1 September 2011Re/insurance

Deepwater Horizon: one year on

Deepwater Horizon grabbed headlines around the world last year as BP and its partners struggled to contain the growing environmental catastrophe in the Gulf of Mexico, with events raising concerns about safety and emergency response measures on other offshore platforms. Insurance pricing spiked as a result and calls for additional capacity likewise followed rates upwards, and one year on, the aftershocks of Deepwater Horizon are still being felt by those insuring the energy sector, particularly offshore. As Robert Stauffer, president and chief executive officer of both Oil Casualty Insurance, Ltd. (OCIL) and Oil Insurance Limited (OIL) made clear, Deepwater Horizon resulted in a “real awakening—both at the board level and in the area of risk management”, which prompted the industry to approach operations and coverage differently “and for the better”. Matters have settled since the event, but the full ramifications of Deepwater Horizon continue to play out in terms adjustments to pricing and capacity, and a likely mandated political response.

Deepwater Horizon: among upward drivers

Addressing OCIL’s position following Deepwater Horizon, Jerry Rivers, senior vice president and chief operating officer of OCIL, said the event had a significant initial impact on liability pricing and coverage as the industry struggled to get to grips with the full ramifications of the accident. Following an uptick at the January 1 renewals, the industry has since seen a gradual increase in pricing across all liability lines, Rivers said, with the offshore E&P (exploration and production) sector experiencing the most significant increases of “anywhere between 15 and 40 percent, depending on risk characteristics and limits purchased”. In addition, most underwriters are now insisting on limits to scale for interest. Addressing OIL’s response to events in the Gulf of Mexico, George Hutchings, chief operating officer at OIL, said that due to its status as a mutual insurer for the energy sector, “we don’t see market forces in action”— with pricing instead being based on historic losses—adding that nevertheless the insurer had seen “an increase in interest in additional capacity and membership” in the light of recent conditions and the threat of possible mandatory coverage.

"Deepwater Horizon resulted in a real awakening-- both at the board level and in the area of risk management, which prompted the industry to approach operations and coverage differently and for the better."

However, Deepwater Horizon is not the only driver of rate increases, with the changing dynamic of the “supply and demand curve” also impacting pricing. Rivers said that a significant factor affecting this dynamic has been the increasingly proscriptive requirements set out by Lloyd’s performance management director, Tom Bolt, in the wake of the disaster, insisting in recent days that Lloyd’s syndicates cannot underwrite offshore energy liability business within package covers. This has led Lloyd’s underwriters to “trim back capacity”, Rivers said, with Bolt evidently concerned that London players may be holding potentially dangerous aggregations of risk. However, Stauffer questioned whether Bolt’s move was heavy-handed, stating that there is more “discipline in the energy market at present—at Lloyd’s in particular—than I have seen in the last 10 to 15 years”. It remains to be seen how Bolt’s demands will play out, but they appear likely to have an effect on capacity and pricing.

Whilst Lloyd’s underwriters draw back from the energy market in response to Bolt’s concerns, there has at the same time been a reduction in the number of players in the energy sector, with Rivers citing the departure of Bermuda-based Torus as a case in point. At the same time, there has been increasing interest from risk managers and the boards of directors of energy companies in additional capacity as they have sought to increase their limits, Rivers said. This has led to rising demand and falling capacity, and coupled with reinsurance pricing and terms pressure, is creating the conditions for further price rises.

Addressing the geographical impact of Deepwater Horizon, Rivers said that price rises had not been confined to the Gulf of Mexico, but that events had proved sufficient to affect pricing globally, with increases evident in geographies as disparate as Australia and the North Sea. The disaster, it would seem, proved to be a global game-changer.

Calls for capacity

Demand for capacity has likewise risen on the back of Deepwater Horizon, with Rivers noting that whilst OCIL has not increased its maximum limit of $100 million, it has selectively increased existing member limits. Hutchings likewise indicated that OIL members had been looking for additional capacity on the back of Deepwater Horizon and potentially increasing liabilities, with shareholder discussions regarding possible additional capacity due to take place in September. Hutchings added that in the case of OIL, its energy sector exposures weren’t all offshore, which could serve to lessen calls for additional capacity, although he said that offshore E&P exposure remains the major driver of calls for additional industry capacity. Returning to Deepwater Horizon, Hutchings said that the event had “raised the bar at the board level”, leading companies to question whether they have sufficient capacity to cover those risks they are exposed to. And such capacity concerns have not been confined to the offshore oil industry, with Hutchings citing a firm in the onshore chemical sector that felt compelled to re-examine its coverage and exposures in the face of insured losses from Deepwater Horizon. Concerns, it would seem, have extended beyond offshore E&P.

