Energy insurance market in 2017

Understanding the future requires appreciation of the past

James R. Pierce, JLT Specialty USA

For the first time in several decades, the energy insurance market cycle has not tracked with a depressed energy market. This year, 2017, will be seen as the year insurance savings came to a grinding halt.

For the last several years, the energy insurance market has been rife with capacity. In short, this means that a surplus of capital has been committed to the energy industry, amid investor expectations of a steady return on investment. In actual fact, that return on investment disappeared a couple years ago. Underwriters have been pricing energy insurances on a break even or marginal loss basis since 2015. By way of example, if we look at just the upstream sector, we can see how premiums and losses have transected, with losses now exceeding total premiums underwritten in that sector (See Table1).

The resulting low rates in place for buyers of energy insurance have been driven by the excess of capital committed to the space. Underwriters in the United States and in Lloyds of London have been maintaining loss leading rate levels in order to secure market share. The market share approach allows firms to be in position to benefit from increasing rates when the market begins to harden.

In the macro, it would not be too big of a stretch to suggest that the commercial insurance market is simply the largest mutual insurance company in the world. Yes, the commercial insurance market is comprised of hundreds of for profit companies vying for market share. But when a capital event (or series of capital events) occurs, the impact on the commercial insurance market is far reaching. It now appears the windstorms, flooding, earthquakes, and fires of the summer of 2017 are extending their reach. It is widely estimated throughout the insurance industry that the aggregate losses emanating from the myriad natural disasters this summer will amount to a figure in excess of $100,000,000,000. In short, there is no way that amount of loss will not influence virtually every segment of the insurance industry.

These losses will affect the insurance companies in their 2018 cycle. An insurance company has a defined amount of capital to employ. It will decide how much capital is committed to the different industries and product lines it offers to the consumer. Not surprisingly, it will shift capital around each fiscal year to capitalize on the best possible returns. To put all this in perspective, it does not take a rocket scientist to realize that in the aftermath of all these losses, the property market will be charging more money for property insurance related products. Insurance companies that have been hit hard by the various disasters in 2017 won't stop there. They will look to increase rates across the portfolio of risks underwritten. The energy market will not emerge unscathed. It is, at the end of the day, a case of simple supply and demand. For the last several years, there has been a surplus of capital supply, and a reduced demand (due to the energy slump) for the offered product. In 2018, the cost of capital will increase, and to the extent demand increases, there will be a compounding effect on pricing. Forewarned is forearmed.

I do not want to be the messenger of doom and gloom without mentioning that there are some positive trends in our business. In particular, on the M&A front, developments have been made for creative Reps and Warranty products that routinely help get acquisitions "across the line." In most cases, this is because it has been that we have managed to alleviate onerous earn out provisions for the sellers, and used manuscript insurance products to allow for sellers to realize the full value of their equity at the closing of the transaction rather than relying on outdated escrow mechanisms. Further still, as insurers have increasingly gained comfort and familiarity with underwriting energy acquisition risks, their appetite for more exotic risks, such as fraudulent conveyance or successor liability risk (among others), has also increased.

The energy insurance market has a long history of standing behind its energy clients. In this hardening market, companies which have valued relationships will emerge less impacted than those who have viewed the purchase of insurance as a commodity driven process. We strongly recommend energy companies approach their 2018 renewals with a view toward active (and early) engagement. It has been a long time since the insurance renewal process captured the attention of the C-Suite. That time now approaches. Be prepared.

About the author

Jim Pierce is Chairman of JLT Specialty USA, an insurance brokerage firm. He is a graduate of Kenyon College and the Program for Management Development at Harvard Business School. He began his insurance career at Johnson & Higgins, and then joined the marine and energy department of Marsh & McLennan, first serving offices in New York and London, and then moved to Houston to head the marine and energy group in the Southwest Region. Pierce joined Energy Insurance International in 1986. Following the acquisition of Energy Insurance by Aon in 1995, he rose to the position of managing director of Aon Natural Resources. In 2006, Pierce rejoined Marsh to lead its global marine and energy operations. This role was expanded in 2012 to include global responsibilities for that company's aviation, construction, energy, infrastructure, marine, power, and rail industry practices. Pierce joined JLT Specialty's US retail operation as its chairman in 2014.

© Theo Gottwald | Dreamstime