International Risk Management
International Risk Management FINA 4355
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Energy Market Review Changing Pr en j es December 2006 Willis Hum hEWmstvvmdsmW Wax an mum bum the enemy and me mltuvanm mdusnws In this issue Changing priorities While the absence of major losses this year has brought some much needed stability to the energy insurance market there are now signs of changing priorities within both the buyer and supplier communities The drift from commercial insurance Generally buyers of energy insurance continue to value the commerCial insurance market although self insurance captives and mutuals are noW often regarded as equally important risk management tools Furthermore buyers priorities are changing as they look towards retaining more risk towards maximising alternative sources of protection for their exposures and towards finding new ways of managing risks Which have either been traditionally uninsurable or have now become increasingly expensive to insure The longterm Buyers also believe that the insurance market could do more to offer a longerterm commitment to its clients in order to proVide a less volatile priCing enVironment They also want the market to proVide them Wit speCific products tailored totheir own indiVidual requirements delivered in a more effiCient manner Protecting market share Insurers priorities are also changing and the early part of 2006 was spent reassessing their commitments to this sector in the light of further underwriting limitations and other corrective measures However folloWing the benign hurricane season they are now seeking to protect What has rapidly become a highly profitable portfolio Com petition is therefore espeCially being generated for those programmes that do not test current market capaCity and are located in regions free from natural catastrophe risk Introducing sidecars Increased capaCity notably from Bermuda and in the form of reinsurance quotsidecarsquot Will eventually find its way into the energy insurance market in 2007 either directly or indirectly This may be partially offset by recent mergers and Withdrawals Retaining Gulf Wind risk IVIore Gulf of Mexico Windstorm capaCity may be available in 2007 for approximatelythe same premium spend as in 2006 as neW vehicles such as CV Starr and Argenta join the market Howeverthis capaCity is essentially reinsurancedriven and still very scarce in relative terms compared to the preKatrinaRita enVironment We foresee clients realigning their own requirements haVing had a year to come to terms With the new price enVironment Signs of softening Away from the catastrophe arena and Where market capaCity remains unthreatened the combined pressure of increased capaCities reduced demand from buyers and strong profitability ratios suggest a general softening of rates in 2007 Most underwriters Will be caught in the classic dilemma hoW to satisfy increased premium income demands from their management While maintaining current rating levels Restricted leadership NotWithstanding this the current lack of alternatives to the recognised panel of market leaders for energy business might serve to act as a brake on this process Developments at OIL Despite all its difficulties and the recent Withdrawal of nine companies the majority ofthe membership of OIL look set to continue to support the industry mutualWith a proposal to differentiateAtlantic Named Windstorm exposure likely to be endorsed at its March 2007 AGIVI However we believethe premium quotpoolquot Within OIL may decrease further in the future leading to increased loss volality Willis Energy Market Review December2006 1 Contents Foreword 7 PnrHrp EHrs CnarrmanWrHrs Energy 5 Introd uctron U1 8 Cnangrng Prrorrtres rn Energy Industry Rrsk Management N Upstream Property 18 Downstream Property 24 Lrabrrrty 29 Rernsurance 33 Power and UtrHtres 35 OnsnoreConstructron 36 Terrorrsm 38 Drrectors and Offrcers Lrabrrrty b 0 Condudrng Feature tne Outrook for OIL g 1 Energy Market News 5 8 WrHrs Grobar EnergyApporntments 2006 Willis Energy Market Rev39rew December2006 3 Foreword resolving the disconnects in the energy insurance market 4 Willis Energy Market Review December 2006 The big quotdisconnectsquot that afflict the energy insurance sector will give us plenty to do in 2007 and for years to come First the demand on our industry to deliver financial reports in quarters and calendar years is not connected to the nature of the risks that our clients are managingA fine illustration of this is wind related risk the insurance market has just experienced possibly the best loss year on record after the worst in its history and its best minds and finest predictive tools foresaw neither of them in advance Yet the market writes poliCies that can sometimes be little morethan quotpuntsquot each year and prices them as such The nature of Wind losses can be best understood over multiyear cycles but to date the insurance industry has had little to offer by way of either multi year products or priCing So as you will see in this reVieW our clients increasingly use other tools Which are at their disposal tools Which to them are of equal significance tothose prOVided by our industry A second disconnect is the way the market develops a price for an insurance product that does not always reflectthe quality ofthe risk being underwritten However this gap is closing due to the increasing appetite of insurers for information that adequately captures the risk profile of a client a technology or a location Much remains to do to completely close the gap but clients With good loss histories andor lowerrisk technologies and locations are demanding that they be valued differently from those Without those qualities For the latter clients wakeup time is coming Another disconnect is the client appetite for alternatives to commerCial insurance and the eVident price ofthese alternatives Mutuality is under threat after the most catastrophic loss in OIL s history At the time of writing nine members have elected to eXit and more are eying this option in the coming halfyear This is of course linked to differentiation of risk Which ought to be the huge strength ofthe commerCial market Hence our challenge and enormous opportunity g0ing forward to rapidly innovate price and offer products and serVices Which reflect and transfer the risks our clients truly face On the one hand this is quotmotherhoodquot our raison d etre But the rise of alternatives to our quotoffersquot should call us to neW forms of action Mutuals Captives and Enterprise Risk Management are gaining in share of minds and wallets 7 and it is our iob as brokers to ensure that this mix is enriched With improved insurance products and services Wherever possible We re full of good ideas as an industry but we lack the process dialogue and leadership at this pOint to act on the best oftheseWillis Energy is committed to working With clients carriers and indeed other brokers to regain the initiative Phillip Ellis Chaiiman Willis Energy Introduction And here iS the weather forecast 1e 2006 Hurricane Season Weii the insurance worid waited and watched 199571005 1006 1006 and w 39 Threatened Average Forecasts Actual with dire warnings about the nature oi the 2006 W North Atiantic hurricane season the quot quot Hurr tamkam 5 3395 6m 5 the Nationai Hurricane Predictor website irom insurers Ma m HW EEHES m 3 5 4 3 6 2 in Lon on C nei ou iy r 4 4 in Juiy continued hopeiuiiythroughoutAugust and hyinrecasters iinaiiytaiied oii with an aimost disbeiieving sense oi reiiei at the end oi October quotThere are currentiy no tropicai cyciones atthistime ior the North Atiantic region read the caption on the NHP website day aiter Driuses excuse5 day and when iour maior storms did iinaiiy materiaiise veered northwards heading iorthe vast emptiness oi embarrassment quotexpertsquot are now oiiering various the midrAtiantic ratherthan the energy instaiiations expianations ior this unexpected ii iortuitous outcome and driiiing rigs oi the Guii oi Mexico Initiai reports suggest that possibie causes inciude originaiiy anticipated dust ciouds over the Sahara a higher wind shear over the western tropicai Atiantic d the rapid onset oi an unexpected Ei Nino in the n Eastern midrPaciiic during August and September A bumper year Whatever the underiying reasons it is now saie to say 3 I reiated energy iosses in 2006 there wasaiso very iittie evidence oi any other iosses that wouid in any way seriousiy impact market conditions Oniy Hurricane Aiberto threatened the Guii oi Mexico in 2006 7 and produced nn discernabie damage 0 energy i Source Unisys Introduction continued Worldwide energy losses 1990 2006 above US1 million upstreamdownstream UOllll l fl Loxxexexcexx USrm Exnmated Worldwrde Premium U59 UOllll lK 0 00 l990 l99l l99Z l993 l994 l995 l996 l997 l998 l999 Z000 Z00l ZO0Z Z003 Z004 Z005 Z00639t0date Souvoe WllllS Energy lo DatabaseWilli Estimates The extraordrnar y r ecordbreakrng loss year of 2005 rs lrkely to be followed by one ofthe best rn recent trmes 7 at a trme when premrum levels rn the commercral market are at an alltrme hrgh Desprte some recent loss actrvrty rn the downstream sector the market finds itself in a similar srtuation to 2002 when theturmorl caused by the P36 platform srnkrng the serres of US refrnery explosrons and the events of September 11 were followed by one ofthe most benrgn energy loss years on record So rn this editron oftheerlrs Energy Market Review we wrll be focussrng not so much on natural catastrophe losses but on howthe prrorrtres ofthe market 7 and rts customer basei mrght be changrng grven the very drfferent tradrng atmosphere to that of twelve months ago 6 Willis Energy Market Review December 2006 There can be lrttle doubt that rn 2007 energy rnsurers wrll be gearing up to take advantage ofthe current posrtrve market envrronment From the supply srde we can confrdently predrctthat capacrty levels and market appetrte for most lrnes of energy busrness wrll generally be greater rn 2007 than rn 2006 What risk managers really want But what ofthe demand side Can the market continue to expect buyers to value their current insurance products and servrces sufficiently to keep their order books flowrng in today s conditions To find out more about how the energy industry s current View of the most significant risks that it faces we asked a panel of eight risk managers a series of questions designed to capture their own vrews on their organisation s approach to risk management and how they feel the commercial market fits into their thinking As usual a round up of each market sector is also proVided showrng recent developments recent changes in rates deductibles coverage and capacity as well as changes in underwriter personnel and the overall outlook for 2007 We then focus on the recent developments at OIL and howthe mutual is rising to the very serious challenges posed by its 2005 underwriting losses We hope you enjoythis edition ofthe Willis Energy Market ReView and if you have any questions or queries regarding its contents please let us know Selected Insurer month results 200506 Reinsurer Net IncomeProfit Net IncomeProfit 1st 9 months 2006 1st 9 Months 2005 5m 5m Ace 1600 792 Alllanz 8696 6034 AWAC 31 5 148 AlG 10600 10003 Axis 645 143 Berkshire Hathaway 7430 3400 Endurance 299 171 Everest Re 635 57 lPC 287 549 Liberty Mutual 1170 773 Munich Re 3670 1780 Platinum 244 35 SCOR 199W 106W W R Berkley Corp 502 378 White Mountains 377 80 1280 440 All figures rounded to nearest USSm EuroDollar ROE EURl US128166 Sources Company Websites What a difference a year makes With the exception ofAIG all the insurers listed above have announced significantly enhanced figures for the first nine months of 2006 and several have turned last year s deficits into substantial profits We expect an even greater disparity in Lloyd s syndicate results when they are published as Lloyd s energy portfolio has a pronounced upstream bias Willis Energy Market Review December 2006 7 Changing Priorities in Energy Industry Risk Management Company Response During the autumn of 2006Willis Energy invited eight senior risk managers from some of the most reputable organisations in the energy industry to respond to a series of questions These were designed to show the respondents39 current attitude towards risk and their specific risk management concerns as well as the role of both the commercial insurance market and insurance brokers in their thinking The results obtained from the respondents are summarised below It should be pointed out that generallythese companies represent the more sophisticated end ofthe risk management spectrum and so we do not claim that their answers Will be relevant to all buyers of energy insurance However they do perhaps provide some insight into some ofthe mayor factors shaping the deCisions of senior people responsible for risk Within the industry Willis Energy would like to take this opportunity to thank the respondents for taking part in the survey To what extent has your organisation39s risk management priorities changed during the course of the last ve years 4 3 l I 0 A B C D E E G H 8 Willis Energy Market Review December 2006 Respondent Companies Petroplus Hess Corp MOL Question 1 Changing Priorities see chart below The panel responses shthhat the risk management priorities ofthe respondents have changed and in the majority of cases significantly 0 The Chief Financial Officer is now playing a dramatically more important role in risk management deCisions than in the past Which shows hthhe traditional risk management role has evolved into a process Which is now generally regarded as a vital part of an organisation s overal management philosophy The respondents also Cited a more holistic approach to risk managementThe risk management function is now increasingly seen as the responsibility ofthe entire organisation as well as being an integral part of its culture 7 one respondent indicated thatthe new culture is now offiCially embedded in the company s five year business plan Risk Managers are increasingly liaising With HSE departments There is generally a much greater awareness of health and safety Within energy companies employees are encouraged to take Not at all Comprehensively personal responsibility for preventing accidents and swrftly shutting down operations where faults have developed Furthermore increased liaison and convergence wrth HSE departments has allowed more accurate risk assessments to be established 0 Respondents now have a greater involvement earlier in the life of maior proiects and closer involvement With the company s legal and commercial departments 0 Amongst the larger energy companies there iS an increased focus on the development of selfinsured retentions and the use of captive insurance companies 0 There is also no doubt that changes in the regulatory envrronment have had a profound effect