Lawsuit raises ERCOT subrogation potential. Ramifications for ILS markets

Subrogation recoveries related to the February 2021 winter storm and Texas freeze losses are now being seen as increasingly possible, perhaps even likely, by our sources in reinsurance and insurance-linked securities (ILS) markets, as a lawsuit has been filed against ERCOT and many expect that some kind of payout will be the end result of the legal process.

Last February, a polar vortex event and winter storm Uri drove record freezing temperatures that caused significant issues across energy organisation the Electric Reliability Council of Texas, Inc’s (ERCOT) power network and utilities in Texas, with the levels of demand for power unable to be met by any sources at its disposal.

The resulting power outages for millions of energy customers, homeowners and businesses, meant no power and heating for days, which significantly exacerbated the insurance market claims burden, particularly from freezing pipes and burst pipes in homes and businesses that were unable to be heated, as well as ramifications and costs related to business interruption.

As we explained early last March, the scenario that unfolded in Texas and especially related to ERCOT, raised speculation over the chances of subrogation becoming a possibility for insurance carriers.

Now, the filing of a subrogation lawsuit by some 131 insurance entities that were active in Texas at the time, has begun to get reinsurance and retrocession providers that suffered significant losses after the winter storm event discussing the potential for eventual recoveries to flow down as any payout could reduce their cedents ultimate net losses.

We’ve had a recent case of subrogation and how that can flow through the different layers of the insurance and reinsurance market that we can take from, as the PG&E subrogation and recoveries flowed to the benefit of insurers, on to reinsurance companies and some retrocessionaires, with even some reductions in loss expectations for some catastrophe bonds.

That provided a clear example of how a subrogation case, related to a major insurance industry catastrophe loss, can end up reducing losses at ILS funds, ultimately helping to reduce the return-related impacts to their investors as well.

The 131 insurance industry plaintiffs feature most of the major players in the US market and buoyed by recent subrogation success, related to the California wildfires, it’s assumed that they won’t have filed this petition for damages against ERCOT and 36 related utilities and infrastructure entities unless they felt they could win it.

The case was filed in the 126th Travis County Judicial District Court on December 29th 2021 and alleges that ERCOT and the other defendants hold all fault for the electric power failure in Texas that began on February 15th 2021 and continued into the following week.

ERCOT and the other defendants are accused of being responsible for the energy failure that drove significant property damage to many policy holders of the 131 insurance company plaintiffs across Texas.

While the plaintiff insurers say they are the subrogees to their insureds, meaning they are subrogated to any rights or claims against any entity or person held liable for causing the damage to the insured.

In layman terms, the insurance firms are suing for damages, to recover losses they paid out as claims to their insureds as a result of the property damage caused by the loss of power during the winter storm and deep freeze event.

The lawsuit says that it is ERCOT’s responsibility to balance power availability across the State of Texas and as it failed to do this, while its power grid essentially failed to deliver the promised electricity, this failure led to significant insured property damage, which the insurers believe ERCOT and the defendants should be repaying.

It also states that ERCOT failed to weather-harden its electrical network, despite clear signs such an extreme event was possible, with this failure contrary to prior case law examples.

Winter storm Uri and the polar vortex event that drove the deep freeze south into Texas and surrounding states was the first really major insurance market loss event of 2021 and drove losses through reinsurance, into retrocession and to ILS funds.

At around $13 billion to $15 billion, the industry loss has also ended up being a contributor to significant aggregate retro losses later in 2021.

Along with the two other $10 billion plus losses of the year, in the European flooding and hurricane Ida, the winter storm Uri and Texas freeze losses triggered impacts to a number of collateralized retro writers with ramifications for ILS funds, as well as some traditional reinsurance markets that wrote similar aggregate covers.

All of which means that, if the legal action against ERCOT is successful and a payout made, that payout will flow to the benefit of the insurers in the case, which should reduce their ultimate net losses related to winter storm Uri event in Texas and that can also reduce their claims against reinsurance protection, and so on down into retro.

In the case of the PG&E subrogation with the California wildfires, the subrogation flowed through to the benefit of retrocession providers and ILS funds, even one catastrophe bond.

A smaller wildfire related subrogation recovery from SoCal Edison, another California utility, has also flowed to the benefit of retro and ILS markets in some cases.

Meaning, any subrogation success from this lawsuit, if sizeable enough, could drive reductions in ultimate losses from the winter storms right the way through the tiers of the insurance and reinsurance sector, including to ILS funds.

It’s very uncertain at this stage whether subrogation from a lawsuit against ERCOT will end up being significant enough to really move the needle down at the retro and ILS end of the chain.

But our sources are increasingly feeling confident that some subrogation benefits may eventually flow, as they feel the lawsuit has a good chance of making positive headway, although it could take months.

If a subrogation was of a reasonably large size, it could have interesting ramifications for some ILS and collateralized players.

Those ILS markets that were hit by the major event aggregation over the course of 2021, have faced significant losses as a result.

Those losses and the negative returns they have had to report have, in some cases, driven investor redemptions and significant challenges in rolling forwards their renewal portfolios.

If subrogation eventually reduces the ultimates for the winter storm event, it could make a reasonable difference to their 2021 performance. But that will come too late, as the damage has, in some cases, already been done and left a challenging situation for 2022.

Subrogation can’t be relied upon though and there is precedence for these cases to not make much headway, or for payouts to be greatly reduced.

But the examples set by California wildfire related subrogation lawsuits shows that, if the cases move in the industries favour, the payouts can be meaningful and make a positive difference to the markets that shouldered large shares of the loss.

The last factor that it is important to consider, is that when subrogation cases go through the courts, there is always a potential liability claim that the defendants might make against their insurance panel. Meaning that, as subrogation recoveries flow, some insurers could just as easily be funding some of them through liability payouts.

Finally, with freezing winter temperatures expected to reach down to north Texas in the latest spell of cold, insurers and reinsurers will be pleased to know ERCOT said this week that it has assessed its infrastructure for winter-readiness and finds “The Texas electric grid is more prepared for winter operations than ever before,” according to Interim ERCOT CEO Brad Jones.

Demand leapt yesterday in the latest cold spell and is expected to remain high today, but ERCOT believes it is in a far better position to continue delivering electricity through whatever this winter can throw at the state of Texas.

ERCOT said it has inspected 302 electric generation units in December, between them making up 85 percent of the megawatt hours lost during Winter Storm Uri due to outages, as well as 22 transmission station facilities. Only three resources were identified as in need of review and the rest passed its “winter weatherization readiness” assessment.

“We are confident these 321 inspected facilities either meet or go beyond the new requirements from the Commission and we will continue to work with the other 3 facilities to ensure they correct remaining deficiencies,” explained Woody Rickerson, ERCOT Vice President of System Planning and Weatherization. “Our teams spent thousands of hours preparing for and conducting these 324 on-site inspections to ensure the electric grid is prepared for winter.”

So it sounds like the winter storm related outages of 2021 that drove such large insured losses may not happen again, without a particularly exceptional weather event occurring.