Mining: Big Risks, Big Rewards

Mining is a crucial component of the Canadian economy and the commercial property insurance industry plays an important role in keeping this financial train on the tracks.

Canadian Prime Minister Stephen Harper underscored the mining industry’s importance earlier this year during the Summit of the Americas in Cartagena, Colombia. “Resource development has vast power to change the way a nation lives,” he told the gathering. Harper noted that mining contributed $50 billion to Canada’s gross domestic product in 2011 and employs more than 300,000 Canadians. One out of every 50 jobs is associated with mining.

Canada also has 19 of the world’s 100 top mining companies, two more than China and several more than any other nation. In fact, during the past two decades, minerals and metals have contributed between 2.7% and 4.5% of the nation’s GDP, notes the Mining Association of Canada. Mining produced an estimated $8.4 billion in taxes and royalties for federal, provincial and territorial governments in 2010.

With so much at stake, banks and lenders have intensified their scrutiny of the quality of insurance for mining companies – an industry that is rapidly advancing its use of sophisticated technologies, equipment and facilities to extract, process and transport minerals in mind-boggling quantities. Today, an advanced copper mine can extract hundreds of times more ore than the mines of a few decades ago. As the industry transforms, underwriters must adapt their policies and underwriting practices to reduce uncertainties and improve their portfolios.

Unique challenges

The challenges facing mining industry underwriters are complex, large-scale and unpredictable. A 2012 Mining Market Review released by Willis Group Holdings identified natural catastrophes, supply chain disruptions and resource nationalism as the three major risks facing mining companies.

On top of that, underwriters must consider a tangle of unconventional details involving a mine’s geology, geography, equipment and processes. For example, every pit and underground mine is unique with diverse geotechnical exposures. Mine exposures can be spread over a vast area, raising the question of ownership and maintenance of roads, railway lines, electrical transmission lines or slurry pipelines – all of which can span hundreds of kilometres. Equipment sizes are startling: truck tires can be three metres high and grinding mills can be 12 metres in diameter.

Add to that no two mining processes are exactly the same.

In this environment, losses in the mining industry and to underwriters can be massive. If a pit wall in a copper mine fails, it could result in loss of life and destroy multiple pieces of equipment, such as shovels or drag lines. These machines are capable of lifting hundreds of tons of earth in one scoop, and they cost anywhere between $5 million and $175 million to replace. This is not to mention the business interruption associated with losing these machines: replacement can take one to five years and cost hundreds of millions of dollars. If an underground mine’s hoist rope fails (the cable that hauls personnel and ore from below in vertical mine shafts), time element exposures can run six months. Considering the remoteness of most mines, spare parts and equipment must be kept near the mine site in an appropriate environment.

The challenges for mining underwriting are even more mercurial for companies seeking untapped resources in less industrialized, remote locations around the globe. Multinational companies face political risks such as the threat of resource nationalism. There are infrastructure issues to address – unreliable power grids, poor roads and lack of water – combined with indefinite and evolving regulations and practices that can affect production and supply chains. Lead times on replacement equipment can vary sharply, an issue that factors into obtaining replacements and restoring production after a loss. A ring gear that takes nine months to replace during the low part of the economic cycle can take 30 months on the other side of the cycle. Rectifier transformers for large electro-metallurgical smelters can take as much as two years to obtain.

Overcoming underwriting challenges

Underwriting mining risks is not for the faint of heart, but the potential heartburn of financial loss can be soothed with effective underwriting. The success of properly underwriting this industry is tied to properly understanding and identifying the industry’s myriad complexities and exposures. With this understanding, underwriters can walk the tightrope of writing policies with realistic coverage, deductibles, pricing and capacity.

Ask the right questions. Underwriters need to determine if a client is managing exposures appropriately. A policy form that clearly outlines uninsured risks and property will help reduce uncertainty. For example, if a company-owned road fails, is your intent to restore the road or just the surface? Are you going to replace land that used to be under the road, or remove land that now sits on the road? A clear policy form is needed that provides a high level of contract certainty.

Bring appropriate resources to the table. A client, wherever it is operating, is a better risk if the client is meeting industry best practices. These standards are even more important if operations are located in places with less stringent regulations or enforcement.

Evaluate the quality of a mine’s overall management. A sampling of items that should be part of the review process include equipment maintenance programs, operator quality and training, safety and emergency response programs, operating history, contingency plans for addressing equipment failure and supply chain disruptions. Can a company be up and running within a 15-day timeframe following the breakdown of a piece of equipment? Are contingency plans in place if a port is blocked or a product pipeline is disrupted? Is a pit wall being managed properly to assure its integrity?

The quality of an insured’s management and operators heavily affects underwriting decisions.

Last year’s damaging series of floods, tornadoes and earthquakes underscored the need for underwriters to avoid or minimize potential exposures within a client’s supply chain. Insurance losses from Canada’s mines weren’t as great as losses elsewhere last year, which was a particularly harsh period for underwriters. However, disasters in other parts of the world severely affected insurers. Natural disasters are inevitable, and insurers should be prepared for those losses. Understanding the impact of these scenarios is needed to adjust your terms and capacity appropriately. Consider, for example, how much floodwater found its way into a number of open pits in the last few years, and the issues related to pumping that vast quantity of potentially contaminated water back out into the rivers.

Ultimately, underwriters can protect their portfolios by partnering with mining operators; combining expertise; and bringing resources to the table that provide information to help reduce risk to operations and supply chains. By applying this kind of due diligence, an underwriter suffering a loss should be able to look in the mirror afterwards and say with conviction that the insurer made the right decision to accept the risk.