on risk management strategies wrth corresponding increase in focus on risk reduction techniques and a greater awareness ofthe increased burden of modern day insurance requirements 0 For some companies Business Interruption has become more of an issue as refining margins increase There would therefore appear to have been a shift in energy industry risk managers focus away from the purchase of insurance and towards additional or indeed alternative techniques to address these new priorities Question 2 ihe Most Pressing Risk Management Concerns What would you now therefore consider to be your most pressing risk management concerns Please rank in order from 110 where 1 is the highest and 10 is the lowest concern Risk Average rank out of 10 Damage to brandreputation 26 Environmental risks 4000 Regulationthe legal environment 5125 Business interruption 5250 sionfire 5450 Terrorismpolitical risks 5550 Executive riskscorporate responsibilities 5750 Commodity price volatility 6000 Natural catastrophes 6620 E risks computer shut downs etc 8870 Although some clear trends emerged from the responses to this question the answers varied considerably between each respondent With one ranking seven of these concerns as being equally important 0 Damage to brand or reputation clearly emerged as the most pressing risk management concern For one respondent a press release following hurricane Katrina stating that his company was adequately insured for sustained losses helped prevent serious questions being asked aboutthe compaan solvency For another the possibility of an envrronmental disaster wrth myriad third party claims 7 on the scale of another Chernobyl or Bhopal awasthought to have the most impact on the companys brandreputation Other respondents stressed the significance of business risks such asthe failure to find oil in productive areas and the disruption ofthe integrated gas chain 0 Business interruption was the most pressing concern for respondents from the independent refining sector citing the recent rise in refinery margins 0 However concerns such as executive risk commodity price volatility and erisks were generally placed further down the order than traditional exposures such as business interruption explosionfire and terrorism One respondent said that his organisation Willis Energy Market Review December 2006 9 Changing Priorities in Energy Industry Risk Management continued did not have any specific external protection against Selfinsurance captives and mutuals commodity price volatility Respondents from most of the larger energy companies stated that self insurance is now their Another stressed that rather than any ofthe primary weapon in managing the physical asset risk concerns listed above the mayor strategic risk faced and levels are generally significantly higher than in by companies such as his own was their aggressive the past Most only used the insurance market where growth strategy with the risk of companies that did they had to and that more competitive market terms not match growth expectations in the current would not necessarily mean that more insurance margin climate being acgUired bythose that did would be purchased Others agreed that use of self insurance would increase in line With commodity priCing and growth in production capacities Question 3 Addressing Major Risk Concerns Whilst some respondents used their captives At the moment how effectively do the following extensively others did so only when there was a entities address your major risk concerns genuine business case to do so although most please mark on a scale of 110 whereby 1very agreed that there was a definite need to use their ineffective and 10 very effective captive more innovatively Average rank out of 10 Recognising the value ofthe mutual principle respondents from eXisting OIL members generally continued to give their backing to the organisation For those With nonUS Gulf exposures it was cruoal that OIL should vote to quot ring fencequot Atlantic Named Windstorm perils at itsAGM in March 2007 at in tin gtIIJEI BEEJBAV One respondent described the events of 200405 as an aberration for OILthat was extremely unlikely to reoccur whilst another suggested that the only significant benefit of OIL membership was the additional risk transfer capaCity that it generated Commercial Insurance Market There were some positive endorsements ofthe commercial insurance market from the respondents perhaps surprisingly so One partiCipant noted that in Captive Mutual mam ARTmavket the market is now more in tune With his company s requirements than in decades making the effort to By a small margin the commercial insurance market just emerged as the entity that most listen and offer a more commercial attitude than in effectively addressed respondents I ISllt management concerns Perhaps it was not so surpi iSing the past Others noted that the market had a cruoal that selfinsured i etentions captives and mutuals were seen as almost equally effective tools in managing risk as the insurance market although alternative risk transfer products proved distinctly less popular With the respondents 10 Willis Energy Market Review December 2006 o o o role to play in providing construction all risks insurance for the multitude of new projects planned for the next ten years Even those respondents that used the commerciai market the least did appreciate its value especiaiiy where required to purchase cover by iocai iegisiation However some simply didn t consider commercial market products vaiue for money In particular severai respondents raised the issue of the vaiue provrded by current business interruption products whiist stressing the need for more capacity in this area Others asked for a greater recognition of energy customer needs With cioser contact to deiiver bespoke products rather than the quotoff the shelfquot products of today One respondent from a mayor energy company suggested that they would consider it significant if the convergence between the commercial insurance market and the capital markets continued Respondents quotWish listquot from the commerciai market also included more recognition forthe steps companies are taking to mitigate risk muitiyear poiicies wrth fewer reputiation ciauses iess ambiguous wordings much quicker responses to requests more responsive and professronai ciaims quotbehavrourquot and more transparency on pricing modeis ART Markets 0 0 Respondents suggested that a quotsecond generation quot ofART products that properly compiied wrth modern accounting reguiations are now needed by the industry In the words of one respondent quotART is aiways out there but to date no one has really grabbed the issuequot Notwrthstanding this several respondents suggested that the only practicai risk transfer solution for some oftheir more cruciai risks wiii eventuaiiy come from the alternative market rather than insurance One respondent beiieved that new products which were now much more userfriendly and more commerciaiiy priced may be on the horizon Several regard these products as cruciai in offsetting the dominance of a seiect group of ieaders from the insurance market 0 The majority stressed that they would be prepared to considerART products if avaiiabie but in the pastthey had proved to be significantly too expensive to seriousiy consider as an aiternative to the commerciai market 0 Several suggested that simpiy buying aiternative risk products deveioped by and suppiied through mayor insurance companies would not be sufficient to address the difficuity and caiied on the broking community to help deveiop products that truiy met their own indivrduai requirements Conclusion 7 a challenge to the market The respondents were keen to point out how their risk management priorities had changed during the course ofthe last few years However it seems that the insurance market community has some way to go before provrding risk transfer solutions that adequateiy address these priorities The respondents answers to our questions show that the insurance market is still needed and valued to a degree by most energy companies but their changing risk management priorities suggest that its overall significance Within the entire spectrum oftheir risk environment is becoming increasingly iimited Put simpiy buyers want more cover that responds effectively to the risks that they are now facing Perhaps it is up to all of us Within the insurance community brokers and insurers alike to provide fresh products and services to buyers before the drift away from traditional risk transfer becomes ever more commonpiace Willis Energy Market Review December 2006 11 Upstream Property Upstream losses excess US10 million to date 2006 Type Cause Country PDLIAB OEE B Total Source Wiis Energy Loss Database So fai during 2006 only five upstieam losses in excess of US25 million have been reported to the Willis Energy Loss Database However we are aware that recent typhoons may have affected some installations in the South China Sea We have also noted the recent Sinking of the heavy lift vessel Mighty Servant Although not strictly speaking an energy loss the drilling rig that thevessel was carrying had been offloaded prior to the Sinking we understand that this loss may result in a claim of approgtltimately US100 million to the marine market From the ridiculous to the sublime It seems such a short time ago that we were expecting comparison to the two disastrous years that have to write in gloomy terms ofthe continued difficulties of preceded it and it would certainly have been a brave the upstream sector Nowthat we can safely markthe upstream underwriterwho would have forecast such a passmg of a thoroughly benign hurricane season for scenario back in June It is still very early days for the once we are perhaps somewhat surprised to report a 2006 year and there Will ineVitably be some further Virtual inver5ion ofthe underwriting result for last year deterioration in the Lloyd s incurred ratios as reflected Losses for 2006 have been unusually infrequent and in the charts below but the picture to date looks modest by any historical standard let alone in encouraging for the market 12 Willis Energy Market Review December 2006 Lloyd39s ET Offshore Property incurred loss ratio summary 1993 2006 quot0 400 r005 i996 r007 1000 1000 2000 z00r 2002 2003 2004 2005 I Uincurred Ram Solute lloyd39s It is strii ear iy days but Lioyd s upstream insurers maybe iookrng at a bumper year in 2006 Lloyd39s EW Control of Well incurred loss ratio summary 1995 2006 i995 i996 r997 r992 1999 Z000 2001 2002 2003 Z004 Z005 2006 quotto date I EW mowed Ratio Souke Lloyd39s Leavrng asrde the hurricane iosses of 2005 Controi ofWeii has generaiiy been a profitabie sector for Lioyd s insurers in recent years Willis Energy Market Review December 2006 13 14 Willis Energy Market Review December 2006 For some upstream underwriters one could almost describe it as too good a year So spectacular have been the results that pressure Will almost certainly be brought to bear to maintain this year s profitability at all costs by defending existing portfolios Throwing it all away7 No wonder the message from leading upstream insurers has amounted to a predictable series of cliches such as quotone swallow doesn t make a summerquot and quotdon t count your chickens before they re hatchedquot followed bythe ineVitable quoting of military manoeuvres such as quotholding the linequot and quotmaintaining ranksquot So Will market discipline hold This Will largely depend on whether the upstream programme in question threatens the capacity currently available The 2007 capacity crunch it39s not just Hibernia For the first time in many years there is certainly a possibilitythat total upstream capacity may be insufficient for some risks in 2007 In 2006 realistic commercial insurance market capacity was still little morethan US2 billion at best for operating risks and considerably less than this figure for construction risks due mainly to problems securing commitments from insurers for periods in excess of 12 monthsWhereas once it was really only the Hibernia platform offshore Newfoundland that could be truly termed a capacity risk now there are several giant FPSOs currently either under construction or just becoming operational whose values are certainly approaching this figure While the upstream market has been augmented bythe arrival of CV Starr Novae and Argenta we believe that this will not be sufficient to avoid the potential lack of capacity So although overall stated upstream capacity for 2007 may be up a little from 2006 we do not believe itWill be enough to proVide sufficient cover for some of the exposures that we have mentioned It will therefore be interesting to observe how buyers and their brokers Will respond tothis potential difficulty No doubt various strategies Will be used to ensure that available capacity is maximised to allow full value policies to be issued for these exposures but such a scenario hardly points to a softening market Stepping up to the plate Furthermore the global panel of insurers willing to lead this class remains as limited as everWhilst we do not believe that the recent merger of Catlin and Wellington Will result in any meaningful loss of underwriting capacity this development does serve to restrict the pool of available leaders still further One ofthe market s most besetting difficulties recently has been the lack of availability of qualified staff to act as deputiesWhatever the reason for the disparity between supply and demand for key energy underwriting personnel perhaps this factor alone Will cause insurers to think tWice before offering more competitive terms than the existing leadership There can be no doubt that no one will feel comfortable about leading off a highly competitivelypriced programme only to find that the terms offered fail to find any support Within the folloWing market Finally some good news for buyers Despite all these factors however we do believethe market for the majority of programmes that do hottest the capaCity ofthe market in this way Will indeed soften during 2007 and that this softening will even apply to the market for Gulf of MeXico Windstorm cover where capaCity remains extremely limited and dependent on developments in the reinsurance market Perhaps the best way to explain our rationale for this assertion is to remind the reader of the somewhat chaotic atmosphere surrounding the lst July 2006 renewal season Generally speaking fears of another horrendous Windstorm season tended to prompt buyers With Gulf of MeXico exposures to renew their programmes before the onset ofthe season on the understandable basis that the limited amount of capaCity available would dWindle to virtually nothing by the start ofthe seasonThe renewal season for such programmes was therefore artificially constricted into a short period from May to July this year With a minimum rate on line