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Downstream market ‘not out of the woods yet’ as rate rises ease off

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Downstream energy underwriting sources have warned that the class of business is “not out of the woods yet” as rating increases continue to decelerate following a period of notable hardening since 2018.

Rates in the sector are now increasing at between 10% and 12.5% and the trajectory is downwards, having begun the year at around 20%. This time last year downstream rate rises were around 30%.

Sources said that the most sophisticated buyers were now altering the structures of their programmes, often taking on larger retentions to secure better deals.

The easing of pressure comes after the downstream market returned to profitable underwriting in 2020, following a spell of painful losses that led to a substantial re-rating of the class.

However, underwriters cautioned that it was imperative to hold firm and continue to push for rating increases, with loss activity still high and Covid-19 having introduced a host of uncertainties into the picture, including a notable reduction in BI claims.

Having only recorded two years of underwriting profitability in the past decade, underwriters said that the market premium pot remained vulnerable to the threat of major losses, for example in the event of catastrophic hurricane activity.

Despite this, some broking sources were optimistic about the prospects of rating deceleration continuing and predicted flat pricing in 2022.

Deceleration of pricing change in the downstream sector forms part of an emerging market-wide shift in rate increases, with a host of classes including marine hull and cargo, property direct and facultative, and D&O all registering smaller price rises than those experienced in 2020.

However, pushback is growing from underwriting executives about the need to maintain underwriting discipline in the face of multiple uncertainties.

Both Fidelis CEO Richard Brindle and QBE International CEO Jason Harris recently used interviews with this publication to urge risk carriers to hold their resolve.

Downstream sources highlighted the ongoing threat of major unmodelled claims as a large risk, citing the winter storms in Texas as a prime example.

The largest downstream claim to have arisen from the freak weather event in February stems from Dow Chemicals, which has been pegged at $600mn-$650mn, and sources speculated that other claims could bring the total bill for the energy market to in excess of $1bn.

Willis Towers Watson energy report graphics July 19 2021

In addition, there is concern about the potential fallout from the resumption of refining activity at plants that were mothballed due to a collapse in energy demand during the pandemic.

“As some of those plants that were shut down temporarily, or in some cases, quasi permanently, come back online, have the maintenance aspects of those plants been taken care of and been adequately addressed?” said Anthony Vassallo, who leads Allianz Global Corporate & Specialty’s downstream energy unit in London.

“Because that is one of the biggest areas of concern, and historically, in layman’s terms, one of the biggest areas of loss is when you turn things on and turn things off.”

Major writers of downstream business in London include AIG, Liberty Specialty Markets, Axa XL, QBE, Zurich and Chubb.

Creating long-term profitability

In its recent energy market report for Q2, which welcomed the changing dynamics of the downstream market, Marsh acknowledged that the sector was “sensitive” and that a negative underwriting result in 2021 could cause a capacity contraction and consequent increase in rates.

Underwriters said that the period of re-rating had been necessitated by a consistently poor spell of profitability, and that management would not tolerate any significant slide in rating conditions.

The downstream market has only registered two profitable years in the past decade.

In its energy market review published in April, Willis Towers Watson said that 2017 was a “particularly horrendous year” of losses, and that deteriorating loss figures from 2018 and 2019 were causing “apprehension in the market”.

Sources talked of a woeful period marred by a relentless string of accidents, explosions and hurricane damage on a scale that had been totally unforeseen.

The major loss activity led to the rapid re-rating of the class, which began in earnest during 2018.

You have seen good programmes, solid clients with good loss records, sometimes paying in excess of 40% or 50% increases, with no real change in exposure or profile
Anthony Vassallo, AGCS

Vassallo said that some of the rate rises seen were “previously unheard of” but had been necessary because of the scale of losses.

“You have seen good programmes, solid clients with good loss records, sometimes paying in excess of 40% or 50% increases, with no real change in exposure or profile,” he said.

Underwriting sources were in agreement that a positive year of underwriting profits in 2020 was not enough to allow for a significant market shift.

“The sector was in dire straits,” one source said. “The market needed to respond in order to continue to underwrite.”

Another added: “There have been a number of incidents which still keep the focus on the class. It is not out of the woods yet.”

Brokers pushing back

However, broking sources were optimistic about the negotiating positions of clients after several years of rating uplift, with some predicting that rates were likely to be flat next year.

Marsh’s Q2 energy report struck an optimistic note about the state of the market and said that in some instances, underwriters had offered flat pricing or “meaningful reductions” as they looked to retain market share.

The broker said that there were indications that rates were “topping out” and a “marginal, but significant oversupply of capacity” had built up during the second quarter.

As data from Willis Towers Watson demonstrates, there has been an upward shift in available downstream capacity in 2021, following two years of contraction.

Willis Towers Watson energy report graphics July 19 2021

“This means that insureds now have greater opportunity on both premium and policy terms, and major placements generally can be completed without involving all lead markets,” Marsh said.

The broker explained that the shift in market dynamics had allowed insureds to push back against insurers who had “proved to be expensive”, and that if the trend continues, insureds will be in a stronger position to re-negotiate restrictive terms and conditions established in the recent challenging market.

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