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Oil Rig Disaster Has Potential to Impact Offshore Energy Writers' Ability to Buy Reinsurance

Source: BestWire

Posted on 11 May 2010

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The destruction of the Deepwater Horizon oil rig last month in the Gulf of Mexico, and the resulting massive oil spill, has the potential to cause major ripples throughout the offshore energy market.

"At the moment, the market is in a state of shock from a loss of this magnitude," said David Croom-Johnson, active underwriter at Aegis London. He estimated the disaster would "blow about five years worth of offshore casualty premium out of the water in one loss."

It will definitely impact the offshore energy and casualty market, but the significance will depend on underwriters' ability to purchase reinsurance in the future, Croom-Johnson said.

Many of the losses will end up with the reinsurance market, resulting in major price hikes that will be passed along to direct insurers, who would likely pass it along to insureds, Croom-Johnson said.

However, in an earnings conference call this week, Daniel Glaser, chief executive officer of Marsh Inc., pointed out because the insurance marketplace is so huge, any individual loss from a single insured "has a remote possibility of affecting the entire marketplace."

"I think what you would find is that there may be some upward pressure or concern in the offshore-drilling-rig marketplace. I don't even think that this loss is large enough to extend that concern to the entire energy marketplace," Glaser said.

While insurers and reinsurers are likely to be on the hook for about $1.4 billion in connection with disaster, the bulk of the losses may be paid not by the private insurance market, but by the energy companies' own self insurance, Robert Hartwig, president of the Insurance Information Institute, said on May 5.

Swiss Re on May 6 said estimated total insured losses may range from $1.5 billion to $3.5 billion

The Deepwater Horizon oil rig owned by Transocean Ltd. and operated by BP Exploration & Production Inc. had a total insured value of $560 million. Transocean said it is insured for total loss coverage and for wreck removal. The rig sank off the coast of Louisiana after an explosion and fire April 20 that killed 11.

BP's Guernsey-based captive, Jupiter Insurance Ltd., does not buy reinsurance and has an underwriting limit of $700 million per occurrence, according to BestLink, which provides online access to A.M. Best's Global Insurance & Banking Database. Jupiter provides cover solely for BP's subsidiaries and its equity share in joint ventures, and about 75% of its gross written premium in 2009 stemmed from property insurance and business interruption lines.

Jupiter had $6 billion in capital and surplus at year-end 2009, according to BestLink.

Transocean said in the event of a total loss of a drilling unit, a deductible ranging from $500,000 to $1.5 million would apply. According to the company's annual report, Transocean has a $10 million per occurrence deductible on personal injury and collision liability claims for crew and $5 million per occurrence for third-party, noncrew claims.

Transocean also carries $950 million in third-party liability coverage, said the report. Liability losses of more than $950 million are retained by Transocean.

In addition to property insurance, other lines to be triggered by the Deepwater Horizon incident include liability, including general liability and environmental/pollution liability.

As the oil continues to leak from broken pipelines 5,000 feet under water, the cost to clean up the oil spill may continue to rise -- but not necessarily increase the insurance industry's ultimate bill, Hartwig said.

The most expensive oil spill in U.S. history, the 1989 Exxon Valdez incident, which released 37,000 tons (10.8 million gallons) of crude oil into Alaskan waters, cost $2.5 billion to clean up, according to the International Tank Owners Pollution Federation, with fines and penalties adding at least another $1 billion.

But the insured losses from the Valdez "wound up being a fraction of the total losses. Most of those losses ended up being funded by Exxon," Hartwig said.

Likewise, he suggested the bulk of the losses from Deepwater Horizon incident would be borne by BP.

Offshore energy facilities, especially those in the Gulf of Mexico, "are among the most hazardous and risky of all energy markets," Hartwig said. "This will add pressure to what is already a difficult market."

Also, he said trial lawyers are likely to try to "wiggle more dollars out of every party that is involved in paying for the losses, including insurers. There will be allegations of gross negligence, which could have an impact on increasing the loss. There are more attorneys in Mississippi than oil right now."

One potential bright spot for insurers: the oil leak threatening the Gulf Coast may drive more businesses, including hotels and businesses along the beach, to consider buying environmental insurance, said Joe Boren, chief executive officer of Ironshore Environmental.

"I think you'll see people starting to think about whether they should have pollution coverage," Boren said. "I anticipate we'll have more people looking at how to protect themselves from a future event like this."