being gUickly formed and adhered to bythe market Buyers were therefore faced With a Simple dilemma to buy or not to buy One or two buyers tookthe risk and elected not to purchase this cover but many more deCided thatthey had no ch0ice but to pay up A year39s reflection But in 2007 demand for Gulf of MeXico Windstorm cover cannot be taken for granted bythe market Bythe time these programmes come up for renewal in 2007 these buyers will have had time to reflect on the value for money offered by their current purchase and to conVince their management ofthe merits of adopting alternative strategies including greater use of captives and selfinsured retentions Thistime round buyerswdl have had the time to prepare analysts shareholders banks and senior management of any alternative strategies and the market Will not necessarily have it all their own way Simple economics therefore suggests that the price must fall if demand does indeed reduceWe therefore believe that as 2007 progresses pressure to reduce reinsurance priCing Will be brought to bear by a direct market keen to maXimise revenues from this sector but which is mindful of its own reinsurance costs Reductions by re design How Will such a softening manifest itseiffor this sector We are not suggesting that likeforlike premium reductions Will generally be offered but increased policy limits may well be available for the same price Furthermore buyer pressure Will force brokers to remarket and relayer their programmes in a more innovative way alloWing saVings to be achieved without existing leaders losing the fig leaf of not granting a likeforlike reduction in rates Now let s take the International portfolio There is no doubtthat the eXisting panel of upstream leaders have long memoriesWe have already mentioned their determination to maintain the current market status quo and it is certainly possible that commitments not to offer reductions under any circumstances which were offered to underwriting managers and capaCity proViders earlier in 2006 might indeed act as a brake on the softening process Willis Energy lvlarlcet Review December 2006 15 16 Willis Energy Market Review December 2006 Freedom from reinsurance restraints However the market appetite for the nonUS portfoiio has ifanything become even more pronounced than eariier in the year We therefore expect a generai softening of this ciass which Wiii be fueiied by the foiioWing factors 0 An acceptance by insurers of freshiy restructured programmes designed by brokers to achieve more competitive overaii terms for their ciients rather than iose the business aitogether c Having generaiiy purchased iess reinsurance this year upstream insurers are not so tightiy controiied bytheir reinsurance premium commitments o The recent Withdrawai of nine members of OIL whiist testing avaiiabie commerciai market capacity wiii inevitabiy proVide fresh premium income opportunities for insurers not restricted by existing programme participations However we do not expect a softening for programmes With significant ioss frequency or extreme capaCity draws Coverage Turning to the nature ofthe cover proVided by the market there is iittie to report by way of new product deveiopment The new Loss of Production Income LOPI poiicywording produced by the market foiiowmg Hurricane Ivan is now evoIVing aithough it has not yet been tested by any serious iosses Unsurprisingiy brokers are aiready working on variations ofthis poiicy form in order to secure a more workabie customised product thattruiy refiects indIViduai ciient requirements There is aiso room for manoeuvre for both physicai damage and iiabiiity coverage for construction risks In the meantime subiimits for Redriii and Making Weiis Safe cover remain popuiar With the market usuaiiy in the region of US50 miiiion and insurer demands for higher deductibies remain as strident as ever in spite of the potentiai for softening rates In View of escaiating vaiues reiating to weii AFEs contractor day rates and raw materiais such as steei during the course of 2006 these continuing demands are perhaps oniy to be expected The contractor book The driiiing contractor account for so iong a major concern for upstream insurers is beginning to recover from the 2005 hurricanes To date oniy two driiiing rig iosses have been recorded by theWiiiis Energy Loss database in 2006 At present we are seeing severai programmes being extended past the end of the 2006 hurricane season as underwriters fight to defend their estabiished positions One consequence of this that the market may weii extend some expiring programmes at iess than prorata and it is aiso aiready possibie to negotiate indiViduai unit LayUp Returns whiist Canceiiing Returns Oniy rates continue to appiy to the remainder ofthe driiiing fieet Construction a question of policy period We mentioned eariier than the iargest offshore units are now chaiienging the capacity of the market This is especiaiiy a concern reiating to the Construction Aii Risks sector as cover offered for periods in excess of 12 months remains a constraint on capacityHowever this sector has experienced a more impressive ioss ratio of iate than its reputation wouid suggest and more insurers are beginning to commit to this ciass In particuiar the merger of Catiin and Weiiington couid weii restrict avaiiabie ieadership and there may now be an opportunity for new ieaders to emerge for this ciass Nevertheiess the market remains generaiiy wary of iarger proiects specific naturai catastrophe iocations and quotat the edgequot technoiogy Accessing capacity on a stagebystage basis as required in iine with project vaiue buiidups is therefore an essentiai part of brokers marketing strategies in this iine of business Uniike the remainder ofthe upstream portfoiio rates are therefore expected to be broadiy fiat for this sector during 2007 The ball39s back in the broker39s court So perhaps the mayor chaiienge for brokers as we move into 2007 is this whiist more advantageous terms might be negotiated next year for buyers whose programmes do not threaten the capacity of the market depending on risk profiie and ioss record how is sufficient capacity going to be secured for those that do at terms that remain acceptabieto the buyer This chaiienge Wiii certainiy continueto test the ingenuity ofthe broking sector in the months ahead Willis Energy Market Review December 2006 17 Downstream Property ond39s incurred loss ratio summary 1995 7 2006 Downstream v Upstream 400 350 r 300 7 250 7 ZOO 39 7 39 i5 7 7 7 7 7 i00 39 L 39 39 39quot 50 I 7 I 7 7 7 7 7 7 i995 i995 i997 i998 i999 2000 z00i 2002 2003 2004 2005 2005 quottodate I Dwvnsirearninmiied Ratio Upstream incurred Rano Souroe39 Lloyd39s Whiist the 2005 Lioyd s incurred ratio for upstream property currentiy stands at 350 the corresponding figurefor downstream property is considerabiy iowei at 190 Divergence continues The divergence ofthe markets for downstream energy has underwriting iocation Not oniy has the spiit between US continued during the second haif of 2006 as the mayority and nonUS business continued to Widen but so has the of insurers around the worid continue to focus on their diVision between naturai catastrophe exposed and non own geographicai comfort zones rather than to estabiish naturai catastrophe exposed programmes a truiygiobai downstream portfoiio from a singie 18 Willis Energy Market Review December 2006 Have we been here before As 2007 approaches there iS a certain degree of de ia vu when revrewrng the downstream market Once again we find ourselves looking at a market that iS still regrouping after mayor property losses Once again we are seeing new entrants to the market perhaps keen to take advantage of the damage sustained by eXisting insurers Once again we are Witnesses to a market that is seeking to defend current pricing levels which to some extent have been raised to unrealistically high levels by fears of further losses of a similar nature In the world of insurance what goes around comes around and there can be little doubt that the cyclical nature ofthe business Will never be entirely flattened out Recent downstream underwriter appointments John Bryce Brit Colrn Kelly pending lnfrassure Mike Garrison Starr Tech Peter Godfrey Allianz Marie Fayet SCOR Laurent Hoguet pending AlG Andrew Raven Starr Tech Russell Sims Zurich David Stewart Starr Tech US market Legacy v non legacy again However there is an important difference between market conditions today and those of four years ago which was the last time that mayor property losses 911 and a series of refinery explosions had such an effect on the downstream market environment The new markets that provrded fresh capacity in 2002 have now had their baptism offirethankstothe 2005 hurricane season and can now be said to form part ofthe legacy market although the longstanding problems associated With those insurers who were writing this portfolio before 2002 continue to persist USA downstream losses excess US10 million to date 2006 Type Cause Location PDLIAB BI Total SourceWilis Energy Loss Database Willis Energy Market Review December 2006 19 Downstream Property continued 20 Willis Energy Market Review December 2006 Too early for any real change As we explained in the preVious edition ofthe Energy Market ReViewthe 2005 US Gulf coast hurricane losses had considerably less impact on downstream insurers than their upstream counterparts and therefore the opportunities to enter the downstream market after a mayor upsWing in prices have not perhaps been quite as enticing as they were in 2002 Furthermore any new capacity proVided bythe likes of Lancashire Re and Starr Tech has been offset to an extent bythe absorption of GE Frankona by SWiss Re and the Withdrawal of Commonwealth although existing players are now talking about increasing capacity for 2007 So whilst we may see a fresh challenge to the existing market from new players in 2007based upon our market analysis going forward we do not anticipate that this in itself will lead to any dramatic market softening Furthermore the two mayor losses sustained in 2006 as per our chart above have also discouraged insurers to radically aitertheir underwriting philosophies OIL will the market really compete A recent example ofthe determination of the market for US risks to maintain its current stance isthe initial insurer reaction to the recent Withdrawal of nine members of OIL Our own market soundings indicate that existing leaders for US business will not be offering their capacity to these companies at similar terms and conditions to OIL and Will instead insist that cover will be offered at the existing market rate pointing out wryly that they can hardly be expected to make an underwriting profit where OIL had failed to do so However our own experience has often been that when push comes to shove insurers may prove more flexible than these somewhat bellicose initial comments might suggest Signs of competition With overall capacity levels remaining relatively stable and the market fragmentation of earlier in the year continuing perhaps the biggest differentiator as we move into 2007 is whether or not a given programme requires the participation ofthe majority ofthe market to enable it to be completed Realistically although total US noncatastrophe market capacity is at least US17 billion and official figures suggestthat this total may be even higher any programme with a policy limit in excess of US750 million could be considered capacitydriven as at this level it would be difficult to generate sufficient com petition to significantly affect the programme s rating levels Programmes reflecting significant business interruption values and high EIVILs can therefore expect similar market conditions in 2007 as they experienced in 2006 That the catastrophe and US portfolios generally still require as much of the current limited market capacity as possible is unsurprising and so we also foresee similar capacity levels being availableto buyers for these categories during 2007 US market developments NotWithstanding this there is certainly evidence that the US market in particular may be looking to expand their presence in the downstream market next year One ofthe most notable features ofthe US market has been the emergence of Houston as an alternative centre for US and associated catastrophe risks The local Houston market as a practical matter the Houston market also includes the Liberty International underwriting office in Dallas for downstream energy has evolved dramatically over the past year Whilethe split between Starr Tech and AIG may have acted as a catalyst the reality is that a number of US insurers were already in the process of either relocating or adding underwriting and engineering resources to their Houston operations In the past the Houston downstream market played more of a supporting role on large international risks and indeed on many ofthe larger USdomiciled risks preferring to take lead posttions on smaller placements On those occasrons where the Houston market was actually offered lead lines completion had not been possrble wrthout Significant influence from the European London and Bermuda markets This sttuation has changed With the emergence of Houston as a market not only for smaller risks that require smaller limits but also as a lead marketwith enough clout to set theterms for and complete more stzeable placements or at least be able to lead layers of stzeable placements We now count the followrng insurers and potential capacity as being a part ofthe HoustonDallas downstream energy market Insurer Capacity U55 AlG 150 million Starr Tech 185 million Liberty 75 million Allianz 100 million Arch 75 million Zurich 100 million Navigators 25 million Markel 10 million AscotAbroad complements London 30 million Tokio Marine 50 million Total 800 million While many of these markets may be accessed via other underwriting offices the consolidation and geographic relocation of so many USbased downstream energy buyers to the Houston area has in turn led to a consolidation of underwriting in this market which gives every indication of continuing Furthermore the emergence ofthis market has in some cases resulted in Significantly reduced orders to other traditional marketing centres in London and Europe In light of all the factors described above we believe rates for this class wrll remain roughly static during 2007 with the potential for conditions to soften a little should the current benign loss record continue Remember by historical standards it39s still a hard market Aside from the issue of pricing we do not foresee any other mayor developments in the US downstream market during the months ahead The market is maintaining the fragile stabilitythat has now held stnce the beginning ofthe year and it is worth remembering that rates are still considerably higherthan before 2002 and we certainly do not believe that the current market