Significant market movements have been identified in the offshore and onshore energy insurance fields but will these bring positive or negative repercussions for the sector as a whole? Lynn Rouse reports
In its review, State of the Market 2005, published at the end of last year, broker Heath Lambert identified two significant changes shaping the energy insurance market, adding that rates have reached a precarious point. Firstly, it noted that the offshore market has begun moving closer to the onshore market to the extent that some insurers no longer separate these underwriting areas. Secondly, that general property players have begun writing the onshore risks of energy companies, such as refining and other downstream processes. Previously, such business was the domain of specialist energy underwriters.
On the subject of rates, the report said: "The question for 2005 is not whether rates will drop on valued accounts but how far they are willing to go." Referring to the 'knee-jerk' element of price hikes in late 2001, it added: "The rate at which they have corrected downward may have been too much too soon. Indeed, energy underwriters within the Lloyd's market are coming under pressure from the market's franchise board over the pace at which rates have been reducing."
But do other energy players agree with these statements? Are there any dangers inherent in the convergence of the onshore and offshore underwriting areas as well as in generalists beginning to write the onshore risks of energy companies? Opinions would appear to vary quite considerably.
Charles Gordon, partner and head of insurance and reinsurance at law firm DLA Piper, says about the underwriting of the two markets converging: "This is certainly something we have noticed being done by a number of companies, bringing the two more closely together."
So from a legal perspective, does this development concern him at all?
"I do not believe it will create a major problem - it comes down to a question of expertise and experience. In fact, I have often thought the rigid divide between the two was a bit artificial."
However, Philip Thorpe-Apps, director of underwriting at Aegis Energy Syndicate 1225, explains that his company continues to view the disciplines as different.
On the offshore and exploration and production side, Aegis has a marine underwriting team for particular classes, including control of well, offshore platforms and general E&P exposures. Then there is a separate team for the onshore account, which is primarily a power utility account.
"It is very important from our perspective to maintain these two disciplines - although you do come across people in the market who profess to be experts in all energy lines," says Mr Thorpe-Apps. "My personal view is that it is a bridge too far to try and have your finger on the pulse of every different line of the business. It is far more sensible to have distinct underwriters for various disciplines."
He adds one caveat for when there is an insured with both onshore and offshore exposures and an integrated energy package is produced. "We then have to involve all the underwriters and liaise fully to make sure we make the right decision on each piece of business."
Others disagree that this convergence of underwriting is occurring. "I do not think offshore is moving closer to onshore - I cannot think of a single underwriter that has recently merged its books," comments Charles Franks, active underwriter of marine and special risks at Kiln Syndicate 510 and chairman of the joint rig committee, a London Market committee for offshore energy insurance.
"I think that, by and large, the client base still supports markets that are pretty distinct between the two areas. The sort of client that straddles both, such as the big multinationals, are not great buyers of insurance.
By that I mean they are big enough only to buy it at very high levels."
There is more consensus surrounding Heath Lambert's statement that general property markets have begun to write the onshore risks of energy companies.
Commentators confirm this is happening but hold differing views on issues that could arise as a result.
"Turning the clock back two or three years we were seeing the non-specialist property markets participating in onshore risks on the power side, writing excess layers," says Mr Thorpe-Apps. "However, in the last six to 12 months, we have witnessed more and more players coming in on primary layers."
He identifies the fact that more capacity always brings with it the risk of a potential softening of the market. "But, having said that, we have not seen a great increase in capacity over the last year or so."
However, he points to another concern - that of the "tendency for non-specialist, non-marine underwriters to pick up some of the less desirable exposures - and thus be slightly selected against". Due to a lower level of technical knowledge, he believes generalists could be looking at what appears to be good business but not seeing elements on which the specialist markets would probably impose different terms - such as the business interruption waiting periods, higher excesses or conditions on newer technology. "So there is a danger they may be exposing themselves unwittingly to technical problems that could take two or three years to come out of the woodwork."
As managing director of Heath Lambert's power and natural resources division, David Way is responsible for the energy section of the broker's market review that noted this development. So does he believe the increasing presence of general markets writing the onshore risks of energy companies brings advantages or disadvantages? "In my view the pros significantly outweigh the cons," he says.
He outlines three factors that support this view: the greater size of the property market compared to the smaller, more volatile energy market that could bring a stabilising influence with more continuity; similar exposures in terms of windstorm, earthquakes and flooding risks, with onshore refineries for example having more in common with power stations than offshore oil platforms; and transferable skills such as business interruption expertise that property underwriters hold.
He concedes that there are, of course, risks specific to the energy sector such as control of well, which demand specialist skills but says that, equally: "The specialist knowledge involved in rating business interruption is every bit as significant as specialists in control of well. So there is great advantage for property underwriters to get closer to energy market risk."
And what about the question of rates - do commentators agree that they have reached a precarious point?
