Energy Insurance and Risk Management
Energy Insurance and Risk Management FINA 4359
Popular in Course
Popular in Finance
This 26 page Class Notes was uploaded by Miss Quentin Grady on Saturday September 19, 2015. The Class Notes belongs to FINA 4359 at University of Houston taught by Dan Jones in Fall. Since its upload, it has received 53 views. For similar materials see /class/208189/fina-4359-university-of-houston in Finance at University of Houston.
Reviews for Energy Insurance and Risk Management
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 09/19/15
ENERGY MARKET REVIEW MARCH 2009 Gulf of Mexico Windstorm Still the Insoluble Risk Management Problem 25 WELD ENERGY LOSSES 1990 2008 VERSUS GLOBAL ENERGY PREMIUM INCOME 25 Losses excess USSIm I Estimated Worldwide Energy Premium USS 20 15 C 8 gquot i l 10 5 lI lo 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Following Ivan in 2004 Katrina and Rita in 2005 and now Ike in 2008 is Gulf of Mexico Windstorm still the insoluble risk management problem quot incurred to date Source Willis Energy Loss Database W ELD Willis gures include both insured and uninsured losses IN THIS ISSUE Once again the fallout from a major Gulf of Mexico Windstorm is casting a shadow over the energy insurance market As Hurricane Ike overtakes Hurricane Rita to become the third most expensive event in insurance history a number of key energy insurers have found to their dismay that their initial loss estimates for this Windstorm particularly for upstream losses have proved to be less than adequate In light of the lessons learned insurers are restructuring their Gulf of Mexico Windstorm offering with a view to achieving longterm pro tability for this class In particular fresh capacity from Berkshire Hathaway may go some way to redress today s capacity shortfall Notwithstanding this the overall output of this process is unlikely to satisfy the energy industry Afull consensus has yet to emerge as to the best way to offer a product and in the meantime the market for Gulf of Mexico windstorm risk is still more confused more volatile and more expensive than everbefore Indeed in 2009 buyers are facing the prospect of paying increasingly higher prices for the limited insurance cover available whilst at the same time being asked to retain an increasingly signi cant share of this risk on their own balance sheets The implications of these developments from an energy insurer perspective are equally serious For some time additional premium generated from increased asset values brought about by superheated commodity prices have been making up for premium sacri ced in the competitive environment ofa softening market Now as this trend levels off and even starts to decline insurers must nd new ways of making up for income shortfalls caused by this factor and the sharp decreases in investment incomes in 2008 With recapitalisation becoming an increasingly expensive prospect an increased focus on underwriting pro tability is now the inevitable result For the moment any drive for increased underwriting pro ts may be thwarted I Encouragingly for buyers the development of new catastrophe modelling techniques and enhanced alternative risk transfer instruments might soon help underpin existing Gulf of Mexico Windstorm capacity In particular a parametric windstorm trigger that is designed to correlate closely to actual energy industry losses sustained is likely to attract investors from the capital markets Should such a capital market instrument prove equally attractive to energy market reinsurers it may serve to underpin the supply of more plentiful and consistent risk transfer capacity for this key risk in the future An alternative of further mutualisation of this risk within the energy industry is also a possibility In the meantime the energy industry is facing a changed world The nancial market meltdown and the onset of the global economic recession have rapidly cooled 2007 s commodity price surge that we highlighted in our last Review With crude oil now trading at a third of its 2008 peak the energy industry is now facing the very different challenge of 39 39 quot in T J J J 1 1 J1 the face ofnlnmmet39 A has implications for future capital expenditure plans and existing asset values by t 39 t t q m With little or no withdrawals from the market at January 2009 stated capacity levels for energy risks have actually increased by approximately 5 Any insurer initiatives towards a harder market are being partly tempered by the basic laws of supply and demand as a result the most favoured programmes have generally escaped the worst effects ofthe more focused underwriting environment Abig question mark therefore hangs over 2009 Whilst the market has begun 2009 in a resolute mood it remains to be seen whether or not competitive pressures will take their toll on this resolve as the year progresses As insurers drive towards risk di pmn a nn continues buyers will need every assistance from their broker to navigate their way pro tably through a con icted and apprehensive market Willis Energy Market Rewew 2009 1 ENERGY MARKET REVIEW MARCH 2009 Foreword Alistair Rivers Chief ExecutiveWillis Energy 4 Gulf of Mexico Windstorm Still the Insoluble Risk Management Problem 6 Reinsurance 32 Upstream 36 Downstream 50 OIL Update 60 Construction 64 International Liabilities 68 74 US Excess Liabilities Willis Energy Market Review 2009 l 3 FOREWORD Underscoring all these issues are further developments in the global economic climate which makes making too many predictions at the moment something of a fool39s gamequot Its an intimidating challenge to follow the Foreword from last year s Energy Market Review so accurate was Phil Ellis in predicting a deteriorating nancial crisis and an oil price fall a true achievement as it was scribed in January 2008 As the world now nds itself confronted by the most challenging economic circumstances that perhaps any of us can remember it seems almost obtuse to highlight the relative stability of the energy insurance industry as we move further into 2009 Although in general terms our markets are beginning to harden we estimate that overall capacity levels for energy business have actually increased for 2009 this has for the time being tempered the extent ofany hardening dynamic despite the macroeconomic factors currently at work in the insurance industry increased capital costs reduced investment returns and an increased management focus on underwriting for pro t rather than for