The Influence Of Natural Catastrophes On Insurance Markets

Peter Draper, Founding Partner, answers questions about NAT CAT risks and their impact on wind and solar power

Q. What role do natural catastrophes play in damaging renewable energy projects?

Natural catastrophe or “NAT CAT” refers to extreme weather events that can cause significant damage to a project, its associated infrastructure, and its overall financial viability. Wildfire, Windstorm, Severe Convective Storm, Flood, and Earthquake are all considered natural catastrophes. They affect wind and solar projects differently, though the latter is considered more vulnerable to damage. Solar project developers have searched for a trifecta in maximizing their return on investment: low installation cost per MW, high rates in offtake agreements $/ MWh, and excellent irradiation resource. But project siting is a growing concern for (re)insurers. Underwriters have seen an uptick in the frequency and severity of NAT CAT losses partly due to locating projects in more exposed areas. Some of these sites follow the trend of decreasing the levelized cost of electricity (LCOE) while accepting greater long term investment volatility.

Unlike mechanical and electrical breakdown risks, damage resulting from NAT CAT has the potential to impact larger proportions of assets during construction and operation.

Q. Why are natural catastrophes receiving increased attention from insurance companies? Why now?

As climate change intensifies, so will natural catastrophes. They will continue to grow in severity and frequency. An increase in these events correlates to a higher probability of an insured’s assets being impacted, especially in more exposed locations. Global insurers and reinsurers are aware of this and take it into consideration in interpreting their cat aggregates, portfolio vulnerability, and the limitations of cat modelling.

Consider the recent quad tornado that struck on December 11 in the US. A surge of devastating tornadoes across Arkansas, Illinois, Kentucky, Missouri and Tennessee killed at least 88 people with another 100 unaccounted for. They also destroyed critical infrastructure and housing, with more than 1,000 properties destroyed. Several trains in the Midwestern areas were left derailed. At least 26,000 homes and businesses in Kentucky were left without electricity.

Initial indications suggest it was one of the largest storm outbreaks in U.S history, with the swarm of tornadoes in the ‘strong’ to ‘violent’ categories of EF3, EF4 and EF5 (according to the Enhanced Fujita Scale).

The EF Scale is used to assign a tornado a ‘rating’ based on estimated wind speeds and related damage. Wind speeds for EF3 (strong) range from 219-265 km/hr; EF4 (violent) 267-322 km/hr; and EF5 (violent), over 322 km/hr. An EF5 tornado is the strongest designation for a tornado. They are exceptionally rare and can produce wind speeds higher than 322 km/hr. The last EF5 tornado to strike the US was at Moore, Oklahoma, in May of 2013. The country has reported only 19 EF4 tornadoes during December and only two EF5 tornadoes. The last EF4 tornado to strike the US during December was in 2015. The last EF5 tornado to strike the country during the month was in 1997.

What has made this event stand out was a couple of particularly long-track tornadoes that stretch from Arkansas into Kentucky. One particular storm produced an extremely long-track tornado. The exact track is unidentified as yet but it will probably find itself in the upper echelon of the longest track tornadoes in history.

Q. What changes in NAT CAT modeling are we expecting to see this year?

Both RMS and AIR will release updated model versions in 2022, though the impact is not fully known at this time. The release will be mid-year for both.

Wildfire modeling is still very immature and not as robust as Hurricane or Earthquake modeling. The models will continue to evolve for this peril, but more reliance on wildfire scores and risk mitigation techniques should be taken into account as opposed to pure PML and AAL numbers. The modeled output is still a piece of the puzzle, but is not as widely accepted by underwriters as of yet. Tornado-Hail modeling is getting a lot more attention by underwriters as pricing for this peril is beginning to be model based as opposed to being a portion of the AOP rate. Exposure management for this peril should also be taken into account as clusters of inland risks can cause PML issues for carriers.

Q. How have underwriters responded to change caused by natural catastrophes?

Underwriters and the insurance businesses are progressing with renewable energy. The industry is further developed compared to where it was 10-15 years ago. This means there is additional research and first-hand experience for underwriters to consider. We are now seeing higher deductibles and lower sub-limits when it comes to NAT CAT claims due to the information that is available. With advancing technology and understanding, we expect there will be more exclusions, lower sub-limits, fastidious attention to wordings and diligent analysis in the future.

Q. How might insurance companies change in the future in relation to natural disasters?

With the evolving state of natural disasters, insurance companies are paying greater attention to risk mitigation. Protective strategies vary depending on the natural disaster a project is most exposed to. Wildfire risk mitigation should include vegetation management plans, cooling systems for any electrical infrastructure threatened by overheating, and contact with local fire departments. Hail, wind and hurricanes is about the performance of the technology. In the case of a wind or hail event, it’s becoming common practice to manipulate stow angles to reduce impact to solar panels. Moreover, if an area is prone to storm surge it would be beneficial to invest in technology that allows electrical equipment to be raised above base-flood elevation.

We are seeing an increase in safeguard endorsements or warranties related to risk mitigation. For example, you may not be entitled to an insurance payout if you cannot prove you kept vegetation maintained in the event of a wildfire. We expect harsher discriminating criteria similar to this with new research on proper mitigation strategies for other NAT CAT incidents.

Q. How do you find the solutions for clients in relation to natural catastrophes?

We assess risk exposure using modelling software, insured/contractor risk mitigation plans, and site surveys; all part of pairing clients with underwriting capital for all risks, primary, and excess NAT CAT (re)insurance.

Key to our success in this has been anticipating how underwriter risk appetites have changed based on losses in the market. We have also found solutions that save insureds from having to seek waivers that deviate from commitments their lenders and tax equity made at the outset of their financial commitment to developers.

Ultimately, (re)insurance broking is a match-making service. Some have the foresight and patience to support strategy that is thoughtful, proactive, and allows our team to secure the best deals that are sustainable. And some want to treat this business like Tinder. Our goal is to keep both sets of clients happy in a challenging market.

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