Willis Energy Market Review 2013 PDF
Willis Energy Market Review 2013 PDF
Willis Energy Market Review 2013 PDF
WELD energy losses 19902013 (excess of USD 1m) versus estimated global energy premium income
USD billions 30 25 20 15 10 5 0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013*
Losses excess USD1m Estimated Worldwide Premium * incurred to date
As premium incomes continue to rise, energy insurers have generally had a good 2012 as losses look set to be the lowest for four years. However, the annual total for 2012 masks the different underwriting climates in the upstream and downstream sectors.
Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
1998
1999
2000
Downstream
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
The number of global insurers in both upstream and downstream markets has remained relatively stable for over a decade. This has served to smooth the volatility traditionally associated with the energy portfolio.
Source: Willis
cONTENTS
EXECUTIVE SUMMARY SPECIAL FEATURE WHAT NEXT FOR SUPPLY CHAIN RISK? LARS HENNEBERG TALKS TO WILLIS offshore CONSTRUCTION onshore CONSTRUCTION INTERNATIONAL AND MARINE LIABILITIES North American EXCESS LIABILITIES 3 7 35 53 71 79 83 INTRODUCTION 5
While the Upstream market has had an excellent 2012 in terms of premium income and loss record, the mood in the Downstream market could not be more different.
Executive Summary
The Upstream and Downstream markets have had contrasting fortunes in 2012. Stable market conditions have recently been the norm in both markets; with capacity levels remaining buoyant, losses have generally been more modest than in 2011 and the dramatis personae of key underwriting leaders has remained essentially the same. With very few new entrants, no losses over USD1 billion and even fewer market withdrawals in 2012, it seems that the traditional volatility which has so characterised both markets in the past has flattened out. However, this volatility may soon re-assert itself as we move further into 2013; while the Upstream market has had an excellent 2012 in terms of premium income and loss record, the mood in the Downstream market could not be more different. Indeed, some Downstream insurance insurers may be on the cusp of withdrawal from the market. Until the onset of Hurricane Sandy in December, it looked as if 2012 would prove to be a benign year for Downstreamrelated natural catastrophe losses. However, this tragic event, in conjunction with historically low rating levels, has helped to prompt a mild hardening of conditions in the market, where an atmosphere of pessimism seems to now hold sway following two poor underwriting years in succession. Although theoretical capacity levels continue to increase, past history suggests that if one or two leading insurers withdraw from this class, others may follow suit. With the market stuck firmly at the bottom of the underwriting cycle, some major composite insurers may be looking to cross-class package business to generate additional premium income. Meanwhile, the industry continues to be faced with an increased supply chain risk. As supply chain exposure is so complex, risk managers and insurers alike are finding that not enough information with regard to key suppliers is being made available. This not only prevents effective risk management strategies from being developed, but also results in the coverage offered by both the Downstream and stand-alone Supply Chain Interruption markets being somewhat limited. As we explain in our Special Feature, energy companies may consider the adoption of a comprehensive Business Continuity Plan to develop the information required to enable this critical risk to be managed more effectively. In contrast, we consider that the outlook for the Upstream market is now much more positive. A combination of the impact of Hurricane Sandy, together with the deterioration of the Costa Concordia and Macondo losses, did shock some Upstream insurers at the end of last year. However, Gulf of Mexico windstorm losses notwithstanding, this is a market that has proved to be consistently profitable in recent years. History suggests that alternative leadership competition for such profitable business usually emerges in one form or another; however, to date this has not materialised. While we do expect the softening in this market to continue during 2013, we anticipate that the extent of this is likely to be relatively moderate, given the continuation of the existing leadership status quo and the lack of alternative aggressive competition. Market discipline remains tight, and underwriting decisions continue to be monitored closely by senior management. In the International Liability market, we report a tale of two cities. While a confident Non-Marine market continues to underwrite a profitable portfolio, the Marine/Upstream liability market remains dominated by a small committee of leaders, whose underwriting philosophies continue to be shaped by recent catastrophes such as Macondo, Enbridge and Costa Concordia, allowing little or no room for individual programme differentiation. Meanwhile The North American Excess Liability market continues to harden. With a renewed insurer focus on pipeline operations, hydraulic fracturing and high risk drilling as the loss record deteriorates, the outlook for this market from a buyer perspective remains gloomy.
