The shadow of past losses (marine)

As Dieter Berg, senior executive manager, marine at Munich Re indicated, some recent increases achieved on reinsurance rates have reflected the “‘unprecedented’ losses during the last couple of years”—Deepwater Horizon, Gryphon Alpha and Rena, which have amounted to hundreds of millions of dollars in losses—but market losses are not always reflected on the line. “A huge portion of recent losses were passed on to the reinsurance market,” said Berg, adding that Munich Re expects “development towards risk adequate pricing to continue” in reinsurance, but that “by contrast, price development in the primary insurance market is still predominantly flat”.

Felix Vogler, head of marine and energy at Arch Re, said that major losses such as “West Atlas, Deepwater Horizon and Gryphon Alpha have taken billions of dollars out of the energy market in recent years and reinsurers have picked up the majority of the claims”. Citing the gas leak on the Elgin platform earlier this year, Vogler said that if a major incident had occurred it “could have taken a further $7.5 billion of market premium easily”. The threat posed by potential losses from events such as Elgin “should have proved an eye-opener for risk managers as regards the kind of exposures we are dealing with in this class of business. While the reinsurance market is there to cover such catastrophic events, we need to ensure that we are charging the correct price for the exposures we take on”.

Jerry Rivers, senior vice president and chief operating officer at OCIL, gave a rather different picture of the pricing environment, indicating that for OCIL—which is predominantly an insurer— “pricing in the energy insurance market is experiencing its third year of increases in exploration and production, pipelines and integrated oil. But for new business coming into the market, capacity is tight”.

"Underwriters have to maintain full transparency regarding potential clash scenarios on property losses and liability losses, as well as connected coverages."

James Summers, head of global marine and energy at Guy Carpenter, predicted that the pricing environment for reinsurers would remain largely flat. He indicated that recent major losses such as Deepwater Horizon had by now “been priced into the market”, although he did indicate that stress points will remain around the retention levels of primary insurers. “Reinsurers don’t really want to be paying losses below $200 to 300 million in original values, so what they are trying to do is price themselves out of those areas, ensuring that primary markets are writing sensibly and that losses kick in at a higher retention level.” He said that the major issue for reinsurers was the prospect of their paying for significant levels of attritional losses. “Insurers need to take on more of the risk themselves and instil greater integrity over the lines they are writing,” said Summers. This would help to reduce exposures and involve reinsurers only in major events—something that, Summers said, should really be their focus.

Vogler said that “values and exposures in the energy market have constantly increased in the last decade”, with little sign of this upward development abating. “Thus far, the re/insurance market has reacted by making more capacity available whenever it was necessary, but this cannot be sustained forever.” In the face of rising exposures and asset values, “underwriters will have to focus their attention ever more closely on getting the right price for the exposure they are taking on”, said Vogler.

“With a client base that, to a large extent, is financially strong and therefore able to retain a substantial amount of exposure themselves, the ability to charge risk adequate premiums is not an easy one for reinsurance underwriters”, said Vogler. “If insurers see rates increase beyond a certain point, they may opt to self-insure, thereby taking additional premium out of an already relatively small market. It is a fine line between charging the right price and making sure the clients continue to buy”, he said.

Vogler concluded that the industry needs to pay close attention to the pricing environment. “The energy reinsurance market has made significant efforts in recent years to achieve a rating level that allows the industry to offer a sustainable product and, I believe, with a certain success.”

Lessons from Deepwater

Those who—like Vogler—are cautioning against over-exposure need only consider the implications of Deepwater Horizon. The 2009 event was a cautionary tale for the sector and its effects have been lasting. As Berg indicated, Deepwater Horizon was an “eye-opener for risk managers and insurers with regard to the increasing liability exposures in allareas where environmental issues are concerned”. The event halted what had been sliding pricing in the marine energy sector, said Vogler, and encouraged more players to “buy more operators’ extra expense cover”. Rivers said that OCIL likewise experienced rising demand for higher limits in the face of the Gulf of Mexico losses, particularly in the face of shrinking coverage from London and Bermuda as those markets gave energy liabilities a wide berth.