is one that can be described as soft by historical standards Deductible levels remain stable and the extent ofthe cover provrded across the US downstream sector remains broadly the same as in 2005 Nevertheless as we have already said what goes around comes aroundThe market remains fragile and we believe it would only take a couple more mayor losses for insurers to seize the opportunity to try and increase rates once more 7 as has happened in the past Willis Energy Market Review December 2006 21 Downstream Property continued 22 Willis Energy lvlarket Review December 2006 Non US market International downstream losses excess US10 million to date 2006 Type Cause Location Country PDLIAB B Total Actual U55 Actual U55 Actual U55 Plant i l l l Mazeikiu Lithuania 75000000 75000000 150000000 Plant l l l l Sicily ltaly 40042000 65029000 133720000 Plant i 39 Las Piedras Venezuela 55000000 55000000 Plant Landslide Quebrada Los BoliVia 28000000 28000000 Plant i 39 Johor Port Malaysia 25000000 25000000 Plant Heavy weather Balezand Netherlands 17766000 17766000 Plant i39 l39 l 39 l 39 Ontario 17019000 17019000 Plant i39 39 39 Queensland Australia 14000000 14000000 Plant i Vienna Austria 12440000 12440000 SourceWilis Energy Loss Database An improved loss record The chart above also shows that to date 2006 has been kind to the nonUS downstream sector With perhaps onlythe exploSions in Lithuania and Sicily representing serious market losses Such an improved loss record for this sector is largely put down by insurers to the improved standards of risk engineering and due diligence being developed bythe market although perhaps other less kind observers would Simply put it down to pure chance We therefore expect overall capacity and market appetite for the international noncatastrophe portfolioto increase significantly during 2007 The gloves are off Significant competition especially for programmes featuring policy limits below US11 billion is therefore now being generated for programmes in this sector from incumbent and new markets as the pressure on income forces rate reductions for good bu5inessThe rating levels for this area ofthe portfolio have essentially been maintained at an artificially high level Sincethe 2005 hurricanes and nowthatthe 2006 season has passed Without incident and the low incidence of manmade losses has been maintained any artificial restraints on competition for this bu5iness have certainly been lifted Fresh leadership The international noncatastrophe market capacity is approXimately US23 billionwhich we expect to increase to approXimately US26 billion in 2007Armed With US100 million offresh capacity new player Starr Tech is almost certain to make a significant impact and Will want to lead business whilst the arrival of Peter Godfrey at the Allianz suggests an enhanced market profile for this composite We also expect traditional markets such as Liberty Mutual and Zurich to assert the leadership credentials once more whilst capacity from regional markets such as If Africa Re and Alba is also now adding to the competitive atmosphere Downstream Market Forecasts 2007 2007 Time to compete So in order to defend their eXisting market share for this sector there is no question that eXisting leaders are now going to have to change their priorities and begin to compete seriously for the premium dollars available Already we are seeing signs that some insurers are happy to quote improved terms for both programmes which they currently do not subscribe to and indeed egtltisting business Should the current favourable loss record be maintained we believe that the market can only soften further in the months ahead Exposure Capacity approx Market conditions US natural catastrophe Gulf Wind US500 million Flat to modest rises California Earthquake US100 million Fiat to modest rises US nonnatural catastrophe US2100 million Slight softening International natural catastrophe China US1000 million Flat lndonesia US1000 million Flat Northern Middle East US1000 million Flat International nonnatural catastrophe US26OO million Sinni rant ofteninn Willis Energy Market Review December 2006 23 Liability 24 Willis Energy Market Review December 2006 Rolling gently down the track Hurricane Katrina and her Siblings are but a distant memory in the liability marketWhen reVieWing the impact ofthe 2005 losses earlier this year we noted little impact even indirectly on liability rates or capacity Nothing has happened in the intervening period to cause us to take a different View indeed ifthe liability market was a railcar we would describe it as currently rolling gently downhill in terms of premium ratingThe question isWill it continue to be a controlled descent or Will it pick up speed in 2007 A dash for revenue In our earlier market reVieW this year we also commented on the apparent disconnection between the actions of front line underwriters and insurance company senior management Calls for management of the underwriting cycle and the need to reflect higher reinsurance costs in rating appeared to be going unheeded We now wonder whether in some sectors of the market management and the shop floor have aligned their objectives in a dash for revenue Clearly this can be good news for clients particularly as hard market overpricing unWinds However no one in the longer term benefits from extreme volatility in cost and the ensuing insolvencies amongst the weakest as a soft market overshoots In this edition we Will explorethe reasons for the continued softening and try to draw some conclusions about developments over the next year or so There are certainly some changing priorities amongst buyers and sellers of liability insurance Asthe market turns its attention away from pricing and capacity availability as the most difficult issue facing insurers so risk managers are nowturning their attention to other key concerns in relation to liability programmes We Will review some ofthese including the perennial question of quothow much limit is enoughquot Liability market conditions The steady decline in rates for liability capacity has continued through 2006 For general industrial risks rate cuts have been very significant depending to an extent on sector and territory With aggressive competition for good risks The fall has been less marked in the energy and utility sectors but this sector is still characterised by average rate reductions of up to and in excess of 10 which follows the slightly lower rate reductions in 2005 So over the last two years an average programme may have benefited by a total fall in premium exceeding 15 In some cases it has been possible to achieve greater saVings whilst maintaining or improVing cover Quality information remains the key The key for buyers achieVing such positive results is being ableto demonstrate a good quality risk and a Willingness to invest the time to work With their broker to position their risk profile effectively in the market In this respect underwriting discipline is being maintained and insurers are continuing to provide the best terms for the bestpresented programmes With good quality up to date information Regional variation remains an important issue In certain territories such as Australia an oversupply of local capacity has fuelled local competition leading to significantly higher than average rate reductions Liability market capacities 20002007 un ii QKS US market developments Converseiy reports are coming in of some iarge capacity accounts particulariy in the US receiVing smaiier price increasesWhiie in the US this more readily applies to iarge capacity accounts for aii energy buyers it is aiso a sign ofthe lack of lead excess layer competition and dominant limitstagnant capacity The maturity ofthe market has many carriers attaching at a comfort point Within buyers programs not Wiiiing to compete or move We have foiiowed this phenomenon With some interest over the past several years and believe that for capacity buyers it Wiii take a dynamic change in programs the introduction of new and Significantiy iarge capacity or an industry specific event to shake things up the industry event of course may weii send things in a contrary direction We couid also see renewai rises prompted by a decline in excess capacity foiioWing the downgrading of OCIL and the ioss of Geriing who have puiied out ofthe US energy iiabiiity marketThis clearly runs against the softening trend described above and it remains to be seen whether this experience generaiiy deveiops further turns out to be a minor quotbiipquot which is iimited to some quotcapacityquot accounts and those With Significant US exposures or also becomes a factor for nonUS buyers With big iimits NO moves on Coverage Asoftening market is aiso not aiways eVident when it comes to coverage conditions There is stiii ciose scrutiny ofwordings and exclusions are not removed easiiy Faiiure to suppiy and EMF cover are exampies of areas Where capacity remains relatively tight As we move into 2007 we expect iittie change and indeed the signs indicate that the current softening Wii continue Whilst insurers remain weii capitaiised and there are few mayor iosses there is no pressure for changeWhether this softening is at a measured pace or whether quotthe brake comes offthe raiicarquot and the momentum accelerates remains to be seen This may not necessariiy apply to capacity buyers History has shown that due to its iong taii naturethe iiabiiity market remains iess voiatiie than the property market So our expectations are that this softening Will remain controiied certainly for the energy sector However beyond 2008 if current trends continue we may see a situation Where rates have dropped to the point that attritionai iosses Wiii produce overaii underwriting deficits which Will then be the point at which insurers Wiii caii a hait to the rate siide Market capacity Our latest chart updated since the last edition of this ReView shows that capacity continues to fiow into the iiabiiity market For most industry sectors more than enough capacity is now avaiiabie to achieve required iimits We noted the increase in Zurich capacity to US75 miiiion in our iast editionAlG have recentiy announced i000 2000 z00i 2002 2003 2004 2005 Z006quotio date Willis Energy Market Review December 2006 25 26 Willis Energy Market Review December 2006 that they wiii be abieto offer an additionai US50 miiiion from the end ofthe year on some risks effectiver doubiing their existing capacity Thetotai additionai capacity is reiativeiy smaii when set against totai theoreticai market capacity What is important to note and address head on is this theoreticai capacity versus reaiistic or practicai capacity Whiie the generai woridWide capacity may hover near US2 biiiion energy insurance buyers are hard pressed to find more than USN12 biiiion It is here we see constraints in overaII capacity pricing and reinsurance capacity and conditions The practicai iimits avaiiabie for US energy risks or those With extensive US exposure particuiariy refining and petrochemicais are iower in the region of US800 miiiion to USI000 miiiion In the current market conditions even reiativeiy modest capacity increases can produce reai competition Most companies are buying iess than the maximum capacity avaiiabie which naturaiiy increases the competitive pressure that can be appiied In pianning a piacement market conditions aiiow ciients to pursuetheir own objectives freer atthe expense of insurers These objectives can inciude 0 Economic purchase of higher iimits 0 Reduction of dependence on Occurrence Reported capacity ifthis re ects the buyer s phiiosophy this may not be an option for the iargest energy buyers 0 Improvements in cover for exampie deietion of terrorism echusion o Improvements in programme security by moVing to higher rated carriers 0 Muitiyear programmes aithough the market for this is iimited If it ain39t broke don39t fix it In most cases we do not advocate a compiete breakup of weiiestabiished programmes and reiationships There is a trend towards shortterm thinking in the market With even compiex iiabiiity piacements being treated as a commodity to be traded on an annuai basis This is particuiariythe case in the property market where capitai infiuxes in Bermuda and eisewhere re ect a desire to capitaiise on the hard market pricing Some ofthis capitai is voiatiie and WIii disappear in a sustained soft market Instead secure iiabiiity piacements shouid be buiit around a core of insurers With whom the insured has buiit a iongterm reiationship A cautious approach to new capacity proViders is sensibie particuiariy where there are aiternatives However IUdICIOUS use ofthe quotspotquot market can piay an important roie in introducing competitive ieverage and of course aii iongterm reiationships have to start somewhere If you fail to plan you plan to fail Carefui goai setting and pianning ofthe piacement strategy is essentiai to capture the maximum benefits from current market conditions whiist maintaining vaiuabie iongterm reiationships The cheapest capacity couid in the ionger term prove to be an expensive choice Whiist we see no immediate prospect of reducing capacity in the iongerterm history teiis us that the businessWiii become unprofitabie and capacity WIii faii However in our View this is at ieast two years away US Primary Casualtyquot Accounts With good loss records and strong financials are being sought by underwriters In addition to more aggressive pricing for these risks the market is again offering multi year programs and more innovative collateral programs Based on market pricing and the current interest rate enVironment carriers are buying less facultative reinsurance today Unlike the retail insurance market the facultative market is not experiencing a soft market it though even With these conditions carriers are still buying facultative reinsurance for tougher risks Larger more complex accounts With volatility may still experience pricing increases in the flat to 10 range The main underwriting concerns continue to be Employee concentration especially in a large metropolitan areas Collateralization of expected losses Within loss sensitive programs Maintaining suitable terms and conditions pertinent to exposures Adverseyudicial developments taken from Willis Marketplace Realities amp Risk Management Solutions 2007 authored by Pamela Ferrandino Casualty Practice Leader Market news AIG London Will now quote primary layers of excess liabilities As already stated they Will also have an additional US50 million from the end of 2006 An additional 25 million capacity from Zurich became available from mid 2006 giVing this insurer a total capacity of US 75 million in all o It has recently been announced that the rating of OCIL has been reduced from A to 1388 by Standard and Poor s The full implications ofthis are not yet clear but it is causing concern to a number of liability clients It is reported that a number