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Gulf of Mexico risks buoyed by influx of fresh capacity

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[MONTE CARLO, Monaco]—There is, literally, a gulf between rates that energy insurance buyers will face at year-end renewals.

Buyers with risks outside of the Gulf of Mexico can expect stable or even softening market conditions when renewing at the end of the year.

But the best that energy companies with Gulf of Mexico exposures can hope for are flat rates and terms, according to reinsurers and reinsurance brokers at Les Rendez-Vous de Septembre, which is the annual meeting in Monte Carlo, Monaco, that marks the beginning of discussions for the year-end renewal season.

Capacity for offshore risks in the Gulf of Mexico almost evaporated and prices rocketed during last year's renewals because of the massive losses caused by hurricanes Katrina, Rita and Wilma. Companies with oil installations in the Gulf of Mexico suffered $15 billion (e11.8 billion) in offshore damages from hurricanes Katrina and Rita, according to a May energy market report from London-based broker Willis Group Holdings Ltd. Losses from Hurricane Wilma were still being reported.

Before those hurricanes last year, operators of offshore oil platforms in the Gulf could find insurance capacity up to $2.5 billion for their risks. By contrast, 2006 capacity for Gulf wind cover totaled about $150 million, according to brokers at the Rendez-Vous.

Capacity does, however, appear to be returning to the energy market as the buoyant underwriting conditions, due to higher rates, continue to attract new insurers.

Most of the fresh capacity created by the Bermuda startup companies in late 2005 and early this year—coupled with sidecars, which are special-purpose reinsurance vehicles often capitalized by hedge funds, and industry loss warranties, which are reinsurance coverages that are tied to an index of industry losses—have been directed at those lines hit hardest by the storms, such as U.S coastal property catastrophe coverage and marine and energy business.

Also a subject of discussion in Monte Carlo was the possibility of additional fresh sidecar capacity and equity capital arriving for the coming renewal season, spurred by the reinsurance market's apparent resilience and potential for satisfactory returns for capital providers.

Interest in energy and U.S. coastal property catastrophe business also is evident in the London market.

C.V. Starr & Co. Inc., headed by Maurice R. Greenberg, New York-based American International Group Inc.'s former chairman, recently announced the formation of a new syndicate at Lloyd's of London. Syndicate 1919, which plans to begin underwriting effective October 1, will write energy, marine and aviation business.

And, according to sources, Lloyd's managing agency Argenta Syndicate Management Ltd. is also planning a new energy team in London. However the company declined to comment.

Differing opinions

Some brokers said they believe this fresh capacity will force a softening in the reinsurance market and, subsequently, the direct market for energy risks at this renewal, even for Gulf-exposed offshore risks.

Tim Fillingham, London-based chairman of natural resources and energy at Aon Ltd., certainly thinks that the fresh capacity will force the underwriting community to soften its stance this year-end.

"I am sure the reinsurers will talk it up and point out that they are still paying losses for the 2005 storms, and that the retrocession market is very tight. But this is a bit old hat, because there is no doubt the market is seeing some changes," Mr. Fillingham said.

"Not least, we are expecting a profitable year for 2006, hurricanes allowing, and this will bring competitive pressures to bear," Mr. Fillingham said. "We will see new entrants to the market, and I cannot imagine any existing energy underwriter that does not have an increased budget for 2007. There is also much talk of fresh capital and sidecars being raised for this renewal generally, which will add capacity to the market as a whole.

"We have seen the formation of C.V. Starr's Lloyd's syndicate, and I certainly expect more to come to the table as premiums build after Monte Carlo and Baden-Baden," the October gathering of reinsurers and reinsurance brokers in the exclusive German spa town. "I cannot believe the buyers will not be demanding reductions or looking for alternatives. They will not just roll over and pay the same figure again," Mr. Fillingham said.

The hardening this year was driven not just by increased rates, but also much tighter terms and conditions, Munich Reinsurance Co. said. Deductibles are up, reinstatements are rarer and Munich Re, for example, insisted on providing only second-event coverage for Gulf of Mexico risks in its offshore excess-of-loss contracts.

Mr. Fillingham said buyers will be looking for more than just a softening in prices at the coming renewal season. "Whether it is reductions achieved by restructuring (the program), bigger retentions, better use of captives or securitization through the capital markets, the clients will seek improved terms," he said.

Outside the Gulf of Mexico, Mr. Fillingham sees a further softening in what is already a healthy market for buyers.

He said that the Middle Eastern energy market is highly competitive, because the risks are generally high-quality and insurers have sought to diversify their books away from the Gulf of Mexico.

The broker estimates that market capacity for onshore energy risks is at least $2 billion in working capacity. He said there is a "good chance" that this will increase. "It certainly gives opportunities where clients are buying $500 million to $700 million" in limits, he said.

Other brokers do not share Mr. Fillingham's optimism, at least not for Gulf of Mexico energy risks.

Just prior to Rendez-Vous, London-based broker Benfield Group Ltd. said in its first-half 2006 results report that it sees little room for growth in the primary energy market.

"The severe impact of last year's hurricane losses on the pricing of and the capacity for Gulf of Mexico energy risks has led to less movement of business between brokers, and in some cases, has discouraged buyers from entering the market," the broker said in a report.

"Market conditions remain challenging in loss-affected segments. Whether or not early predictions of another active hurricane season are fulfilled, we expect further hardening of U.S. property catastrophe and energy markets to be evident at year-end renewals," continued Benfield.

Ulrich Wallin, member of the executive board at Hannover Re Group, the Hanover, Germany-based reinsurer, said during the Rendez-Vous gathering that he sees "stable" conditions for the Gulf of Mexico.

Mr. Wallin said that 2006 underwriting of primary and reinsurance offshore energy markets for the Gulf of Mexico had been "successfully completed," and this led to significant increases in both premium and retention levels.

Looking forward, Mr. Wallin said he expects "stable" conditions in both primary and non-proportional reinsurance. "Depending on the loss situation, we do not expect further increases for Gulf of Mexico-exposed business," he said.

Rating agency A.M. Best Co. Inc., based in Oldwick, N.J., said much of the new capital raised since the U.S. storms of 2005 had been directed toward the most affected lines-namely U.S. coastal property catastrophe and offshore energy lines.

But Best pointed out that the impact of the fresh capacity has been limited, partly because of the shortage of retrocessional capacity for reinsurance companies. Another factor that has limited the impact of the fresh capacity is increased capital requirements placed on insurers by a raft of new and updated catastrophe and capital models from catastrophe modeling and rating agencies.

Best also suggested that buyers of energy coverage should not become too excited by the arrival of fresh capacity, because it may not be around for too long.

"When the current market opportunities in property, marine and energy business begin to diminish, the new capital that flowed into the market through special-purpose vehicles will seek alternative investment strategies," stated Best in a recent report about the Lloyd's market.

In that same report, Best said it sees a further hardening for energy business anyway.

"Best believes that overall opportunities for underwriting profits are good. Currently the market (Lloyd's) is bifurcated between classes that were affected by the catastrophes, and those that were not. For affected classes such as property catastrophe and energy, rates are hardening," commented the rating agency.