More storms on the horizon: record hurricane losses are the costliest--but not the only--problems facing energy insurers.

Times are turbulent for energy insurers. A string of emerging risks threatens global energy markets: two straight years of devastating hurricanes in the Gulf of Mexico; natural gas disputes in Eastern Europe; civil unrest in Nigeria.

The impact on energy insurance rates from the hurricanes of the past two years is expected to be tremendous. Experts say the impact will be clearer after the bulk of the energy reinsurance renewals go through between the March 1 and July 1 renewal seasons.

"The losses have been horrific" said Bill Martin, head of the Houston office for broker Benfield Group's corporate risks group. "The profile coming out so far from London renewals is that platform rates have gone up 300% to 400%."

Martin added that "probably the more troubling aspect we've seen" in renewals so far is that there are annual aggregate windstorm limits of about $50 million being put in. "London is naturally restricting excess windstorm limits due to the aforementioned losses. This leaves energy industry balance sheets exposed to catastrophic windstorm loss," Martin said.

Price Concerns

For some insureds, the combination of a 400% price hike and the previously nonexistent $50 million windstorm limit translates into a real price increase closer to 600% or more, Martin said. With many energy players having $1 billion or more of exposure in the Gulf of Mexico, facing possible annual losses of hundreds of millions of dollars, a $50 million aggregate windstorm limit gives management an issue "that has to go to the board of directors," Martin said.

Ian Morgan, head of GE Insurance Solutions' facultative energy underwriting team in London, said cross-border supply disputes and the kidnapping of oil workers may grab headlines, but those hurricanes chewing up the U.S. Gulf Coast still have by far the biggest impact on energy insurance. This results in a capacity crunch for windstorm coverage for offshore energy risks, particularly from reinsurers.

The cumulative effect of hurricanes Ivan in 2004 and Katrina and Rita last year on the energy insurance markets, maybe as high as $10 billion, is "many multiples" of total global energy premiums, said Bruce Jefferis, head of broker Aon Corp.'s natural resources group in Houston.

About $450 million is paid in annual premiums for offshore risks in the Gulf of Mexico, Martin said. Hurricane Ivan in 2004 cost about $1.4 billion to that sector. Last year, Katrina and Rita each caused an estimated $3 billion to $4 billion offshore. "Over two years, that's $9.4 billion in losses, compared with about $1 billion in premium, so the numbers really don't work very well," he said.

With the heavy concentration of gas and oil refining operations along the Gulf Coast, some energy companies took a double hit from Katrina and Rita in particular, said Martin. Those that had both offshore assets in producing platforms and onshore refineries in the region will have seen substantial losses, he said.

"Prices for headline platform physical damage [damage to platforms that grabs the headlines when the general media reports on hurricanes] in the Gulf of Mexico are rising as much as four- and five-fold," said Morgan. But coverages for other Gulf of Mexico offshore energy insurance risks are not rising by that same magnitude--the net effect being that the overall price is averaging out at a two- to three-times increase. "Outside the Gulf, prices are increasing 15% to 20%," he said.

"We in the insurance market rely heavily on natural catastrophe reinsurance, particularly windstorm coverage, and reinsurers are being parsimonious with their capacity," Morgan said. "They've obviously taken some big hits."

Jefferis agreed there has been severe tightening of capacity for windstorm coverage in the Gulf of Mexico. Reinsurers have pulled back quite a bit in the amount of capacity they were willing to provide.

Pricing, terms and conditions for Guff insureds are "all over the place" right now, said Morgan.

The big test for the market is now under way as much of the energy sector is included in reinsurance renewal rounds from March 1 to July 1, said Martin.

As this issue of Best's Review went to press, Martin, Jefferis and Morgan all said it's too early to gauge results for energy lines from March 1 renewals.

A further sign of the extent of last year's devastation is the plight of Oil Insurance Ltd., said Martin. A Bermuda-based mutual covering nearly 100 members in the energy market, OIL has a $1 billion aggregate limit per event a limit that was breached by both Katrina and Rita last year, something that had never happened since OIL started business in 1972.

In late February, OIL's estimate of aggregate losses by its shareholders was nearly $1.9 billion from Katrina, and slightly more than $1 billion for Rita. Given that losses likely will rise over time [OIL plans to issue updated estimates after each financial quarter so its members can adjust their excess-of-loss claims], members can expect to get about 50 cents on the dollar in payouts from Katrina claims.

OIL said in a statement that it projects payouts for Rita to average about 80% of losses, 40% in the short term.

The Big Squeeze

Morgan said that, so far, what GE Insurance is seeing is tightening on windstorm aggregation limits, which take into account all aspects of a program, including physical damage and business interruption.

Retention levels also are rising on windstorm policies. Business-interruption terms are tightening, with more specific definitions as to when production stops, said Morgan. There seems to be a "lack of appetite" in the market for providing capacity for loss-of-profit coverage, he said.

As is usual in insurance markets when capacity shrinks and prices balloon, new entrants are appearing in the energy markets, said Jefferis. For example, Lancashire Holdings Ltd. raised more than $1 billion in funding and debuted on the London

Alternative Investment Market two months ago. Registered in Bermuda, Lancashire said it would pursue an underwriting strategy for exposure to low-frequency, high-severity losses, with an emphasis on retrocession, marine and energy, and property classes.

Berkshire Hathaway Inc. insurers also have "significant capacity" they can deploy in the market, albeit at "significantly different prices" than in the past, said Jefferis.

There is "opportunistic capital" coming into the market, mostly from Bermuda startups, and that capital may have a positive effect on pricing [for the buyers], though "we haven't seen that effect yet," said Benfield's Martin.

