Negative Outlook for Energy Insurers May Force Sector Exit: Willis Towers Watson

Energy insurers continue to feel the pressure caused by over-supply of capital and falling demand from buyers, which may lead them to exit or scale back their participation in the energy sector, according to a report published by Willis Towers Watson.

For the 10th year in a row, capacity has increased in both the upstream and downstream insurance markets, while in the wake of the oil price crash, an even greater challenge comes from falling buyer demand, said the Energy Market Review.

As energy companies seek to cut costs, they are reducing their program limits and self-insured retentions, the report explained, noting that in this climate, underwriters have to compete even more fiercely for the reduced pot of premium available.

“Faced with this predicament, insurers have had to choose between a strategy of retrenchment, waiting for a market upturn, as other eventually withdraw, or maximizing market share, in the hope that the premium income earned will be sufficient to enable them to continue to trade,” the review affirmed.

On face value, lower prices would appear to be good news for the beleaguered energy industry, said Neil Smith, Willis Towers Watson’s Global Product leader for Natural Resources.

He pointed out, however, that the energy insurance market “has provided a stable platform to enable the smooth transfer of risk in a predictable and manageable fashion.” As a result, Smith warned that there could be “negative consequences for all parties involved” if this balance is disrupted.

In such a business climate, there is an urgent need for product innovation in the sector. For example, the review said energy companies need help managing their growing environmental liabilities.

“Specialist insurance products can address this threat in part,” said Smith. “But the lessons of both Macondo and the recent mining disaster in Brazil suggest that more advanced risk transfer mechanisms, featuring limits in excess of what is offered by the conventional insurance market, are increasingly needed by the energy industry.”

(Smith was discussing the Deepwater Horizon oil spill of 2010, also known as the Macondo blowout, where 11 people died and an oil gusher poured into the Gulf of Mexico for 87 days. In November 2015, an iron-ore tailings dam burst in Brazil, which led to environmental damage and at least 17 deaths. The operation is owned by Samarco, a joint venture of BHP Billiton Ltd. and Vale SA).

“The Macondo well blowout in 2010 highlighted the potential for liability exposures running into tens of billions of dollars,” said the review. “Even liability losses from a seemingly modest loss such as a tank farm explosion can run to excess of $1 billion.”

While liability exposures are increasing, rates continue to drop – the net result of over-supply of capacity and reducing demand, the review continued.

Exiting Open-Market Liability Business

Willis Towers Watson said there is evidence that underwriters are “writing more intelligently and strategically, focusing on risk selection, reducing their line sizes where prices are getting “too thin” and starting to pull back from the unprofitable sectors.”

The reported pointed to the fact that three insurers, AXIS, Dual and Marketform, have pulled out of open market liability business. “[W]e expect to see market consolidation eventually act as a brake on capacity growth, albeit not this year.”

As a result of these harsh realities, even if the market did offer innovative, more user-friendly, wider and more responsive products, there would not necessarily be enough demand to sustain such products, the review affirmed. “[I]n all likelihood, the buyer would simply prefer the existing product at a cheaper price.”

Innovations in Alternative Risk Transfer

Nevertheless, alternative risk transfer (ART) is one area where innovation is commonplace, it noted.

These risk management solutions are now being actively considered by the energy industry in part because risk managers in the sector are confronted by emerging risks that are difficult to insure with traditional insurance solutions.

These risks arise from areas such as non-damage business interruption, environmental risk, climate related issues, reputational and cyber threats, all of which amount to billions of dollars of exposure, the report continued.

ART solutions can be “employed to provide more efficient structuring for traditionally insurable risks, to access deeper pools of risk capital or to provide capacity for otherwise uninsurable exposures, such as supply chain vulnerability, cyber, pandemic and brand/reputational risk,” the review confirmed.

“Key to the growth in the deployment of ART solutions is the ability to integrate traditional re/insurance products and capital market techniques with forms of self-funding, flexible multi-year, multi-line and multi-trigger products,” the report said.

Cyber Risk

Another risk that organisations in the energy sector are wrestling with is cyber. “Cyber risk is becoming more and more pervasive and threatens the core operations of energy companies,” said Peter Armstrong, executive director – Cyber, at Willis Towers Watson, who wrote for the review.

“Organizations have a fiduciary duty to understand and quantify their exposure and make appropriate provision for it,” he added. “However, most organisations are not including the quantification of their cyber exposure in the overall picture. This means that most organisations have unaddressed exposure on their balance sheets because of cyber vulnerabilities.”

Source: Willis Towers Watson