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Energy industry risk managers and insurers cannot get their arms around the wind.
Both groups acknowledge that they still do not have a good idea of potential aggregate losses in a highly exposed, geographically defined area like the Gulf of Mexico.
The inability to forecast these losses is a primary factor causing insurers to shrink capacity and raise premiums for windstorm coverage.
Meanwhile, some still doubt the effectiveness of modeling systems being developed to make better projections about damages from future windstorms.
"Before the record-breaking hurricane season of 2005, underwriters generally assumed that the largest-valued site of any policyholder was the largest potential loss under that policy," Bruce A. Jefferis, managing director of the natural resources group at Aon Risk Services in Houston, said in an e-mail response. "The possibility of losing many sites in one storm was not considered, or it was very heavily discounted."
Some underwriters have divided the Gulf of Mexico into sectors that represent possible storm tracks in order to limit their exposure in any one sector. Of course, any storm could take a track through the Gulf that cuts through several sectors, he said.
"The question with windstorm modeling that's being raised is: Just how good are those 100-year models?" said John W. Schaefer, president of Global Risk Advisors, an enterprise risk management consulting firm in Redwood City, Calif. "It's almost becoming a political issue, because the question is if, and how, global warming should be factored into those models."
The attempts to analyze future potential exposures are hitting corporate wallets hard, even at companies that have excellent claims histories.
"There's definitely been a real sea change in the past year. It's fair to say if you have Gulf of Mexico operations, you're paying three to five times more in premiums, and there's also much less coverage available," Mr. Jefferis said. "Coverage is still available offshore, but because of the significant reduction in windstorm limits, there's a greater risk of being underinsured after a windstorm."
Before last year's hurricane season wreaked its record-breaking havoc, obtaining wind coverage was never an issue for those doing business in the Gulf of Mexico. Windstorm damage was covered up to the full policy limits of the applicable policy without any limitation other than the general policy limit, Mr. Jefferis said.
Since the storms, underwriters are imposing a sublimit lower than the general policy limit and they are also aggregating that limit for total claims during the year, he said. Previously, they would respond up to the general limits for any one occurrence and they could pay that limit multiple times if there were multiple storms during the policy year.
In the aftermath of hurricanes Katrina and Rita, "the biggest challenge risk managers face in our industry is trying to find enough capacity for wind coverage," said Frank Costa, president of AIG Oil Rig in New York. "Today, it's greatly reduced. In the past, wind coverage was always an unlimited product, written on each platform like any other peril. Now there's a hard cap on wind coverage for all of [a company's] platforms combined, an aggregate limit for any year, regardless of how many losses you may have and how many disasters."
John A. Rathmell Jr., president of broker Lockton Marine & Energy in Houston, said the amount of wind coverage insurers are willing to offer has been reduced by 60% to 75%. So if you had $100 million (€78.8 million) before Katrina, you might only be able to get $25 million to $40 million today.
"I would say the risk management and insurance marketplace is probably confused today," said C. Jeffrey Triplette, vp of continuity, insurance and security services at Duke Energy Corp. in Charlotte, N.C., and a board member of Hamilton, Bermuda-based mutual insurer Oil Insurance Ltd. "Part of that is that there has been such an explosion of the value of insured facilities over the last several years: Replacement costs of new plants and energy platforms have been escalating rapidly over the past several years, so overall, exposures have gone up much faster than anticipated.
"Add to that the anomaly of having two 500-year storms back-to-back in a 30-day period, and suddenly no one knows if they have enough premium for what's needed to cover future storms or (understands) exactly what they've been insuring," said Mr. Triplette. "The fact is that both risk managers and insurers have not understood the aggregated exposures they have had to these natural catastrophes."
That misunderstanding has become all too clear in the aftermath of Katrina and Rita, with related claims totaling somewhere between $15 billion and $19 billion and the market having generated only $3 billion in premiums, said Anthony Carroll, chief underwriting officer for the global energy division at Liberty International Underwriters in New York.
"For the risk manager, the issue is balance sheet protection," said Mr. Carroll. "The question remains, what will happen to rates and capacity going forward, and what [must a company do] today to differentiate itself so that underwriters are willing to expose their capacity to that company?"
"There's a shift going on within the insurance industry, where insurers are trying to differentiate those oil assets in the Gulf from those located elsewhere around the globe," Theo Guidry, vp-business risk management at San Antonio-based oil refiner Valero Energy Corp. "They're trying to make the Gulf exposures seem greater due to the recent hurricane season."
But, Mr. Guidry said, "these hurricanes of the past year were a one-time phenomenon, coming in and hitting us for the first time in many, many years. We're a little bit taken aback with what has happened with coverage and its cost, particularly when you consider that there are other operational losses on a much more regular basis elsewhere due to poor design or man-made errors.
"We have done as much as we can to withstand these types of natural events, and our assets are mostly onshore, so we've definitely been a little more penalized than we should have been. The insurance companies haven't done their homework; they haven't gotten the premiums they should have. But to penalize good operators who have paid premiums into the market year after year after year with infrequent claims is a bit much," Mr. Guidry said. "Good operators have probably been penalized as much as other companies with poorer operations."
Push for data
To obtain whatever coverage they can, risk managers have been asked to produce a far greater amount of information about their individual platforms and other properties than in years past.
"The requirement for more and better data from underwriters is definitely true," said Aon's Mr. Jefferis. "They're requiring more data because they realize they have a lot of gaps in the data they've had. So now, some are requiring [global positioning system] coordinates, for instance, so they can plot [a policyholder's] every existing facility on the map."
"It's absolutely true that underwriters need more information than ever before. Level of detail is the name of the game," AIG's Mr. Costa said. "The information has always been there, but if insureds could get away without providing it, why would they?"
