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Falling oil prices place new emphasis on risk management in energy sector

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The ongoing drop in oil prices is putting new emphasis on risk management in the energy sector as insurers brace for potential market changes.

While exploration and production companies raced to open wells in recent years due to surging demand and advances that made extraction less expensive, many drilling companies have started idling their least profitable wells as a supply glut suppresses prices.

With crude prices dropping over 50% in the past six months to less than $50 a barrel, experts say the energy sector and insurers must re-examine longstanding assumptions.

“The falling prices are impacting every risk manager in energy,” said Reed Wykes, Houston-based director of risk and insurance for exploration and production firm Hilcorp Energy Co.

“Commodity prices are always something we consider when we look at our enterprise risk models,” Mr. Wykes said. “It will always be a top exposure for us.”

Bruce Jefferis, Houston-based CEO of Aon Risk Solutions' energy practice, said while most energy companies won't change their basic insurance coverage, they will reconsider how they structure and optimize retentions, limits and other factors to reduce costs.

“When oil prices were over $100 a barrel, perhaps some of these things didn't matter as much, but now people will make more careful decisions regarding all their expenditures and how to better manage their retained loss costs,” Mr. Jefferis said. “The good news for the companies is that the market is incredibly soft for basic energy insurance. The price has come down each of the last few years, and it doesn't look like that is going to change anytime soon.”

Some companies may seek to tweak their coverage in light of market conditions, said Matt Waters, Boston-based vice president and chief underwriting officer at Liberty Mutual Insurance Co.'s commercial insurance energy practice.

For example, large energy companies with large deductibles may seek to change collateral requirements, Mr. Waters said.

“Usually the focus is on fixed, hard insurance costs for managing claims and excess premiums, but with lending a little tighter and banks charging more for lines of credit, I think big companies may focus more on what they are putting up for collateral,” he said. “When the markets are booming and credit is easy, there is less focus on collateral.”

Paul Garrot, Houston-based vice president and product line manager of energy at Ironshore Inc.'s specialty casualty business, said one boon of declining oil prices for insurers is that the quality of risks may improve as firms with worse loss histories leave or reduce their presence in the sector.

“On the casualty side, these prices force some of the bad actors out of the business,” he said. “A year ago, drilling activity was so intense that if you had a pulse and a strong back, there were some (exploration and production) companies willing to hire you and put you on a rig. Now that this is scaling back, contractors will have a better pool of skilled employees to choose from, which should help reduce accidents on rigs.”

Mr. Waters agreed, saying many claims the energy industry has generated in recent years have been due to accidents caused by inexperienced fleet drivers.

“I do see opportunities for risk managers who are doing the right thing to improve driver quality,” he said. “The good companies will use this downturn as an opportunity to thin out their driver pools and leave themselves with only the most qualified drivers.”

Still, some insurers may restrict their underwriting, he said.

“I would expect some carriers to tighten capacity, especially in the lead umbrella (area), where they have been getting hit most with commercial auto losses,” he said. “So brokers might start building their towers through more carriers, and capacity might have to be shopped a little more.”

But Mr. Garrot does not foresee the amount of capacity for energy risks changing appreciably.

“In North America, there will continue to be plenty of capacity for energy needs,” he said.

Likewise, Jeanne Jankowski, Houston-based head of energy for global corporate in North America for Zurich North America, said insurers have become accustomed to the cyclical nature of the energy businesses, adding that Zurich focuses more on providing claims and engineering services and less on oil prices. “If you look at price of oil historically, it goes up and down,” she said. “So, we tend to take a long-term view of it.”