Disclaimer: The events depicted in this scenario are fictitious. Any similarity to any corporation or person, living or dead, is merely coincidental.
Nothing beats working with the best. That’s what Jerry Oliver, a senior vice president with Manhattan-based Lupex, told himself as he left the morning meeting.
In that meeting, executives with Lupex, an energy trading firm, voted to buy two million barrels of crude and store it offshore. A precipitous decline in oil prices was the motivation.
All the firm had to do was keep the oil safe and sound until the prices rose again, which they inevitably would. Major domestic drillers were already laying off staff and cutting production. These latest low oil prices were just another bend in the cycle.
Oliver’s marching orders from that morning’s meeting were clear. Working with other members of the Lupex team, it was Oliver’s responsibility to find the right vessel and a safe place to moor it.
The strategy was to keep the oil safe by avoiding CAT-exposed locations and hold it long enough for the firm to cover its storage costs and still make a handsome profit when the price rose.
“Let’s get this done,” Oliver said to himself before walking into his office to get on a phone call with a colleague in Texas.
After consulting with his colleague, Oliver decided to use the Miller Line, a company based in the energy hub of Houston. The Miller Line was an owner of Very Large Crude Carriers — or VLCCs.
One of the company’s ships, the Mariana, had the capacity that Lupex needed and was available. Adding to the attractiveness of the Mariana was that she was already in Southern California, not far from the tank farm in El Segundo where the oil was stored.
The Lupex team decided to moor the Mariana off of Long Beach, once she’d taken on the Lupex crude.
“We don’t want to store it in the Gulf, or anywhere near Florida,” Oliver told his team, pointing to the hurricane hazards in those locations.
“Long Beach has also got the security infrastructure we like,” Oliver said.
Lupex procured the oil at $50 per barrel the following morning, making its value at purchase $100 million. To wrap up the deal, Oliver and his associates took care of some final details, among them, getting insurance in place.
Loading at the tank farm went off without a hitch and the Mariana was moored off of Long Beach. Within days, it looked like oil prices had bottomed.
Weeks later, after a particularly sharp, sustained rise in the price of oil, Lupex executives gave the “sell” order.
With oil at $80 per barrel at the time of the sale, it looked like the company’s strategy was playing out as well as could be hoped. The Mariana made her way to Houston, to offload the oil for the buyer.
At 2 p.m. on the afternoon the oil was offloaded in Houston, Jerry Oliver got a call from Antony Ellis, his associate in Houston.
“We’ve got a problem, a very serious problem,” Ellis said.
“What is it?” Oliver asked.
“The oil’s contaminated,” Ellis replied.
“What?” Oliver said.
“It’s true,” Ellis said. “Apparently, the ship was carrying gasoline before it picked up the crude load and wasn’t cleaned properly.”
“The gasoline additives that remained in the tanker contaminated the crude, lowering its grade and market value,” Ellis further explained.
‘Somebody’s got to tell the executive committee. I’ll do it,” Oliver said.
Then he hung up the phone.
On their follow-up call, Ellis and Oliver began to put the pieces of a disturbing picture together.
“So we can re-blend it?’ Oliver said.
“In essence, yes,” Ellis said.
“It’s a lower product grade, and far less valuable, and then there’s our mixing costs and other related expenses,” he said.
“If we’re very, very lucky and we get this done in no more than two days’ time. We might be able to get $42 per barrel for this lower grade product. I don’t see how we can hold it any longer,” Ellis said.
“Nobody up here has any patience for anything more than that,” Oliver said.
Oliver wasn’t sharing with Ellis the exact tone and temperature of the conversation that he’d had with senior management when he brought them the bad news to begin with. He’d spare his colleague that extra pain.
Working as quickly as they had ever worked, with neither of them sleeping more than four hours over a 48-hour period, Oliver and Ellis arranged for the re-blending of the ill-fated oil from the Mariana.
When all was said and done, Lupex got $41 per barrel for the re-blended product. A down day in the markets worked against them, but as traders, they knew that timing was everything. They were already down millions. They could not afford to wait a day longer.Two days after the sale of the re-blended product, Oliver was speaking with a senior executive, conducting a post-mortem on what became an instant legend at Lupex, “The Long Beach Loss.”
“What do our insurance carriers have to say about this?” the executive asked.
“Ummm, I haven’t talked to them yet,” Oliver said. He was back in his office and on the phone with Lupex’s broker within a minute, his ears still hot from the tongue-lashing his superior had given him.
