A Possible New Market
Government regulation is often portrayed as the bane of free markets, but in the case of new rules governing electrical power generation in the Northeast and Midwest, regulation is actually creating a new and specialized insurance market.
After a series of electricity shortfalls over the past few years, two regional power wholesale organizations in the eastern U.S. now have federal approval to institute a system under which generators that fail to provide the power they have promised at peak times will pay for the cost of replacement power. In one interesting twist, it is not so much the risk that is emerging, but rather the risk-transfer market itself.
Last year, ISO-New England (ISO-NE) got approval from the Federal Energy Regulatory Commission (FERC) to institute a system of charges and payments. In July of this year, PJM, the regional transmission operator for a wide swath of the Middle Atlantic and eastern Midwest, also got FERC approval for a similar system.
The United States and Canada are divided into regional independent system operators (ISOs) and regional transmission organizations (RTOs), which differ only in a few legal senses.
It is straight cost of replacement for non-delivered goods, in this case, electricity.” — Matthew White, chief economist at ISO-NE
At present, ISO-NE and PJM are mandatory markets, where all power providers must participate and mandatory charges are in place. Others are voluntary.
Utility industry organizations note that pending federal legislation could recognize the preferability of mandatory participation and payment systems, but that is a long way from being passed and signed into law.
Even though the ISO-NE and PJM regimes were approved at different times, they both go into effect with the delivery contracts starting in June 2018. Those contracts have already been bid and accepted, and in most cases power generators have already figured the costs into their rates.
The purpose for the new rules is to ensure sufficient power at peak demand, especially during hot summer days and winter storms. The charge-and-payment system is a double-settlement contract, standard in commodity markets.
If a supplier fails to provide the commodity — grain, oil, power — in the agreed amount at the agreed time, the supplier has to pay a set compensation, which the buyer then uses to fill the gap on the spot market. It is a straight transfer to ensure delivery.
“These are fully insurable risks,” said Matthew White, chief economist at ISO-NE.
“It is straight cost of replacement for non-delivered goods, in this case, electricity. Insurance is a critical part of our ability to deliver power, and we considered the insurability of the risk in market design whenever we make significant changes.”
It is also important to note that the core purpose of the new regimes is to encourage generators to invest in their infrastructure, operations and reliability.
Seeking a Just System
Both ISO-NE and PJM have said that they would much prefer that all their generators provide every watt they have contracted to supply. But realistically that won’t happen, so the new arrangement, they hope, will enable timely, transparent and fair replacement power.
“There are no penalties in our design,” White said. “This is a true two-settlement obligation, just like any other commodity contract.
“We know that penalties are not insurable, so we were careful not to structure the market that way. This is covering a short position where every party knows the terms.
“The risk can be indexed to a transparent development outside the control of the insured, so there is no moral hazard. Insurers can model the system.”
Insurers are doing exactly that. Manfred Schneider, head of engineering in North America for Allianz, confirmed that fines or penalties would not be covered under standard business interruption (BI) coverage.
“We are working with our alternative risk transfer group looking for financial solutions to this non-typical exposure. We have to find the framework, the limits, the exposures. This is not just something you can lift out of the drawer.”
Schneider said that it could take another six to 12 months for Allianz and other carriers to work through the full underwriting, including assessing the needs, costs and potential size of the market.
A History of Coverage Ambivalence
One important concern for underwriters is that owners may choose not to buy policies after they invest time and effort into developing coverage for generators’ exposure under the new rules.
That would not be unprecedented.
One carrier recalled that BI coverage was not triggered when an ash cloud from a volcano in Iceland essentially locked down all transport in Europe for more than a week in 2010 because there was no physical damage.
Raw materials, inventory and parts could not be delivered, and many operations were halted. Insurers developed new policies, but owners deemed them too expensive and did not buy them.
“This is very new and we are being very careful.” — anonymous electricity industry source.
The same thing happened after Hurricane Ike swept over the Gulf Coast in 2008.
Cities were evacuated and refineries and chemical plants had to close for lack of workers. The storm did relatively little damage, but plants incurred the costs of shutdown, idleness and restart.
Again, at least one carrier developed “spin-down” insurance to cover such non-damage costs, but owners did not buy it.
“Swiss Re has seen a sharp increase from risk managers, CFOs and the heads of power trading inquiring about coverage options for generators participating in binding capacity performance markets,” said Brian Beebe, head of origination in North America for environmental and commodity markets with SwissRe Corporate Solutions.
