Oil and gas companies need to very precise this year regarding their insurance needs for Gulf of Mexico operations because insurance providers report that their own financial returns are severely squeezed after a number of hurricanes in recent years.
“This has really tested insurers and resulted in unprecedented uncertainty in the insurance market,” said Paul Dawson, energy underwriter at specialist insurer Beazley Group PLC of London. “Insurers at the moment are very nervous.”
A series of exceptional insurance losses started with Hurricanes Ivan in 2004 and Hurricanes Katrina and Rita in 2005. Hurricanes Gustav and Ike in 2008 caused still more losses.
The withdrawal of some insurance players combined with a reduced risk appetite from remaining underwriters means reduced overall underwriting capacity is available for oil and gas companies trying to renew or initiate new insurance policies this year. Higher insurance premiums are coming at a time when oil and gas prices are falling.
Ike’s storm surge put in motion about 50% more water than the 2005 storms, and Ike alone cost energy insurers more than $4 billion, Dawson said of estimates based upon information from Lloyd’s of London.
Lloyd’s is an insurance market where multiple financial backers come together to pool and spread risk.
Reinsurers provide insurance to insurance companies; reinsurance is arranged early in the year.
Various insurance markets exist worldwide for oil and gas companies, although Lloyd’s historically has been a key market for upstream insurance, Dawson said. Another source of insurance for offshore operators is Oil Insurance Ltd. (OIL), a mutual insurance company that includes Chevron and Royal Dutch Shell among its members.
OIL reported its estimated losses for the various storms at $895 million for Ike, $1.5 billion for Rita, and $2.1 billion for Katrina.
“Ultimate settlements will depend on the final adjustments of all the losses, a process we expect to take quite some time,” OIL said.
Beazley’s Dawson said none of the hurricanes in recent years is “the worst that we will ever see.” Difficulty in predicting hurricane frequency and scale has resulted in some insurers withdrawing from Lloyd’s, which insures 60% of the world’s upstream oil and gas risks with an overall premium approaching $1.8 billion.
Dawson believes coverage is available at a reasonable price for oil and gas companies whose risk managers are prepared and willing to help insurance underwriters reduce uncertainty over potential liabilities
Underwriting collaboration rising
Generally oil and gas risks are shared among a number of energy insurers through a process known as syndication. This allows insurers to spread risk better in their portfolios.
The ability to efficiently build insurance capacity through a syndicated process allows insured companies to obtain coverage for large and complex risks.
In 2009, it will be more difficult to achieve consensus among multiple insurers to complete a policy placement together. Insurers may set individual terms governing their participation. While this process might solve the short-term problem of building capacity, it adds considerable administrative complexity and is likely to complicate claims negotiations, Dawson said.
“Communication is very important” for underwriters trying to understand their exposure and trying to align the coverage they offer with oil and gas companies’ future economic interest in specific projects, he said.
As insurers put their own reinsurance programs in place this year, oil and gas companies will find insurers requiring more details about which oil company assets are to be insured, where, and at what value.
“Oil and gas companies themselves have to be very explicit in the risk that they wish to transfer,” Dawson said.
Insurers require certain information before they are prepared to underwrite the risk.
Risk managers at oil companies need to review the resulting documentation carefully and ask questions to understand better how coverage will work in practice, Dawson said.
Assessing likely loss value
If a production platform is damaged or destroyed, it is reasonably straightforward for an underwriter to assess loss value, Dawson said. But potential claims values are harder to determine with damage or loss of wells.
A “control-of-well” policy, which insures against the consequences of losing control of a well, typically estimates exposure based upon the number and depth of wells. This assumes that all wells have equal status and are worth salvaging.
Typically, older platforms have a number of unproductive wells that would need to be abandoned if the production platform were damaged severely. Storm-related abandonment costs can be 10 times higher than the costs that would have been incurred before the storm because of the increased complexity.
Dawson said underwriters trying to understand their exposure to wells will need oil companies to outline which wells are scheduled for abandonment and the expected abandonment costs.
Likewise, operators may have a number of producing wells, but the value of the estimated remaining reserves is relatively low. Underwriters will need to know what plans companies have to reenter or replace wells if the platform were lost.
Insurers might want to provide only limited coverage for wells that the company would not replace, Dawson said.
Typical detail scenario
Energy companies own around 3,800 platforms in the Gulf of Mexico. The cost of abandoning these wells once they are no longer economic rises tenfold if storm damage has so destabilized them that access becomes problematic and repair processes much more complex.
Because of exposure to the inflated costs of redrilling or capping off storm-damaged platforms wells, insurers operating through Lloyd’s of London will need the following data as standard:
- Asset name.
- US Minerals Management System complex identification.
- Gulf of Mexico block and area name.
- Deck height and water depth.v Number of well slots.
- For assets not in federal lease blocks, latitude and longitude.
- For pipelines, block number start and end points.