The broker, Danny Parker, a young gun with a multinational firm, listened to the details of the loss as relayed by Oliver.
“Well, I’ve got a question for starters,” Parker said.
“What?” Oliver said.
“Why didn’t you contact me earlier?” Parker asked.
A List of Ills
Falling oil prices in 2014 were something that got everybody’s attention. Everyone of driving age could see it as gasoline prices at the pump plummeted.
Lupex executives couldn’t be blamed if they were practically obsessed with the rate at which oil prices were going down. After all, this was what they did; it was their bread and butter.
They had the capital and the connections to do very well on what looked like a historic trading opportunity. A two-year average oil price of more than $110 per barrel was becoming a dream-like memory as oil prices fell to below $80 per barrel, then $70 per barrel and on and on down.
Lupex executives were bright and well-schooled. They knew the history of the energy sector. They’d worked extremely hard, done very well over the years and felt they had earned this moment.
As with anyone, it was what they didn’t know that dealt them such a painful blow.
It fell to Danny Parker, the energy insurance broker, and his colleague, Lee Ann Farmer, a cargo specialist, to give Lupex the most painful messages of all.
“Jerry and Antony … let me ask you something. When you arranged to lease the Mariana from the Miller Line, did you ask them about what the Mariana previously held, and whether the vessel posed a contamination risk?”
“That’s on me,” Antony Ellis said. “The short answer is no. You have to understand — we weren’t the only traders on the planet that had their eye on this opportunity. VLCC rates were showing a lot of volatility of their own in late 2014,” he said.
“A lot of people were after this opportunity,” Oliver said.
“We understand …” Danny Parker managed to get out before Antony Ellis interrupted him.
“We’re talking about storage rates of tens of thousands of dollars per day, and in one week alone in November, we saw a 20 percent increase in those leasing rates. There was a lot to consider here,” Ellis said.
“I’m sure there was,” Lee Ann Farmer said.
“I know you had a lot to consider,” she continued. “But you should have thought about a cargo policy. After all, once that product leaves land and goes into a ship, you’re in a completely different ballgame from a coverage perspective.”
“Okay, but how exactly?” Jerry Oliver began.
“Just hold on a second,” Danny Parker said.
“That contamination issue you had? I bet you I could have covered that for you,” Lee Ann said.
Oliver felt nausea roil his stomach.
“You’re kidding me,” he said. “All of it?”
“I’m pretty sure the carrier would have you retain some of it,” Lee Ann said. “But in our world, these days, there’s a lot of capacity out there.”
“I never knew,” Antony Ellis said.
“Sorry. But now you know,” Danny Parker said.
Lupex would live to seek other opportunities in coming months and years, but its insurance coverage lapse in the Long Beach loss cost the company an opportunity that might have been once in a lifetime.
Risk & Insurance® partnered with XL Group to produce this scenario. Below are XL Group’s recommendations on how to prevent the losses presented in the scenario. These “Lessons Learned” are not the editorial opinion of Risk & Insurance®.
1. Consider an Ocean Cargo Policy: For a relatively low cost compared to the value of goods, an ocean cargo policy can be structured to cover perils of the seas (i.e. sinking, fire, collision, explosion, heavy weather), General Average, Theft, Fire, Acts of War, Shortage, Leakage and contamination. In the “Tainted Goods” risk scenario, if Lupex had purchased an appropriately structured ocean cargo policy, the company would have been covered for the loss due to contamination.
2. Choose Appropriate Limits: When evaluating an ocean cargo policy, risk managers need to ensure that the amount of insurance will be sufficient to cover the goods at the maximum foreseeable financial interest. This is especially important in dealing with commodities, like oil, where there’s a chance of financial fluctuations.
3. Valuation of Goods: For an effective ocean cargo policy, it should be structured to allow the buyer to be indemnified for the highest value of goods for several different situations, including:
- The invoice value + 10% (for ancillary/related costs)
- The selling price (if sold)
- The market value on date of loss
With these different evaluations structured into the policy, this will allow for recovery of the amount paid at a minimum, or the full mark up if sold or unsold at a maximum.
4. Ensure Professional Handling of Goods: Bulk liquids and solid goods pass through a number of loading mechanisms, holding tanks/locations, pipelines, conveyor belts, loading machinery and pumps when moving from shore to vessel and vice versa upon unloading. This opens up the potential for many types of losses, including: shortages, contamination and loss in weight. In order to reduce this risk, companies should take the steps to ensure professional handling of their goods by working with tenured logistics providers.