income Ironically the impact of the global economic downturn on the energy industry including less construction activity and reduced business interruption values is having a somewhat negative effect on insurers overall premium income levels at precisely the time when they need these levels to rise So why have the existing market players decided to stay in the game One reason is that energy business has by and large remained pro table for most insurers in recent years 7 particularly for business that is free from natural catastrophe risk And therein perhaps lies the perennial issue for the energy market We have posed the question in the title of this Review that some of us have been asking since 2005 7 whether or not Gulfof Mexico windstorm remains the insoluble risk management problem Certainly if in answering this question the only criterion to be used is the quot quot d m ing from t 2009 the answer is probably yes The news of further capacity for 39 in urance marketin this risk from Berkshire Hathaway provided on a multiyear basis but subject to an annual aggregate cap may help to alleviate the problem to some extent what cannot be provided at present is the sleep easy unaggre gated protection that the energy industry really needs Maybe this initiative from Berkshire Hathaway will trigger the other major insurers to declare their hands Notwithstanding this we at Willis are excited by recent developments in the catastrophe modelling and capital market industries that we believe will eventually lead to the provision of such protection and these are discussed fully in this Review To achieve this ultimate goal will require the goodwill and cooperation of everyone involved risk managers catastrophe modellers brokers and their capital market specialists insurers and reinsurers To date this cooperation has not always been in evidence however the needs of the energy industry now require us all to step up to the plate Meanwhile the market remains beset by a con ict of trends and it will be interesting to see which will win out Will expensive reinsurance costs outweigh the effect of increased direct market capacities Will the focus on underwriting pro tability outweigh the threat of declining premium revenues Will the need to maintain partnerships with key clients outweigh the need to adopt a disciplined portfolio approach to energy business Will insurers hold their nerve or succumb to the pressure to maintain premium income 2009 will hold the answer to all these questions But underscoring all these issues are further developments in the global economic climate which makes making too many predictions at the moment something of a fool s game The one certainty is that Willis Energy is committed to supporting our clients in these challenging times through innovation technology unrivalled technical expertise and sheer perseverance Alistair Rivers Chief Executive Willis Energy Willis Energy Market Review 2009 l 5 GULF OF MEXICO WINDSTORM STILL THE INSOLUBLE RISK MANAGEMENT PROBLEM The upstream market has once again recognised the return of GOM wind as its number one underwriting headachequot EW VA With the Gulf of Mexico windstorm GOM wind book in ruins once more it s back to the drawing board for upstream insurers as they seek to revise their underwriting strategies for 2009 But just how much demand will there be for the products they will be willing to offer Is this class of business truly sustainable in the long term Or will GOM wind still remain the insoluble risk management problem World39s 10 most expensive insured losses 19992008 Loss Insured loss 2008 USbn Hurricane Katrina 68515 2005 11 23654 2001 urricane lke 15000 14115 13339 2005 10704 2005 urricane Ivan urricane Wilma Hurricane Rita According to the most reliable market statistics in inflationadjusted terms Hurricane Ike is the third largest insured loss in the last ten years with Gulf of Mexico windstorm losses quot for seven out of the top ten most costly events Hurricane Charley 8840 2004 Winter Storm Lothar 7223 1999 Winter Storm Kyrill 6097 2007 a a I Hurricane Frances 5650 2004 The Gulf of Mexico GOM is back in the news with a vengeance It seems such a short time ago that Ivan Katrina and Rita were seriously disturbing the sleep patterns of the world s leading upstream energy insurers in addition to this terrible trio we nowhave lke the full rami cations of which from an insurance perspective are only now becoming clear Already reeling from a series of serious subsea construction losses noti ed during the summer of 2008 the upstream market has once again recognised the return of GOM wind as its number one underwriting headache 2006 AN D 2007 T00 GOOD TO LAST Before the 2008 GOM Windstorm season began the market had perhaps begun to think that the 2005 season had been something of an anomaly Following the catastrophes of 2005 dire predictions of further heightened hurricane activity for 2006 had insurers on the edge of their seats a renewed focus on the newlyintroduced Lloyd s RDS model could be discerned together with the imposition of aggregate limits increased retentions and sublimits not to mention a dramatic increase in rating levels and the market collectively held its breath as the summer approached hoping that it had done enough to amend its premium and exposure base so that it could withstand another catastrophic season And then as we all know nothing happened nor did anything signi cant happen in 2007 either Combined with relatively inactive claims years in other areas the upstream energy market was able to enjoy two years of spectacular pro ts as pressure began to build for insurers to abandon strict underwriting stances taken following Katrina and Rita and offer more competitive terms for 2008 Re Munich ReWillis gures produced prior to 310109 quotI believe we are in a period of high activity within which there has been greater severity because of climate change Whatever the reason we are going forward underwriting on the basis that there will be a similar level of activity in the Gulf of Mexico on an annual basisquot Dominick Hoare Watkins Syndicate Willis Energy Market Review 200917 Monthly Values for the Atlantic Multidecadal Oscillation 18562008 The fact that the Gulf of Mexico shall 0396 remain in the warm phase of the 04 Atlantic Multidecadal Oscillation for possibly the next thirtyfive years 02 39 shows that the benign hurricane g I l years of 2006 and 2007 are likely to g I 1 be aberrations rather than the norm I39ll ml I I v u lt