Introduction
been more complicating factors in play in making up todays market dynamics than simple economic laws, a trend we consider is likely to continue into the future. However, it appears that good news may now be on the horizon for the majority of Upstream energy insurance buyers, and we show why later in this Review. Indeed, we now find this market in much better shape than we thought might be the case last year, although recent interpretations of the law by Texas courts suggests that the basis on which various parties insure their Upstream risk in the future may need to be re-examined. In contrast, the Downstream market remains mired at the bottom of the underwriting cycle, and although as yet there have been no major market withdrawals, another poor loss year in 2013 will surely cause some insurers to think seriously about a change of underwriting strategy. Meanwhile the Marine Liability and US Excess Liability markets both remain tough environments in which to do business, with both continuing to offer somewhat limited and expensive cover from a somewhat restricted panel of underwriting leaders. In the meantime, some parts of the energy industry are discovering a potential time bomb following the recent natural catastrophe losses of the last two years a significantly increased global supply chain risk. Our Special Feature, which last year focused on the emotive issue of hydraulic fracturing, explores this issue in some depth and offers a potential solution to this increasingly pressing concern. We do hope you enjoy this years edition, and look forward to any feedback that you may have.
Welcome to this years edition of the Energy Market Review. All in all, this has perhaps not been the most dramatic year ever for the energy insurance markets; we seem to be in an extended period of stability as investors continue to regard our industry as a safe haven from the turmoil of the overall global economy. Having said that, the Upstream market in particular was certainly relieved that the situation on the Elgin platform was resolved so satisfactorily in the weeks after last years Review went to press; a major ignition of the leaked gas, resulting in an explosion and fire akin to the Piper Alpha incident of 1988, may certainly have threatened this stability. What may have surprised some of our readers during the last couple of years in particular is how the Upstream market has continued to experience an upward trend in rating levels at a time when capacity has also continued to increase an apparent supply/ demand anomaly. It seems that there have
Special Feature
Allianz Risk Barometer survey, January 2013 top 10 global business risks for 2013
Business Interruption, Supply Chain Risk Natural Catastrophes Fire/Explosion Changes in Legislation and Regulation Intensified Competition Quality Deficiencies, Serial Defects Market Fluctuations Market Stagnations or Decline Eurozone Breakdown Loss of Reputation or Brand Value 0 5 10 15 20 25 30 35 40 45 50
Experts at Allianz put supply chain risk at the top of their overall risk management concerns Source: Allianz
PERFORMANCE
TIME
According to MIT Sloan Management, supply chain disruptions can cause a 25% drop in share price, with a potential 2 year recovery timeframe Source: Yossi Sheffi & James B. Rice Jr., MIT SLOAN MANAGEMENT REVIEW, 2005
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As usual for our Special Feature of the Energy Market Review, we have sought the help of a panel of London-based experts to help us evaluate how energy companies can more effectively manage supply chain risk today. These experts are: Michel Krenzer, Onshore Energy Manager, SCOR Steve Sykes, Senior Class Underwriter, Talbot Validus Nick Wildgoose, Global Supply Chain Product Leader, Zurich Global Corporate UK Tim Holt, Head of Intelligence, Alert 24, London Some of their observations are quoted directly on the following pages. We would like to thank them for their time and their willingness to give us the benefit of their expertise. However, we would point out that, apart from when quoted directly, the views expressed in this article represent Willis own conclusions as a result of our research and should be in no way be specifically attributed to any individual member of the panel.