5. Reduce Your Contamination Risks: It’s common for companies to conduct and pay for testing and approval of tanks as well as a certificate by a qualified surveyor. However, it’s important that additional samples are taken at loading and unloading to determine if, where, or when the contamination occurred. This is also recommended for barges, lighters, tank cars and port side tanks. Most of all, a company operating in this space should make sure the handling guidelines are adhered to. By following the handling guidelines, the insurance coverage will remain valid.
6. Consult with your Marine Broker & Underwriter: Marine brokers and underwriters can offer specific knowledge and experience that can be leveraged in certain classes of businesses. They can discuss best practices and provide recommendations to reduce your risk. In addition, they can provide value added services in terms of Risk Engineering, Claims, and various technical white papers, which can serve as readily available resources.
And Back Again
The first time Hank Greenberg visited China, in 1975, there were few cars on the streets and seemingly thousands of wobbly bicycles crowding the roads. The high-rises that now dominate the skylines of China’s major cities were non-existent.
That was the way Greenberg remembered China in his 2013 book, “The AIG Story,” co-written with Lawrence Cunningham, a George Washington University law professor.
Following the opening of Communist China in 1972 by President Richard Nixon and his Secretary of State Henry Kissinger, Greenberg — then CEO of AIG — sought and cemented during that 1975 visit a reinsurance agreement between AIG and the state-owned People’s Insurance Co. of China.
Greenberg was infamously pushed out of AIG in 2005, after four decades spent building it into a company with assets in the hundreds of billions.
Over the years though, Greenberg’s love of China, particularly Shanghai, never ebbed.
“I have very warm feelings for Shanghai,” Greenberg told Risk & Insurance® during an interview in his Park Avenue office.
After all, the C.V. Starr Co. was founded by Greenberg’s mentor Cornelius Vander Starr in Shanghai in 1919.
“China is not without its problems, obviously. But it’s the second largest economy in the world. Think about that. The second largest economy in the world in a very brief period of time,” Greenberg said.
Last year, Greenberg’s Starr bought a former state-owned insurance company, announcing that it had acquired 93 percent of the Dazhong Insurance Co.
“It wasn’t a walk in the park. It took a lot of negotiation and a lot of time.” — Hank Greenberg, CEO and Chairman, Starr Companies
Starr purchased approximately 20 percent of the company in 2011 before increasing its stake to 93 percent in March 2014, according to published reports.
“Even though we had management, we didn’t have freedom of management — big difference — and so I spoke with the people in Shanghai and over time we were able to convince them that the company would do better over any period of time if we had not only operating control but financial control,” Greenberg said.
The purchase was not without its struggles, according to Starr’s chairman.
“It wasn’t a walk in the park. It took a lot of negotiation and a lot of time,” said Greenberg. But Greenberg believes that over time, the investment will be well worth it.
With a population of 1.4 billion, China is viewed by many industries, property/casualty insurers included, as a country with enormous potential.
Recent regulatory changes, in particular the decision three years ago by Chinese regulators to allow foreign insurers to underwrite mandatory third-party auto liability, are viewed positively by Western insurance and business executives.
And those observers think more good news is on the way. “In and of itself it is a very critical step and it is clear that the intent is to broaden that further,” said Mark Wheeler, London-based CEO of Ironshore International, of that milestone third-party auto liability change.
“It was a major positive development for foreign insurers,” said Dave Snyder, vice president of international policy for the industry trade group the Property Casualty Insurance Association of America.
“We are very encouraged by high-level statements and are anxious, as always, to see them implemented.” — Dave Snyder, vice president of international policy for the Property Casualty Insurance Association of America.
Snyder said the trade group, which represents more than 1,000 insurers, continues to be encouraged by statements from Chinese government officials that they intend to open the country further to foreign insurance carriers.
“I’m reluctant to use terms like positive or negative. It is what it is,” Snyder said.
“But we are very encouraged by high-level statements and are anxious, as always, to see them implemented,” Snyder said.
“We believe there is an environment of honesty, if you will, between the governments and the private sector and the private sector and governments. That has improved significantly over time with benefits for both China and the U.S.,” Snyder said.
“It would also be fair to say that the market isn’t opening as quickly as we would expect,” Ironshore’s Wheeler said.
“A good example of that would be the much-heralded Shanghai Free Trade Zone,” he said.
“There was a lot of press coverage around that 12 months ago, but there is little evidence to see that it has driven much traction,” Wheeler said.
