Supply Chain An Insurer Perspective Willis Energy Summit 21 January 2016 Jamie Summons, Head of Weather Solutions, Asia Pacific
The Supply Chain: Current approach to risk transfer Contingent Business Interruption: Customers and Suppliers extension An incident at suppliers or customers premises could badly affect the turnover of the insured s business, although the insured has not suffered a physical loss. Triggered only if there is a physical loss at the suppliers or customers premises. Reasons for CBI Increasing dependency amongst industrial and medium-sized companies ( Just in time production) One important customer may make the difference Alternative suppliers may be difficult to find Complex trade relationships & special assembly parts Underwriting challenges Potential accumulation exposure, hence heavily sub-limited Lack of transparency (unspecified suppliers/customers) Unavailability of material facts Demanding contingency planning analysis Pricing difficulties Coverage uncertainties 2
The Supply Chain: Threats 3
Parametric Solutions: Introduction http://www.swissre.com/corporate_solutions/innovative_insurance_solutions_ for_your_business_catastrophe_recovery_.html 4
Parametric Solutions: Basics WHEN? Parametric products mostly apply: When traditional capacity can not be found for e.g. CBI / BI risks, T&D risks, other non-insurable risk When traditional capacity is scarce i.e. for California earthquake or US hurricane When mechanistic recovery and fast payment is sought WHAT? Cover that relies on the measurement of a natural phenomenon or index Event / Weather indices: EQ magnitude, temperature, wind speed, precipitation, etc Combination with economic indices: CPI, commodity prices, etc 5
Parametric Solutions: Trigger considerations Choice of Trigger / Index: Objectivity: independent, verifiable data Reliability: data source to provide consistent and timely measurement Availability: historical statistical records to allow modelling Correlation: with economic loss Basis Risk In order to design the trigger, minimize basis risk and determine the expected loss an independent modeling company such as EQECAT, AIR or RMS need to be engaged A parametric index can be weighted and structured to closely fit the underlying portfolio exposures and loss layer Depending on the exposure parameters and data available, various triggers can be applied: pure parametric, parametric index, modeled loss 6
Traditional vs. Parametric Cover Traditional Insurance products are Indemnity based Repair / replacement of damaged asset and indemnification for consequential loss incurred Economic Loss / Business Interruption only covered as a direct consequence of physical damage to the property insured Parametric covers are Index based Cover is triggered if pre-defined event parameters are met or exceeded Payout of specified amount, regardless of actual financial loss sustained or use of funds Alternative to complement traditional insurance programs for pure economic losses or "uninsurable" perils 7
Traditional vs. Parametric Cover Traditional Insurance Parametric / Index based Cover Trigger Loss or damage to physical asset Event occurrence exceeding parametric threshold Recovery Basis Risk Loss assessment and Payment Reimbursement of actual loss sustained Policy conditions, deductibles and exclusions Months to several years depending of complexity of loss Pre-agreed payment structure based on event parameter or index value Correlation of chosen index and structure with actual exposure Very transparent and settlement within e.g. 4 weeks Term Usually annual, multi-year difficult Single or multi-year up to 5 years Structure Standard products and contract wordings Customized product with high structuring flexibility (single trigger, multi-trigger) Form Insurance Contract Insurance or Derivative 8
Focus on Weather It is well documented that adverse weather represents the number one cause of supply chain disruption, particularly in the energy sector. Climatic change is driving unprecedented technological change. Renewables are at the forefront of the supply/demand balance disruption. The risks driven by rapidly increasing renewable penetration into traditional grids are uniformly global and manifest themselves as: Production variability; Wholesale spot and forward market price impacts; Flow on impacts from increasing renewable penetration i.e. thermal reliability Regulatory mechanisms and subsidies; Funding availability and leverage levels; Rapid technological advancement is lowering long run marginal cost; and Grid capability to support renewable penetration and changing customers. 9