As well as the major natural catastrophe losses, there have also been more minor incidents which have not involved physical loss or damage at the suppliers site through the emergence of a global economy we have created more single points of failure and rationalised costs, even in the energy industry. Where you have a single point of failure and it fails, you have got a significant issue you could say a minor crisis.
Nick Wildgoose, Zurich
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To provide our readers with a clear exposition of how supply chain losses occur in the energy industry, lets take a fictional example of a petrochemical complex which has a clearly defined supplier and customer chain, as shown in the diagram below.
SUPPLIER TIER 2
SUPPLIER TIER 1
PETROCHEMICAL COMPLEX
CUSTOMERS
Power Plant
Producer A Producer B
LLDPE Plant
NAPHTHA
Refinery
Naptha/Ethane Cracker
Oil Field
PIPELINE
Spare Parts
OFFSHORE PIPELINE
PP Plant
Gas Platform
ETHANE / PROPANE
Butadiene Plant
Producer H Producer I
Own Utlities
Our fictional petrochemical complex consists of a naptha/ethane cracker and several other associated plants producing a variety of petrochemical products. These products are then supplied to a variety of plastics and chemical producer customers. The key materials that are supplied to the complex in order for it to function are: Naptha, Hydrocracker Residue and Liquefied Petroleum Gas (LPG), supplied by a nearby refinery Ethane and propane, supplied by a nearby gas separation plant The refinery and the gas plant are therefore the direct suppliers of the complex and are referred to as tier 1 suppliers by the insurance industry. However, in conducting a supply chain risk assessment for this complex it is also vital to identify the entities that supply the tier 1 suppliers (known as tier 2 suppliers). In this instance, these consist of utilities (power, water etc.), oil tankers, an oil field and various spare parts for the refinery, and an offshore gas platform and spare parts for the gas separation plant. From our research, we understand that approximately 90% of supply chain failures across a number of different organisations occur either in tier 1 or in tier 2 suppliers premises, although of course it is perfectly possible for suppliers further down the chain to cause just as much disruption under certain circumstances.
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Producer C
So how can the supply chain be disrupted in our fictional illustration? In general terms, we can divide the complexs supply chain exposure into two separate areas: 1. Failure to supply originating from physical loss or damage from perils insured under the complexs downstream energy property programme (typically Fire, Lightening, Explosion, Aircraft (FLEXA) we will refer to these events as Damage Business Interruption losses. 2. Failure to supply originating from events that do not involve physical loss or damage from perils insured under the complexs downstream energy property programme we will refer to these events as Non-Damage Business Interruption losses. Below we have outlined a few scenarios that may develop from these two event categories, which we will refer to from time to time during this Feature. (Of course, the disruption possibilities are by no means limited to these scenarios.) A. Damage Business Interruption - Potential Scenarios: 1. There is an explosion or fire at the refinery site, preventing any products from the refinery from being supplied to the petrochemical complex. 2. There is a lightning strike at the off loading facility where the tanker supplying crude oil docks to supply the refinery. This puts the offloading facility out of action for three months, which means the refinery owners, if they cannot find alternative sources of crude oil, can no longer supply the petrochemical complex. 3. There is an explosion on the gas platform that supplies gas to the gas separation unit. Although the owners of the gas separation unit may be able to buy gas on the open market on a short term basis, there is still the potential for an interruption of the supply of ethane, propane or LPG to the petrochemical complex. 4. Gradual wear and tear of the gas pipeline causes a leak which results in a shutdown of the pipeline, which in turn means that the separation plant cannot supply any products to the petrochemical complex. 5. There is an explosion and fire at Producer Ds plant, shutting it down and preventing the petrochemical complex from supplying LLDPE to this customer. B. Non-Damage Business Interruption - Potential Scenarios: 1. The refinery owners become insolvent, and the refinery has to close down. 2. A flood shuts down the power utility site that supplies the refinery. This prevents any products from the refinery from being supplied to the petrochemical complex, as the power is supplied from an external source (unlike the gas plant which has its own power generation facility). There is no damage at the refinery itself.
