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By GREGORY DL MORRIS, who has covered the chemical and financial industry issues for the past 20 years

To paraphrase Winston Churchill, a man who knew how to handle a crisis, BP's capping of the runaway Macondo oil well in the Gulf of Mexico in July was not the beginning of the end of the disaster, but it was certainly the end of the beginning. That beginning on April 20 was horrific, when the well exploded, destroying the Deepwater Horizon drilling rig and killing 11 people.

The effects of the loss and the implications for risk management and insurance in the entire energy sector are only starting to be assessed. Two things are known for sure at this point. Premiums in the offshore energy insurance market went from decreases of roughly 8 to 12 percent to increases of at least 15 percent and sometimes more. The other is that for the one known loss to date, the rig itself, the international insurance business has acquitted itself well.

Deepwater Horizon, one of the largest and most sophisticated rigs in Transocean's fleet, was insured for $560 million, the company said. With the charred hulk at the bottom of the gulf, there was no question of a total loss, and Transocean had checks in hand six days after the incident.

The rig was insured primarily in the London market, with QBE Marine and Energy as the syndicate lead, and Chartis as the company lead. Syndicate 1036 underwrites direct risks withinthe Lloyd's Insurance Market, headed by Colin O'Farrell as managing director and managed by QBE Underwriting Limited. The syndicate has a projected gross income of £334 million ($501 million) for 2010. Syndicate1036 forms part of Umbrella Syndicate 2999, which has a total capacity of £1 billion ($1.5 billion) for 2010. QBE is one of the largest managing agents at Lloyd's with £1.365 billion ($2.07 billion) of capacity under management. QBE Underwriting Limited is a wholly owned subsidiary of QBE Insurance Group, which provides all of the syndicate's capacity. Chartis is a subsidiary of AIG.

"In the loss of Deepwater Horizon the insurance market did its job well, and we can all be very proud of that," said Susan Swails, executive vice president of Chartis Oil Rig, based in London. "Transocean was appreciative of that."

From here on out, however, nothing is quite as settled. "The bulk of the Gulf of Mexico risk and wind renewals were done by the time of the accident," Swails said. "The global upstream markets were softening at the time, even after several years of hurricane losses and some non-cat losses worldwide.'' Everything stopped for a week or 10 days after the event, she said. When business resumed, softening had been reversed. "From a market position, this could have happened anywhere," Swails said. "There has been no change in capacity, but since Macondo, premiums have increased on average 15 percent worldwide. The real watershed will be in the fourth quarter of this year, when most of the upstream market renews its reinsurance. Those carriers that are dependent on reinsurance may be jolted if the re-market decides they are in a bad humor over this."

Reinsurers are not making any promises, but so far they do not seem to be in a bad humor. "The insurance market has always considered deepwater drilling a high risk," said Dominick Hoare, joint active underwriter at the Munich Re-owned Watkins Syndicate of Lloyd's. That said, "much has changed since Macondo," he said. "Underwriters have always been looking at drilling plans, completion costs, contractors and subcontractors, whether or not proper warranties are in place, and who are the operators and the staff. The process we had in place before Macondo was very rigorous. We are now redoubling those efforts."

Which is not to say there won't be any pain. "Undoubtedly there will be increases in reinsurance rates and retentions for the 2011 renewals," Hoare said. "That in turn may push energy insurers to reassess their own operations. At the moment no one is pulling out of the class, but we may see another contraction next year."

Insureds and brokers stress to carriers that one loss, however tragic, should not necessarily tighten the global market. But Hoare notes simple arithmetic. "The estimated worldwide offshore premium is about $3 billion. The estimates for this one loss range from $1.5 billion to $3.5 billion. Even the best-case scenario is half the premium volume. The basic underwriting metrics are not sound. The price base is inadequate. That is where the market is right now."

Beyond pure premium, other terms, conditions, and attachment points are in flux. As has been reported, BP is largely self-insured, as are the other super-majors and national oil companies. Most underwriters, brokers, and insureds expect that situation to remain. "It is simply not possible to protect a whole balance sheet the size of BP's," said one energy industry risk manager. However, most of the other parties involved--Anadarko had a 25 percent interest in the well; Mitsui owned 10 percent; Cameron, maker of the blowout preventer at the center of the investigation; and Transocean--all bought coverage to some degree, often in Europe and Bermuda.

"The Bermuda market is being more stringent about new coverage, and also taking a look at its existing book of business," said Christopher Heinicke, senior vice president of Foram Brokerage, in Hamilton. "We are seeing a big influx of companies looking for quotes for additional limits mid-term, of which some are buying. At renewal next year there are chances of higher premiums, attachments, and maybe higher retentions. Bermuda has always been a high-limit, high-excess market, and in general we do like to see insureds take bigger retentions." That said, he stresses that there has been a great deal of increased capacity in the past several years, and that U.S. operators should consider looking to Bermuda, London, and the rest of Europe for competitive prices and terms come renewal time.

Indeed, some are saying competitive prices and terms are still available now. "The events at the Macondo well have certainly been catastrophic," said Jim Pierce, chairman of Marsh's global energy practice, based in Houston, "but it has not been catastrophic to the industry as were Katrina, Rita, or Ike. We have to be on guard that sentiment in the market does not become a self-fulfilling prophesy. Our job is to resist that."

