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The intense hurricane activity in Florida and the Gulf Coast over the last two years has turned the marine and energy insurance market upside down, triggering a long overdue re-examination of best practices. What new models will emerge is unclear, however insurers and policyholders alike must brace for radical change. The status quo is dead.

Both onshore and offshore energy operations were disrupted severely during the last two hurricane seasons. Primary insurers and reinsurers are now in the process of assessing damages, resolving claims, and facing the fact that the insurance requirements of the future are needed now. The primary lesson from the storms of 2004 and 2005 is simply that today's insurance programs and plans are inadequate and must be revised if the marine and energy industry is to remain a viable market.

Forecasters suggest that there is a pattern of more frequent and more severe hurricanes that may last for decades. Future storms of the magnitude of hurricanes Katrina and Wilma could create potential losses equal to or greater than any that occurred during the recent past.

This likelihood of future catastrophes will require meticulous planning in how insurance companies prepare themselves. For example, insurers will have to look more closely at risks, assessing the routes ships take, the rig placements, the air gap, the age of vessel and/or drilling rig/platform, and oil prices--both at the time of issuance and time of loss.

LOSS PREVENTION

By the same token, marine and energy policyholders must initiate substantive measures to better prepare themselves, building more damage-resistant structures and developing more detailed contingency plans. For pipelines and power transmission lines, it may be necessary to bury them as a matter of standard procedure. The practice of storing cargo out in the open, exposed to the elements, even if housed in containers, needs to be rethought.

Both policyholders and insurers need to rethink their loss-control activities beyond fire prevention, perhaps toward waterproof warehouses and double-roof construction, just as in the case of double-hull ships. To rebuild facilities damaged by hurricanes and other catastrophic events will require new designs and incorporate new technology not present in the damaged facilities. Underwriters must plan for replacing old with new and provide the necessary code upgrade coverage limits that will be needed in the years ahead.

RIPPLE EFFECTS

In addition to the initial havoc created by so-called "megacats," policyholders and insurers alike must recognize and deal with the ripple effects of such events, which spread worldwide as we now have learned. The four 2004 hurricanes in Florida taught us a painful lesson about the need to understand every detail about a risk and the costs of insuring it. Prior to those 2004 storms, demand surge was not calculated into many catastrophe models. After Katrina, demand surge was estimated to be as much as 30 percent, and could well go higher in future storms.

While the emphasis today is on the Gulf Coast damage, its effects are not limited geographically, even though many carriers were not materially affected by these hurricanes. Locations, concentrations of ships and goods, harbors and land-based facilities will all be subject to review, as well as offshore operations and facilities.

The "it can't happen here" scenario is dead, or should be in the marine and energy industry. One major question, however, is how will the world react to the necessary changes in coverage and increases in premiums?

In our case, the production, transportation and marketing of oil is a major activity. Take the price of a barrel of oil. In the current situation the price of oil when the policies were written was substantially lower than the price of oil at the time of loss. The consequential loss from the downtime of production, refining, and transportation due to the hurricane was not factored into the coverages and premiums at the time they were written. Today's marine/energy insurance industry must factor into its policies and premiums the overall economic effect on the future marketplace of such catastrophic events.

Hurricanes cause extensive loss to property. An even greater problem is the indirect loss caused by the interruption of business and the effect that has on dependent activities down the line. Such claims may be extensive and difficult to settle. Even nonoperational activities can seek claim payments following a disaster.

The insurance industry must now also pay closer attention to the overall loss exposures that can result from such disasters. Demand for new coverages will increase. Overall premiums will increase. Terms and conditions of coverages will change. Limits, deductibles, waiting periods and layered coverages will be affected as well. Some business will not be able to obtain coverage in the future without extensive changes to their facilities and operations.

Factors that must be revisited by underwriters, producers and risk managers include the following:

CONFLAGRATION

Once a major concern of property insurance underwriters, the fear of a major, far-reaching fire resulted in selection of fewer neighboring risks and lower overall dollar exposure. Hurricanes can be more devastating than fire in many cases.