are not reneWing or reducing capacity purchased from this market and there appears to be an impact on pricing for some US risks as described above At the same time OCIL confirmed rumours that it is cutting capacity to US100 million With the ability to soften the loss of limit by proViding certain of its members With US125 million for one renewal 0 CV Starr is currently setting up a liability operation in London With excess liability capacity expected to be available soon In the US CV Starr has come forward With limited capacity currently US10 million With Everest National a subsidiary of Everest Re Although CV Starr s appetite for energy business is not apparent its staff are geared to write tougher risks Limits of Indemnity As we have outlined above for most risks capacity is readily availableA key question for all buyers is What limit is enough In the energy sector the catastrophe exposure is often explosion The events at Toulouse in 2002 Buncefield in the UK and the BP Texas plant more recently are graphic illustrations ofthis There are two broad approaches to decision making in deciding on limits being benchmarking and risk profiling Willis Energy Market Review December 2006 27 Bend1marking This approach iS probabiy the most common methodoiogy in assessing iimit adeguacyWiiiis maintains extensive benchmarking data in reiation to energy and utiiity risks This data provrded on an anonymous basis provrdes a usefui decision support tooiAn exampie of a typicai benchmark chart for a petrochemicai risk iS shown here This aiiows buyers to consider their iimit in reiation to those oftheir peer group Our database aiso cieariy demonstrates an upward trend in iimits purchased over the past three years To some extent there iS budget avaiiabie as rates faii aiiowing companies to move iimits to an appropriate ievei 28 Willis Energy Market Review December 2006 Risk profiling Benchmarking iS a vaiuabie tooi However in our View it can never be a substitute for a revrew of the indiViduai com pany s potentiai exposure The iatest estimate for theTouiouse expiosion iS that iiabiiity ciaims wrii exceed EUR12 biiiion Benchmarking wouid not at the time have indicated that a iimit ofthis ievei was required indeed we understand that iittie morethan EUR700 miiiion of insurance capacity was piaced Increasingiy insurance buyers are considering in more detaii the way in which their risk profiie impacts their catastrophe exposure An exampie ofa simpie methodoiogythat can give a vaiuabie insight into exposure is a revrew of property surveys They wrii normaiiy contain two key pieces of information for a iiabiiity exposure point ofvrew an assessment of the expiosion EiVIL and at ieast some information on surrounding property Ifthe anaiysis suggests that the expiosion overpressure map extends into thirdparty premises at high ieveis then an adequate iimit might needed to refiect destruction of the neighbouring piant and consequent business interruption This couid be a very high figure which may be iargeiy independent of territory at ieast as far as the noninjury ciaims are concerned iVIore compiex risk mapping and evaiuation processes may be needed where data does not currentiy exist This may be more time consuming and invoive expense but uitimateiy couid heip ensure that decisions are based on a sound methodoiogythat refiects the buyer s own risk exposure Marine and energy Searching for a miss factor FolloWing the record hurricane season of 2005 the reinsurance market has been forced to reconsider its underwriting strategies As we reported in the last edition ofthe Energy Market Review greater transparency of underwriting information from clients has been demanded bythis market as reinsurers have begun to systematically split their portfolios by territory or peril into mutually exclusive quotcolumnsquot of cover the most obVious example being catastropheexposed locations versus non catastropheexposed locations The rationale behind this new approach has been to ensure that in future should a mayor loss such as a hurricane or earthquake materialise it would not affect all business written at the same time This search for a quotmiss factorquot has been accompanied by increased pricing 7 dramatically in the case of Gulf of Mexico Windstorm 7 as demands for quality reinsurance security have increased One trend that always applies to the reinsurance market is that it tends to worry about yesterday s problems rather than those of tomorrow Rei nsurers focus may be on Gulf of Mexico Windstorm today but another act of terrorism an explosion in the North Sea or deterioration in the political situation in the Middle East could change thisfocus Within 24 hours Dealing with the hurricane legacy In the meantime the market is still in the process of settling the backlog of claims emanating from the 2005 hurricane season During the last renewal season these losses were still forming part ofthe quotoutstandingquot ledger now as they are paid reinsurers reserves and cas accounts are being tested as never beforeAs of November 2006 it is estimated that less than 40 of Katrina claims and 30 of Rita claims had been paid bythe market As the overall totals continue to mount there are rumours in the reinsurance market that another US1 billion of KatrinaRita pipeline claims may have to be added to the potential final bill for the 2005 hurricane season These numbers leave a huge amount to be found and paid for by reinsurers over the coming months The most affected vehicles are likely to have some difficulty in considering any relaxation in terms and conditions While the bulk ofthe mayor losses remain unpaid As for the possibility of utilising the retrocessional market to generate additional capacity this remains unlikely EolloWing the 2005 hurricanes this market all but dried up and now remains extremely limited although there are now signsthat it may begin to reform at the beginning of 2007 Signs of improvement as the Bermuda market stirs However despite the scarcity of adequate reinsurance cover experienced bythe direct market during 200506 we do anticipate that more reinsurance capacity may well be available during the course ofthe next year Allianz Montpelier Re Platinum Re still operating in the US and GE Insurance Solutions may have Withdrawn from the market butthe most significant development of the last year has been the development ofthe Bermuda market and particularlythe formation of quotSidecarquot reinsurance vehicles A sidecar is a separately capitalised reinsurance vehicle that operates alongside a parent company accepting risk as a pre determined quota share ofthe parent company s book of business Willis Energy Market Review December 2006 29 Reinsurance continued New Bermudan Reinsurers 2006 In the aftermath of Katrina and Rita the deployment ofthese sidecars has been a significant development Reinsurer Capitalization USm As temporary vehicles they perhaps represent an Harbor POW Re 1300 quoteiastopiastquot solution tothe current capacity Am iIIBe39mUda WOO shortages Capacity is provrded for an initial 12 month Ariei Re 1000 period and if underwriting results are unfavourable H they can then simply return the money tothe capital m provrder This is in contrast to more orthodox methods of raising capital whereby new companies are formed FlagstmeRe m or capital is added to an exrsting vehicle under these arrangements should poor underwriting losses Hiscmsennuda soo materialise share prices would be directly affected and it would be too complicated to hand back capital to the prevrous suppliers Bermudan Sidecars 2006 It is also possible that other forms of capital might be deployed in the reinsurance arena In the past Company Primary Initial Business written parametric solutions designed by actuaries With security provrded by the capital markets have played a part in the reinsurance market However these solutions have proved to be expensive and the quottriggerquot to unlock the capital in the event of a loss has often been too prescriptive to be truly beneficial to the direct marketAiong With the Bermudian sidecars they have benefited from the hard market environment but if 2007 also results in a catastrophefree year their lifespan is likely to be limited as the commercial reinsurance market begins to reestabiish itseif The hard work39s been done At the time of writing no losses of any significance have been reported during 2006 The prevailing feeling in the market is thatthe reunderwriting and sanitising of direct energy programmes has been both drastic and effective and that this new approach has made the task for reinsurers much more manageable as the 2007 renewai season approaches The renewai criteria are likely to be 30 Willis Energy Market Review December 2006 as demanding as last year but the exercise for 2007 is covering a familiar territory wrth transparency and accurate RDSs maintained for this year So at the moment provrded there iS no adverse claims development between now and lstlanuary 2007 it iS likely that rates retentions and available capacity wrll remain generally unchangedThere may be some restructuring of programmes to secure some saying to the direct market and it seems likely that whole account reinsurers may be prepared to be a little more flexible With regard to the provrsion oqulf of Mexico windstorm coverage The Lloyd s RDS path for Gulf of Mexrco hurricanes is unchanged for 2007 butthe recalibration of RiVISO6 the model that is used to evaluate return periods in the Gulf of Mexico is currently being revrewed This may have an impact on the analysis of exposure information Factors affecting the reinsurance market Loss free year 2006 Increased capaci Potential lack of demand at 2006 prices A slight improvement on Gulf Wind We therefore expect the largest reinsurance programmes to have a maximum Gulf of Mexico aggregate of approximately US100 million up slightly from the 2006 figure of US80 million However some markets may decide to take a more significant position of Gulf of Mexico risks to make the most of the current favourable undenNriting climate A market in balance Thereforethere might be potential for pricing levels to dilute aswe move into 2007At thetime ofgoing to press the market is caught between the two contrasting forces as shown in the chart belowWhich way Will the market tilt during 2007 Perhaps it is still too early to say With any true degree of certainty KatrinaRita loss deteriorations Loyalty to quality markets Significant uncollected claims Underwriter guidelines Alternative Risk Transfer methods A The reinsurance market hangs in the balance as various forces compete to increase or reduce available supply Willis Energy Market Review December 2006 31 32 Willis Energy Market Review December 2006 Onshore Reinsurance Market Much ofthe dynamics that have affected the marine and energy market have also affected the onshore marketihe proVision ofquality underwriting information remains paramountAsmall number of downstream energy losses have been noted but have yet to make any Significant impact on market conditions New capacity may be introduced in 2007 as a new venture headed by noted reinsurance underwriter Andrew Elliott the quotAspen Trioquot and Aeolus Re may all take an interest in some energy programmes Regional splits The territorial split between USA and the rest ofthe world is becoming more pronounced With worldWide covers becoming increasingly difficult to place In general termsthe increased pricing that marked the ist January 2006 renewal season has been maintained or even increased over the summer As we approach 2007 it would appear that European reinsurers in particular are shoWing increased appetite for business With Bermuda able to offer capacity despite differentiating more strongly between US and nonUS business Rates for US catastropheexposed business increased dramatically at ist January 2006 and were further increased later in the year So far there are no indications to suggest that these increases Will not be maintained as aggregation limits for this portfoliowiii continue to be strictly adhered to However for programmes that are not exposed to US natural catastrophe risk there is now grounds for suggesting that pricing Will come under pressure next year as reinsurers seek to compensate for their aggregate limitations in the catastrophe portfolio STOP PRESS in a first for a Lloyd39s syndicate Hiscox plc39s syndicate 33 has nalised a sidecar dealThe syndicate has concluded a quota share reinsurance arrangement with Bermuda based vehicle Panther Re which will take a 40 share of the syndicate39s property catastrophe reinsurance forthe 2007 undenrvriting year and a similar share for 2008 Hiscox39s plan is to take advantage of strong undenAriting opportunities particularly in US catastrophereinsurance risks Panther Re is financed by US144 million equity and US216 million in two term loans Lead equity investor in the vehicle isWL Ross amp Co LLC managed fund WLR Recovery Fund lll 2006 r a nonevent 2006 has been a year of stability in the power utility market after the upheavais caused by the US hurricanes in 2005 For many insurers perhaps the best thing that could be said about 2005 is that it was hardly duii In contrast 2006 has seen little in terms of excitement especially as this year s US hurricane season has been as quiet as 2005 s was turbuient One might even go so far as to describe the current utiiity market as a little boring In any event 2006 has allowed underwriters to catch their breath and take stock As you were As a result utiiities that are not exposed to catastrophe events have generally seen fiat rates this year With rate reductions being achieved in some cases Deductibies have also been generally fiat Catastropheexposed risks on the other hand have seen price increases and restrictions in cover as insurers look for the best areas to commit their capacity Many insurers reaiised in 2005 that their catastrophe modeiiing was flawed and that they might be overexposed to certain catastrophe events and in this respectthe experience of power utiiities has been no different tothat of buyers in other industry sectors Technology failures This is not to say that there are no specific power utiiity issues currentiy exercisrng underwriters mindsThe main concern is probabiy the faiiures that have been seen in some CCGT technoiogythat had previously been consrdered to be proven and therefore past the point where any desrgn fauits couid normaiiy be expected to have become apparent The technicai power underwriters are monitoring this srtuation cioseiy and some have been asking their ciients to provide details for each appiicabie machine inciuding dates and findings ofthe manufacturer s inspections However there is no reai indication at this stagethat the main power underwriters are looking to restrict the coverage they are Willing to provrde to utiiities that empioythistechnoiogy provrded that