Some companies say they've always provided a significant amount of information to their underwriters, so any new requirements haven't been cumbersome.
Mr. Costa said that data has been available about newer Gulf facilities for some time, but not about older ones. "The deep-water platforms have always been on the radar screenthey're well documented and engineeredand we've known what their value is. But the older platformsthose 20 or 30 years oldreally haven't had the same level of focus. Information about them has been scarce, and they've been viewed as a benign risk. But that thinking was turned on its head with these hurricanes; the older facilities did not withstand the hurricanes as well, so today they're also viewed as a critical issue."
Getting that dataand formatting it in a way that meets underwriters' needshas been a significant preoccupation for some companies. "Some buyers have had to scramble to get up to speed, because the information may not always be available," said Richard Inserra, president and owner of Insurance Strategies Ltd., a Ridgefield, Connecticut., consulting firm, and a former risk manager at Union Carbide Corp. "We've seen this beforeabout 10 years agowith flood exposure, when underwriters said they wouldn't cover a flood-related risk, or there would be higher deductibles if the information wasn't provided. It became clear that a lot of companies did not have a good understanding of their exposures in these flood areas."
Mr. Inserra said that simply having a facility that's built to withstand catastrophesand the engineering studies saying somay not be enough to tell underwriters what their total exposure really is. "At Union Carbide, I was asked about windstorm for our facilities: How many miles per hour could our facilities withstand? But you can also have serious damage caused during a windstorm just by the things flying through the air, almost like shrapnel, and that's sometimes forgotten."
Seriously curtailed capacity overall and windstorm-related sublimits aren't the only new financial uncertainty risk managers are facing: So, too, are changes at Hamilton, Bermuda-based mutual insurer Oil Insurance Ltd., which until this year had a $1 billion aggregation limit for each storm to help its members collectively as a first line of defense against catastrophes. OIL covered windstorm damage without question.
After Katrina and Rita, however, members were able to collect far less than their total damages because of the claims cap. In its 2005 annual report, OIL estimated that Katrina caused $1.87 billion in damages to members, while Rita caused $1 billion in damages.
And nowof far greater importance going forwardOIL has imposed a $500 million claims cap for future storms.
"Historically, OIL has been an invaluable primary all-risk insurance provider to its members and undoubtedly will continue to be. However, with the reduction to $500 million, you really have to ask yourself as an insured how much recovery you're going to get through OIL," said Derek Whipple, vp of global property heading the new energy practice at ABD Financial Services in Redwood City, Calif. "If you have additional hurricanes like those of the past year or so, and you're only going to collect something like 25 cents on the dollar, are you budgeted for that?"
Making matters worse for companies in the energy sector: Companies will find it difficultif not impossibleto obtain a so-called "dropdown provision," where claims above what OIL could pay out were covered by the commercial marketplace. "The last thing... you want if you're a commercial insurer is to be stuck with these excess needs not covered by OIL," said Mr. Whipple. "Now those other insurers are going to say, 'If that's all you can get from OIL, that's not my problem."'
Some OIL members acknowledge the difficulty its new limit of $500 million will cause. "There was explosive growth at OIL over the past four or five years, and not simply because of new members," said Duke Energy's Mr. Triplette. "In addition, existing members added a number of new facilities to their existing coverage, so there was even greater aggregation of large amounts of value in certain geographic areas."
OIL has "created quite a gap in the marketplace," said Thomas G. Kaiser, New York-based president of Arch Insurance Group's business divisions that handle marine, energy, aviation and construction risks.
Those struggling through this market don't have much choice but to swallow their premium increases and reduced coverage and hope that succeeding, relatively mild hurricane seasons will result in premium reductions and increased coverage.
"There have been a lot of emotions running high, and one of our biggest jobs is to keep the buyers who want to tell the market 'drop dead' continuing to work with the insurers, to get both of them in a frame of mind to reach an agreement," said Lockton's Mr. Rathmell. "And in fact, most of our buyers have stayed with the same underwriters with a different-looking program."
Valero's Mr. Guidry said he is staying put with his underwriters. "We have long-term relationships with people in the marketplace, and we haven't felt the need to shift our business," he said. "The only time we would go with a new underwriter was if there was a lack of capacity in the marketplace. Our underwriters understand the risks they're taking, and they have full access to us and our loss control staff."
Mr. Guidry said he understands the increased rates for now. "We all have losses, and if you have several years that are bad, you can expect the rates to go up," he said. "It doesn't do us any good if an underwriter goes under. It's to our advantage to have strong underwriters, so when there are losses, they can pay them." But even if Mr. Guidry finds it understandable for rates to rise for a year or two, after that, he said, "We expect them to come down."
Meanwhile, some risk managers expect the catastrophe bond market to continue its current effort to tailor itself to the energy market and its needs. "I think it will be another year or so before you see new products and solutions," said Mr. Triplette, who noted that some reinsurance sidecars already have formed to boost capacity.
"You will see them: There are lots of smart people on Wall Street and at the hedge funds, and so risk managers probably will be able to access new capital before too long," he said.
For the moment, Arch's Mr. Kaiser thinks energy risk managers shouldn't expect traditional windstorm coverage to look much more appetizing in the near future.
"The ratings agencies want the insurers to diversify, so this will keep the windstorm situation pretty much the way it is," Mr. Kaiser said. "Another pressure point is the realization that more capital has to be applied to the short-tail end of insurancewind events, in other words.
"These issuesand the need to recalibrate the windstorm modelswill force things to stay the way they are longer," said Mr. Kaiser. "In other words, the cycle will stay flat and not come back as quickly as people would like."