Compared with many other insurance lines, energy insurance claims tend to be low frequency and high severity. When an insured has suffered a loss, its loss record will often impact upon the premium charged by underwriters upon renewal. This practice is complicated by the fact that energy insurance claims often take several months or sometimes years to resolve. Therefore, at the time that a particular policy is renewed or extended, it is not uncommon for there to be a lack of clarity regarding the quantum of a particular loss, or perhaps even whether the loss will ultimately be recoverable under the policy at all.
In order to account for this, underwriters and an insured may agree for a "loss load" to be applied at renewal. Such a clause will typically provide for the agreed renewal premium plus an additional premium which will apply in certain circumstances e.g. if the indemnity for the notified loss exceeds x amount, then y will be payable by way of additional premium. An alternative consequence may include the reduction of a renewal incentive bonus scheme.
As a loss load is part of a new contractual agreement between underwriters and an insured, it is not a claims matter. Therefore, strictly speaking, the claim settlement should proceed in the usual way without consideration of any underwriting consequences. The need for this strict separation between claims and underwriting is reinforced by the fact that the underwriters (and their respective proportions) on a renewed risk may not mirror those for the policy under which the loss(es) have been notified. Additionally, any outwards reinsurance will likely not benefit from the agreed loss load.
However, from the perspective of the insured, a risk manager will likely be responsible for both the negotiation of its claims and the negotiation of its renewal. Consequently, the risk manager is unlikely to divorce the settlement of a particular claim from the effect of that settlement on an agreed loss load. Moreover, an insured's balance sheet probably will not differentiate between claims monies received and a resultant outgoing additional premium which becomes due. The balance sheet will simply reflect the net settlement. Matters can be complicated further by claims made by additional insureds, who may not experience the direct effect of a loss load, leading to greater claims scrutiny and involvement from principal insureds.
The fact that a principal insured will be keen to factor the loss load into agreed settlements is not problematic in and of itself. However, it can lead to a mismatch between settlement expectations of an insured and the claims handler. If one considers a problematic claim in respect of which there may be differences of opinion regarding quantum and/or coverage, both parties to the negotiations will have a view on what the particular claim is "worth". In energy insurance claims, where litigation is rare, these assessments usually lead to a settlement. However, the prospects of reaching an agreed settlement may well be reduced if the insured's calculation of the claim's worth takes into account the effect of the loss load whilst the claims handler's assessment does not, indeed should not.
This dynamic is not one which can be fully eliminated but the difficulties associated with it can be mitigated by:
- Progressing adjustment of a loss as quickly as possible prior to negotiation of renewal so that the likely claim outcome can be estimated more accurately;
- Using the loss load mechanism sparingly;
- Engaging in express discussions at the time a loss load is agreed, making it clear that claims handlers will not be influenced by the loss load when negotiating settlement of an existing claim; and
- Ensuring that the claims handler is aware of any applicable loss load early during a negotiation in order to manage the insured's expectations and mind-set at that stage.
Despite these mitigation measures, it is likely that loss loads will continue to cause difficulties during claims negotiations, particularly when the sums in question are significant.
Originally published 16 June, 2020
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