Oil & gas market turns harder after taking a 1-2 punch

'08 windstorms and financial storm batter the Gulf Coast energy insurance market

By Phil Zinkewicz

The energy insurance arena encountered a double threat during 2008: first, Hurricanes Ike and Gustav, which caused tremendous destruction in the Gulf of Mexico area and, second, a financial crisis the likes of which has not been seen since the 1930s. Either of these situations could have serious effects on the energy insurance industry. But taken together, they could be devastating.

A recent article in a Lloyd’s of London Marine and Energy newsletter discussed the general state of the market as of the third quarter of 2008. Noting that the industry was “rocked” by events in 2008 that are likely to have a significant impact on the energy market in 2009, the newsletter pointed to two powerful hurricanes in the Gulf of Mexico and the “ravaging” of the financial markets, which included a bankruptcy filing by Lehman Brothers, a hasty takeover of Merrill Lynch by Bank of America and a U.S. government-sponsored bailout package for AIG.

Regarding the hurricanes, the Lloyd’s newsletter said: “Most forecasters’ predictions were for an above average hurricane season this year [2008], and these have proven to be accurate. According to meteorologist Scott Braun at NASA’s Goddard Space Flight Center, ‘Looking back to 1995 and earlier, most seasons have had only 5-7 storms by September 2, whereas this year has had 10. [The year] 2008 has been surpassed only by 1995 (13), 2003 (11), 2005 (14) and matched by 2004 (10).’”

Rough Notes spoke with Robert Daniels, president and principal owner of Burke-Daniels Co., Inc., which Daniels describes as “the only remaining independent wholesale broker in the United States solely devoted to energy insurance.” Daniels stressed that the energy arena consists principally of two groups of insureds—the owner-operator and the contractor. The owner-operator designs and drives the search for oil and gas and hires the contractors to do the day-to-day drilling and field work.

“We specialize in insurance for operators, although we do have some contractor accounts,” says Daniels. “Ninety-nine percent of our business originates through independent insurance agents in the Southwest. Over the last couple of years, there has been a slight softening in insurance product pricing in the energy arena, but now we’re seeing a serious hiccup.

“Two issues combined in 2008 to possibly radically transform the energy insurance marketplace,” he continues. “One of those issues is Hurricane Ike, which is working its way up to second only to Katrina in terms of insured loss costs to the industry. This alone will undoubtedly cause energy insurance pricing to go up.”

Daniels referred to a November 3, 2008, energy insurance market report completed by Burke-Daniels Co. The report says: “In the months following Katrina and Rita, the energy insurance worldwide marketplace severely increased all energy-related insurance rates worldwide, reduced available Named Windstorm capacity for every insured, and increased all deductibles and tightened terms and conditions within the coverage forms.”

The report continues: “Within 18 months of Rita, on the back of a hurricane-free 2006, the insurance market began to relax the afore-mentioned ‘hard market’ actions and by the fall of 2007 and throughout the first six months of 2008, rate reductions for both well control and physical damage coverage on renewals were averaging 10% to 20%, deductibles were easing slightly, and wind limits were being increased.

“However,” says the report, “numerous costly onshore domestic well control losses, featuring higher than normal frequency and high severity, coupled with some very large offshore construction losses, were rapidly eroding the basic premium income and capital derived from the positive underwriting results of 2006 and 2007. Most industry reports now advise that there were 52 Gulf platforms completely destroyed by Ike, whereas Katrina took out 47 and Rita 63. At least 29 platforms suffered severe damage and another 33 suffered moderate damage from Ike. Several mobile rigs and at least one platform rig were also lost in the storm.”

The report goes on, “Beginning with the late September ’08 energy insurance anniversary dates, many markets began to refuse to give any rate reductions, rather proposing rates ‘as expiring’ or, in some cases, increasing rates for accounts with no direct relationship to any hurricane exposure, much less any loss.

“As October passed, more severe reactions began in earnest and as of November 1, it appears that the major leaders in London are once again in turmoil and not completely in concert as they struggle with the adjustments necessary to remain committed to writing U.S. Gulf energy risks. At least one significant domestic energy underwriter has responded dramatically with huge premium increases for those clients with ‘wet’ exposures and serious increases for onshore well control risks.”

Daniels told Rough Notes, “Independent agents and wholesalers are watching this situation very closely.” We believe that prices will be increasing dramatically; deductibles will rise while limits of coverage will drop. Hurricanes Ike and Gustav have brought the energy arena back to the hard markets of late 2004, 2005, and early 2006.”

As far as the financial crisis goes, Daniels says that it is hurting both agents and operators. “The financial crisis has made it difficult for many operators to raise capital,” he said. “It is inevitable that the Main Street energy companies begin to feel that the insurance industry, with its rapidly rising pricing, is kicking them in the stomach, while the financial community’s reluctance to lend money is kicking them in the backside.

“Independent insurance agents with an energy book are going to suffer as they watch operators cut back operationally which leads to a similar business downturn for the contractors they employ. All we can do is work through the crisis as it runs its course, as many of us have done during each similar cycle of the last 30 years.”

As for the AIG situation, Daniels said the financial issues of concern regarding the insurer were and are confined to the parent company; and while they may be detrimental to the reputation of AIG Oil Rig as well as other members of the AIG family, they have not affected the claims-paying ability of AIG.

“We use AIG as an insurance market for more than 60 clients, and while we have received more than a few calls of concern, we have only had two instruct us to move their coverage from AIG to another insurer,” explains Daniels. “All our new and renewal clients have, so far, stayed the course with AIG.”