Risk selection must consider, under the current situation, how much exposure the insurer can accept in a particular location and what aggregate limit of liability is acceptable. Whether it involves onshore facilities such as warehouses and docks, or offshore ones such as ships and cargo, today's underwriters must look at the entire picture and be more selective.

FALL-BACK OPERATIONS

Risks that have "all their eggs in one basket," or risks with no alternative source of operations, create an unacceptable exposure in today's market. Whether it is a production, storage or transportation facility, the operation must not be the sole location for an insured. Such fall-back operations can be developed by joint agreements with similar operators in another location or by splitting up the activities into two or more locations.

BACKUP SYSTEMS

Loss of power is a hazard that can increase loss. It can be overcome by short-term backup systems that can provide adequate emergency power for a proscribed period of time. This is especially true in situations where loss of power causes the facility or product to be too hot, too cold, too wet or too dry. Any type of operation that is continuous is a candidate for stand-by power. Failure of power in such cases can cause a shutdown that damages the facility or its equipment. External equipment such as transformers, transmission lines, pump houses and pipelines should be buttressed with alternative sources that can be used to maintain operations. Facilities needing continuous power should establish outside sources that cannot be shut down by a major storm.

DOWNSTREAM EXPOSURES

A facility exposed to potential loss by a hurricane can be dependant on suppliers and customers who may or may not be affected by the storm. A damaged facility or operation cannot be restored if it cannot obtain raw materials, machinery, equipment and parts from its suppliers. Likewise, a damaged facility or operation cannot supply goods and materials to its customers. If out too long it may also lose its customers.

The entire cycle of business of an insured must be considered when marine and energy insurance is sought. Facilities and operations that may be temporarily or seasonally shut down must also be included in the insurance review.

EMPLOYEES

Crisis planning must also consider the employees of facilities and operations. Where do employees gather after the hurricane hits? Which employees are needed immediately? Which skilled employees must be covered even if they are not needed right away? Where do you house employees during the repair or rebuilding period? How do you replace those employees who will not come back? What specialized equipment and operators will you need? This analysis of the employees is a must when considering marine and energy insurance.

MODELS

The current debate over the catastrophe models underscores the problem of their use. Modelers differ widely in their short-term and long-term assumptions and many insurers do not scrutinize them as closely as they once did. Models are an important tool in assessing risk, but only to the extent they're analyzed carefully in the context of one's own book.

Underwriters, producers and risk managers have been aware of these areas of concern and have addressed them to some degree. However, these areas become more important during the development of a new underwriting model for marine and energy insurance.

WEATHERING THE STORM

Even with insurance in place, a disastrous natural or man-made event can result in significant delay and litigation. Such events can take years to settle under the policies in force at the time of loss. They can also result in some insurance companies simply leaving the market or concentrating only on certain types of businesses. Such "knee jerk" reaction can only harm the overall insurance industry.

Instead, in the wake of these megacatastrophes, we who are active in the marine/energy insurance industry must take a fresh and critical look at what we insure, where we insure and how we insure. We need to rethink and remodel our approaches to coverage, loss prevention and claims handling.

Renewals will require extensive reunderwriting if the insurers are to stay the course. Underwriting management will require changes in policy provisions before policies will be issued. Underwriting must be approached carefully and cautiously.

What is needed and what must be done is to develop a new model for underwriting the marine and energy businesses. This will involve a thorough study of the equipment itself, the locations and concentrations of vessels, cargo, storage, transportation, power sources, personnel and facilities. Redundancies and duplication must be identified and considered as well.

It's also clear that the industry must do a better job of risk selection and help policyholders take the necessary steps to reduce their exposure. Insurers can take an active, vocal and visible role to help create viable solutions to better protect individuals and businesses around the world from the severe economic fallout from these super catastrophes.

The marine and energy insurance industry can weather the storm if it heeds the warning signs and takes action now. Marine coverage is the oldest line of insurance in the world and has overcome war and conflagration to survive and prosper. Those of us who have seen the storm have also seen the daylight.

This industry will survive and be able to develop and provide the needed coverages, not just for the Gulf Coast but for the worldwide market as well.

STEVE CULLEN is president and chief operating officer of Markel Global Marine & Energy, a unit of Markel Corp.

September 15, 2006

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