"Despite a $2.7bn (£1.4bn) industry loss from the US hurricanes at the end of 2004, we have still not seen the hardening in rates that we would have hoped for," says Torquil McLusky, business development manager at Ascot Underwriting. "We believe that many risks are underpriced, in particular given the fact that most rigs are working to maximum capacity to take advantage of the current high oil price. We believe that the effect of high oil prices on industry discipline is not sufficiently factored in."
Well output and rig operations
Obviously, with oil priced at around $50 a barrel, there are huge financial incentives to get wells pumping hard - but this brings with it an increased risk of insured losses. "With the high price of oil, the cost of business interruption claims becomes huge much more quickly. When rigs are running flat out for months on end there can also be a tendency for more problems to arise. That is not anyone's fault but, if rigs are operating at 100% or 110% output, there is a massive strain on the machinery. We feel that is an additional issue that should be taken into account with ratings."
In terms of the different sectors, Mr McLusky says the upstream risk rates are "certainly holding up better", with the term 'upstream' often being interchangeable with 'offshore' - one notable exception being explorations rigs on land. And Mr McLusky is more positive about the upstream side of the business, despite the pressures he outlines above. "This is a reflection of how bad things have got with downstream." In fact, Ascot has made a conscious decision about the balance of its energy account, with a shift towards upstream risks at the present time, and is being much more selective.
Mr Thorpe-Apps agrees with the distinction made between downstream and upstream risks. He describes offshore E&P rates as presenting a "slightly more rosy picture".
During early 2004, Aegis was concerned that the market was approaching the point where profit margins were being squeezed right out. "The Lloyd's franchise board became more involved as two or three high-profile accounts reduced rates by between 25% and 30%." And he believes the franchise board does police the market in quite an effective way. "After all, the board needs to approve our business plans for us to be able to transact at Lloyd's."
Just prior to the hurricanes hitting, he says the market was showing signs of taking a more sensible approach and then Hurricane Ivan occurred - at $2bn, the largest offshore energy loss in history.
Mr Franks agrees that, following Ivan, offshore business is seeing flat renewals - apart from those in the Gulf of Mexico, which are seeing rate rises of between 10% and 20%. "Where we had seen reductions in the first six months of last year, these had largely come to an end and Ivan has definitely had a steadying effect on the pricing of risk. We are all also being asked to understand fully the extent of aggregate that is exposed in the Gulf of Mexico."
When it comes to onshore rates, Mr Thorpe-Apps stresses that he can only comment on the power utility side but confirms that competitive pressures are in play. "This class is very profitable and, because of that, people naturally want a larger slice of the cake. There are some new players and the non-marine property players are also trying to increase their share."
Consequently, rates over the last two to three years have been coming off, he explains, and have put a "severe dent" in margins. "In 2005 we have reached the point where we have got to curtail these reductions."
Nick Metcalf, director of underwriting at Arch Europe, is not overly concerned about the current level of rates. He reports: "The non-cash element is holding up well, such as terms and conditions and deductibles.
The cash element, however, was under pressure on the offshore side although this pressure has been released by Ivan and the subsequent losses, combined with the resistance of the reinsurance market to reduce prices."
Regarding onshore, he adds: "We have certainly seen greater pressure on rating. That said, it has not been as great as reported - the evidence from our system is that rates have not come off to a great extent. We are certainly not in a soft market - rather a softening hard market."
What about the energy casualty markets specifically? Are they facing rate pressures too?
"Like most areas of the business, the energy casualty markets saw significant price increases between 2002 and 2004, largely driven by market forces but also due to poor experience in the preceding period," comments John Cavanagh, chairman of broker Carvill Re.
He explains that the tail-end of the 2004 year saw a levelling off of pricing and modest reductions in some areas, adding that: "The results for the last three years are looking good, with no major severity in the sector and, as a consequence, we have seen new capacity creeping in. Most major markets are attempting to hold the line on pricing, but there is some expectation of price reductions in 2005. There is clearly adequate capacity available to meet the limit requirements of the large utilities and integrated oils."
Going forward, however, Mr Cavanagh predicts things could get interesting: "There seems to be a great deal of energy business 'up for tender', largely in the wake of the recent Spitzer revelations, and the expectation is there will be a broker interchange on major energy accounts."
Overall, energy underwriters are confident that the market is sufficiently robust and disciplined to stave off any rate crises or flights of capital.
"My feeling is that we have reached the point where prices for onshore and offshore are sustainable for both parties to the deal - we have enough premium to make a reasonable profit and the client base also views prices as fair," says Mr Thorpe-Apps. "But they cannot be allowed to continue down."
In his view, the market is much better placed to transact business than it was five or 10 years ago and that any downturns will not be as severe or sharp as in previous underwriting cycles. "A lot has changed since then - not least the fact that our capital base is much more informed and professional with expectations of consistent returns. In the old days, the percentage of corporate capital was much lower, as was its knowledge base. Consequently, the whole market is a lot more professional and aware of the requirement to produce a consistent return."
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