"If increased capacity is mandated, the question will be how it will be delivered, because there is only a finite amount of risk capacity."

With rates rising and capacity clipped by the departure of certain carriers and the caution of Lloyd’s, it would seem that now is the time for a possible play from potential entrants. As Rivers outlined, “from a liability perspective, I would be surprised if there weren’tsome opportunistic plays to deploy capacity”. He admitted that the “book of business is not for the faint of heart”—with cedants typically looking to long-term players to place liabilities—but added that opportunities nevertheless remain for those considering entry. However, the window of opportunity may be brief—“one thing that we have learned from seeing new capacity in the past is that hard market swings are often radical and short-lived”, Rivers added. Hardening isn’t necessarily sustained in the energy sector, he said, with customers often retaining higher limits, prompting pricing to rapidly fall and extended capacity to never be filled. Those considering the sector would do well to pay heed.

Political wrangling

Asked how the energy sector looks likely to develop going forward, Hutchings said that much depends on what happens at Lloyd’s and how the US and UK governments respond to the fallout from Deepwater Horizon. He said that the industry is waiting to hear what will be mandated by the UK and US governments in order that the sector can calculate what is required from a capacity point of view. He added that “if increased capacity is mandated, the question will be how it will be delivered, because there is only a finite amount of risk capacity”. Stauffer said that there was an expectation that modest increases in coverage would likely be mandated by the UK government, but that those numbers being proposed in the US are so high that “available capacity would be stretched to the nth degree in order to satisfy those limits”. He added that expectations on Capitol Hill had been raised by “markets advertising the deployment of billions of dollars of capacity” only for it to not materialise, creating the impression that significant, mandated coverage would be achievable. Stauffer said that due to present economic conditions, changes to mandated coverages had been put on the “back-burner for now” by Washington, although concerns relating to Deepwater Horizon are unlikely to go away, he said. Present capacity is “adequate for reasonable changes”, Stauffer said, the concern being that once Washington’s attention returns to offshore energy, its mandated demands may just prove excessive.

Another Deepwater Horizon

Significant lessons have been learnt from Deepwater Horizon, with firms in the Gulf of Mexico much chastened by events. Greater emphasis has been placed on safety measures and emergency response, with few energy companies keen to emulate BP. New measures should help to reduce the likelihood of another major event, but the unthinkable still remains within the realms of possibility. Touching upon the likely affect another Deepwater Horizon would have on the market, Rivers said it would “change the landscape fairly significantly and the politics would get even more heated”. Such an event would significantly “tighten up pricing and capacity”, but perhaps the more significant impact would be on mandated coverage, with such an event likely to act as a major driver of compulsory insurance.

Despite those ructions caused by Deepwater Horizon, it seems that the energy sector continues to enjoy the support and coverage of insurers such as OIL and OCIL. But matters are far from settled a year on, with moves by Lloyd’s and the UK and US governments yet to play out. It seems that these remain interesting times for the energy sector.

Additional capacity speaks volumes

Deepwater Horizon prompted a number of industry players to make moves to extend additional capacity on marine energy lines, with the Sudden Oil Spill Consortium one such organisation established in response to events. A joint venture between Aon Benfield, Guy Carpenter, Munich Re and Willis Re, the Consortium was established to “provide larger liability limit insurance coverage for deepwater drilling operations in US waters”. The intention was to build industry-wide capacity for the sector, which could then respond to future events. Although another Deepwater Horizon-type event has not materialised since the Consortium’s inception, there is evidently now the will and capacity to respond to such a disaster should it occur.

And provision of capacity has not only been restricted to the traditional reinsurance sector, with the latest venture being an insurance linked securities offering from US-based CatVest Petroleum, established in August of this year. The firm offers “pre-disaster risk financing techniques to manage and transfer” marine energy risk “from industry participants to capital markets investors”, providing the oil industry with a further outlet for risk transfer in a closely watched market. CatVest is not the first ILS provider to extend coverage to the marine energy sector, Avalon Re having provided a cat bond to OCIL, which was triggered back in 2010 following losses associated with Hurricane Katrina and the Buncefield oil depot fire.

Although the marine energy sector has been relatively quiet since Deepwater Horizon, it would seem that there is some additional appetite to fulfil demand, with ILS and more traditional insurance and reinsurance products available to provide a backstop of capacity to a potentially volatile sector. It remains to be seen whether potentially mandated coverage dictated by Washington—and to a lesser extent, London—will result in a spike in future demand. Once the threat of the current economic crisis has passed, such issues may yet rise up the political agenda. In the meantime, firms such as OCIL and OIL will predominate, with additional, latent capacity waiting in the wings.