World’s Power Companies Undervalue Property up to 30%, Willis Report Finds

July 7, 2008

Given that the industry is being squeezed to maximum capacity by unprecedented demand and rising equipment, commodities and labour costs, under-insurance could prove disastrous for power companies when the time comes to make a claim.

This is one of the key findings of the first Utility Market Update produced by the Global Markets International team of Willis Group Holdings, the global insurance broker, which found that undervaluing of property by power companies is a real problem.

At the same time, worldwide theoretical property capacity, which includes capacity from energy, general property and mutual sectors, is at a five-year high, according to the report.

“There is a sentiment in the market that many clients are maybe (often inadvertently) declaring property values that are up to 30 percent below what they should be,” said Graham Knight, Global Markets and Utilities Practice Group Leader for Willis. “This creates a concern for underwriters that premiums that are rated on the values declared to them at inception may not be adequate to pay for the claims that will be calculated on the actual replacement values at the time of reinstatement.”

The report looks at how changes and challenges in the global power industry are affecting the insurance market in the areas of operational property, renewable energy, claims, liability, terrorism, accident and health, and construction.

Other key outcomes from the Willis Utility Market Update include:

Utility infrastructure was largely unaffected by the 2007 windstorms, and in general terms, where utilities in catastrophe-exposed locations have run loss free, premium rates for this element of the exposure have been lowered by between five and 12.5 percent. Where loss-affected, the premium rating has increased in some cases by up to 10 percent, depending on the severity of the losses.

There is a continued trend of high-frequency risk losses, in particular machinery breakdown losses. This has resulted in flat results for Insurers in the utility sector in 2005 and 2006, when losses reached USD 1.25 billion and USD 1 billion, respectively. Although 2007 saw an improvement (with risk losses totaling about. $750 million), there is an underlying concern about the profitability of this sector over the longer term.

Many of the world’s leading original equipment manufacturers (OEMs) advise lead times for critical components are now ranging between 18 and 36 months; many OEMs have order books filled for the next 10 years to supply existing utility customers and new developers with plant and equipment that is highly efficient.

Last year saw an increase in mid-market construction activity, with continued growth of new and returning capacity to the sector. The total construction insurance capacity for 2008 is approximately $1.7 billion – this represents an increase of more than $400 million from 2007.

The Willis Utility Market Update concludes that expanding conventional power generation technologies to meet ever-increasing demand is no longer an option for power utilities, due to a combination of finite natural resources, high fuel and commodity prices and the growing impact of environmental concerns and legislation.

“The big challenge facing power companies is to reduce carbon emissions and at the same time to extend the operating life of aging technology, which is considered essential to meet the ever-growing demand,” said Knight. “The key to their future success will be to introduce new technology to optimise coal-fired power plant efficiency while reducing – or capturing and storing – the CO2 emissions.”

“The challenge facing insureds in this sector is to be able to demonstrate solid risk management with possession of good strategic spares combined with long-term maintenance agreements with OEMs,” said Knight.

Source: Willis Group Holdings Limited

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