A Lesson in Resilience

The past two years have not been easy ones for the global energy insurance market. Record storm losses and predictions of more storms to come, coupled with operational losses, have resulted in a “ripple effect” throughout the global energy insurance market, affecting coverage availability, terms, retentions and of course, rates. While energy interests in the Gulf Coast may be feeling the insurance strain the most, the effects are also being felt throughout the North American, European and Asian markets.

Previous storm seasons have had the biggest effect, and have affected sectors of the energy industry differently. Fortunately, the storm seasons might have made the least impact on the Canadian energy market, which has established itself as a leader in the global energy industry. Canada is the fifth-largest energy producer in the world behind the United States, Russia, China and Saudi Arabia. Over the past two decades, Canada has become a significant net energy exporter of oil, natural gas, coal, uranium, and hydropower. Additionally, Canada is one of the most important sources of U.S. energy imports.

The Canadian market’s leadership is further enhanced by its attention to managing its potential exposures. For Canadian energy insureds, sound risk management principles – including physical loss prevention engineering – are well established and should always be developed at state-of-the-art levels.

STATE OF THE MARKET

Reflecting on the year so far, energy terms and conditions have been very erratic – but not totally chaotic. The market varies by region, energy segment and the presence of natural catastrophe exposures. Though Canada remains more competitive in general, there is undoubtedly a trend in the North American market towards rate increases in the natural catastrophe areas. However, increased competition in non-cat exposed areas is leading to some modest rate reductions.

Looking ahead, the volatility – though still present – appears to be subsiding somewhat. The recent capacity crisis for wind cover in the United States, particularly along the Gulf Coast, is leading to dramatic changes in program coverages, terms and conditions. There has been a sudden turn in the non-energy market between the first and second financial quarters in the U.S., but the changes seen in the energy market appear to have been less extreme. The rate increases in the oil and gas sector early in the year are expected to continue at least for the remainder of the year. While we would expect eventual tightening in terms with most cat-exposed accounts, capacity is still available. In fact, energy market capacity not only remained stable, but increased slightly from 2005 to 2006.

The energy market, which has a reputation for volatility, is also known for its resilience and ability to weather difficult challenges. The biggest challenge, of course, will be how well it manages its risks through the 2006 storm season. The insurance industry inevitably feels the effects of hurricanes packing the strength of Katrina and Rita, but energy companies must not overlook the inherent risk hazards that are ever-present in the energy market.

A large portion of the energy insurance community is generally affected when large risk losses occur, such as vapor cloud explosions. Such occurrences can have an immediate impact on the market, just as natural catastrophes can. In addition, in today’s volatile energy economy, production and cost concerns can create undue pressure against adhering fully to risk management plans. Add to this the recent dramatic increases in business interruption values, and the vulnerability of the risk profiles becomes evident.

Therefore, despite storm warnings, energy companies are always a bit wiser to re-evaluate their attitudes and approaches to managing risk. As a result of some re-evaluation, in many cases, companies are deciding to retain more of their risk and are adopting more sophisticated risk management techniques. Likewise, insurance carriers are tightening underwriting requirements while at the same time offering more technical assistance to help their clients manage their potential exposures.

UNDERWRITING CONSIDERATIONS

What is considered when writing an energy risk? Underwriting decisions are very dependent on detailed risk surveys and reports conducted and written by professional risk engineers. Energy underwriters are relying even more on these technical appraisals, which are preferably provided by engineers from insurance companies with “skin in the game” – especially in the current market. Likewise, energy firms are learning to use these technical appraisals as a good starting point for finding the best approaches to manage their exposures.

To understand an energy firm’s insurance considerations, it helps to know the factors an insurance company considers when underwriting an energy risk. The underwriting process involves exploring details of the following:

* Plant Description – overview, process units, control rooms, storage and tank farms, utilities and service facilities.

* Design Safety Features and Protection – layout and spacing, control and safety systems, containment, drainage and spill control, fireproofing, fire water supply and distribution systems, plus fire protection systems.

* Management Programs – operations programs and procedures, maintenance programs, inspection programs, process safety and loss prevention programs, as well as emergency response.

Extensive risk analysis doesn’t stop there: insurance professionals will address any concerns about business interruption, bottlenecks, suppliers and receivers, maintenance practices, written risk management programs, impairment management, management of change programs, and training programs, among others.

Underwriters look closely at the risk profile and make decisions based on the ability to differentiate the exposures. As such, the provision of detailed underwriting information is of paramount importance to getting the best support from insurance companies. Insureds that have professional risk management practices in place and fully communicate these practices will help to alleviate underwriters’ uncertainty.

THE RIGHT PARTNER

A handful of carriers in the insurance industry are well prepared to meet the risk management needs of the energy insurance market. Especially in today’s market, finding the right risk partner when seeking coverage is a critical task. Purchasing insurance is an important financial decision for any energy firm; evaluating insurance carriers on a number of factors – including longevity in the market, financial stability, ratings, expertise and dedication to an industry – is an imperative part of making a good decision.

Knowledge of the industry is an especially important part of managing energy firms’ risks effectively. The energy industry functions largely on technology, so the only way to understand a company’s exposures is to have a deep understanding of that technology and how the industry works as a whole. A few insurance carriers have acquired the intellectual (and technical) capital necessary to understand the ins and outs of multiple energy industry segments; they have worked hard to understand the day-to-day issues of the industry in order to develop insurance products and other necessary risk management services.

The last few years have been difficult for both the energy industry and the insurance market dedicated to serving its risk management needs. Fortunately, both industries continue to show the kind of resilience required to serve their clients’ needs.