But capacity may be constrained by price as much as anything. Ironically, the fact that gas and oil prices had already been at record highs before Katrina hit may have kept the market from a "perfect storm," said Martin. "If commodity prices were low, there wouldn't have been the money to pay the increases in premiums."

Higher oil and gas prices also have drawn a lot of private equity capital to fund new exploration and production companies, which start out highly leveraged and in need of risk-transfer solutions, said Martin.

Other Problems

European political circles were disturbed in early January when a price dispute between Russia and Ukraine over deliveries of Russian natural gas led to a temporary cutoff of supplies. Much of Russia's natural gas shipments to Europe pass through Ukraine, so the apparent willingness of the Russian government to use gas supplies as a political weapon unnerved many European governments.

As dramatic as the dispute was, insurance markets likely won't be affected. "We've seen no real effect on the market from the Russian-Ukraine gas dispute," said Morgan. "There might be some short- or medium-term impact on gas prices, but gas is priced pretty high anyway."

Aon's Jefferis added that business-interruption claims aren't viable in connection with the Russia-Ukraine dispute, as normally such a claim would have to arise from some sort of physical damage to assets, rather than a deliberate cut in supply.

In Nigeria, oil extraction and exploration long have created tensions between the foreign oil companies doing the work and local villagers, who complain they are still poor despite the wealth generated by the industry. Local militias periodically have kidnapped oil workers, stolen tankers and damaged oil companies' assets. In the past few weeks, several oil workers were kidnapped.

GE's Morgan said energy insurers generally don't cover kidnap and ransom in Nigeria. Sabotage and terrorism risks also are excluded from most coverage, because of the known risks in Nigeria, he said.

Since those risks generally go uninsured in Nigeria, business-interruption coverage also generally is excluded, said Morgan.

Of all the events to hit energy markets in recent months, the one that likely will have an impact, outside the hurricanes, is the oil depot explosion at Hemel Hempstead in the United Kingdom last December. Insured loss estimates from that disaster ranged as high as $880 million.

France's Total S.A., which had a 60% share in the depot's operations, is putting in a claim to the commercial insurance market of about $150 million. "It was a fairly large claim, but it didn't seem to have a big impact on the market overall," said Morgan.

Insurers are looking more closely at coastal flooding and windstorm risks around the world, said Morgan.

There is some spillover from the U.S. Gulf Coast to other energy markets globally, with some price increases in other regions, "but not nearly of the same magnitude as in the Gulf," said Jefferis.

Finding Solutions

Turmoil in the energy insurance markets is expected to have a significant impact on energy companies, given their need for financial protection in a high-risk business, said Jefferis. Many energy companies will struggle to reconcile shareholder demand for financial protection with high prices and low availability of coverage.

"Some energy companies are among the biggest companies in the world, and they certainly have a lot of financial flexibility," he said. "But the vast majority of energy companies do depend on the commercial insurance market. They have a lot of difficult issues to deal with this year."

"If you're a big multinational, you probably have a number of choices," said Martin. "But if you've recently been funded by private equity or are trying to digest an acquisition where you've loaded up on debt, you're not in a position to go bare [on insurance]," added Martin.

With a new Atlantic hurricane season formally beginning June 1, energy companies have to move quickly to solve their exposure problems. "When the pricing gets to these levels, it's probably time for some companies to look for alternative risk-management financing," said Martin.

Catastrophe modeling is important, since every energy company will have different risk exposures, said Martin. The "money that's poised to respond instantly" to capacity needs will get the high rates, making those insurers willing to "take that chance" in the next hurricane season, he said. "They may look at the models, but the money carries the day."

For those not able or willing to pay the high premiums, modeling can point to alternatives, such as weather derivatives from a hedge fund, a catastrophe Bond, or finite reinsurance contracts, said Martin. "Although finite risk has been the subject of much scrutiny, it remains a valuable tool. In fact, a partially funded or blended risk structured program could be an excellent solution in some excess layers for windstorm."

Energy companies are likely to try various forms of risk retention, including captive insurers, to mitigate the high cost of coverage, said Jefferis. "Longer-term funding vehicles," such as a dedicated funding schedule aimed at building reserves for a future catastrophe, may become more common to cover some insurance gaps, he said.

As in other property/casualty markets hit hard by the catastrophes of the past two years, the energy markets will see the rise of creative, mixed solutions to insurance shortfalls.

Key Points

* The impact on energy insurance rates from the hurricanes of the past two years is expected to be tremendous.

* Annual aggregate windstorm limits of about $50 million are in effect this renewal season.

* Many insurers, particularly in the London and European markets, have pared their Gulf windstorm capacity to as little as 20% of what they had before 2005's storms.

Learn More

Lancashire Insurance Co.

A.M. Best Company # 78141

Distribution: Brokers

Berkshire Hathaway Group

A.M. Best Company # 70158

Distribution: Direct and brokers

GE Insurance Solutions

A.M. Best Company # 00347 (Employers Reinsurance Corp.)

Distribution: Brokers

For ratings and other financial strength information about these companies, visit www.arnbest.com.

Damage to Gulf of Mexico
Platforms and Rigs

                            Ivan    Katrina    Rita

Platforms destroyed            7         47      66
Platforms extensively
damaged                       20         20      32
Rigs destroyed                 1          4       4
Rigs extensively damaged       4          9      10
Rigs adrift                    5          6      13

Source: Benfield Corporate Risk: A 65-year history
of hurricanes and some of their resultant
impacts on the offshore industry, Nov. 1, 2005;
Minerals Management Service.