With the North Atlantic hurricane season (mostly) behind us, attention switches to the risk of winter storms in the UK and Europe. In the power sector, the big exposure lies with overhead transmission and distribution networks, usually referred to as “T&D.”
Meaningful levels of insurance for T&D are hard to find and expensive, and it is well known that T&D is a common “treaty exclusion.” The unpredictability and potentially massive cost of T&D exposures, together with a shortage of similar exposure units that would allow insurers to benefit from the law of large numbers, make scientific underwriting very difficult.
A Brief History of T&D Exclusion
The incidence of catastrophic storms is not predictable. I recall that the October 1987 storm in the UK was considered to be such an unusual event that underwriters were prepared to discount it from clients’ claims experience for the purpose of setting the next year’s renewal terms.
Little more than two years later, the “Burns Day” storm occurred, and underwriters have given short shrift to brokers’ arguments about discounting “one-off” events from their clients’ loss records ever since.
If the Burns Day storm heralded the end of readily available T&D coverage in the UK, the sea-change event in the USA was Hurricane Andrew in 1992. Famously, Florida Power & Light (FPL) had bought T&D cover for a limit of USD 350m per occurrence (unaggregated), at a premium of USD 3.5m. The following year, having suffered T&D damage of around USD 270m, FPL was offered a reduced T&D limit of USD 100m in the aggregate, at a premium of USD 23m!
T&D exclusions do not generally differentiate between transmission and distribution, but distribution networks are more vulnerable to damage than the higher voltage transmission networks. The towers are less robust and the lines are closer to the ground and therefore at much greater risk from flying debris and falling trees. However, the Lothar and Martin storms at the end of 1999, which caused around USD 3bn of damage to Electricité de France (EDF), toppling 280 high voltage towers, showed that transmission assets can also be badly affected.
Cat Bonds and Other Options
EDF responded by becoming the first power company to issue a catastrophe bond to protect itself against T&D losses. The EUR 190m “Pylon Re” five-year bond was issued in 2003. As reported in this month’s Willis Capital Markets & Advisory’s Insurance-Linked Securities Market Update, EDF launched Pylon II Capital Ltd (“Pylon II”) this summer, securing EUR 150m of windstorm coverage for the next five years. Such corporate cat bonds are rare, and are plainly not an option for everyone.
Others have set up self-insurance funds for T&D losses, although accounting standards may make it difficult to accrue year-on-year in order to build up the amounts held in such a fund. Other options include the use of a captive insurance vehicle or a “virtual captive” arrangement. The main downside to these arrangements is the amount of capital needed to generate the sort of funds that could be needed following a catastrophic loss.
Given the strategic value of T&D networks and the human and economic damage that the loss of these facilities would cause, even for a short period, governments – and ultimately the tax-payer – may find themselves acting as de facto insurer of last resort when the next catastrophic windstorm strikes.