they foiiowthe manufacturer39s recommendations and appiicabie technicai buiietins A temptation to cut corners Another concern of some underwriters is the perception that fueiied by increaSing dereguiation and iiberaiisation there may be an economic temptation for decisrons to be made that run counter to best risk management practice An exampie might be a CCGT deferring pianned maintenance or repairs in order to run base load for a period when there are other outages on the grid Since this might provrde several weeks of guaranteed saies Competitive pressure couid force down maintenance budgets thereby increasrng the potentiai for a ioss and a ciaim against insurers Underwriters will look for evidence that their ciients are continuing to follow prudent risk management and maintenance practice and risk engineering continues to be a key discipiine for the technical market In the balance Despite the general stability in the power utility market there is no solid consensus among underwriters over the market s future direction Some say that their book of busrness has not been profitabie over the past couple of years that rates in some cases are at uneconomic ieveis that the market is in need of some correction and that they are therefore not in the mood to entertain thoughts of further price reductions There have been severai iarge iosses transformer faiiures turbine faiiures and a big dam collapse in the USA which have resulted in Significant claims against insurers and underwriters undoubtediy suffered big increases in the cost oftheir catastrophe reinsurance at the start ofthe year which Willis Energy Market Review December 2006 33 Power and Utilities contuinued 34 Willis Energy Market Review December 2006 have to be passed on to buyersAlthough atthetime of writing the 2006 end of year reinsurance treaty negotiationswere still ongoing the trend so far has been for increases for cat areas Which underwriters Will again be looking to pass on to buyers in these regions On the other hand capacity is still plentiful and folloWing a quiet 2006 hurricane season underwriters are increasingly Willing to compete for business It is therefore quite possible that 2007 Will see a softening on the power market at least for superior wellmanaged risks Onshore Construction Onshore Construction Fresh capacity The onshore construction market remains somewhat more stabie than its operating counterpart With the absence of any Significant naturai catastrophes in 2006 preventing any further upsurge in rating ieveis CapaCity remains fairiy static With the overaii market ieadership panei remaining broadiy Simiiar to the past few years Fresh capacity HaVing said that some new supporting capaCity is expected to be avaiiabie in 2007 Lioyd s insurer Aiba Wiii be offering between US3050 miiiion from Singapore next year whiie Infrassure With a capaCity of US30 miiiion is now shOWing a conSiderabie appetite for energy buSiness Geriing is keen to expand their portfoiio on a foiiow market ba5is whiistAspen Re a reiativeiy new entrant tothe market is set to prOVide Significant capaCity on an excess of ioss ba5is We therefore currentiy estimate that capaCity for 2007 is iikeiy to be in the region of US12 biiiion on a Maximum Probabie Loss iVIPL ba5is Broader coverage As a resuit we beiieve that some softening may become apparent during 2007There is certainiy some scope for negotiating broad poiicy coverage and we detect substantiai market appetite for guaiity bu5iness encompassmg a high degree of advanced risk management and guaiity controi This is particuiariy the case for proyects iocated in regions With iittie or no naturai catastrophe exposure such as Europe and the Middie East Insurers With increased appetites who we expect to set the tone of the market in 2007 inciude AiiianzAlG Munich Re Liberty Internationai and Zurich Deductibie ieveis remain static with insurers chaiienging current ieveis for fauity part coverage as per the LEGS form and Where technoiogy may be new or unproven Lender demands The demands of ienders continue to be a key driver on project financed deais This has certainiy had a p05itive effect on the need for the market to prOVide Significant iimits for Deiay in StartUp DSU cover Additionaiiy tunneiiing and wet work risks face particuiar scrutiny from underwriters as due to their unfavourabie ioss history they are Viewed as extremeiy hazardous undertakings Energy projects such as hydroeiectric power stations and LNG receiVing terminais are iikeiy to face more stringent terms and conditions of coverage and potentiaiiy higher rates for these eiements of the proyect Insurers are aiso stressing the importance of receiving adequate and timeiy proyect data and buyers need to aiiocate suffiCienttimefor brokers to coiiate this information prior to the marketing and piacement ofthe proyect Willis Energy Market Review December 2006 35 Terrorism 36 Willis Energy Market Review December 2006 Recent losses Since the last Energy Market ReVieW in May there have been a number of losses notably as a result of business interruption emanating from the recent conflict in the Lebanon especially on the Israeli side ofthe border There has been some discussion in the market as to Whether these losses were actually sustained as a result of war or terrorism and atthe time ofwriting it is still unclear howthis issue Will be resolved In the meantime several losses in South America in the region of US35 million each have also impacted the market Had these losses been spread across the terrorism market we would have expected some hardening in market conditions As it is the losses have only had a significant impact on a particular section ofthe market While those insurers Who have not been affected continue to drive for market share and consequently push prices down Fresh leadership One ofthe new entrants to the market that is certainly fuelling this development is Lancashire Re Armed With a capacity of US200 million Lancashire can potentially write 100 of most placements that it writes and is consequently able to pursue its own underwriting strategy Without reference to the remainder of the market Furthermore none ofthe existing insurers are at the p0int where they would consider WithdraWing from the terrorism market although several have recently suggested thatthey may well do so should prices continue to fall at the present rate Plentiful capacity There is therefore now something of a glut of capacity available for terrorism risks and we estimate that the overall total now stands at approximately US1 billion Aside from Lancashire Re the main leaders remain the same Ascot Hiscox Beazely Wellington and Talbot from Lloyd s andAxisAG QBE and Montpelier from the composite market The longer term It is therefore unsurprising to see more insurers offering longer policy periods PreViously capacity for terrorism coverage has only been prOVided for a maximum of 12 months but now some insurers Will prOVide cover for as much as 48 months for construction risks With others offering 24 months Total long term capacity of this kind is now estimated to amount to US500 million Which is morethan sufficient for most proyects Despitethe relaxation in pricing insurers are remaining firm on deductibles and policy wordings The standard terrorism deductible remains at US250000 With business interruption waiting periods fixed at either 21 or 30 days Coverage remains standard and includes terrorism sabotage strikes riots and ciVil commotions as well as political Violencethat results in insurrection TRIA e an irrelevance Looking ahead to 2007 a working presidential report has just been published in the US Which effectively states that TRIA will expire at the end of next year The report suggests that there is now sufficient cover Within the US terrorism market to render the backing ofthe US government somewhat superfluous In reality government protection generated by TRIA has been of little relevance since the coverage quottriggerquot was increased from US5 million to US50 million 7 for example losses from the UK terrorist attacks of 7th July 2005 were only in the region of US10 million Goad information crucial We also believe that the most advantageous terms Will be secured by buyers that proVide detaiied security information location details and copies of any additional reports conducted by independent security companies Ciientsthat have ienders requirements will in any event have little choice but to comply with market demands for improved underwriting information as ienders Will usually insist on the purchase of this cover particularly at the competitive terms now being offered bythe market Who will survive So for the terrorism market 2007 Will bring increased pressure on rating ieveis In this market enVironment if insurers fail to compete they risk iosing a significant amount oftheir portfolio as it Will be much easier to attack new business rather than to defend eXisting piacements They will have to walk a tightrope between charging sufficient money for the risk and aiioWing an aggressive property market to absorb increasing amounts ofthis class It Will be interesting to see who stays in the terrorist game if the going gets any rougher STOP PRESS Catlin insurance Company Ltd Catlin Bermuda an quotAquot excellent rated AM Best subsidiary of Catlin Group Limited 39CGL London Stock Exchange has developed an insurance and reinsurance product that provides affordable coverage for nuclear chernicai biological or radiological NCBR terrorism One of the reasons why insurers have historically been reluctant to provide coverage tor these events is due to the unacceptable accumulation risk posed by NCBR events Catlin Bermuda has developed a product which overcomes this problem by restricting the coverage to NCBR events which occur in a specified area which is prede ned by the cedant orthe insuredThis coverage is available for most lines of business egWorkers Compensation Property Damage Business interruption etc and is available on an insurance facuitative reinsurance ortreaty basis Typical risks quoted to date include energy installations railway stations ports airports sports stadia major large oi lice blocks with area covered varying from a quarter mile radius to state wide coverage The price will vary dependant upon the size of area covered and the location insured Coverage can be provided inside and outside the United States A location where this cover may be ideal could be a maior oii installation located in Europe or the US where the insured buys protection forthe event occurring inside a 5 mile radius around the plant By restricting the geographical area in this way Catlin has created a product whereby signi mntiy more insurance and reinsurance capacity should now be available for NCBR terrorism at much more reasonable pricing levels For further information on this product please contact either Paul Shedden 14412781653 Jonathan Gale 14412781654 orWiiiiam Steeds l4412781686 Willis Energy Market Review December 2006 37 38 Willis Energy Market Review December 2006 Directors and Officers Liability Limits and Capacity Total global DampO capaCity remains stable in spite of some carrier turnover Among the departures were a longterm speCialty insurer and an excess carrier The loss oftheir capital was mitigated by the increased appetite for BSD risk in both the US and international markets As a result global DampO capacity is greater than ever iwell in excess of US18 billion before considering the additional limits that may be available on an A Side basis for nonindemnifiable claims With one mayor carrier rey0ining the marketplace for primary placements on larger publiccompany DampO risks and With continued competition for privately held and notforprofit organization risks there may actually be more suitors for the primary initial base layer of coverage 7 setting the tone for the rest of the program Aword of caution there still remains a marked difference between stated capacity available and the actual deployment of limits Carriers are increa5ingly signalling their desire to deploy significant limits on preferred Aside DampO programs as opposed to the more traditional more expansive ABC coverage for public companies London Fewer losses The Directors and Officers Liability market in London is usually characterised by small frequency small severity losses Four years agothere were some large losses in Germany but in the UK there have been few losses recently New legislation including Sarbannes Oxley and the recent EU directive against ageism suggested that some serious challenges lay ahead but of course new legislation does not necessarily mean increased claims Aflatter cycle The result has been a flatter market cycle With perhaps a gradual softening that is now gaining some momentum However we believe that it would only take a few losses and the trend would reverse rapidly and it should be remembered that it was only three years ago that the market was much harder as a result of some serious losses The mayor insurers in this class remain familiarAIG Chubb Allianz Ace Zurich Liberty and Starr Excess The market is not predominantly Lloyd s driven but certain syndicates including lVIarkel Odessy Re and SVB can also lead Breaking ranks Despite this stable panel of leaders the softening market conditions have meant that one underwriter in particular has broken ranks Zurich has recently hired two new underwriters who are happy to prowde coverage on a primary US10 million basis on high profile risks Will the rest of the market support them Wethink thatAIGACE and Chubb may refuse to do so but we are confident that the market can prOVide US150 million of capacity excess ofthat provided by Zurich which would be suffiCient for the majority of our clients programmes CapaCity is therefore expected to increase a little in 2007 There are no new entrants as such but AIG and Starr Excess are expected to increase their capacity Overall we now estimate that approximately US300 million of DampO capaCity is now commerCially available With the possibility of securing US450 million at a push but using more expensive markets The longer term Looking towards the future it may be possible for insurers to offer 23 year deals for international business These deals had been difficult to finalise in the past due to treaty restrictions We now believe it might be possible to obtain some capacity for a long term deal by end of 2007 although there is still a danger that no market appetite for such a deal Will be forthcoming There is also evrdence that broader coverage may be available especially With regard to increased sublimits for pollution defence costs generally now up to full limitfrom US500000AIG iS also now provrding broader coverage for extradition costs US holds the key So in 2007we dothink that reductions in the range of 540 reductions might be able to be achieved if nofurther losses materialise Much Will