Production variability risk Renewables are already shutting down thermal and nuclear power stations around the world as penetration becomes significant. Significant penetration is creating demand for fast start thermal supply to fill the demand gap when sun doesn t shine or the wind doesn t blow. Variability will force a government regulatory response in the form of where the cost should reside: Renewables will likely be exposed to government returning this cost back. In deregulated wholesale markets there is a encroaching dichotomy as renewables gather scale having three major impacts: High sun or wind means low wholesale prices; Low sun or wind means wholesale price volatility; Zero SRMC means as penetration and energy output increases it depresses the wholesale market, thermals spend less on opex and capex. 10
Regulatory and technology risk Renewable transition can t happen without regulatory subsidies. Although technology cost, reliability and efficiency is rapidly changing to create shorter pay back periods moving to unsubsidized grid parity. Governments are very poor pickers of winning technology: Subsidies often favor a certain technology despite having no expertise; Subsidies are moving from fossil fuels to renewables Regulatory and subsidy mechanisms impact: Renewable capacity demand for new projects; Debt and equity funding availability; Attainable leverage levels; Achievable PPA pricing; Can displace thermals much quicker than anticipated; Inevitably decrease thermal reliability and therefore system reliability. 11
Grid and technology risk The management of system security is changing due to technology. Governments are looking closely at the cost of managing intermittent sources of generation and who bears this cost: Exposes renewable generators to greater levels of market risk; Frequency control ancillary service requirements provided by thermals are changing. As renewable penetration increases so will the risk of exposure to curtailment because of network congestion: Australia is already looking at over frequency generation shedding, which will disconnect large scale non-synchronous generation; Significant new wind and solar generation can reduce interconnector transfer limits, particularly when demand is low, wind speeds and irradiation are high. Increases reliance on major interconnection because renewables tend to be situated remotely to load center's, generally in weaker parts of the network. 12
Weather related market risks Weather drives energy output and therefore revenue year to year: Wind can vary 15% to 20%; Solar can vary 5%; PPA s only hedge price and not volume: Depending on the nature of the regulatory mechanism to make renewables competitive with fossil fuels, this exposure can virtually double; Underproduction means not being paid for the black and the green components. There are innovative ways to hedge volume risk to compliment a PPA or merchant exposure. Swiss Re have written bespoke parametric derivative hedges for: Renewables Low wind; Low irradiation; Low rainfall. Thermals High wind; High irradiation; High rainfall. 13
Case study weather risk wind Protection based on modelled or metered power production The power production of a wind farm naturally depends on wind speed. The relationship is described below (for a given turbine): Wind Speed (m/s) 13 12 11 10 9 8 7 Average Wind Speed (m/s) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec KW 1,600 1,400 1,200 1,000 800 600 400 200 0 Power Curve 0 5 10 15 20 25 30 35 Wind Speed (m/s) Production (MWh) 3,300 3,100 2,900 2,700 2,500 2,300 2,100 1,900 1,700 1,500 Power Production Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Depending on the availability of historical production information, power production levels can be hedged on the basis of: i) Measured wind speeds (m/s); ii) Metered physical production of power (MWh's); iii) A portfolio of wind farms at various locations. 14 14
Weather risk wind Recent example: multi-location portfolio MWh hedge Six wind farms in WA, SA and NSW > 500MW's Key points of difference: Actual energy production, not wind speed; Incorporates availability scaling which eliminates Swiss Re exposure to "man made" risk and the client being over hedged due to outages; Fixed $'s per MWh worst case tick value inclusive of green certificates. Annual production (MWh) 1,650,000 1,600,000 1,550,000 1,500,000 1,450,000 1,400,000 1,350,000 Bought put strike Sold call strike 1 11 21 31 41 51 61 71 81 91 Percentile Monthly production (MWh) 195,000 175,000 155,000 135,000 115,000 95,000 75,000 Sold call strike Bought put strike Production is highly seasonally variable Expected revenue from power production Percentile Production (MWh) Gross Revenue ($m) Payout ($m) Net Revenue ($m) 1 1,592,910 135.40-5.00 130.40 10 1,510,834 128.42-0.92 127.50 20 1,490,142 126.66 0.00 126.66 30 1,475,863 125.45 0.00 125.45 40 1,461,199 124.20 0.00 124.20 50 1,450,282 123.27 0.00 123.27 60 1,440,517 122.44 0.81 123.25 70 1,429,696 121.52 1.73 123.25 80 1,417,660 120.50 2.75 123.25 90 1,400,542 119.05 4.20 123.25 100 1,356,390 115.29 5.00 120.29 15 15