Pierce said that many offshore programs were scheduled for renewal on May 1, and he credits underwriters for honoring commitments for those programs even after the accident. "For June 1 and July 1 renewals, however, we saw tremendous variation. Macondo has been the focus of every renewal. The losses are estimated at about $1 billion,'' he said. "That is a bad day, but it is not catastrophic for the business. There is certainly a negative impact on deepwater renewals, but we have resisted attempts to harden the market overall. It is reasonable to see a sharp pencil in deepwater, but it is not reasonable to paint the entire energy sector with a broad brush."

Indeed, Halliburton, one of the contractors on the Deepwater Horizon, was able to renew after the event with no major difficulty, said a source familiar with the company's program.

Pierce said both underwriters and insureds are looking very closely at their policies in force. "This event has given everyone pause for thought and cause to look into existing coverage. They are asking, 'Do the policy forms respond to such a situation?' We are at the start of a process of making sure that the coverage is relevant to the real risks and known losses incurred. I anticipate an evolution of the language in existing markets, as well as some entirely new products."

Brokers at Aon are also keeping things in perspective. "Overall the sector has been a safe class of business," said Bruce Jefferis, CEO of Aon Risk Solution's energy practice. He extends that evaluation even to the offshore segment, noting that hundreds of rigs continue to operate safely, and that many thousands of wells have been drilled without incident. "This has always been a competitive market, and I don't see that changing significantly," Jefferis said.

The key to the future of coverage in the offshore segment, he said "is how are contracts going to work for multiple parties. There have always been certain expectations about who is going to pay for what if something goes wrong. Now all those traditions are under a lot of scrutiny.''

"It is much more a question for contractors than for producers. All the big contractors have large excess liability towers because they feel they are indemnified to a certain degree,'' Jefferis said. "If that does not work, then a claim goes from relatively small to very large. The casualty market for contractors, their roles, and their risks is all being reviewed."

Retention is also being reassessed at the most strategic levels. "Supermajors won't change their perspective," said the risk manager at one large contractor. "One loss no matter how big won't make them change. But the other operators are more likely to consider transferring more risk. This is really a question for underwriters, because retention is market-driven to some degree."

Many owners that have been comfortable self-insuring to some degree are reassessing their comfort levels, said Pierce of Marsh. "There has never been a more propitious moment to discuss risk transfer to the insurance industry, both as a risk management tool, but also, frankly, as a hedge against losses to the balance sheet. It is incumbent on the market to examine the products it is offering. At the moment those seem to be imperfect, but it is a work in progress. We are convinced that if the insurance market can step up and provide the support, industry will take a look at what is being offered."

Swails, of Chartis, said that she has already seen new demand. "Operators of all sizes, even majors and national oil companies are all looking to purchase new or expanded coverage. A lot of clients are looking at limits, and like water, capacity has a way of finding its place. But for the moment buyers and sellers are both keeping their powder dry and awaiting what comes from government regulations."

Jefferis said that the major factor overshadowing all others is pending government regulation. "We have been working behind the scenes with some federal officials, helping them to understand this business and this market," he said.

Bain Head, senior vice president at energy broker McGriff, Seibels & Williams, said there are two incipient effects of government regulation already. "Permitting has slowed to a crawl, even in shallow water," where the federal drilling moratorium does not apply, Head said. "There are whole swaths of companies that may not have enough cash to last. Most exploration and production companies can look elsewhere, but the drillers are more specialized."

The other issue, just over the horizon, sounds like a good idea at first: company officials, and in some cases third parties, certifying that safety and environmental equipment and practices are in place and being used. Sounds good, but the directors' and officers' underwriters are very hesitant to extend coverage to those certifications, Head said. Third-party certification of blow-out preventers is one possibility. "Are there even such companies to do that? If there are, I don't know anyone interested in writing D&O insurance for certifiers of blow-out preventers," she said.

More broadly, Head concurs that the operational calculus in the Gulf remains favorable. "The risk managers at the operators have been in the Gulf for six decades," she said. "There have been 40,000 wells drilled, and just this one major incident. The industry is pretty safe statistically, and there are still plenty of people willing to take that bet."

Head also said that the most recent trend in the market has been for policy forms without a pollution exclusion, although retaining a cleanup exclusion. "That is somewhat counterintuitive," she acknowledged, "and we may start to see a different stance now that this incident has happened. But there have been no changes as of yet. There are going to be a lot of questions about pollution exclusion."

Environmental insurance has also been thrown into the spotlight as never before. "None of these actors had any environmental insurance, not BP, not Transocean, not Cameron," said Joe Boren, CEO of underwriter Ironshore Environmental. Even so, he does not expect oil companies and service providers to buy such coverage, rather the market is more likely to be hotels and restaurants. "Right now they have to file a claim against the $20-billion Gulf Coast Claims Facility that BP has established, and wait," he said.

Boren is hopeful that a hospitality form will be created for business interruption insurance to cover contingent environmental exposure. "The hospitality industry has found a gap in their coverage," he said. "Their only recourse now is to the fund."

At the end of the day, the big question is still what are the new rules coming out of government, said Richard M. Blades, managing director at J. Wortham in Houston. After helping clients bind contracts through this year's renewal season, he is looking ahead to two developments?congressional action, and the rest of the 2010 hurricane season.

"Those are the key unknowns. The vast majority of the offshore book was renewed before or just after the accident, so we will just have to see what happens in Washington and with any storms," Blades said.

October 1, 2010

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