Starr and Ironshore work in partnership in some lines and sectors. Ironshore CEO Kevin Kelley is an AIG alumnus who retains great respect for his mentor Hank Greenberg.
Kelley told Risk & Insurance® in 2013 there was “no doubt in his mind” that if Greenberg stayed as CEO that AIG would have remained whole during the crisis of 2008.
The Starr Aviation Agency Inc. is the underwriter for Ironshore’s aviation products, and the two carriers have joined forces in the Iron-Starr Excess Agency, a managing general underwriting agency that underwrites financial lines and specialty casualty with both carriers providing capacity.
Wheeler said it looks like the Starr Group has skirted some barriers to entry with the Dazhong acquisition.
“An acquisition like the one they made makes every sense to me in that context. Just because of the barriers to entry, having something that is already laid out on the ground, with distribution lines and speed to market,” Wheeler said.
Regulatory and cultural barriers in China are falling, but there are complexities for property/casualty insurers to consider there, as there would be in any economy.
“Whilst the opportunities are significant, there are a number of key challenges to overcome, including complex regulatory hurdles, disparity in value, fit with local partners and the need to operate flexibly in a rapidly evolving market,” wrote Joan Wong, a transaction services partner with KPMG China in an April 2014 report by KPMG on the Chinese insurance market.
For his part, Greenberg said he doesn’t see the regulatory hurdles in China as much more complex than those a carrier faces in the U.S., where a carrier needs the separate approval of regulators in 50 states.
“I don’t know if it’s any more difficult than the regulatory environment in the United States,” Greenberg said. “I don’t think so. I think they have their regulations like every country does.”
Greenberg said that since the March announcement, the process of combining the professional cultures of Starr and the Dazhong Insurance Co. is coming along, but will take some time.
“It has gone pretty well,” he said. “It’s not going to happen overnight,” he added.
Greenberg said he is devoting a lot of resources to training local hires as well as bringing in talent with experience working in the United States, London and elsewhere.
According to Alex Yip, CEO of Lockton Cos. for Greater China, the issues of regulatory compliance and integrating work cultures are of paramount importance for insurance companies that want to do business in China.
“It is, understandably, a challenge for a U.S.-based company to integrate its business with a local Chinese entity,” Yip said.
“The day-to-day differences are enormous, and include history, culture, corporate mentality, value propositions and ways of doing business, to name just a few common challenges,” Yip said.
“It is often underestimated just how different we can be from one another,” Yip said.
What’s also often underestimated, according to the analysts at KPMG, are the expectations of Chinese consumers.
According to KPMG, Chinese consumers are highly likely to use social media and other channels to communicate their expectations of and experience with service providers to their fellow consumers.
For the banking, general and life insurance sectors, around 70 percent of Chinese respondents to a KPMG survey recommended their banks and insurers to others. That’s compared to between 21 to 53 percent of those surveyed in other countries.
Although industry advocates hope for a day when foreign carriers can sell a variety of coverages to Chinese consumers and businesses online, Greenberg said there will always be the need for sophisticated underwriters and brokers in highly CAT-exposed China.
“It will never be adaptable to large, complicated risks,” Greenberg said of the online selling channel.
“That will still be done through the brokers and companies that have the sophistication to write those kinds of risks,” he said.
“But there is an awful lot of business that can be produced online and through social media.”
There are barriers to entry in China and insurance penetration there is in its beginning stages.
But according to Greenberg, once that country of 1.4 billion becomes more of a consumer economy, it will take off, and the insurance business right along with it.
“Once China becomes less dependent on exports and more dependent on the domestic economy, it’s going to soar,” Greenberg said.
Webinar – Travel Risk Management: Going Beyond Travel Assistance and Insurance
Business travel has never been more global or more compromised by volatility. The search for new markets, suppliers and energy sources is leading employers and their employees into new geographies and political environments, some of them fraught with risk.
This webinar will look at travel accident insurance and travel assistance programs and how best to marry the two products into a travel risk management program that can give employers and employees better peace of mind.
Expert panelists will discuss the following:
- The concept of “Duty of Care”, its limitations and the exposures it can create.
- The different insurance coverages that converge in the travel risk space, where they converge and where they might leave gaps.
- A history of travel accident insurance.
- Organizational challenges: Melding the roles of human resources and risk management so that they work in concert in managing travel risk.
- Employer/employee: Who bears which responsibilities in insuring safe outcomes.
- Loss scenarios and claims examples: Stories from the road of real losses and real claims.
Webinar attendees will be e-mailed a link to the recording of the webinar and its supporting visual materials.