Paul Dawson, Lloyd’s insurer Beazley
In the wake of Hurricane Ike, estimates are that offshore energy losses in and around the Gulf of Mexico have cost the insurance market over $4 billion. As the 2009 hurricane season approaches, oil companies and their insurers are wrestling to reach a consensus as to what level of cover is appropriate and at what price.
Hurricane Ike in 2008 represented a significant loss to the insurance industry and is believed to have been the third most costly hurricane ever. For offshore energy installations the effect was profound. Ike put in motion 50% more water than Katrina did in 2005, destroyed 60 platforms and damaged a further 124. Coming just three years after the 2005 losses, Ike has caused energy insurers to question their ability to predict and price adequately for the increased frequency and severity of such storms.
As a result, many insurers have reviewed their participation in this risk class and available capacity has shrunk by around 40%. London-based insurers continue to provide the bulk of the cover that remains, particularly since recent attempts by brokers to generate new capacity outside London have failed.
The reduction in capacity has not been limited to the direct insurance market. Energy insurers have found difficulty also in covering their own risks through reinsurance, which is acting as a further disincentive.
The second quarter of this year is critical for GoM renewals as it is during this period that the majority of oil and gas companies bring their risk to the insurance market. Evidence so far suggests that oil and gas companies should prepare for some robust negotiations.
Generally, premiums are increasing even though many companies are electing to insure fewer assets. Insurers also are requiring companies to retain more risk. In many cases they are increasing the amount of loss which oil companies must pay for themselves (often known as the deductible or excess) by on average a factor of four. Many oil companies already are attempting to mitigate this increase in costs by reducing the amount of cover that they buy.
Costs up, attitudes hardening
While changes in premium rating levels and deductible levels have occurred previously, this is the first time that higher prices and more onerous conditions have been accompanied also by a fundamental shift in underwriting approach.
Hurricane Ike, like Rita and Katrina before it, brought claims costs associated with oil and gas wells into sharp focus. If a platform is damaged or destroyed, it is reasonably straightforward for an underwriter to assess likely loss value. However, with damage to, or loss of wells, potential claim values for abandonment or re-drilling can be unclear.
Currently, well exposures are covered typically within a control-of-well policy and exposure is estimated according to the number and depth of the wells. This approach assumes that all wells have equal status and may be worth salvaging.
In practice, however, this is rarely the case. An older platform may have a number of unproductive wells that will need abandoning if the platform or structure supporting them is severely damaged. These abandonment costs can be 10 times the expense that would have been incurred prior to storm damage, either because the well may have been made inaccessible and the equipment and tools within it badly damaged, or because the whole structure has become more difficult to access and repair.
Due to the significant costs involved, underwriters are seeking a much fuller understanding of the exposure relating to wells and are asking companies to explicitly detail the wells they wish to insure and what basis of coverage is required. Lloyd’s of London underlined that trend earlier this year by issuing a new reporting format requiring the provision in standard form of a raft of more detailed information to enable the market to price exposures more accurately.
Solutions being found
The Lloyd’s market has a long track record of providing cover for upstream energy clients, despite the shock of repeated severe hurricanes, or fires such as Piper Alpha. Its ability to withstand such events is in large part down to the way it shares risks between insurers through a process known as syndication. This ability to parcel up risk is what allows insurers in the Lloyd’s of London market to take on around 60% of the world’s upstream oil and gas risks.
Against this backdrop, it is becoming increasingly clear that 2009 is going to be something of a watershed year for oil companies and their insurers.
Reduced commodity pricing is impacting the cash flow of oil and gas companies. This in turn has a significant impact on the amount that they are prepared to pay for their cover and, indeed, the amount of risk that they are able to retain. At the same time, insurers, with their increased cost of capital and continuing uncertainty as to when that capital will next be called upon, face their own set of challenges. This means that all parties will be hoping for a quieter hurricane season in 2009.