depend on developments in the US as there has recently been a discernable trend for European companies to be sued in America Other quothot topicsquot for 2007 Will include the questions of ageism and extradition North America Pricing Upward premium adyustments are anticipated for companies facing claims activity andor financial challenges but market indicators on new an renewal business suggest that premiums are competitive for worryfree accounts With risk differentiation and market timing in mind we believe that premiums for companies With large market capitalizations are generally remaining fiat or decreasing by 540 Where there are risk adjustments premiums are increasing by at least ten percent and possibly much moreAs always risk differentiation is critical Due to the abundance of available capacity and as more carriers target mid to smallmarket cap companies and private firms premiums in these classes wrll continueto reflect greater reductions potentially in the range of 1015 Taken from Marketplace Realities and Risk Management Solutions 2007 Ann Longrnore 0amp0 Practice Leader Terms amp Conditions For all companies the focus on quot hot buttonquot issues wrll continue for the remainder ofthe year and well into 2007 Nonrescindable coverage originally available solely forASide coverage which may now be extended to inciudethe rest of the BSD contract wrth non rescindable B and C insuring agreements on some accounts still a challenge for Fortune 500 companies 0 Thresholds for the personal conduct exclusions illegal profiting intentional illegal conductiwhich may dovetail With the firm s indemnification provrsions o Narrowrng the imputation of knowledge provrsion and the definition of quotApplication 0 Tailoring global programs to fully balance the need for local policies 0 Modified claims reporting notices to eliminate the overassertion of latenotice claims denials 0 Potential coverage clarification wrth newly introduced DampO extradition endorsements Willis Energy Market Review December 2006 39 40 Willis Energy Market Review December 2006 Concluding Feature the Outlook for OIL Recent challenges In our last Energy Market ReVieW issued in May 2006 we highlighted the challenges faCing the OIL management foIIOWing the mutual s catastrophic 2005 Gulf of lVleXICO hurricane losses and in particulartheir struggleto maintain capital adequacy and security ratings These challenges have been unprecedented in OIL s long history 0 Two unprecedented cash calls of US800 million and US900 million 0 The downgrading of OIL s security rating from A to A7 by Standard and Poor s o The diminution of the quot per occurrence capquot from USIbiIIion to US500 million bythe OIL board on June Ist 2006 to protect their solvency margin A major crisis RecogniZing that OIL had suddenly become a quothigh barrier to entrylow barrier to eXitquot faCility and haying paid offthe majority of the hurricane losses With cash calls the OIL management was left accepting that a mayor crisis could potentially be on their hands Little wonder that some industry observers and indeed many OIL members have been left questioning Whether OIL still represents a cost effective and effiCient purchase of capaCity Within an energy insurance programme Recent developments Soyust What has the management done in 2006 to secure OIL s capital base stem the dissenting v0ices ofthe nonGulf exposed sector ofthe membership and remarket the positive benefits of membership And has it done enough Prior to the Special General Meeting of shareholders last October the OIL Board made two important deCisIons They issued US600 million in preference shares which raised shareholders equity to USI7 billion and also reduced the US1 billion multiinsured aggregate limit to US500 million Membership diversity 7 does it help In the buildupto this meeting a major talking point amongst many observers was the diverse nature of today s OIL membership To the casual observer the deCision by OIL s Board to open upthe mutual tothe minerals mining and utilities sector in 2004 may have seemed like a divergence from the original concept of the founding fathers which was the pooling ofthe somewhat more homogenous risks associated With the US OIl industry OIL s move may also have been seen as a kneejerk reaction to the declining number of members in the pool or as a means of ameliorating the dominance of one particular sector Within the pool However we understand that the current OIL management Views this development as a natural extension ofthe membership base since many of their integrated members already declared minerals mining and utility assets to the pool No longer prepared to share Whatever the rationale the effect was clear as the impact ofthe US Gulf losses began to be feltA number of OIL member companies With interests unaligned With those ofthe traditional membership signalled that they were not necessarily prepared to continue to share in the fortunes of other members 7 particularly When those fortunes were tied to such grave natural catastrophe perils as US GquWindstorm EampP v the rest The foilowrng charts highlight the disparity between the assets declared and consequent premiums paid by each OIL sector and the losses arising out of each sector from the hurricanes Hurricane Katrina and Rita Losses by OIL Sector I Pipelines Utiiities I EampP Onshore I EampP Offshore 2005 Unmodified Gross Assets Declared to OIL by Industry Sector I EampP Onshore I Mining I Elecmc Utiiines These charts show the disproportionate degree of OIL s Offshore EampP losses from Hurricanes Katrina and Rita compared to the overall gross asset base of this sector Within the mutual Calls to further differentiate risIlts according to the level of significant losses generated to the pool were substantiated in a member survey carried out by OIL In the summer of 2006 Of the 79 of respondents 74 called for more differentiation whiiethe maiority called for additional premium calls to be avoided Management options As the October meeting approached the OIL management considered a range of risk limiting options including o Deductibies o Quota shares Retros 0 Separate aggregation limits 0 Premium differentiations At a Special General Meeting of shareholders held in October 2006 members were asked to vote on a resolution to establish An additional 2 business sectors to the exrsting eight sectors one forAtiantic Named Windstorm ANWS onshore and one forANWS offshore A US750 million nonANWS perils aggregation limit to be mutuaiised amongst all members A US500 million ofANWS periis aggregation limit to be mutuaiised amongst all members 0 An additional US250 million of Optional ANWS periis quottop upquot aggregation limit to be mutuaiised oniy amongst sharehoiders electing to participate Willis Energy Market Review December 2006 41 Concluding Feature the Outlook 42 Willis Energy Market Review December 2006 for OIL continued For shareholders this meant that a Significant amount of the premium load would be shifted from members With nonANWS assets to members With ANWS assets In real terms 61 would be contributed by the Business Sectors With 39 being contributed by theANWS Sectors A fair proposal The advantages and disadvantages ofthe proposal were identified as follows Advantages Premium differentiation forANWS exposed assets Differentiation methodology consistent With current system Closer alignment of current premium allocation With loss experience Disadvantages Verythin loss history for ANWS Onshore sector three years from Which to calculate exposure Time regUired for accurate differentiation to fully take effect Difficulty in collecting defining and auditing ANWS exposed assets Ihe March 2007 AGM In the event the proposal failed to be carried by a very narrow margin However it was decided that the resolution would be reevaluated for the March 2007 AnnualGeneral Meeting We understand that the management of OIL is gUietly confident that the resolution Will be promulgated atthis time and has made specific provision for two policies to be issued in 2007 0 One to be issued January Ist to May Sist reflecting the current OIL limitsbusiness sectors One to be issued for June Ist to December Sist to reflect the reVised limitsbusiness sectors Members Wishing to opt into the out oftheANWS sectors for the 2007 year may elect to do so by March Sist Members also havethe opportunity to issue notice of full Withdrawal from OIL at June Ist Ihe nine withdrawals In advance of this and having carefully reViewed their OIL position nine members have issued notice of Withdrawal from the 2007 year at October 315tWhilst not confirmed by OIL it is our understanding that these were Royal Dutch Shell Koch Duke Tenaska American Electric Power NiSource Inc Kuwait PetroleumAtmos Energy and Kinder Morgan Inc Together they comprised 12 ofthe gross weighted assets ofthe pool OIL 7 the benefits So has the OIL management done enough to ensure the pool remains Viablethrough 2007 and does it continue to provide the much vaunted benefits it once did These are generally acknowledged to be 0 Significant property capacity at a lower cost structure than the commercial market 0 Broad Form coverage 0 Greater contract certainty With standard coverage proVided under a single shareholder agreement 0 A perpetual coverage termWith no annual renewa per se the risk manager is freed up from the onerous task of annually marketing his account OIL 7 Recent Rating History 60 A strong networking community among feiiow sharehoiders The OIL management insist that there are few if any commerciai markets offering the size of iimit that OIL is prepared to offer They point out that their cost ratio is iower than any commerciai market insurer and beiieve that the OIL premium modei based on retroactive ioss experience to the pooi offers a iower cost structure than that ofthe commerciai market Capacity From a capacity perspective it s worth stressing that OIL stiii offers US250 miiiion ofA rated capacity to the energy sector for property damage on a broad form cover Currentiy a muitiinsured aggregate iimit of US500 miiiion appiies for exUS 6qu and 6qu exposures Premium rates are set on a quarteriy basis and refiect the ioss experience of the pooi over the preVious five year period 2000 z00i 2002 2003 2004 2005 2006 2007 Erreavekatemodmevenvied OIL s ieputation as a tooi for smoothing the pricing voiatiiity ofthe commerciai market has een undermined bythe 2005 hurricane season Cost Structure But at a iower cost structure IVIost risk managers citethe reason for transferring riskto be to exchange an uncertainty ie a risk of ioss With a certainty ie of being indemnified for a fair premium caicuiated on the expectancy ofthat ioss It has not escaped the notice of industry observers that the retroactive premium modei which OIL empioys is in itseif an uncertainty as those members who saW premiums paid to OIL rise neariythree foid in the iast three years can now testify Furthermore the 2005 cash caiis and the subsequent severe rate hikes of 2006 came hot on the heeis of the 40 rate hike to cover the Hurricane Ivan iosses in 2004 aithough the risk weightings between the different sectors have served to minimize the impact of iosses on unaffected sectors such as utiiities Coverage On the issue of coverage whiist it is true that the cover proVided has narrowed significantiy With the dropping of the Broad Form Poiiution coverage at Ist January 2006 it shouid be pointed out that OIL continues to offer an aii risks poiicy form which affords cover for operationai construction and onshore terrorism risks With the iatter an aiiimportant issue for some members Contract certainty With regard to greater contract certainty this is certainiy of paramount importance tothe London insurance market as insurers and intermediaries are now reguiated With the rest of the financiai services industry by the Financiai SerVices Authority FSA According to the FSA aii business which comes through London now has to be contractcertain at inception So the fact that OIL is contract certain at inception wiii perhaps no ionger be the differentiating factor of oid in the future Willis Energy Market Review December 2006 43 Concluding Feature the Outlookfor OIL continued 44 Willis Energy Market Review December 2006 The OIL Form So is the OIL Form able to offer any greater degree of certaintythan its commercial market rivals Perhaps not but What is true is thatthe OIL product offering is standard across all sectors and all members and it must remain as such in order to ensure that the concepts of equality and fairness are upheld Perpetual coverage On the issue of a perpetual coverage term we would comment that Whilst risk managers are not requved to proVide an annual underwriting submission With detailed value breakdowns engineering surveys and explanations of risk mitigation techniques practised they are in fact required to provide a statement of gross assets Should the resolution to separate US Gulf assets onshore and offshore be adopted at the nextAnnual General Meeting in March 2007 a significant amount of detailed exposure information Will be required of risk managers Community and networking Perhapsthe most obVious and enduring benefit of OIL membership over the years has been the sense of community and the networking opportunities that membership undeniably proVides and it might be this very factor which prevented more of an exodus of OIL during 2006 A number of Withdrawalsfrom OIL at the October Slst deadline particularly ofthose members who had no US Gulf exposure but who had been called upon to make a significant contribution tothe hurricane losses was anticipated by many observers The much discussed exit penalties for 2006 were equal to the amount of premium the exiting members would have paid over the next five years had they remained in the pool and had OIL suffered no more losses So what was the reaction ofthe membership to 2005 the year of significant hardship for so many 0 Nine members issued Withdrawal notice at October Sist 0 Many members took the opportunity to reposition their OIL capacity raising the attachment point and taking an avoided premium surcharge Some members restructured their OIL entry adopting an external quota share from the commercial market alongside to stretch the OIL capacity Conclusion It is clear that the actions taken by OIL over the last year have somewhat steadied the ship Only 9 out of 87 members served notice at October Sist Those Withdrawing members do not appear to represent one particular type of company and would seem to have different reasons for exiting the poolWhat is also clear now the disaffected members have Withdrawn isthat the likelihood ofthe resolution to adopt the two additional ANWS sectors being passed in March has increased A dwindling premium pool However this is perhaps not qUite the end of the story As the commercial market begins to soften there is no doubt that other