i l i o2 I l w I 04 06 1860 1880 1900 1920 1940 1960 1980 2000 Source Rosentod 2008 GUSTAV AND IKE But the experts at Colorado State University and other specialists kept telling us it couldn t last and of course the market also conscious of the effects of the Atlantic Multidecadal Oscillation see above was well aware that another major storm or series ofstorms 7 would signi cantly impact energy infrastructure in the GOM at some stage September saw the arrival of Hurricane Gustav although Gustav proved L t 39 a quot p a 39L as far as t 1 gy industry was concerned insurers attention soon turnedtowards Hurricane Ike as it tracked northeast past Cuba and straight towards one of the largest concentrations of offshore energy infrastructure in the world Although lke had weakened to a Sa ir Simpson Category 2 storm by the time it made landfall it had produced hurricane winds over a massive 125 mile radius and tropical storm winds over an even larger 255 mile radius The damage 1 quot and gas 1an a ti uctuie with 54 platfw t and a further 95 platfw quot A Now as the latest gures from the Willis Energy Loss Database show overall losses emanating from Hurricane Ike eclipsing even those of Hurricane Rita the majority ofa shocked upstream market nds their GOM wind portfolio once again lying in ruins with their reinsurers also bearing their full share of the pain Hurricane Ike Loss Deterioration and lvanKatrinaRita Comparison January 19 2009 392 Ike loss figures have deteriorated 3 significantly since November The 10 Upstream 5 effect of all four storms Is much more Downstream significant for upstream insurers 3 than their downstream counterparts Furthermore whilst Ike caused very 5 5 little by way of upstream Bl losses 3 it produced much larger OEE losses 4 compared to previous storms 2 Ivan atrina Rita Ike Ike Ike SOLIICB WELD losses are excess of USS 1million Dec 07 Dec 07 Dec 07 Nov 08 Dec 08 Jan 09 and include bathinsmed and uninsured amounts 8 l Willis Energy Market Review 2009 WHY THE GOM WIND MARKET IS AT A CROSSROADS So how is the market going to respond this time around Following a fraught and prolonged January 1 reinsurance renewal season we understand that the long term Athouqh initia y we sustainability of the Gulf Wind insurance product has now been seriously questioned by were hopeful that a Cat 2 storm wouldn39t cause much damage both the reinsurance and direct markets As a result major changes in the GOM wind insurance market products are on their way in 2009 Faced with an even more limited and expensive product we also understand that some it is clear that Ike was energy companies are also likely to question the viability of continuing to purchase no normal cat 2 storm this cover Given the otential disconnect between su l and demand for GOM wind p pp y and In terms of the number of platforms damaged this is a very lnitial indications in early 2009 suggest that these doomsayers may be wrong and that sizeable event we insurance products it is little wonder that market pessimists are forecasting the end of GOM wind as a viable insurance class the trad1t1onal insurance market for GOM W1nd W39lll cont1nue to carry on 1n the years shouldn39t be surprised ahead although with demand continuing to outweigh supply that we Will be paying However supposing developments in 2009 prove them right Suppose key market a SUbStantial ClaimH leaders with little or no orders at the terms offered this year simply turn on their heels and walk away Without a viable insurance market for GOM wind the only alternative Paul Dawson 39 Beazley Syndicate for energy companies for the foreseeable future would be for them to absorb the risk themselves whether they felt able to afford to or not This part of the Energy Market Review is dedicated to answering as best we can four key questions What have been the major e 39ects of Ike and other recent GOM Windstorm losses on the upstream energy portfolio How is the upstream market likely to respond in 2009 fill energy companies see these revisedrisk transfer products as worth buying How can truly sustainable risk transfer solutions for GOM wind be developed In conducting our research for this article we canvassed the opinions ofa quorum of highly distinguished insurance and risk management professionals They are 7 Axel Broth Swiss Re 7 Paul Dawson Beazley Syndicate 7 Dominick Hoare Watkins Syndicate 7 Greg Holland Willis Research Network 7 George Hutchings Oil Insurance Limited 7 Luke Johnston Swiss Re 7 Jim Lyness Chevron Corporation Some of their observations are quoted directly on the following pages We would like to thank them for their time and their willingness to give us the bene t of their expertise However we would point out that apart from when quoted directly the views expressed in this article represent Willis own conclusions as a result of our research and should be in no way be speci cally attributed to any individual member of the panel Willis Energy Market Review 2009 9 WHAT HAVE BEEN THE MAJOR EFFECTS OF IKE AND OTHER RECENT GOM WINDSTORM LOSSES ON THE UPSTREAM ENERGY PORTFOLIO EFFECT 1 CONSISTENT UNPREDICTABILITY Offshore GOM Wlnd Energy Losses as a Proportlon of Overall Offshore Enerqy Losses 19992008 20 18 All other offshore Enequ Losses 15 Gull Wind offshore Losses 14 g 12 72 10 8 6 4 IIII II 5mm losses excess of 06 07 as US1million only Perhaps the best way to understand the overwhelming impact of GOM wind losses on the upstream energy insurance market is to refer to the chart above compiled from the Willis Energy Loss Database Whilst few meaningful GOM losses have been recorded in seven out of the last ten years it can immediately be seen that the otherwise reasonably even distribution of offshore energylosses has been radically skewed by the three signi cant spikes of 2004 2005 and 2008 caused ofcourse by the Big Four hurricanes of the last decade 7 Ivan Katrina Rita and Ike The ultimate effect ofjust four events has been to give the upstream energy portfolio a level of volatility perhaps unmatched in any other industry sector a major concern of the Lloyd s Franchise Performance Directive From a risk management perspective the implication of these dramatic statistics is clear enough Conventional wisdom would suggest that infrequent but severe losses such as these should almost always be transferred rather than retained so as to smooth earnings volatility and lower the overall cost of risk Ofcourse this depends on two overriding factors rstly does the cover on offer