“Since the magnitude of potential penalties for generator non-performance is extraordinary — millions of dollars an hour for a 500 Mw plant — the risk mitigation topic has been elevated within generation company senior management, including boards of directors.
“In response, generator risk managers and insurance brokers are seeking a variety of forward starting coverage options for key generation capacity.
“Clearly, the evolution of increased transparency and client knowledge of generator capacity prices is underway in deregulated markets. However, in traditional regulated utility markets, I do not see evidence that these areas are adopting any type of market-based mechanism to encourage generator availability.”
The high penalty charges have indeed caught the attention of corporate boards at generators, and they are pressing their risk managers for answers.
None that Risk & Insurance® contacted were willing to speak publicly, given that the situation is in flux and that they have to report first to their boards.
A significant concern among risk managers is not the availability of risk-transfer options, but the price, terms and conditions.
Several large generating companies serve both ISO-NE and PJM. Those contacted did not reply or declined to comment citing “competitive issues.”
One official observed, “This is very new and we are being very careful.”
It is expected that some of the larger corporations will retain the risk posed by the charges. That expectation in turn is making some risk managers anxious that lack of demand will limit participation by carriers and keep rates high.
Only time will tell how broad and deep this risk-transfer market becomes, and where capacity and rates settle. But one other concern raised about the new charge-and-payment scheme can be addressed. There has been a thought that small generators, especially those in renewable power, are essentially shut out, because they cannot commit to large delivery contracts.
That is not the case, said ISO-NE’s White.
“We know the status of every generator, updated every few seconds. If a wind generator cannot make a commitment to deliver, they don’t get the up-front payment, but they can be on standby.
“If the wind is blowing and they can supply during a delivery event, we will pay them the rate same as anyone else.”
Disclaimer: The events depicted in this scenario are fictitious. Any similarity to any corporation or person, living or dead, is merely coincidental.
Buckets of Money
Maxine DaGuerre, the risk manager for the Middle Atlantic power generation company Corsair Corp. was decidedly uncomfortable.
Along with the rest of the Corsair Corp. management team, she was waiting to hear the latest decision from PJM, the regional electricity wholesale market. Under guidance from federal regulators, PJM was establishing incentives and penalties for power generators willing to guarantee delivery of electricity to the grid at times of crisis or peak demand, otherwise known as Emergency Load Response events.
The Northeast saw a near blackout in the frigid winter of 2014. Demand during several days of intensely cold weather almost knocked off the grid and generators reported a number of problems trying to feed the beast.
The regulators did not want to risk that scenario again.
The incentives were lucrative, game changers, and despite the protests of large buyers of electricity, the incentive plan was moving forward. Now, in mid-August of 2015, Corsair executives were awaiting word from PJM on what the incentives would be for the energy auctions for June 2018 to May 2019. Word was that they were going to be even more than they had been for the corresponding period for 2017-2018.
The questions included what to do with the increased revenues? Plow them into plant upgrades, purchase insurance to cover the cost of any penalties for non-delivery, lock in natural gas delivery for the year to guarantee price and supply?
It was a complicated set of questions. DaGuerre knew which way she was leaning.
The incentives were one thing, but the penalties were staggering. The regulators were ready to fine power generators that failed to deliver electricity on emergency demand at more than $3,000 per megawatt hour in some cases.
For a 1,000 megawatt plant that was a penalty that could run into millions of dollars per hour.
“Where was the backstop against that?” she thought to herself.
DaGuerre’s internal monologue was interrupted by the ringing of her desk phone. It was the company CFO, Eric Petruzzi. He sounded excited.
“Hey Maxine, can you join us upstairs? The announcement from the market is just in for the 2018-2019 incentives and we want to look at our options.”
“Sure thing, I’ll be right up,” DaGuerre told Petruzzi.
The exuberance in Petruzzi’s voice was off-putting.
In DaGuerre’s mind this was not a time for celebration, it was a time for careful consideration.
When she got upstairs there were three men at the table, Petruzzi, the operations chief Ben Ochstein and the CEO, Bill “Red” Miller.
“It’s what we thought Maxine,” Petruzzi began.
“PJM raised the incentive for 2018-2019.” He glanced briefly at the electronic pad in front of him.
“It’s raised the incentive by almost one third,” Petruzzi said with enthusiasm in his eyes. DaGuerre could swear she saw dollar signs there.
From $120 Mw-Day the incentive had been raised to almost $160 Mw-Day for 2018-2019. One 1,000 Mw plant could bring in more than $60 million in annual revenue.
Margaret watched as Ochstein and Miller exchanged glances. It seemed like some key decisions had already been made.