members Will now also be considering their longterm position by the time ofthe next renewal season in luneJuly 2007 It is sometimes asserted that some ofthe more recent OIL intake has been more interested in securing the premium advantages offered by OIL before the 2005 hurricane season rather than being truly committed to the core principle of homogenous risk mutualisation for the long term Some ofthe options open to dIsaffected OIL members threshoIds suggests a reducing OIL prequm pooI for In 2007 to secure more favourabIe overaII rIsk transfer the Iong term ThIs In turn wouId serve to Increase the terms mIght be very voIatIIIty that OIL had attempted to rectIfy by the haIVIng of Its aggregate event IImIts earIIer thIs year c WIthdrawaI Iater In 2007 Our recommendatIon to buyers Is that weII In advance reposItIonIng OIL at a more remote posItIon within oftheIr renewaI date and wIth an eyetothe next OIL theIr overaII rIsk transfer programme WIthdrawaI date cIIents seek the adVIce of professIonaI brokers and adVIsors to heIp assess o o IncreasIng the quota share partIpratIons ofthe commercIaI market captIve Insurance companIes 0 StructurIng optIons for OILcapacIty or seIfInsured retentIons CommercIaI market aIternatIves to OIL capacity Taken together the combIned effect of member WIthdrawaIs WIth the appIIcatIon of hIgher retentIon The benefIts of OIL membership In the round OIL 7 Recent Rating Histmy I990 I99I I992 I993 I994 I995 I996 I997 I998 I999 2000 200I 2002 2003 2004 2005 2006 2007 The number of OIL members Is stIII reIatIver hIgh compared to pre 2001 7 but how many remaIn truIy commItted to the mutuaI for the IongteIm Willis Energy Market Review December 2006 45 Concluding Feature the Outlookfor OIL continued OIL 2006 Facts and Figures in Review The increase in gross and net premiums IS primarily Unscaled losses to OILfrom Hurricane Katrina due tothe increase in premium rates The standard amounted to US2046 billion scaled to and fiat premium rates for the second and third US1 billion dueto the multiinsured quarter 2006 were 1732 cents and 1731 cents aggregation limit compared With 1175 cents and 1362 cents for the comparative period last year c Uhscaled losses to OILfrom Hurricane Rita amounted to US1265 billion scaled to OIL rates for 2006 4th quarter billing as follows US1 billion dueto the multiinsured aggregation limit EL Pool A Preliminary Standard Ratee paid by all members 1701 cents c To date OIL has suffered one single claim in 2006 of US195 million a mining exploSion E Pool B ProViSiohal Fiat Premium Rate 7 additionally paid by Pool B members 1643 cents 0 Membership currently stands at 74 0 Two new members Arlltema Group and IVIariner Energy Inc oihed OIL in 2006 o Shareholders egUity increased by US824 million during the first half of the financial year due to issuance of US587 9 million of preference shares net underwriting income of US1642 million and investment income of US775 million Shareholders egUity at lune 30th 2006 stood at US17006 million 0 For the first half ofthe year gross premiums written were US858m up 414 on the same period last year 0 Net premiums earned increased by 38 upfrom US306 million earned in the same period last yearto US4232 million 46 Willis Energy lv larlcet Review December 2006 Energy Market News 0 o o o o o o o o 0 Since our last issue Catiin andWeiiington have announced a merger between their companies Stephen Catiin Wiii be Chief Executive With Preben Prebensen as his deputy AIG has estabiished AG Giobai Marine and Energy headed byAIG Vice President Raiph Mucerino Chaucer has formed a new underwriting operation in Singapore With London market broking and underwriting firm John Cahiii Group and has recruited former Weiiington underwriter Chris Wiidee as Chief Executive ofthe new operation Beazeiy has aiso expanded its engineering and construction team into Singapore With the opening of a new office that Wiii underwrite Engineering and Construction insurance and reinsurance business The office wrii be headed by Byran Lee Guan Leong and Wong Jyh Lih OIL iiabiiitycasuaity sister company OCIL has been downgraded by ratings agency Standard amp Poor s to BBB from A Lioyd s managing agency Canopius has acquired Creechurch another Lioyd s agency for an undisciosed sum It is pianned that next year Creechurch s syndicates wrii be wrapped into Syndicate 4444 which is expected to increase its capacity form E300m to some 400m Martin Schweighauser has ieft SWiss Re to pursue other interests Coim Keiin has ieft SWiss Re to ioin Infrassure Laurent Hoguet has ieft Partne Re to ioin AG Jason Pouiastides has moved to new Lioyd s operation Novae o o o o o o o o o o DaVid Hope has ieft the NaVigators Group in London to pursue other interests and has been repiaced by Stephen Coward Lioyd s insurer Heritage has promoted NickJones to the position of active underwriter of Syndicate 1200 foiioWing the retirement of Les Rock Commonweaith Insurance ofVancouver has announced that it has Withdrawn from writing upstream and downstream energy business CV Starr has iaunched a new syndicate at Lioyd s Syndicate 1919 managed by Berkshire Hathaway subsidiary Mariborough Underwriting Agency on 1 October The Syndicate Wiii have a capacity of 50 miiiion in 2007 Keian Hunt hasioined Arch Insurance Europe from the energy team atAIG London Peter Godfrey has ieft SWiss Re and ioined Aiiianz to head their energy underwriting operations He is joined by his former coiieague at SWiss Re Robert Vincent Eispeth BreWin has resigned from her position at OILto ioin Thomas R Miiier Heath Caiium has moved from Aegis in London to Lioyd s insurer Argenta John Bryce has ieft SWiss Re and ioined Brit Insurance to write their downstream portfoiio NCCI has announced that it has signed an agreement With Munich Re which Wiii aiiowthe Saudi insurer to offer a maxrmum capacity of US100 miiiion for energy and other reiated industries Willis Energy Market Review December 2006 47 Willis Energy key appointments in 2006 48 Willis Energy Market Review December 2006 On August 10 we announced the formation ofWillis Energy a worldWide multidisciplinary business serVing the oil and gas industry on a global basis The new business draws on teams from Houston Calgary New York and London and incorporatesWillis global retail networkTo strengthen our new global platformwe have made some important new appointments during the course of 2006 which are summarised below Houston Loyd Esler has been app0inted Energy Practice Leader in North America Located in Houston his primary focus Will be to coordinate Willis energy operations in Houston Calgary and New York and to promote organic business development across the continent He Will report to Phillip Ellis Willis Energy Chairman Forthe last two years Loyd has een Managing PartnerforWillis Houston operation In this role Loyd ran energy and nonenergy operations where he significantly increased revenue growth while advancing client advocacy and enhancing recruitment efforts The greater part of Loyd s 18year insurance career has been focused on structuring and placing casualty insurance solutions for Fortune 1000 companies PriortojoiningWillis in 2004 he spent five years at Marsh in various roles including Regional Practice Leader for the Private EquityMergers ampAcquisitions diVision His underwriting experience eight years With Liberty Mutual adds to the perspective he brings that Will serve the best interests ofWillis clients 0 Doug Shockley is one ofthe most wellknown names in the Houston LossAdyuster market Doug began his career in the Oil and gas sector as a roustabout while attending college in 1972 and soon progressed to senior surveyor with Rush Johnson Marine SerVices Inc In the mid 1980 s Doug was senior adjustersurveyor for some of the largest ever drilling rig losses including a notorious trio of Constructive Total Losses for one drilling contractor in 198485 In the 1990 s Doug was at IH Blades Where he and his colleagues handled over a thousand claims adVices each year More recently a spell in theAsia Pacific region was followed by a return to Houston working for Bateman Chapman Calgary Kathy Underhill yoms us as our new Calgary Office Manager PreViously Risk Manager of EnCana Corporation Kathy spent the first 16 years of her career at Shell Canada as a qualified chemical engineer Shetherefore has a natural empathy for the Canadian energy industry as well as a deep understanding of its most challenging risk management concerns Cees van der Slikke isWillis Canada s new Natural Resources Leader Cees was Risk Manager for Unilever and Shell International for many years before ibining Aon Where he served as an adVisor to several ofthe world s largest natural resources companies in the US Canada and Europe Held in particularly high regard in the Oil and gas sector Cees Will be working closely With Neil McIntyre and the other members of the Global Energy team in Canada Bill Chan also has a risk management background in the Canadian energy industry sector Where he is highly respected by his peers His expertise is in the specialist areas of risk identification quantification and retention capacity as well as alternative risk financing captive management and enterprise risk management Bill yoms us from Aon Where he recently retired as Vice President in the company s Alternative Risk Solutions department New York 0 0 Frank D39Ambrosio began his career over 30 years ago as an energy underwriter wrth theAii American Marine Siip in New York HiS underwriting career spanned some fifteen years With various insurers before yoining Marsh in 1991 As SeniorVice President and Offshore Property Manager Frank had ciient executive responsibilities for severai iarge integrated oii companies and brings toWiiiis a formidabie reputation both as a competitor and as a weiiknown piiiar ofthe New York energy insurance community Jack Camilla iS a highly respected casualty speciaiist He has over 25 years experience With Marsh in New York where he managed the Marine and Energy Casualty Department for more than ten years HiS particuiar speciaiity has been the design and placement of high profile Excess Liabiiity programmes for mayor integrated energy companies that have posed particuiar chaiiengestothe conventionai casuaity markets as weii as havrng deep knowledge of Primary Casuaity programmes London 0 Neil Smith hasyoined us foiiowrng an insurance career of aimost 20 years With Sedgwrck Energy subsequentiy Marsh foiiowrng the takeover in 1999 Sincethe early 1990 s he has speciaiised in the roie of Ciient Advocate for a range of mayor integrated European South African and Canadian clients As a resuit he brings toWiiiis his substantiai expertise in the deveiopment and impiementation of soiutions for a broad range of petrochemical refining construction and exploration risks As a Ciient Advocate his roie is very much as an access point for the deiivery of the best possible solutions and servrces that we can offer 0 o o Alan Nash has speciaiised in marine and energy insurance for the last 23 years ofwhich ten were spent wrth Sedgwrck Offshore Resources before yoining Alexander Howden Energy iateern in 1991 In 1999 heyoined Marsh Energy as a Senior Vice President where his roie was enhanced by taking responsibiiity for new business production AtWiiiis his role as a senior ciient director aiso invoives deaiing on a day to day basis With mayor oii companies overseeing operating programme renewals including OIL quotwrapsquot and placing their offshore construction proyect programmes Paul Braddock started his career in 1988 at Sedgwick iater Marsh as an account manager working predominantiy on US and Canadian wholesale businessWhiist at Marsh Paui led a ciient servrce team that focused on upstream and downstream business sourced from the Middie East and North African regions Paui has also been heaviiy invoived in offshore construction risk programmes wrth particuiar focus on the North Sea the Former Sovret Union and the Guif States AtWiiiis Paui is working on predominantiy upstream energy business and is aiso invoived in the development of business and insurance products for renewabie energy technoiogy David Griffith has over 25 years experience in the insurance market havrng started his career in the marine department of Sedgwick Forbes Biand Payne in 1980 He transferred across totheir energy department in 1990 as an offshore broker where he spent 11 years piacing a huge variety of energy packages and construction risks into both the London and Internationai markets Prior to yoining Wiiiis in 2006 Davrd spent 5 years with Agnew Higgins Pickering as a Senior Offshore Broker Willis Energy Market Review December 2006 49 Willis Energy key appointments in 2006 continued Gerard Maginn has twenty two years experience The foIIoWing have aiso joined Wiiiis Energy in London in the upstream insurance industry and has been during 2006 traveiing to the Asia PaCific region reguiariy for the past 15 years He commenced his career With Jenner Name From Fenton Siade prior to ioining Heddington Insurance Jeremy Bennett Aon Where he deait With aii aspects ofTexaco s Leona Cai WiIIis FINEX department insurance and risk management requirements Chris CoIman Marsh Gerard then ioined Energex Internatiohai Insurance Ian EIweII University of EastAngiia Brokers and headed up the offshore energy team Heien Foster Aon Which handied a predominantiyAsia PaCific Jeremy Furber Newman Martin amp Buchan portfoiio Gerard tookthis portfoiio With him When Chris George Marsh he subsequentiy moved to Marsh In 2002 he Steve Portman MiIIer Group joined Aon as a Director ofthe Energy DiVision Farida Rahman Newman Martin amp Buchan working primarin With ciients from the Middie East Kristina Sisk Bowdoin Coiiege New Brunswick USA and Asia Pacific regions Andy Wei London Schooi oi Economics 0 Robin Somerville began his career over 25 years ago as an upstream insurance market broker for The foIIoWing Wiiiis Associates both Sediick and Aiexander HoWden However contributed to this reVieW since 1996 he has focused on proViding speciaiist energy insurance inteiiigence and communication Martin Beagiey o serVices foern Energy Robin s roie atWiIiis iustin Biackmore Giobai Energy is to ensure that our ciients and Aian Broo s prospects are kept fuiiy informed of aii reievant DaVid Ciark insurance market deveiopments as weii as Aiex Ciaytoh strengthening our own profiie Within the energy Martin Danieis industry worIdWide Phii Eiiis o Pameia Ferrandino Lesiey Harding Graham Knight Ann Longmore Tom Prest KeVin Sparks DaVid Thomas DaVid Turner 0 o o o o o 0 Editor Robin Somerviiie 50 Willis Energy Market Review December 2006 W n Energy hadcc L Dr lnd Jadanu One Camom e Street London EC3A 7LA Te1ephone 44 020 7488 8111 7 Hanover Square New Vork NV10004 Te1ephone 800 234 8596 1 212 344 8888 from overseas One R1venAaySu1te 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