actually provide the required protection and secondly does it do so at a realistic economic price From the insurance market s perspective however not only has it proved to be impossible to forecast the frequency and severity of major windstorms accurately it has also proved to be impossible to model these exposures to insurers satisfaction so that their actual impact on their upstream energy portfolio can be assessed properly in advance 10 l Willis Energy Market Review 2009 Insurers and reinsurers are therefore beginning to abandon the use of Sa ir Simpson as a basic underwriting guide for the future the chart below serves to explain why Big Four Vital Statistics Comparison Ivan Katrina Rita Ike Sa ir Simpson Cat 4 Cat 5 Cat 4 Cat 2 Hurricane Severity Index 33 47 42 36 IntegratedKinetic Energy 44 51 43 52 No of Platforms Destroyed 7 46 69 54 No of Platforms Damaged 24 2O 32 95 S nmmercialMarketLoss USI250m US3000m US3500m US3000m Duffs Perhaps both the direct and reinsurance markets will pay more attention to the Integrated Kinetic Energy of a given windstorm rather than simply rely on the Saffir Simpson scale in the future The chart shows the characteristics of each individual hurricane regardless of the key metric used be it the storms Sa ir Simpson Index Hurricane Severity Index or Integrated Kinetic Energy all the statistics point to different dynamics ofeach storm causing the resultant damage Perhaps the only consistent factor other than for Ivan is the nancial impact on the insurance market This is particularly the case for Hurricane Ike only a Category 2 storm when it made landfall Ike s Internal Kinetic Energy was even larger than that ofKatrina and therefore produced signi cant wave action which together with its huge width created the potential for as much damage to upstream infrastructure as either Katrina or Rita The Lloyd39s RDS no longer became a benchmark for the account Instead it became a key metric of the account from an underwriting point of View from a broking point of view from a reinsurance point of View and from an internal management point of View A sacrosanct figurequot Dominick Hoare Watkins Syndicate Willis Energy Market Review 2009i 11 Hurricane Ike Wind Field With a few notable exceptions it appears that most upstream insurers may have relied too heavily on the maximum loss gures produced by the Lloyd s Realistic Disaster Scenario RDS 7 designed in any case as abenchmark rather than a replacement for underwritingjudgement 7 and as a result found that they were exposed to a far greater loss from Ike than their management and indeed their reinsurers would have expected from a Sa ir Simpson Category 2 storm Why did the market get the impression that their catastrophe models had let them down Perhaps it was a little unfair of certain insure rs to rely on them so much For a start the catastrophe modelling industry itself is only about 1820 years old and so according to one analyst at Willis Catastrophe Management Services canbe likened to an adolescent about to move into adulthood with all the associated pains of growth and learning through mistakes Secondly the modelling industry only has access to sparse data particularly for infrequent but severe events such as major hurricanes Because of the limited observational record the catastrophe modelling industry can t yet tell us what is going to happen and when particularly over longperiods of time 12 i Willis Energy Market Review 2009 Past experience or overreliance on the Lloyd39s RDS proved to be of little use in anticipating the impact of Ike39s extreme bandwidth on energy installations in the GOM Lloyd s EDS sourc e Lloyd s Hurrie anes Katrina and Rita some e MM S Hurricane Ike sourc e Watkins Syndie ate quotCat models are only one tool in the box no modeller will say out the data in turn the handle and get the expected loss go back to the client and charge It39s not something that needs to be used in isolation it needs to be used in conjunction with traditional underwriting skills People who take models in isolation will get into trouble it39s not providing the answerquot Luke Johnston Swiss Re USS Bn USS Bn EFFECT 2 CONSISTENT UNPROFITABILITY Enerqy Insurance Market Gulf of Mexico Premium v Claims Estimates 200408 GOM Wind Premiums GOM Wind Claims 2004 2005 2006 2007 2008 Totals The above chart has been kindly provided to us by the Watkins Syndicate at Lloyd s one of the leading GOM Wind insurers The same volatility that we saw in studying the loss statistics from our database can also be seen from these gures The effect ofthe Big Four on this portfolio has been to produce an overall incurred premiums V paid and outstanding claims ratio over ve years of over 360 despite a considerable increase in premium income for this class following the hurricanes of 2005 Furthermore such is the magnitude of the insured loss for Ike 7 estimated by the offshore market to be in the region of US53 billion as at December 2008 7 that this in itselfwould be su icient to Wipe out the global premium income for the entire upstream sector for that year GOM wind Insured losses compared to overall estimated upstream energy premium income 2008 losses 50 l39 quotquotquotquotquot 39I 45 E l E Further Ike 40 E and other E i upstream E 35 g I I I I GOM wind Insured Losses as of December I 2008 Estimated Upstream Energy Premium Income Source Watkins Syndicate The offshore enerqy portfolio incurred loss ratio for 2008 is likely to be significantly greater than 100 once the final figures are collated and adjusted Willis Energy Market Review 2009i 13 SO WHY DO UPSTREAM INSURERS STILL ACCEPT GULF WIND BUSINESS Impact of Gulf of Mexico Premium Income on Global Upstream Portfolio 2008 Walking away from the GOM wind book now would mean waving goodbye to over 90M Nonwind 25 of upstream insurers39 premium GOM Wind income and probably a further 875 of GOM nonwind business as well The remainder of the portfolio including Total vital revenue from global energy companies could also be impacted USS 2571Mn Source Watkins Syndicate Estimate Given the challenges associated with underwriting the GOM windportfolio the reader might be forgiven for wondering why up until now at least the upstream market has continued to offer this product albeit on a much more restricted basis than in the past We would suggest that there are three basic reasons for this 7 GOM wind on its own represents over 25 of the upstream market s premium income In general terms the market has been under