Taming Risk

From a business point of view, very little looks attractive in the current large risk general property insurance market. Recently, and partially to compensate for restricted revenue, a number of markets have commenced underwriting onshore energy in the Canadian property market. Given current soft market conditions, what were the reasons and challenges that make this compelling?

ENERGY MARKET

The energy property market is quite diverse and not all insurers define it in the same way. The occupancies generally include Onshore Oil and Gas, Petrochemical, Pipelines, Power Generation, Pulp and Paper, and Mining. Insurers may include some of these occupancies in their general property portfolio.

Risk-managed business

The Canadian economy is predominantly resource-based and, therefore, a large segment of risk-managed business is tied to this sector. Energy business in Canada has historically been quite profitable. That said, company results can be volatile depending on risk selection, placement and size of accounts and, as such, risk selection and placement position is critical in this area.

Large energy risks have significant assets, some well in excess of $50 billion in value. Considering the large loss potential, they also have a substantial need for coverage with limits of liability, in excess of $1 billion.

Many risks have been forced to use unlicensed participation from international insurers in order to achieve adequate coverage. International insurers have a distinct disadvantage with high excise and premium taxes, particularly in Alberta where a tax of 50% for unlicensed insurance is applicable.

Volatility is substantial

The energy market is volatile, exposures are substantial and losses, although infrequent, can be considerable. The key for successfully underwriting this risk is collaboration. Project engineers and underwriters need to work together to understand current engineering information and market conditions to properly evaluate risk. This allows the insurer to deploy capacity in the most effective and informed manner.

The size and type of loss potential varies by industry. Oil, gas and petrochemical risks have sizeable fire and explosion potential; power generation has sophisticated turbines that are finely tuned and, therefore, can be subject to breakdown and considerable loss.

Effectively, all targeted occupancies have much more potential loss from machinery breakdown when compared to the general property exposures. Understanding property and boiler and machinery coverage, pricing and potential issues are necessary.

Underwriting energy risks requires a concentration on key elements. There is a heavy emphasis on hard physical protection such as separation, construction, fireproofing, fire protection and water supply, but most of all, management of risk. This includes process safety management (PSM) procedures, which have many elements and are designed to reduce operational risks and attritional losses.

CANADA VERSUS ELSEWHERE

The Canadian energy market differs from the rest of the world in a few key areas. Not only is the exposure to catastrophic loss considerably reduced compared to other markets, Canadian oil and gas occupancies are concentrated in Western Canada as opposed to worldwide risks located in areas exposed to wind, flood and earthquake.

This provides a distinct advantage by reducing the frequency and severity of loss activity.

Much of the premium attributed to Canadian energy is related to the upstream market in the oil sands. An upgrader differs substantially from a refinery in that it takes bitumen and produces crude, whereas a refinery’s supply is crude oil.

Recognizing that refinery margins are limited, this results in significantly more business interruption profits and, thus, much more exposure from an event.

Since worldwide insurance capacity is inadequate to assume this degree of loss, many Canadian clients co-insure their risk by capping their business interruption with a “maximum dollar per barrel produced” or a “maximum throughput” indemnification.

Of note for the energy business is that there should be no attritional losses. Premiums are required for the rare large volatile loss, and applicable deductibles need to be appropriate to successfully underwrite this class of risk.

Large Canadian oil and gas clients have recently been trending to participate in the OIL captive. The captive provides for property loss only, with limits for individual companies recently increased from $250 million to $300 million, and increasing to $400 million in the near future.

TRENDS IN DEDUCTIBLES

With many Canadian energy clients having fractional interests in production facilities, the property deductible may be multiples of the captive insurance and equate to multiples for the site deductible. This may mean property deductibles in excess of $1 billion.

Another recent trend with respect to deductibles has been an increase in the waiting period applicable to business interruption. Upstream operations have been increasing well in excess of 90 days. These deductibles then translate to attachment points for insurers increasing by multiples from historic levels.

While the aforementioned have increased, business interruption interdependency exposures have been reduced as a result of the considerable construction activities prior to 2008.

There are now options for sending or receiving product by pipeline to other facilities should an individual insured’s risk be idled. However, this increases potential contingent business interruption exposures as insureds become more dependent upon one another.

One of the key concerns for an energy underwriter is accumulations. Considering contingent business interruption and fractional working interests, a loss at one location can result in multiple claims from different insureds. Underwriters need to closely monitor individual locations to avoid overexposing their companies to losses in excess of those anticipated.

THE CHALLENGES

The market in energy is not much different than general property. Certainly, occupancies such as utility, pulp and paper have many similarities with general property participating on the same accounts in many cases.

New capacity is entering this area, coming from both domestic and foreign insurers, and also from additional capacity from incumbent, existing markets. Capacity is abundant, although somewhat less than general property.

New and existing markets are offering incentives for increasing lines or writing new lines, which can include larger participations, multi-year deals and variable claims bonus arrangements. These features have historically been provided for smaller, less volatile property business where attritional losses are expected and loss ratios can be considerably more predictable.

The underwriting focus should be on profitability for the insurer so that the industry can absorb these inevitable large loss scenarios when they occur.

The potential market for Canadian energy can be profitable when written correctly. The most important component is an insurer that is focused on bottom line profitability. With that – and the support of an educated team that concentrates on risk selection – terms and conditions, accumulations, potential exposures and adequate premiums for individual risk are critical.

Writing this type of business demands understanding there are significant premiums that have to be balanced with knowledge of the real exposures involved. Top line premium growth goals must be tempered with a heavy emphasis on profitability and the need to be viable over the long term.

A sustained commitment to this industry should be understood as a requirement for long-term success in these industries.