Insurance Capacity for Oil & Gas Is Plentiful but Contract Wording May Be Tricky

By Stephanie K. Jones | June 16, 2014

The insurance capacity is there to cover the risks associated with the current oil and gas boom in Texas and the nation, experts say, but agents and their customers should be vigilant in their efforts to understand the wording in coverage contracts.

As of April 17, Texas alone claimed 50 percent of all active land rigs in the nation, according to the Texas Railroad Commission, which regulates the industry in the state. The TRC reported that the average rig count in Texas was 882. In the previous 12 months, total reported produc­tion in the state was 744 million barrels of oil and 7.8 trillion cubic feet of natural gas. In February 2014, crude oil production in Texas averaged 2,002,070 barrels per day, compared with the 1,560,453 barrels daily average in February 2013.

Photo: Texas Department of Transportation

Photo: Texas Department of Transportation

A lot of the increase in production in Texas and elsewhere is largely technology driven, experts say.

“The energy industry has undergone a major transformation and it’s exciting times for agents, underwriters and risk managers,” said Anthony Carroll, executive vice president for marine, energy and construction at Aspen Specialty Insurance. “There are some serious challenges but the transformation is mostly driven by advances in technology over the past 10 years with shale gas bring­ing different opportunities to different facets of the energy market.”

Participating in a webinar on the energy market sponsored by Advisen and Aspen Specialty, Carroll said the expectation for 2014 is “another banner year for U.S. domes­tic energy production where … oil output could hit in the range of 8-and-a-half to 9 million barrels per day versus 7.8 million barrels last year.”

To put that amount into perspective, domestic production just five years ago was around 5 million barrels per day. The increase in production capability all comes from additional drilling techniques, he said.

Nationally, domestic gas production this year is expected to increase by 20 percent over five years ago, exceeding 25 trillion cubic feet, according to Carroll. Gas production in 2013 was at a record level and 2014 will be another record year, he said.

“This is all in the context of an expanding energy market and considerable expected investment not only now but in the next 25 years — to build out the energy capabilities in the U.S. and then expanding outside the U.S. as shale technology expands,” Carroll said.

This increased activity in the energy sector is bringing rash of opportunities for the risk management community, including underwriters and brokers, he said.

“We’ve got to get the gas out of the ground, we’ve got to move the gas, with new pipelines and transmission and storage facilities,” Carroll said.

Terminals that previously were used for importing oil and gas are now being transformed into export terminals. And the new supply of gas is creating demand for petrochemical facilities with an expected $700 billion in projects being brought to the market, he said.

No Shortage of Insurance Capacity

The insurance business seems to have plenty of capacity to handle the increased activity, according to Kurt Tentinger, managing director of Aon Energy in Houston.

“On the operational side [there’s] roughly $6 billion in what we call technical capacity,” said Tentinger, who also participated in the Advisen/Aspen Specialty energy webinar. That’s “the amount of capacity that everybody added together could bring to a given risk. In deployable capacity we see that number as closer to $3.1 to $4 billion.”

All-risk deployable capacity on the construction side is in the $6 billion range, Tentinger said. That figure doesn’t include natural catastrophe risks. For instance, there are constraints on capacity in the case of Atlantic named windstorm exposure, he said.

Business interruption and contingent business interruption are also areas in which there may be limits on capacity, Tentinger said. Capacity for those risks available to a given insured would be exposure driven.

While during the past 10 years the majority of capacity has come from the same traditional markets, new sources of capital now are contributing to the increase in available amounts.

“We’ve seen this number continue to rise with new entrants coming into the market,” Tentinger said. Capacity now is coming from a number of different sources, including reinsurance and other sources, such as cat bonds.

“Non-traditional reinsurance in the form of pension funds has had a dramatic impact over the last year or so. We also see capacity coming into the market via captives, insureds’ captives and … self-insured retentions to name a few,” Tentinger said.

On a corporate level, underwriters in the energy sector made a profit last year, Tentinger said. The upstream or exploration and production sector performed well, but both the midstream business — the pipelines and transportation — and the downstream business have suffered since 2011 from consistent attritional losses and a few large losses, he said.

However, even with losses in the mid-and downstream businesses, underwriters don’t expect capacity to go away any time soon. Tentinger said he recently met with an underwriter who told him “it would probably take a meteorite to make things move. I don’t think I would go quite that extreme. … But from a macro perspective it would take a large event … an earthquake, a financial crisis or something to that extent. There are some people that would say even an earthquake wouldn’t do it just based on recent experience. But I’m not so sure I would agree with that either.”

“There is definitely a lot of capital and capacity,” Thomas Blanquez, an energy risk specialist with San Antonio-based insurance wholesaler Quirk & Co., told Insurance Journal. “The shale gas boom has really caught the attention of a lot of folks. If your contractor book is down, your apartment book isn’t performing well, so on and so forth, you have new players coming in saying, ‘let’s go write oil and gas business — that seems to be a steady flow of business.’”

But excess capacity may not always be a good thing, according to Blanquez. He said that at the end of 2013 and even into the beginning of 2014, “every carrier had marching orders to get renewal increases, get rate increases, and we were selling it.

“But I’d say over the last couple of months the rates have started to go back down to early 2012, late 2011 levels. The rates are depressed, obviously, and you have folks with capacity that are kind of throwing that around.”

Words Matter

In order to effectively manage the risk in the energy sector, or any other line of business for that matter, it’s important to know what is in the insurance contract and what it is trying to achieve, said Costantino Suriano, a partner with the law firm Mound Cotton Wollan & Greengrass.

“I get involved when there’s a problem or in trying to avoid a problem. … We don’t get into pricing or anything like that but we do convey to our clients that words do matter. And the courts sometimes come up with views of what the words mean that is totally outside of what anybody expected,” said Suriano, another participant in the Advisen webinar.

“Things happen that cause major disruptions. Therefore there’s an analysis after the event of — ‘Wow did I buy the right thing? Do I have enough cover? Do I have too much cover?’ The courts are not the best place to get these things resolved,” he said.

Suriano said he thinks courts often don’t understand the consequences of their decisions. But, he added, “on the other hand if we can’t agree to what words mean the resulting litigation has no consequences.”

Suriano’s advice to risk managers and brokers and insurers? “Try to understand what’s going on in the policy that you’re procuring.”

Quirk & Co.’s Blanquez said he often sees problems in policy language for both pollution risks and additional insureds, especially regarding sole negligence.

With “pollution, you have to be careful because everybody has a different coverage trigger — is completed ops included, is it not included? Do you have first party/third party coverages included in that? There are some critical issues there,” Blanquez said.

When it comes to “risk transfer and the additional insured status, I think many insureds don’t understand that within the standard ISO forms, unless there is a company promulgated form where they’ve agreed to accept sole negligence, then you could find yourself in a bit of a pickle if your carrier is asked to provide a defense or indemnification for an act that you are not responsible in whole or in part for. … There is a gap,” he said.

Other areas to look at carefully, according to Suriano, include sublimits and their application, stacking, and business interruption and contingent business interruption.

For example, when it comes to physical damage to a supplier or a supplier of a supplier, “these provisions should be looked at real hard by underwriters and risk managers to see if the business model matches what is being proposed in the wording,” Suriano said.

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