pressure from capacity providers in recent years to grow premium income and market share Withdrawal from the GOM wind market would therefore create major di iculties for insurers that need to at least maintain their dollar share of the upstream portfolio premium income 7 Many multinational energy companies that purchase insurance have a substantial part of their asset base located in the GOM In some instances GOM wind represents a signi cant proportion of the overall premium allocation of the programme Withdrawal from the GOM wind marketwould therefore signi cantly jeopardise an insurer s position on these key programmes 7 Once an insurer has made the decision to purchase reinsurance protection for its GOM wind portfolio the need to recoup that initial outlay usually prevents insurers from withdrawing midterm 7 lfthe market failed to offer a GOM wind product and forced buyers to self insure insurers would be apprehensive that energy companies would then start to consider self insuring other aspects of their risk 14 l Willis Energy Market Review 2009 HOW IS THE UPSTREAM MARKET LIKELY TO RESPOND IN 2009 A REINSURANCEDRIVEN MARKET As most readers will know the GOM wind market for upstream energy risks relies heavily on the reinsurance market in order to provide meaningful capacity to energycompanies The direct market has reported a signi cant erosion of their total GOM wind aggregate limit to their reinsurers From conversations with our reinsurance colleagues and with direct market insurers in recent weeks it appears that many of the negotiations surrounding the renewal of various January 1 GOM wind reinsurance programmes have been both protracted and di icult As this article was being written all our market soundings indicated that signi cantly less reinsurance capacity 7 as little as 70 oflast year s total 7 is to be made available to the direct market in 2009 This year insurers have had to work much harder to demonstrate to their reinsurers why they should offer them support for their 2009 GOM wind offering Below we itemise some of the key areas of discussion which for some insurers and their reinsurers are still ongoing 7 Individual direct market underwriting strategies are being studied in detail Reliance on the direct market s Lloyd s RDS exposures to assess the overall risk has reduced instead reinsurers are now looking for individual insurers exposure aggregate information by GOM block as well as by class value and individual location 7 For Quota Share programmes individual occurrence policy limits are being capped at between 150250 of Original Net Premium 7 For Excess ofLoss programmes the lowest excess point offered by the reinsurance market has been 10 of the direct insurer s aggregate Furthermore cover is only being offered for claims incurred from one event 7 cover for more than one event must be purchased separately 7 Reinsurers are looking carefully at all Operators Extra Expense exposure paying particular attention to how insurers intend offering Extended Redrilling and Making Wells Safe cover These measures represent a dramatic change of approach by reinsurers and for obvious reasons have been highly instrumental in shaping the thoughts of direct insurers in formulating their offering for 2009 Needless to say Reinsurers are chargingmuch higher prices for this cover The Excess of Loss portfolio in particular is becoming increasingly commoditised with a minimum rate on line on offer of approximately 20 It is reported that some insurers have held back from purchasing reinsurance in the hope that terms will improve 7 only time will tell The portfolio has to be reconstructed in a way that for a likefor like event next year the market would actually make money and would hit its target return on capital Unless it can be proved to the contrary that we won39t get these events happening with this degree of frequency this has to be a starting pointquot Dominick Hoare Watkins Syndicate quotWe need to achieve pricing that reflects the fact of the increased frequency of these storms it39s the return period assumptions that we are reappraisingquot Paul Dawson Beazley Syndicate Willis Energy Market Review 2009 15 16 l Willis Energy Market Review 2009 THE IMPACT OF THE LLOYD39S FRANCHISE PERFORMANCE DIRECTORATE From our own research in the upstream energymarket it is clear that whilst there is a general agreement that terms offered for 2009 have to be signi cantly amended there is still not a complete consensus as to exactly what form these changes might take However as indicated earlier the Lloyd s Franchise Performance Directorate LFPD is also taking a keen interest in individual syndicates plans to write GOM wind in 2009 On January 26 the head of the LFPD Rolfe Tolle and members of the London Market Drilling Rig Committee invited various energy brokers and energy underwriters to a meeting At this meeting Mr Tolle suggested that 7 Lloyd s needs to have a more accurate grasp of the exposures that GOM wind insurers have on their books 7 The existing RDS methodology needs to change 7 All underwriters should now run different tracks following Katrina Rita and Ike paths and evaluate their exposure at various distances from those paths 7 Additionally Lloyd s wishes to centrally monitor individual syndicates exposure and will now require information in a standard format to be delivered by the Lloyd s leader only within 30 days of attachment on all GOM windexposed risks attaching after lst January particularly with regard to data relating to xed assets pipelines and mobile drilling rigs 7 Lloyd s also stressed that knowledge of the Minerals Management Service lD code for each structure will be crucial for insurers as well as the water depth versus the air gap of each structure WHAT CAN BUYERS EXPECT IN 2009 Given the recent interest taken by the LFPD in the GOM wind portfolio it is now probable that as far as Lloyd s insurers are concerned a market consensus might soon emerge From our conversations with key direct market leaders the following should be expected to be part of the product offering for 2009 7 Premium rates on policy limit would need to increase substantially 7 Retentions and policy limits would be intrinsically linked to the total asset values declared to the policy As a general guide buyers can expect retentions tobe between 25 and 5 of TlV Total lnsured Value of the assets insured with policy limits generally restricted to between 125 25 of TlV depending on the total value of the buyer s assets