“We know how you feel about the penalties, Maxine,” Miller said.
“But you also know the importance of risk mitigation,” Ochstein said.
“We’re thinking we’ve got a real good opportunity here to upgrade some of the facilities, particularly Peachtree and Susquehanna,” Ochstein said.
DaGuerre cleared her throat and tried to steady herself.
“I’m all for risk mitigation, as you know. And I think we should upgrade some of the plants, particularly Susquehanna,” she said, giving Ben Ochstein a look that she hoped communicated solidarity with his idea.
“But I can’t help thinking that some risk transfer is in order here,” she said.
Petruzzi started to say something but DaGuerre felt compelled to just plow ahead.
“One, this is the first time we’ve been in this situation. The incentives are compelling, but the penalties are severe if we have a breakdown. Four of our plants are coal-fired and let’s face it, could really use some upgrades. It’s not just Peachtree and Susquehanna,” she said, giving Ochstein a meaningful look.
“I’m not asking for a lot but I think 5 percent of the three years’ auction revenue should be invested in some sort of risk transfer,” she said.
“That’s too much Maxine,” Miller said. From his tone, DaGuerre knew she’d be lucky to get a fraction of that.
The meeting ended with DaGuerre making her own odds that the company would be investing 2 percent of any emergency load auction funds into risk transfer mechanisms.
She flat-out doubted that was enough.
While she did her best to partner with Ben Ochstein and the company’s engineering team to make the best use of the company’s capital in plant upgrades, Maxine DaGuerre couldn’t stop doing the numbers in her head.
For power generators that had agreed to supply electricity to the grid during Emergency Load Response events, the penalties from PJM and the regulators could be staggering. They were looking at $3,000 per megawatt hour. For a 1,000 MW plant, that was $3 million per hour.
The variables were driving DaGuerre crazy. She’d only been able to purchase $15 million in coverage for any fines Corsair might face. That might seem like a lot of coverage but she’d have been much happier with five times that.
She studied the preventative maintenance plans and upgrades for Corsair’s 18 power generation plants until her eyes hurt. Ben Ochstein and the company’s engineering team weren’t slouches. They were top-notch professionals. But nobody was perfect.
As fall moved to winter, the upgrades at the Corsair plants, at Susquehanna, Peachtree and others carried on apace. Ochstein and Petruzzi were also congratulating themselves that they had locked in reasonably priced natural gas supplies for the company’s plants that relied on natural gas to produce electricity.
DaGuerre struggled to share their enthusiasm.
DaGuerre hated to be a stick-in-the-mud. She wanted the company to thrive. She certainly wasn’t hoping for a blackout in the Northeast or anything like it.
Then the cold came, just like it did in the winter of 2014, only this time much earlier. Three days of intense cold in the week between Christmas and New Year’s provoked the region’s first Emergency Load Response event, on Dec. 28.
Corsair didn’t miss a beat, while the word got out that one of its competitors had failed to deliver for three hours due to a natural gas pipeline problem near Philadelphia and been fined.
2016 broke with reasonable temperatures, but a polar vortex gripped the Northeast in the second week of January. This time Corsair wasn’t so lucky. Boiler problems at the coal-fired Susquehanna plant caused the 1,200 megawatt plant to go offline for five hours during an Emergency Load Response event. The fine was $15 million.
The formerly sanguine Eric Petruzzi went into full panic mode.
“Can you get us more coverage?” he asked DaGuerre during a late-night phone call on Dec. 29.
DaGuerre could hear laughter and clinking glasses in the background.
“Where are you?” she asked him.
“I’m … at a party. At my mother’s place in Annapolis,” he said somewhat sheepishly.
“I’ll … see what I can do,” DaGuerre said.
She didn’t bother calling her United Kingdom-based broker until very early the following morning.
An Endless Slog
Sorry, the carriers said.
“Not at this point,” DaGuerre’s broker Martin Rule told her the following morning.
“Your best bet for the remainder of the winter is to go full bore on plant inspections and preventative maintenance and hope you can ride it out,” he told her.
“Ride it out.” Those were words that Maxine DaGuerre hated. That wasn’t risk management, it was like playing roulette.
Sleep-deprived from meetings with Corsair Corp. engineers and operations personnel throughout the Atlantic seaboard through January, DaGuerre was trying to catch a nap in a drafty hotel in Wilmington, Del., on Feb. 10 when her phone buzzed.
It was Ochstein. He was a humbled man.
“We were out six hours at Leedsville from 6 a.m. to about an hour ago,” he told her. It almost sounded like his voice was cracking. He sounded exhausted.