Wind farm term sheet Most of the deal criteria below are market leading world firsts Insured Risk taker Covered peril Location Capacity Term Collar strikes Wind production hedge Tick value or notional Annual payout Premium Special payout condition Deal limit Infigen Energy Swiss Re Insufficient annual wind resource measured in MWh's for expected output range WA, SA and NSW (multi-locational spot prices) >500MW's 1 year Call @ 1,500MWh's and Put @ 1,450MWh's Output on an agreed MWh collar for six windfarms in three states $85MWh (represents black and green energy component prices) (Strikes + or MWh's) x AUD $85 per MWh Equated to less than 1% of revenue Turbine availability scaling mechanism to protect the client against outages and Swiss Re against "man made" risks Capped at minimum and maximum client expected earnings range 16 16
Electricity Price and Outage Risk (ELPRO) Product overview Covers thermals for volume and price risk for forced outages and de-rates protecting operators against their contractual sale obligations. Target clients Gen-tailers and generators with operational and contractual risk exposure caused by unforeseen physical events Energy traders wishing to mitigate firm contract risk against spot outcomes by targeting ELPRO on system generators Retailers wishing to mitigate load risk against spot outcomes by targeting ELPRO on system generators Applies regardless of how regulated of unregulated their energy market is Value proposition Can be totally customised for individual or an entire fleet of thermal plants Allows customer to fully contract output in order to optimise earnings eliminating N-1 or N-2 contingency Generally significantly discounted to standard capacity hedges eg caps Avoids exposure to the potential for very expensive short term hedges from competing generators Formulaic settlement means minimal claims process and quick payment for losses 17
Electricity Price and Outage Risk (ELPRO) Cover for power plant outage and price risk Upon a forced outage, power producers face two hard to hedge simultaneous risks: Volume risk, i.e., forgone power production against a PPA Price risk, i.e., now buying at higher spot prices to replace lost output ELPRO can increases financial stability, especially when the power plants have become less reliable ELPRO pays out when one (or several) power plants experience a forced outage and the relevant margin (or market price) exceeds a defined threshold In essence, ELPRO provides protection against forgone profit in case of an outage Example: German dark spreads (electricity price cost of power production with coal CO2 charge) German Dark Spread in /MWh 45 30 15 0-15 10/2011 11/2011 Lost profit 12/2011 01/2012 02/2012 03/2012 Unplanned outage 04/2012 05/2012 Strike Strike 06/2012 18
Electricity Price and Outage Risk (ELPRO) Term Sheet: Australian Generation Portfolio Counterparty Qualifying Events Event Duration Cap Event Deductible: Australian Gen-tailer: Thermal Fleet approx. 4'500 MW Outage and derating 28 Calendar Days AUD 6,500,000 (Can be time based) Determination Period: January 1, 2014 December 31, 2015 Hours Covered Settlement Index: Strike Price: Payout Function Payout Limit NEM Peak Hours (7.00 to 22.00) or working week days NSW and VIC RRP $300 MWh cap Term Premium AUD 3-4m Notional Quantity ((Settlement Index Strike Price) * (Event Duration * Notional Quantity)) Event Deductible AUD 40,500,000 for term 500 MW's Share of Program 100% A similar protection is feasible for nearly any type of power plant 19
Conclusion Physical damage is not required for recovery under the parametric cover. Also, payments can be used to cover a broader scope of losses: Non-damage BI, Contingent BI, Extra Expense, and other losses typically excluded ( non-insurable assets ) or heavily sub limited in traditional NAT CAT insurance cover Renewable penetration and the weather which drives them is creating new future supply chain risks, output variability having flow on impacts to: Wholesale market prices (spot and forward); Regulatory policy and subsidies; Grid capability and thermal reliability; Weather phenomena earnings volatility can be hedged. Customised solutions offer protection against all weather risk by converting to a hedge for the underlying commodity price triggered by: Low or high irradiation (sunshine); Low or high rainfall; Low or high wind. 20
Swiss Re weather market capability Global presence, market leadership Swiss Re Group Leading reinsurer and direct insurer Over 11,000 employees Global presence with 48 offices in over 20 countries Americas New York, Houston EMEA /Asia-Pacific Zurich, London Long-standing experience Global team Market leadership Weather protection business established in 1998 Continuous involvement in weather risk management since then Swiss Re Offices Weather Professionals A global team of more than 30 weather professionals Execution capabilities in all geographies Largest weather protection provider in the world Track record of product innovation Only full-service insurer with market leading position More than USD 1bn of weather risk assumed in 2012 21
Corporate Solutions Thank you Jamie Summons Weather and Energy Direct: +612 8295 9551 Mobile: +61 433 400 055 Email: Jamie_Summons@swissre.com 22
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