Update: Lloyd’s Offshore Energy Market Draws Lessons From Deepwater Horizon

(Clarifies information in paragraphs 10 and 12). The 2010 Deepwater Horizon oil rig disaster in the Gulf of Mexico casts a long shadow over Lloyd's offshore energy underwriters, a market Lloyd's identified in its latest strategic plan as one of six focus areas.

The explosion and blowout of the BP oil rig in the Gulf of Mexico in April 2010 caused 11 deaths and triggered the flow of almost 5 million barrels of oil into rich shrimp habitats and onto nearby beaches. The disaster has been described as the largest oil spill in the history of the United States.

In the view of Tom Bolt, Lloyd's director of performance management, the Deepwater Horizon disaster offered an important lesson for insurers of offshore energy risks: know your aggregate exposures. A poor understanding of aggregations can lead to unpleasant surprises about the extent of total exposures.

"More often than not, people go broke from a failure to understand their aggregations rather than a failure to charge an adequate price," Bolt said.

Offshore energy was among six areas highlighted by Lloyd's when it released its current three-year strategic plan in December 2011. The others were political risks/trade credit, terrorism, casualty, remote underwriting and Lloyd's syndicate pricing review (Best's News Service Dec. 16, 2011).

Bolt was reluctant to make specific predictions on offshore energy premiums, lest he fall foul of European Union competition rules. But, pointing to large losses, he did offer a "general sense" that rates are increasing.

"Offshore energy insurance premiums are trending up around the world," he said.

Deepwater Horizon has been followed by a flurry of litigation that tested the system of operating agreements that has long been part of the offshore energy insurance sector. Under these agreements, insurance payments were subrogated among the owners of the main economic interest in a well and the other participants in the project. These agreements protected the insurer from having to pay out more than once on a claim, Bolt said.

BP's attempt to be designated as "an additional named insured under the policy" offered a challenge to that structure, Bolt said, adding early indications from the United States suggest the courts will uphold these contractual arrangements.

The legal maneuvers over Deepwater Horizon caused Lloyd's to look with some concern to the aggregation of energy liability exposure to the individual syndicates, said Bolt, who in the fall of 2011 asked syndicates to turn in business plans that would indicate how they would underwrite business going into the spring of 2012. These plans were to include analyses of aggregations and be subject to a stress test.

Bolt described the offshore energy market as "pretty important for us."

Most of Lloyd's syndicates underwrite energy risks, and much of this involvement is relatively small, he said. "About 80% of the energy premium gets written by the 11 largest syndicates."

The overall energy liability market "has not been profitable" for Lloyd's, Bolt said. In 2010, Lloyd's took in over 120 million pounds (US$190 million) in energy liability premiums and paid out "materially in excess of that."

The total will depend on how the Deepwater Horizon payout is allocated. And that, he added, will depend on decisions made by courts in the United States. "We'll probably still be talking about this in three to four years," he said.

Catherine Thomas, director of analytics at A.M. Best Europe — Rating Services Ltd., said Deepwater Horizon was among "a number of large single-risk losses that have adversely affected results for the sector. So there has been some upward pressure on rates, but there is still plentiful capacity in that market, which is restricting the ability of insurers to impose material increases."

Bolt agreed that capacity is ample. "It's maybe shrinking a little bit in response to loss activity and people focusing where they allocate their capacity in a tough market," he added.

He also pointed to the appeal of insurance in an environment where investment returns are weak. "So until interest rates rise and other fixed income opportunities get better, I think we'll still have a bit of capacity in the marketplace," he said.

"Lloyd's itself as a market is a significant player in the offshore energy market," Thomas said. "Most of the diversified syndicates writing in Lloyd's would have some exposure to offshore energy."

Although there have been big single-risk losses, results over the past three years have benefited from benign hurricane activity in the Gulf of Mexico, according to Thomas.

Deepwater Horizon, together with other large losses such as Maersk Gryphon, has led underwriters to increase what are known as attachment points where possible, raising the levels of risk retention by clients, she said. There is a growing trend also among insurers to make greater use of engineers within the underwriting process.

As a result of Deepwater Horizon, Thomas said, "there has been a real focus from the Performance Management Directorate on splitting physical damage and liability risks."

Lloyd's warned that 2012 business plans that do not include this demarcation would not be approved, Thomas said.

The sense within the Lloyd's management that aggregation was not fully understood coincides with the close look Lloyd's will be giving the offshore energy market during the first half of 2012, she added.

Alistair Groom, chief executive officer of Charles Taylor & Co. Ltd., which manages the Standard P&I Club, noted the upward pressure on premiums from the reinsurance market, upon which the Standard Club depends.

As a marine liability insurer, the Standard Club does only a small amount of offshore energy business, he said.

"There is still pressure in the reinsurance market to see rate increases, certainly for members or programs which have claims obviously day to day," Groom said.

The Standard Club has continued to write offshore energy business, but with increased attention on the details of contract and the selection and assessment of risk.

"So we're not doing anything particularly differently from what we did before," Groom said. "But we are conscious that we need to take our reinsurers along with us, make sure that they understand what we're doing."

Groom recalled his first reaction to the Deepwater Horizon disaster as relief that it was not the Standard Club's loss.

<p>Groom sees an increase in the long-established practice of the oil companies pushing as much liability as they can onto subcontractors, where most of the Standard Club's members are found.

"Our clients operate in relation to oil fields rather than owning them," Groom said.

Lloyd's has a current Best's Financial Strength Rating of A (Excellent).

(By Robert O'Connor, London editor: [email protected])