For O&G operators, contracts and coverages go hand in hand

(Editor’s note: This is the third article in a series of five addressing risk management for oil and gas operators. The first article appeared in the Aug. 22, 2005, issue of the West region edition on page 66. The second article appeared in the Dec. 5, 2005, issue of the West region edition on page 138. Both articles can be viewed at www.insurancejournal.com.)

When discussing insurance coverages for oil and gas (O&G) operators, the terms that really should be employed are “contracts and coverages.” It is nearly impossible to separate the two — they go hand in hand.

The basic coverages for operators working over land only are relatively simple. Still, it is essential for brokers to read the operator’s contracts along with the coverages and understand how they fit together. If wet exposures are involved — anything from having to build an oyster shell pad for the rig in a marshy state lease to actually drilling in the Federal Lease Blocks — the insurance becomes more complicated and expensive.

Coverage types
Many different types of insurance coverages address the various exposures faced by O&G operators, and those policies can be more involved than they at first seem. The first, and most used, is the Commercial General Liability (CGL) insurance policy. That covers liability for bodily injury and property damage to third parties.

O&G operators commonly get hit with claims from the employees of a contractor, such as a drilling or well service. Typically, the contractor’s employee gets hurt at the well site, makes a claim for workers’ compensation, and then sues the operator for “not furnishing a safe place to work.”

Before the CGL responds to such a claim, it is important to first look at the contract — either a drilling contract or a Master Service Agreement–to ensure that there is a mutual hold harmless agreement (a “knock for knock” clause) making each employer liable for injury to his employee, regardless of fault. If so, the claim is passed to the other party. If there is no mutual hold harmless, the operator’s policy will respond. Study the Anti-Indemnity Acts of Texas, Louisiana, New Mexico and Wyoming to see how the “knock for knock” works, or doesn’t work.

The broker should check the CGL to make sure it has the Underground Resources and Equipment Coverage endorsement covering damage to adjacent reservoirs and to water tables, etc. Read the endorsement carefully to be certain it works as intended.

The policy will exclude the cost to control a wild well, or blowout, but make certain that it does not exclude property damage caused by a blowout or by explosion.

The CGL will usually provide Sudden and Accidental Pollution Liability. Be careful of the discovery period — the period of time allowed to discover the loss. A separate policy that includes gradual coverage also can be purchased, and it is usually written on a claims-made basis.

The policy should have an Automatic Waiver of Subrogation if Required by Contract endorsement; Additional insured where required by contract endorsement; Cross liability (either included in the coverage or endorsed on) and other minor endorsements. Read all of them carefully.

Automobile insurance is required and is written in the standard manner. Make certain there is coverage for hired and non-owned autos.

Workers’ compensation and employers liability for land operations is standard fare. If, however, if there is wet exposure make certain U.S. Longshoremen and Harbor Workers Act coverage is in place, and if there is maritime exposure, make sure there are coverages extended to that exposure, as well.

Of course, there should be an umbrella policy covering the liability in excess of the limits carried in the preceding policies. Make certain that there are no exclusions or wording that will inhibit the policy from being a true excess: Check all definitions. Watch the coverage for maritime exposures and for “Action-Over” claims. Action-Over claims are those made by the contractor’s employee against the operator).

The largest exposure for O&G operators in terms of severity is covered by the Control of Well policy. It consists of three major parts: Coverage for expenses in controlling a well that has gotten out of control; redrilling or restoring the well to the depth at which control was lost; and liability for pollution damage caused by such loss of control.

There is one not-quite-as-major addition: A sub-limit for damage to property in the Care, Custody and Control of the operator, or for which he has contractually agreed to be responsible, e.g., the drill string. Study the Sound Location clause in the International Association of Drilling Contractors (IADC) contract, and compare it to the policy. Be aware that there are several endorsements that broaden the coverage, e.g., damage to the hole caused by damage to the drilling rig.

There are six or seven underwriters that write that coverage. The policies are basically the same, but there are subtle differences that can mean a gigantic difference in a specific claim, so they should be read carefully.

With the coverages, any operator that has wet operations will want to cover the platforms and the business interruption (called loss of production income or LOPI) exposures. At the current state of the market, due to Hurricane Katrina, et al., the cost of those two coverages has increased tenfold over five years ago. It is increasingly difficult to write coverage as broad as was possible pre-Katrina.

Usually the Control of Well, Platform and LOPI, as well as some ancillary coverages are written in a package policy. These ancillary coverages include Charterers Legal Liability, i.e., protection for damage done by a chartered vessel, such as a work barge, and for damage to the vessel. Once again, read the Charter Agreement and the policy to determine the breadth of the exposure and the coverage.

If the operator owns any vessels or has a long-term charter that requires he provide coverage, then Protection and Indemnity and Hull and Machinery must be carried.

What to watch for
As with any risk, there are common problems that may arise in the provision of coverage for O&G operators. Among those that can, and often do, occur, and for which the broker should be on the lookout are:

The IADC Drilling Contract makes the operator responsible for damage to the rig caused by subsurface conditions, such as a crater that engulfs the rig. The Care, Custody and Control portion of the Control of Well policy may cover such a loss, but even so, is the limit enough to cover a $5 million or more rig?

Even if the contract is a pre-2003 form and the operator is responsible for loss in excess of the insurance carried, the contractor’s insurance can still subrogate the loss back to the operator, because the contractor has not indemnified him for the loss, only promised to use insurance first, with no mention of subrogation.

Non-Operating Working Interest Owners are often included, either intentionally or unknowingly, in the operator’s umbrella policy, a situation that dilutes the amount available for the operator.

The joint operating agreement makes the operator responsible for the entire loss if he is grossly negligent. The CGL will respond regardless of the type of negligence, but the Control of Well may not pay the Non-Operating Working Interest Owners’ part. Read the Control of Well policy very carefully.

If the operator is not grossly negligent for the loss, but the loss exceeds the limit of the insurance purchased, who pays for the loss?

New Mexico and Wyoming Law do not allow indemnity for the contractor’s own negligence. The “knock for knock” is unenforceable, almost. Contracts under Texas and Louisiana law permit it, if written correctly.

The operator is responsible for environmental damage to the rig, e.g., a blowout covers the rig with H2S cut mud causing a clean up of $500,000 (actual case). Both the CGL and the Control of Well exclude such a loss.

The operator’s CGL has an “additional insured if required by contract endorsement.” Does it actually add the indemnitee if he is negligent?

Even with mutual indemnifications in the drilling contract and the master service agreements, what happens if the drilling contractor’s employee is injured severely and brings a large claim against operator and his subs? The subs pass the lawsuits to the operator, who hands it to the drilling contractor, but what if the indemnification is only for $1 million?

How do you know for certain that the contractor’s CGL will cover “Action Over” claims?

With the above descriptions of claims that can happen and the admonition that one must not only read the policies carefully but also compare them to the contracts, it’s clear that the broker’s job is much more than just “handling insurance.”

Robert L. Carson, Jr. is vice president in the Energy Division of Ft. Worth, Texas-based Higginbotham & Associates. He also serves as an insurance consulting and an expert witness. His expertise is in oil field contracts, well control and liability coverages. He is the author of the novel “Blowout.” Carson is currently at work on a new book, “PRIMER,” an acronym for Petroleum Risk and Insurance Management Educational Resource.