3. A strike hits the plant which manufactures the catalysts which are supplied to the refinery. As a result, the refinery has to close down which in turn means that production at the petrochemical complex has to grind to a halt. 4. The government nationalises the oilfield which supplies the refinery and outlaws all international exports until further notice. The oilfield and the refinery are in separate countries. The refinery tries to source crude oil from other sources, buts ends up finding this to be uneconomic and so the refinery closes. 5. The gas separation plants IT system crashes. There can be no supply of ethane and propane until the IT system is back up and running. So what immediate risk transfer solutions are available to the owners of the petrochemical complex for these scenarios? It may surprise some readers that: Even where coverage is available from the insurance markets, the coverage available is limited in scope, and/or in some cases extremely costly. Specific stand-alone Supply Chain Disruption policies are now offered by some insurance markets, which specifically cover some of the Non-Damage Business Interruption losses cited above. Let us examine first the coverage afforded by the international downstream insurance markets, and then examine some of the Stand Alone Supply Chain Interruption policies that are gradually being introduced by the market.
13
Some clients have wanted to increase the CBI sub-limits, but in most cases it hasnt worked because it has become such a contentious issue for underwriters. In the absence of more information, insurers will be reluctant to increase the cover provided.
Michel Krenzer, SCOR
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Quality
Very Basic Basic Basic Better than standard Better than standard Good Good Good Best practice Ideal
Frequency
Frequent Frequent Frequent Frequent Fairly rare Fairly rare Rare Rare Rare Very rare
Downstream insurers rarely receive the right level of information to price the risk properly and offer the maximum amount of cover available. Source: SCOR (kind permission of Michel Krenzer) * Incl. Critical points, mitigation, alternative sources, scenarios with EMLs ** Incl. Evaluation of risks, alternative contracts, mitigation plans, alternative products, non-damage scenarios, tier 2, extra expenses, timescales
What we have seen is that the clients are much more aware of the issues we are asking for more information some other underwriters are asking the same thing all underwriters are now concerned to get more information and the clients know that this is an issue for the market and they know its an issue for them.
Michel Krenzer, SCOR
15
We do provide unnamed in some cases, but with low sub-limits, so that is something that has reduced as well. And also its got to be direct so we would only cover tier 1 suppliers
Michel Krenzer, SCOR
The recent natural catastrophes have also brought into focus the extent to which Downstream Energy policies will provide coverage for supply chain events. The trigger remains damage to the assets of the supplier caused by an insured peril; for example if a power station in the Thai flood zone suffered damage from flood water and the supply of power to a refinery was interrupted, as long as the refinerys policy insures flood and the loss is otherwise within the policy terms and conditions, the resultant CBI loss would be insured. However, if say the supply of coal to the power station was curtailed and the power station was shut down as a result, this would not be an insured CBI loss under the Downstream policy. The standard position that the market continues to adopt is that that there must be direct cause of loss due to a peril insured by the first partys policy to a direct supplier or customer.
It should be remembered that the Insured (and therefore their Insurers and Reinsurers) do not control the reinstatement of damaged property and sometimes the third party does not have the same immediate interest in reinstating the damaged property in a timely expeditious manner, it would not be sensible to give a full limit for coverage where the Insured, their Insurers and Reinsurers have no control over the reinstatement of the damaged property.
Steve Sykes, Talbot validus
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lma 9020
Infrastructure
7. Do you have a reliance on any particular infrastructure such as a port/airport/bridge/ railway line and or a particular utility supply? If so, please give details.
Limit/Sublimit
11. What determines the Contingent Business Interruption/Contingent Time Element/ Sublimit that you are seeking to purchase? Is it driven by a particular scenario? If so, please give details.