its spread of risk and its individual risk pro le Given that total 2009 capacity is likely to be approximately 70 of the 2008 gure it is likely that for larger companies the l2525 range would be likely to be somewhat academic 7 The market will no longer be prepared to offer aspects of the Operators Extra Expenses OEE cover such as Extended Redrilling Plugged and Abandonment costs and Making Wells Safe incurred solely as a result ofa GOM wind event on a broad brush basis However if such expenses are incurred as a result of ablowout and not a GOM wind event OEE cover will continue to be provided in the normal way Speci cally in the case of Extended Redrilling cover will be provided for scheduled wells only for a limit per well as declared which may be linked to the well s original AFE Authorization For Expenditure cost A rate will then be applied on the aggregate limit On this basis it is expected that buyers would only declare those wells that they are likely to redrill in the event of a loss to the policy schedule Other factors that will continue to impact the capacity and terms provided will include 7 Whether or not the platform is located in an area where there is a signi cant concentration of upstream infrastructure 7 Whether the platform is located in deep or shallow water 7 The deck height of the platform in relation to the water depth 7 The age of the platform 7 American Petroleum Institute code ONE LEADER39S VIEW In order to provide our readers with an indication of current market thinking we have reproduced with their permission a chart drafted by a leading Lloyd s energy syndicate Whilst this is by no means re ective of every leader s point of view it does at least provide an insight into the mindset of one leader determined to achieve pro tability for this class Figure 1 represents the actual effect oflke on the GOM wind portfolio whilst Figure 2 shows how the market s underwriting strategy in this leader s view would have to change in order to generate a pro t given the same loss in 2009 The Future of 6qu Wind Insurance One Leader39s View Flu I Hurricane Ike fly 2 39As Il39 Hurricane Ike Assured Retained Assured Retained andor Not Insured quotSS 900 Commercial Market Loss Commercial Market Loss USS 3000 Mn quot551100 Mn OIL OIL quotSS 750 Mn quot55 750 Mn Assured Retained USS 2500 Mn Assured Retained Income quotSS 900 Mn quot551300 Mn NB This chart assumes that the market is able to offer the same capacity for GOM wind as was provided in 2008 However Willis estimates that only 70 of this capacity will be available to buyers in 2009 When this chart was originally drafted in December 2008 the total Hurricane Ike loss was estimated at US525 billion as shown in Figure 1 above as we showed earlier this gure has now increased to nearly US7 billion This total was broken down showing 7 US3 billion total insurance market loss 7 US600 million retained by the buyers as deductibles 7 US900 million retained by the buyers in excess of amounts recovered from the insurance market 7 US750 million absorbedby OIL The commercial market loss ofUS3 billion is set against the US900 million which the syndicate estimates as the current global market premium income for the energy GOM wind portfolio Elli I Willis Energy Market Review 2009 l 17 18 l Willis Energy Market Review 2009 In order to make an underwriting pro t from GOM wind it is understood that this particular syndicate s target loss ratio is in the region of 60 taking into account the increased cost of capital and other expenses In the event of Ike Mark II materialising during 2009 see Figure 2 above the syndicate calculates that to achieve its target pro t the entire commercial market offering has to be underpinned by much higher deductibles Speci cally 7 The actual amount of policy limit was designed to remain the same although we now know that there will be approximately 30 less overall capacity in 2009 than there was in 2008 The intention was that in the event of what we might call Super Ike 7 a Category 5 storm with a similar Integrated Kinetic Energy character as Ike producing overall insured losses say in excess of US 7 billion 7 the buyer would still recover a similar amount from the market as for Ike 7 In other words the same product would be provided just excess of higher retentions the total energy industry retention would need to be virtually quadrupled from US15 billion to US34 billion 7 Because of this increased retention the commercial market loss in the event of Ike Mark II would be restricted to US 1100 millionjust over a third of the market s Ike loss as then calculated although the intention was that the same amount ofpolicy limit would be available in the event ofa larger occurrence 7 In order to maintain a 60 pro t ratio in the event of Ike Mark II the GOM wind premium income to the commercial market needs to double from US900 million to US 1800 million quotIncreased retentions are critical because it39s like us buying reinsurance you get to the point whereby at a certain frequency of loss we areJust swapping dollars So we39ve actually got to provide a product that provides real relief to our clients when the big loss comesquot Dominick Hoare Watkins Syndicate WILL ENERGY COMPANIES SEE THESE REVISED RISK TRANSFER PRODUCTS AS WORTH BUYING AN OVERAMBITIOUS APPROACH From the evidence of the model that we have been discussing there can be no doubt that considerable changes in the insurance market GOM wind product in 2009 are being contemplated But just how rea rumble and bu in u y are tL L 0 The underwriting approach that we have just outlined shows how GOM wind mightbe underwritten pro tably on the assumption that a storm of the magnitude of Hurricane Ike can nowbe expected every year Conversely it could instead be argued that such an event is more likely to be replicated roughly three times in ve years rather than every single year even ifinsurers were to take the last ve years exceptional loss activity as the norm this would only amount to four times in ve years The pressure that would be brought to bear on this underwriting model in the event of a lossfree year in the GOM would therefore be considerable one could say that it almost requires a major windstorm to impact the market in 2009 tojustify it in the long term Furthermore the unprecedented and dramatic increase in retention levels suggests that this model contemplates responding only in the event of a major windstorm such as Ike and would therefore act rather more as a second loss