unsustainable over the long term, whenever the next hard market arrives, it is unlikely to be a smooth or gentle process.