Comments
12. Do you have any specific concerns or comments about your supply chain exposures which are relevant?
The LMA 9020 is the standard questionnaire which the downstream market has issued to clients to provide the right level of information required for the market to provide Contingent Business Interruption Customers and Suppliers Extension cover
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Given what we have established to date, it will come perhaps as little surprise to our readers to learn that the Federation of European Risk Management Associations showed in a recent study that commercial insurance buyers generally want more effective insurance products to cover their supply chain risks. How can energy companies fill this gap in cover? Are there any realistic alternatives available to supplement the CBI cover provided by the downstream market? While damage Business Interruption losses represent by far the most pressing risks from an energy company perspective, they are also exposed to a small but growing non-damage Business Interruption risk as well.
Lets assume for example that in our fictional example the owners of the petrochemical plant have taken out an All Risks stand alone SCI policy with a USD100 million aggregate cover. If we have a further look at the scenarios we considered, we find a rather different level of policy response; in all these scenarios the SCI policy would respond (up to the annual aggregate limit), including all the non-damage Business Interruption scenarios.
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Current sample of Major SCI Market Offerings (as at April 1 2013) Carrier
Zurich Kiln
Trigger
All risks Named events: Physical damage, volcanic ash, political, riots/civil commotion, marine, insolvency, regulatory, IP, cyber, product recall and reputational harm Named risks: insolvency, ingress/egress, change of supplier ownership, civil authority closure orders, political (including Import/Export restrictions and confiscation), strike, service interruption (including IT failure) Named risks/events: will depend on client requirements but could include for e.g. regulatory shutdown, insolvency Interruption/reduction of supply and/or service tailored to client requirements: insolvency, utility interruption, strike, precautionary shutdown, denial of access, epidemic
Limits
USD100M USD60M
Deductibles
10% of limit Variable
Comments
Named suppliers and supplies. Exclusions: supply quality, war/nuclear Policy can be tailored to cover any fortuitous peril. Exclusions: war/nuclear
Allianz
50M EUR
Covers upstream, logistics and downstream. Allianz need to be on the property programme. Tier 1 suppliers need to be named.
Swiss Re
USD50-100M
Variable
Swiss Re need to be on the property programme. Policy tailored to client requirements. Named suppliers, supplies and perils. Standard exclusions such as war/nuclear. Covers upstream and downstream logistics. Named facilities, suppliers and regions. Premium 1-x% rate on exposure, minimum premium EUR 350.000.
Munich
Variable
Various underwriting approaches are currently adopted by the leading SCI insurers Source: Willis (as at April 1 2013)
Are physical causes of disruption which is all that traditional policies cover, and even then its only at your suppliers or customers premises the only reasons why supply chains fail? As we know from the studies on supply chains, I can tell you categorically they are not. So you as a client are either making the decision that you will self-insure the other perils , which is what many companies do at the moment or will you consider the other policies that are now available?
Nick Wildgoose, Zurich
19
With correct pricing, coverage and manageable limits, appropriate information on risk and catastrophe elements, strong aggregation management and detailed engineering based underwriting information the risk can be underwritten within an overall portfolio.
Steve Sykes, Talbot VALIDUS
20
Part Four: Is Todays Status Quo a Realistic Option for Energy Companies?
So to summarise the current position, we must acknowledge that there is currently something of a disconnect between the supply chain risk that energy companies are facing and the provision of adequate solutions by the insurance industry. On the one hand, we have a downstream market that is understandably concerned about committing their capacity to risks for which they have insufficient underwriting information. On the other, we have a fledging SCI market which is offering a much wider range of cover but which is still relatively expensive and requires extensive underwriting information before cover can be supplied.
Once companies have got into the habit of buying, they will start to buy a little bit more. Its a journey. They have only got a fixed budget, but if they have say a $50 million overall budget, could not $1 million of that be better spent on purchasing supply chain cover?
Nick Wildgoose, Zurich
21
Risk engineering surveys and reports need to delve into this matter to a greater extent than at present. Information is critical when assessing the price, terms and conditions for the extension and available limit - greater emphasis should also be placed on information relating to catastrophe perils coverage and exposures than has been provided in the past. Good information is invaluable and risk engineers should have a greater focus on this potential aspect of coverage than in the past. In certain critical instances there are clash issues to be dealt with and market capacity is severely stretched and in some instances limited.
