Energy Market Changes After Spill; Insurers Raise Liability Rates, Reduce Property Capacity

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September 6, 2010

NEWS; Pg. 0017

1280 words

Energy market changes after spill; Insurers raise liability rates, reduce property capacity

STUART COLLINS

Energy insurers have reacted to the Deepwater Horizon loss by raising liability rates as much as 100% and reducing the offshore property capacity they offer for a single exposure by as much as one-third, sources say.

However, further changes are likely, particularly in the offshore liability market, depending on the reaction of reinsurers, potential U.S. regulatory changes and the demand for higher limits.

Towers Watson & Co. estimates that the loss of the oil rig in the Gulf of Mexico and subsequent liabilities will cost insurers $4 billion to $6 billion while total economic losses have been estimated at $35 billion (BI, Aug. 3).

Insured losses are likely to be limited because BP P.L.C., which had the operator's license for the rig as part of a joint venture, is self-insured. However, joint operators and contractors on the Deepwater Horizon had insurance limits of $3.3 billion, according to Towers Watson.

Underwriters already have paid $560 million for the value of the rig, but it is too early to speculate on the ultimate cost to insurers because there are so many unknowns and uncertainties over how liability will be determined, said Jim Pierce, global chairman of Marsh Inc.'s energy practice in Houston.

Brokers say while the loss is significant, it is not comparable to the energy market-turning $4 billion to $5 billion of offshore energy losses that resulted from Hurricane Ike in 2008 and Hurricanes Katrina, Rita and Wilma in 2005. The impact of the Deepwater Horizon loss has not spread much beyond the deepwater offshore market, and other marine lines of coverage are largely unaffected, brokers and insurers say.

Deepwater Horizon has hardened sentiment in the upstream energy insurance market, but there is a difference between an impact on market psychology and on the actual business, said Mr. Pierce. There is still plenty of capacity in the upstream market and rate increases have largely been limited to deepwater operations.

He said he had heard talk of upstream energy rates jumping 25% to 50%, but Marsh clients had seen rates hikes of 10% at most.

Underwriters were granting rate reductions on the Gulf of Mexico operators' books of business before the Macondo well loss, but insurers since April have been looking for modest price increases for operational risks such as drilling, fire, explosion and ensuing physical damage, said John Keely, managing director of Aon Risk Solutions' energy practice in Houston, which is part of Aon Corp.

Liability insurers also have used the loss to look to increase rates, he said.

There is a valid conversation to have, but I take issue with increases and changes to the liability product when the quantum of this loss is still unknown. BP does not buy this type of cover in the commercial market, and the (liability) loss has not yet hit the market and we do not even know if it will, Mr. Keely said.

Energy underwriters, however, are steadfast in the belief that the Deepwater Horizon disaster is a market-changing event.

The loss is the biggest nonwind event to hit the offshore energy insurance market since the fire and explosions that destroyed the North Sea platform Piper Alpha in 1988, said Frank Costa, president of Berkley Offshore Underwriting Managers L.L.C. in New York.

Deepwater Horizon is a significant loss and crystallizes the situation for underwriters in a market that has not been profitable for the past five years following hurricane losses in 2008 and 2005, Mr. Costa said.

The $560 million paid out for Deepwater Horizon comes after the $235 million loss of the Aban Pearl in May off the coast of Venezuela and the $400 million loss of the West Atlas rig off the coast of Australia in November 2009.

The combination of losses in the past year alone will exceed the total offshore market premium income, so rates will need to increase, said Simon Williams, head of energy, marine and casualty at Hiscox Ltd. in London.

Rates have already increased 15% to 30% because of Deepwater Horizon, said Dorian Grey, Miami-based president of Chartis Oil Rig, a unit of Chartis Inc. Underwriters are now much more conscious of the risks of deepwater drilling and realize that some of the challenges are not being priced into premiums, he said.

Rates may increase further as the reinsurance facilities that sit behind many direct underwriters are renewed early next year, underwriters and brokers say.

Reinsurers will again be affected by this loss, and I would expect that they will also want to increase prices and retentions when direct underwriters renew their facilities in January, said Mr. Williams.

Despite the loss, overall capacity in the energy sector is not thought to have fallen, and no significant players are known to have exited the market, brokers and insurers say. However, there has been a relative decrease in capacity, in particular for liability, as underwriters pay closer attention to aggregate limits offered to the various parties involved in an offshore venture, brokers and insurers say.

Bermuda-based excess liability insurers have reduced their capacity dramatically, Mr. Pierce said.

A company that purchased $1.5 billion of (offshore liability insurance) at the July 2009 renewals would probably have only been able to secure something in the neighborhood of $1 billion in July 2010. The reduction is because insurers are being more selective and are more closely examining the aggregation of exposures which may be involved in any one event, Mr. Pierce said.

The Deepwater Horizon loss has fundamentally changed insurers' view of aggregation, said David Croom-Johnson, active underwriter of AEGIS Managing Agency Ltd. in London, the Lloyd's of London-based subsidiary of Associated Electric & Gas Insurance Services Ltd. We have reduced our liability capacity by one-third to take into account the aggregation of exposures between operators and their contractors.

Insurers also are likely to change their pricing and coverage terms for offshore liability insurance, said Mark Roberts, director of marine and marine energy at specialist energy broker Cogent Resources Ltd. in London. Each day, underwriters become more resolute in the terms they are willing to give, and they are growing more inclined to say no when they are not happy.

One of the biggest repercussions of the Deepwater Horizon would be the United States changing the way it regulates the offshore energy sector and increasing the federal liability cap from its limit of $75 million, said Mr. Keely.

Companies already are looking to buy additional liability limits as a result of the Macondo well loss, and Aon is working on a facility to increase the amount of available control-of-well and cleanup capacity, he said.

This is an interesting time for the offshore liability market, said Colin Sprott, head of marine and offshore energy at XL Insurance in London. We see higher demand from insureds for higher liability limits, and we expect Congress to increase liability limits under the Oil Pollution Act as well as increasing limits for certification of financial responsibilities.

Rate increases for offshore liability coverage in the Gulf of Mexico have been as high as 100%, though most increases have been in the double-digit range, Mr. Sprott said.

Separate from Aon's initiative and depending on any new requirements, insurers in London are looking at a market solution to increase the amount of liability capacity available, said Mr. Sprott, who also is chairman of the Lloyd's Joint Liability Committee.

The market will be there to provide capacity for demand for increased limits, but it will cost more than it did 12 months ago, Mr. Sprott said.

Copyright 2010 Crain Communications Inc. All Rights Reserved.

September 9, 2010