An $18 million fine. No cover. Not for this.
“Another boiler problem?” DaGuerre asked him.
As Ochstein droned on, dispirited, with the technical details, DaGuerre started tuning him out.
She rolled over and stared at the framed print in her room as Ochstein’s words seeped in. She didn’t even feel sick, she felt numb.
She knew what Miller and Petruzzi would tell her and maybe they were right. Corsair had the resources to keep its plants up-to-speed and perhaps even profit greatly from the incentives it could earn from this Emergency Load Response arrangement with PJM.
But she knew one thing for sure.
She never again wanted to feel what she felt that early afternoon in that drafty hotel room in Wilmington.
These multimillion dollar hits had to stop. They couldn’t afford to fumble again.
Risk & Insurance® partnered with Swiss Re Corporate Solutions to produce this scenario. Below are Swiss Re Corporate Solutions’ recommendations on how to prevent the losses presented in the scenario. This perspective is not an editorial opinion of Risk & Insurance®.
The cold snap during the Polar Vortex of January 2014 brought the northeast United States dangerously close to blackout conditions. As temperatures plunged, many of the region’s key power plants performed poorly, and the region came dangerously close to rotating blackouts and a loss of electric heat. Had the power gone out, a large segment of the population would have been exposed to the severe cold with dire consequences.
Recently, the PJM Interconnection, which manages the electric grid for 13 states (plus Washington DC) and nearly 61 million people, implemented a new electric generator incentive scheme that aims to prevent a repeat of the poor generator performance during January 2014. The new program, called PJM Capacity Performance, will provide increased revenue for power generation companies that participated in capacity auctions. However, while generation companies will receive additional revenues for offering firm capacity, there is also considerable risk for non-performance. An unplanned outage or derate at a power plant during an emergency event could have significant financial costs (a million dollars an hour or more, depending on plant size).
Swiss Re Corporate Solutions understands the risks facing your business. Our electricity price and power plant outage solutions are designed to help you take advantage of the new capacity incentives, and offer protection for unseen mechanical issues impacting power generation.
Power producers can manage that risk through Swiss Re Corporate Solutions’ Electricity Price & Outage (ELPRO) and Capacity Performance coverages, which compensates generators for output lost from unplanned outages based on market conditions at the time of loss. We also offer weather and commodity price risk solutions to help you manage risk. To learn more, visit http://www.swissre.com/corporate_solutions/solutions/weather/
The Doctor as Partner
Professionals helping employees return to work after being on disability or a leave of absence face many challenges. After all, there is a personal story behind each case and each case is unique.
In the end, the best outcome is an employee who returns to the job healthy and feeling well taken care of, while at the same time managing the associated claim costs.
Learn what most employers want from their group disability and life benefits program.
While many carriers and claims managers work toward these goals, in the end they often tend to focus on minimizing costs by aggressively managing claims to get the worker back on the job, or they “fast track” claims, approving everything and paying little attention to case management.
Aggressively managed claims can leave many employees and their doctors feeling defensive and ill-at-ease, creating an adversarial relationship that ultimately hinders return to work and results in higher direct and indirect employee benefit costs for the employer. Fast track or non-managed claims can lead to increased durations, costs and workforce productivity issues for employers.
Is it possible to provide a positive employee benefit experience while at the same time effectively managing disability and lowering an employer’s overall benefit costs?
A Unique Approach
Liberty Mutual Insurance’s approach to managing disability and absence management focuses on building consensus among all stakeholders – the disabled employee, treating physician, employer and insurer. And a key component of this process is a large team of consulting physician specialists, leading practitioners from a variety of specialties, highly regarded experts affiliated with leading medical universities across the country.
“About 16 years ago, our national medical director, Dr. Ed Crouch, proposed that if we worked with a core group of external consulting medical specialists – rather than sending most claims for Independent Medical Evaluations – we could do a better job making disabled employees and their attending physicians comfortable, and therefore true partners in producing better disability management outcomes and employee benefit experiences,” said Tim Kastrinelis, senior vice president, Distribution Partnerships at Liberty Mutual Benefits.
“In this way, our consulting physician and the attending physician are able to work with the disability case manager, the employee and the employer to deliver a coordinated, collaborative approach that facilitates a productive lifestyle and return to work.”
The result of Dr. Crouch’s initiative has produced positive results for the clients of Liberty Mutual Insurance. This consensus building approach to managing disability with consulting physician expertise has helped achieve industry leading client retention results over the past decade. In fact, 96 percent of Liberty Mutual’s group disability and group life clients renew their programs.