rather than a rst loss insurer for most windstorm events Whilst this underwriting philosophy is reasonable enough in itself the overall demand for GOM wind insurance is almost certainly likely to remain for rst loss cover 7 especially for smallercapitalised energy companies Another observation might be that such a model is attempting to provide a blueprint for an immediate return to underwriting pro tability by focusing on GOM wind in isolation from the remainder of the upstream portfolio Followingpast losses ofthis nature upstream insurers have traditionally sought to mitigate their position by taking stock of their entire upstream underwriting philosophy instead this model assumes that these measures will result in the current level of GOM wind rm orders to the market being sustained Those energy companies without GOM wind exposed assets being the majority of the market s clients would surely support this approach In any event this model is attempting to combine dramatic increases in retentions with a doubling of overall premium income levels Is the market right to be con dent that market GOM wind premium levels really are going to double if these measures are implemented lndeed will there be su icient demand for the revisedproduct in the future to enable insurers to continue to underwrite this portfolio on a meaningful basis I39m not sure we need to price this risk based upon one of these major windstorm losses occurring once a year provided however that underwriters are allowed to make good returns in loss free years without a subsequent stampede for rate reductio Furthermore trying to remove Ike or a significant proportion of the Ike claim by moving retentions to a level that is beyond the claim value will be quite hard to sellquot Paul Dawson Beazley Willis Energy Market Review 2009 19 A single platform producer has a completely different risk profile than a company with a multilocation stretch This company39s position is completely different from that of an average EampP company who has to be truthful with its investors if it is going to consider absorbing additional entrepreneurial risks such as natural catastrophequot Axel Brohm Swiss Re 20 Willis Energy Market Review 2009 In order to highlight the potential drawbacks of this approach for buyers let s take two extreme ends of the client spectrum and examine these insurer measures from these perspectives THE MAJOR OIL COMPANY PERSPECTIVE On the face ofit the product certainly looks a great deal less appetising than in the past from the perspective ofa major energy company For a start if the minimum retention demanded by the market were to be say 25 of total insured assets a major energy company with a GOM schedule valued at tens of billions of dollars might see its retention increase by say tenfold in 2009 Given that the maximum capacity for any one buyer is likely to be approximately 70 of what was on offer in 2008 then it can be seen that the value offered by the insurance market is considerably diminished given that not only is the buyer expected to retain ten times the amount in 2008 but also retain even more exposure in excess ofwhat will be provided by the commercial insurance market Major companies are therefore likely to be much more selective in deciding which assets really need to be declared to the policy In practice in order not to alienate the buyer we would expect the market to split a major oil company programme of this nature into individual geographical sectors within the GOM and then treat these separate areas as individual client programmes with separate limits and retentions THE SMALLER EampP COMPANY PERSPECTIVE Most insurers that we have spoken to believe that the majority of smaller energy companies in the GOM without the spread of risk and nancial muscle of the major energy companies have little option but to insure their assets against windstorm given shareholder considerations and the fact that the product has paid out four times in three years But consider the position of a small E8cP company that is the owner of a single platform in the GOM worth say US70 million Under the underwriting guidelines outlined above not only would his existing US1 million deductible double to US 2 million but the policy limit providedwould only amount to some US175 million 7 scarce comfort in the event ofa total loss of his only GOM asset In this instance the company can demonstrate to its shareholders that it is obliged to absorb 75 of its exposure in any case so it might consider whether purchasing an expensive insurance product to cover the remaining 25 is really viable These examples are of course two extreme ends of the spectrum and it maywell be that more exible solutions will eventually be offered to buyers 7 at a price as 2009 progresses In particular we have cited the second example to show how applying a strict 25 limit on TlV might apply taken to its logical conclusion and it is likely in reality that some additional capacity would be available on an excess basis although at a price Most companies that currently purchase GOM wind insurance will of course nd themselves somewhere in between the positions of our two extreme examples What cannot be yet determined is whether the riskreward ratio of the revised commercial market offering will appeal to enough buyers to enable insurers to continue to underwrite this class on a worthwhile basis THE RISK MANAGER39S QUANDARY WHEN IS THE BEST TIME FOR A MARKET APPROACH The price scope and quality of the cover offered are not the only obstacles confronting buyers of GOM wind in 2009 another problem is the issue of the timing of any market approach The 2009 Gulf Wind Dilemma who will hold their nerve Buyer self insures Later voluntary Sooner Offer Capacity Offer Capacity Buyer self insures compulsorily Buyer self insures Refuse Capacity voluntary CHDHCIIY Refuse Capacity Exhausted This chart is designed to show the dilemma facing both buyers and insurers of GOM wind insurance in 2009 given the gap in time between the conclusion of the rst reinsurance treaties at January 1 and the o icial onset of the hurricane season at the beginning of June Should a buyer approach the market early in the year to guarantee access to capacity they are likely to nd the market to be in a resolute mood If the risk is su iciently attractive to insurers then the buyer can expect to be offered terms at say Price X However it is also possible that the market might refuse to provide capacity for some risks preferring