Insurers Refute Oil Spill Rumors, Prepare for Consequences

The oil well may have been capped, but the fallout from the Deepwater Horizon spill is far from over for the offshore energy and insurance industry. However, as of right now, rates and capacity in the insurance marketplace have not been as affected by the spill as much as people have been led to believe, according to Marsh’s recent “Energy Monitor” report.

“We think there is a disconnect between the sentiments in the underwriting market and the reality of the underwriting market,” says Jim Pierce, chairman of Marsh Inc.’s Global Energy Practice. “The sentiments have hardened considerably since the incident but the reality is that while this was a tragic loss, it was not a catastrophic loss to the upstream marketplace.”

Pierce says other major events have occurred in the last five years that are considered catastrophic because they made an impact both on the insurance marketplace and on a human scale, such as Hurricane’s Katrina, Ike and Rita.

Marsh’s findings came about because the company has still been able to secure discounts for some of its upstream energy prospects and wanted to put that information into the marketplace.

“Clearly the sentiment has hardened towards this market and that can become similar to a self-fulfilling prophecy,” says Pierce. “As the sentiment hardens, our job is to make sure that the sentiment doesn’t become a self-fulfilling prophecy so we inject logic into the process so risks can be differentiated from each other. There are different risk exposures in the offshore energy sector and you can’t paint them all with the same brush.”

Another sign that the fallout from Deepwater Horizon may not be affecting rates or capacity as much as originally thought comes from Chartis, which just announced it is increasing underwriting capacity for the Oil Rig unit of its Global Marine and Energy Division from $150 million to $200 million.

Dorian Grey, president of Chartis’ Oil Rig unit, says that the plan to increase capacity was put into motion before the Deepwater Horizon event and the company was still comfortable with making this change after.

“The increase in our capacity is really related more to the fact that the value of offshore platforms, drilling rigs and other assets have been increasing very significantly over the last two to three years,” says Grey. “This is to provide our brokers and policyholders with a viable and reliable market, not specifically in response to the Deepwater Horizon event.”

Grey says that rates for offshore energy risks dropped 5 percent in the month before the spill because of the quiet hurricane year in 2009 and that was part of a natural course since they had been so high after Hurricanes Ike, Katrina and Rita. After the Deepwater Horizon spill, everything in the market froze up and policyholders asked insurers to put their renewals on hold until the market got itself together.

“Since then, however, the market has smoothed out,” Grey says. “Rates have gone up but we look at things on a case by case basis.”

Pierce agrees that this market is changing because of this incident but the fallout is still being determined.

“There has undoubtedly been a hardening to Gulf Stream risks and scrutiny on deepwater drilling risks, but it has not hardened across the board,” says Pierce. “It is too early to tell how the reinsurance market is going to treat the 2011 fiscal year. The fourth quarter of 2010 we will be watching very closely to see how underwriters negotiate. This will be a leading indicator for what we expect for 2011—it is a work in progress.”

Changes in the Offshore Energy Market, So Far

Even though insurance rates have not hardened to the extent that was expected just yet, the insurance marketplace has started to change because of the Deepwater incident to a very serious degree, say underwriters. The offshore energy segment has already begun to see increased scrutiny on offshore energy risks and more regulations are next, which will no doubt change the way this risk is underwritten and priced.

“The regulations are definitely going to play a part in how the insurance industry reacts going forward,” says Grey. “And I think of course it’s going to increase the cost for drilling companies and operators. The impact of this is yet to be fully understood but everything points to it being a more challenging operating environment for operators and drilling companies and certainly for insurers it will bring more opportunities and challenges.”

Grey says any new legislation and regulations will likely mean operators will need to buy higher limits for liability coverage and control of well coverage. Chartis has already received requests from clients for higher limits for these exposures, as well as inquiries as to whether or not their liability limits are adequate.

The Deepwater Horizon incident has opened the eyes of insurers and insureds, and underwriters agree that this event will change the way this class is insured and operated.

Before this event, insurers generally accepted that drillers and operators were functioning within the limits of technology and had an understanding of what could happen. As it turns out, the risk is much greater and there is more to take into consideration than insurers previously thought.

“I think that this event clearly marks a turning point in several areas,” says Grey. “Certainly for us as insurers it highlighted that we need to have a better understanding of deepwater drilling than we did. There was a tendency prior to this for deepwater risks to be considered preferable to shallow water in the Gulf of Mexico. Underwriters were more concerned at the time with windstorm. Now I think whether its deepwater drilling in the Gulf of Mexico or off the coast of Brazil, insurers are more aware that technology was under strain at these depths.”

“The issue at hand is that the deepwater loss brought into focus for a segment of the underwriting community the fact that underwriting an exploration and production company, a drilling contractor, or an energy manufacturing and energy service company could position an underwriter to be involved in one loss at multiple angles,” says Pierce. “Sometimes it takes a very large loss to focus attention on the aggregate exposures that come from one incident.”