However, despite suggestions that the event might prompt the US government to introduce mandatory liability coverage for the sector, political attention shifted away from the Gulf of Mexico incident and the idea of imposing mandatory coverage was shelved. Reinsurers did express interest at the time in the potential of providing mandatory coverage, with a number of significant markets making known their intention to extend capacity, but Washington never proceeded with the idea. Nevertheless, as Berg made clear, “the public and local governments react extremely sensitively to any threat of damage to the maritime environment”. He added that the industry faces a similar—if less severe—incident following the grounding of the Rena on a reef off New Zealand, “for which the costs for wreck removal and other liabilities now exceed more than $300 million”. Recent events have encouraged a “strong trend towards purchasing higher liability insurance limits”, said Berg, with the energy sector keen to re/insure its exposures.

Mandatory preparations

Despite mandatory coverage—particularly as it relates to environmental liability—not in the end materialising following Deepwater Horizon, it is apparent that the political will to introduce such measures may yet return. Rivers said that interest had died away in the face of an election year—the Obama administration’s attention evidently piqued by the rise of Romney—but Washington’s appetite for mandatory coverage could yet re-emerge. Vogler said that should another incident like Deepwater Horizon occur the potential for a renewed push for mandatory coverage for offshore energy would be significant. He said that from a re/insurance standpoint “any coverage that is mandatory can be an interesting product, depending on the structure and pricing”. He added that it remains unclear how such a market might develop—whether governments would step in to control pricing or whether a specialist market would be created—indicating that there are a “number of options that need to be considered should mandatory cover be put in place”.

Bolted shut

Washington wasn’t alone in considering responses to events in the Gulf of Mexico. At Lloyd’s, Tom Bolt’s office of performance management responded to Deepwater Horizon by restricting marine energy underwriting at Lloyd’s. The move “reduced limits offered on individual risks as a method of reducing aggregated exposures to cat events”, said Rivers, as Bolt sought to navigate around the danger posed by a future sizable loss. This raised some concerns that capacity would be constrained, but as Berg outlined, the move was a sensible one from Bolt. “It is very important to monitor the aggregates of offshore energy exposures better,” said Berg. “Underwriters have to maintain full transparency regarding potential clash scenarios on property losses and liability losses, as well as connected coverages. For offshore energy projects in particular, we are witnessing an enormous aggregation of values.”

Berg cited the example of rescue operations off the Elgin platform in the North Sea early in 2012 following a gas leak, which led to supporting mobile platforms being towed into place. He said that this had led to aggregate insured values in excess of $7.5 billion being exposed to the potential threat of a gas explosion—a figure that is multiples of the level of premium in the sector. Such incidents suggest that Bolt was right to be concerned about potentially dangerous aggregation on the line.

The other element of Bolt’s initiative was a desire to unpackage those insurance products extended to the offshore energy sector. “Lloyd’s office of performance management stressed the importance of a clear division of coverage into physical damage per risk, natural catastrophe and liability coverage,” said Berg. “This is fundamental to achieving transparency and a precondition for calculating an adequate price for each product, with individual coverage underwritten and priced on a stand-alone basis.” The necessity of such an approach was stated loud and clear by Bolt, he said, with the initiative made clear to both Lloyd’s and the international energy markets.

Vogler added that Bolt’s initiative had been a “good thing for the sector, helping to focus industry attention and ensuring the quality of underwriting”. He said that the main focus of Bolt’s concern had been “how energy liability is priced and underwritten and how limits were being dealt with by the sector”. Vogler indicated that on the liability side there is a real danger of accumulated losses, adding that Bolt’s edicts on the matter had helped the Lloyd’s market keep a tight rein on marine energy underwriters and had ensured they “don’t overexpose themselves, knowingly or unknowingly”.

It will be interesting to see how rates develop on line for marine energy. Despite calls for price rises, it seems likely that only a major event will turn the market, suggesting another flat renewals season ahead for reinsurers. The question will be whether a future major incident will find the industry pricing somewhat short of where it should be. Only time and significant losses will tell.