to reserve their capacity for those buyers offering potentially higher premium income In this event the buyer can either opt for selfinsurance offer to pay an even higher price than Price X from an opportunistic insurer or wait until later in the year Several buyers may decide that by postponing the decision to purchase they are more likely to obtain more competitive terms from the market as by then insurers could be faced with a declining order book at their original terms and may need to ensure that their up front reinsurance costs are recoupedbefore the onset of the hurricane season However by adopting this strategy the buyer is taking something ofa risk capacity may have already become exhausted or may be in such short supply that he is forced to accept a price higher than X rather than lower A key contributor to the GOM wind premium pool is the drilling rig industry which at this stage can be viewed as being cash rich A key question in 2009 is therefore whether these buyers will continue to purchase insurance and protect their balance sheet or elect not to insure but riskjeopardising their potential for further growth by incurring further GOM wind losses in 2009 Im l Willis Energy Market Review 2009 l 21 If you were a company with only two platforms in the Gulf of Mexico then shareholders may be a little concerned about no insurance But if you are a company with hundreds of platforms in the Gulf and more worldwide shareholders are likely to be more comfortable absorbing risk particularly if the available insurance is minimal compared to the exposurequot Jim Lyness Chevr n 22 Willis Energy Market Review 2009 SUMMING UP AN UNSATISFACTORY SITUATION TO SAY THE LEAST Taking all these factors into account how should we sum up the current situation in the GOM wind market Still Confused As this Reviewwent to print we understand that smaller GOM wind capacity requirements can be satis edwithout needing to access the full range ofmarket leaders However where larger amounts of capacity are required we must report that no common market stance has yet emerged leaving buyers confronted with a patchwork quilt of differing terms and conditions The dramatic increase in retention levels sought by our cited leader may have widespread support in the following marketbut is unlikely to be shared by all other market leaders particularly those more interested in generating additional premium income by offering cover at lower deductibles From a Lloyd s perspective we believe that the in uence ofthe LFPD will be critical what cannot be determined is the exact extent of that in uence Furthermore whether any Lloyd s consensus will extend to the company market is still very much open to question Still Restricted We have seen that the market is going to offer approximately 30 less capacity than in 2008 However as this Reviewwent to press we understand that Berkshire Hathaway is to provide a ve year xed premium US500 million annual aggregate facility on a pooledbasis for oil and gas companies operatingin the GOM A choice oflimits up to a maximum of US 100 million per occurrence will be available with a variety of attachment points ranging from US20 million to US 250 million per occurrence Whilst this fresh capacity will naturally be welcomed by buyers it will be interesting to see how they will respond to what is essentially an uncertain recovery the key may rest on their perception ofjust how much of their per occurrence limit would be would be able to be reimbursed in the event of an exhaustion of the annual aggregate GOM wind insurance products are therefore still unable to provide any realistic sleep easy factor that most risk managers strive for Still Volatile Risk managers face an increasingly stark choice between securing capacity early or holding out for potentially cheaper terms later in the year at the risk of paying an even higher price or even not securing any capacity at all Still Expensive The market is clearly looking to offer a product that works for them in the long term although they only offer short term 12 month solutions As well as general rate increases new rating methodologies for exposures such as redrilling are going to L J in dltel I i k hndo et HOW CAN TRULY SUSTAINABLE RISK TRANSFER SOLUTIONS FOR GOM WIND BE DEVELOPED Although it is still likely that many buyers will accept the more restricted product likely to be on offer from the commercial market in 2009 there is a real danger in the long term of either the market deciding that this class can not be written pro tably or buyers deciding that what is on offer from the commercial market is no longer worth buying We believe that a collapse of the GOM Windstorm market brought about by either of these eventualities would be a disaster not only for energy companies devoid of protection for what constitutes a major physical risk to their asset base but also for the global energy insurance market which for decades has always been willing to provide cover for entirely fortuitous risks such as damage from hurricanes Only time will tell whether energy companies will buy at the terms currently being considered by the market or whether underwriters will feel compelled to retreat from this stance in order to generate su icient premium income TL L quot a C11 r r 14 Tim T lvput itto us is to determine how windstorm risks can be priced on a stable and reliable basis so that the product remains valuable to both parties But givenwhat s happened over the last ve years how is this going to be achieved in the long term lfthe existing commercialmarket offering fails to meet the energy industry s needs we believe that the answer may lie in three possible developments 7 Increasing energy industrymutualisation of this risk The energy industry has an excellent track record in nding alternatives to traditional reinsurance from within the industry itself 7 Future developments in the catastrophe modelling industry If the annual frequency and severity of GOM windstorms for each year can be predicted with greater accuracy then return periods for future losses might be able to be gauged more accurately by the insurance market 7 The underpinning of existing commercial market GOM wind capacity by a capital wer e to transfer risk into the capital markets allowing them to generate GOMwind capacity to the direct market this in turn might alleviate any supplydemand imbalance for this class lfmajor Willis Energy Market Review 2009 l 23
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'