“By getting all stakeholders on the same page and investing heavily in consulting physician specialists, we have been able to lower claim costs and shortened claim duration for our group disability policyholders. …In the end, it’s a win-win for all.”
–Tim Kastrinelis, Senior Vice President, Distribution Partnerships, Liberty Mutual Benefits
A Collaborative Approach
In the case of complex disability medical health situations, Liberty Mutual’s disability case managers play a vital role in seeking additional expertise—an area where the industry’s standard has been to outsource the claimant for independent medical examinations.
However, Liberty Mutual empowers its disability case managers with the ultimate responsibility for the outcome of each claim. The claimant and the case manager stay together throughout the life of the claim. This relationship is the foundation for a collaborative approach that delivers a better employee benefit experience and enables the claimant to return to work sooner; which more effectively controls total disability claim and absence costs.
Sending a disabled employee with complex medical needs to an external specialist may sound like a cost-effective path, but it often comes at the cost of sacrificing the relationship and trust built between the employee and case manager. The disabled employee must explain their medical history to a new clinician, which he or she is often reluctant to do. The attending physician may be uncooperative as this move can appear to question his or her treatment plan for the employee.
As a result, the entire claims process takes on an adversarial atmosphere, building major roadblocks to the ultimate goal of helping the claimant return to a productive lifestyle.
Liberty Mutual takes a different approach. Nearly 100 physicians representing more than 30 medical specialties are available to consult with its medical and claims professionals, working side-by-side with case managers.
More than 95 percent of these consulting physicians are in active practice, and therefore up-to-date on the latest clinical best practices, treatment guidelines, therapies, medications, and programs. Most of these physicians are affiliated with leading medical universities across the country. “We recruit specialists from around the country, getting the best from such prestigious institutions as Harvard, Yale, and Duke,” said Kastrinelis.
These highly-credentialed physicians help case managers focus on providing the support needed for the disabled employee to successfully return to work as quickly as appropriate. Their collaborative work with the attending physicians provides the behind-the-scenes foundation that leads to a positive claimant experience, results in a better outcome for the claimant, and more effectively reduces total claim costs.
Coordinated Care Plan
When one of these consulting physicians reaches out to an attending physician, there’s an immediate degree of respect and high regard for his or her opinion. This helps pave the way to working together in the best interest of the employee, improving treatment plans and return to work results.
In this process, the claimant is not sent to yet another doctor; instead, the consulting specialist works with the attending physician to help fill in the gaps of knowledge or provide information that only a specialist would have. Although not an opportunity to direct care, these peer-to-peer discussions can help optimize care with the goal of helping the employee return to work.
The attending physician may have no knowledge of the challenges the employee faces in order to return to work. A return to work plan created in concert with the specialist, disability case manager, employer, and attending physician can set expectations and provide the framework for a proactive and effective return to a productive lifestyle.
“Our consulting physicians bring sophisticated medical expertise to the discussion, and help build consensus around a return-to-work plan, helping us more effectively impact a claim’s outcome and costs, and at the same time provide a better claimant experience,” said Kastrinelis.
“We can work more collaboratively with the attending physician, manage expectations, and shepherd the employee through the process much more effectively and in a much more high-touch, caring, and compassionate manner. Overall, we’re able to produce better outcomes as a result of this consensus building approach.”
“Our approach – including the use of consulting medical experts – helped us significantly reduce disability costs over two years for one large health service company,” notes Kastrinelis. “We cut average short-term disability claim durations by 4.2 days in that time, while increasing employee satisfaction with our unique disability management model and collaborative, partnership approach.
How did Liberty Mutual’s unique approach lower claim costs, reduce disability duration and improve the benefit experience for one customer?
“By getting all stakeholders on the same page and investing heavily in consulting physician specialists, we have been able to lower claim costs and shortened claim duration for our group disability policyholders,” said Kastrinelis.
“Plus, we, the employee, and the employer also get the bonus of creating a better employee benefit experience. This model has shaped our disability and absence management program to more aptly reflect our core mission of helping people live safer, more secure lives. In the end, it’s a win-win for all.”
How does Liberty Mutual provide a superior employee benefit experience?
Tim Kastrinelis can be reached at email@example.com. More information on Liberty Mutual’s group disability and absence management offerings can be seen at https://www.libertymutualgroup.com/business-insurance/business-insurance-coverages/employee-benefits.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty Mutual Insurance. The editorial staff of Risk & Insurance had no role in its preparation.