Steve Sykes, Talbot Validus
22
PHASE 1
Geographical Regions
Business Unit
Supplier
PHASE 2
WIDEN STUDY FOCUS
- Additional Product Lines - Additional Geographical Regions - Additional Business Units - Additional Suppliers
PHASE 3
PHASE 4
A thorough BCP will involve a four stage process designed to lead to improved risk mitigation strategies and underwriting information for the market Source: Willis
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To determine the natural catastrophe risk exposure at the suppliers site, the most important task is obviously to try to identify where the suppliers are located. As far as the energy industry is concerned, most companies will of course know where their key feedstock suppliers are located; however, it will also be a useful exercise to determine the location of other suppliers to the plant. Once their locations have been determined the company can then be given access to the latest natural catastrophe and risk mapping data. Those exposures can then be mapped together to form an understanding of the flooding, earthquake, hurricane, volcanic activity. Some of those data sources are in the public domain, some of those data sources are specific to various sources but they can now be brought together at the click of a button. This data can then be available for the company to monitor 24/7.
This part of the Phase 1 analysis focuses on the financial strength of the immediate parent or the global carrier. The analysis assesses the credit rating variations between the Global Parent, Immediate Parent and Supplier Risk profiles. There have been a number of circumstances where there has been a high local risk as a result of a financially fragile parent starting to strip the assets of the direct supplier, thereby leading to a financial risk exposure as a result of the supplier potentially becoming insolvent.
ETHANE / LPG IMPORT (SOURCE 2) Actual kTe/yr Maximum NK kTe/yr Tks Tks
GAS OIL / HEAVY IMPORT (SOURCE 2) Actual kTe/yr Maximum NK kTe/yr Tks POLYETHYLENE UNIT (2) Actual kTe/yr Maximum kTe/yr ETHYLBENZENE IMPORT Actual kTe/yr Maximum kTe/yr USD million
NAPTHA IMPORT (SOURCE 1) Actual kTe/yr Op Max. kTe/yr USD million kTe/yr kTe/yr ETHYLBENZENE UNIT Actual kTe/yr Maximum kTe/yr kTe/yr kTe/yr STYRENE UNIT Actual kTe/yr Maximum kTe/yr
Tks
kTe/yr kTe/yr
USD million
ETHANE / LPG IMPORT (SOURCE 1) Actual kTe/yr Maximum kTe/yr PROPYLENE IMPORT Actual kTe/yr Maximum kTe/yr KTe/yr KTe/yr
Tks
GASOIL / HEAVY IMPORT (SOURCE 1) Actual kTe/yr Maximum kTe/yr KTe/yr KTe/yr USD million POLYPROPYLENE UNIT (1) Actual 220 kTe/yr Maximum 250 kTe/yr
Tks
STYRENE IMPORT Actual kTe/yr Maximum kTe/yr ACRYLONITRILE IMPORT Actual kTe/yr Maximum kTe/yr
Actual Maximum
kTe/yr kTe/yr
PROPYLENE Actual kTe/yr Maximum kTe/yr kTe/yr kTe/yr KTe/yr KTe/yr USD million KTe/yr KTe/yr kTe/yr kTe/yr USD million kTe/yr kTe/yr C4 FRAC Actual Maximum PO / DER UNIT (1) Actual kTe/yr Maximum kTe/yr kTe/yr kTe/yr OXO Actual Maximum
STEAM CRACKER
kTe/yr kTe/yr %
RAFFINATE EXPORT Actual kTe/yr Maximum kTe/yr kTe/yr kTe/yr USD million BUTADIENE UNIT Actual kTe/yr Maximum kTe/yr
kTe/yr kTe/yr
USD million
C5 FRAC Actual Maximum kTe/yr kTe/yr kTe/yr kTe/yr BENZENE Actual Maximum kTe/yr kTe/yr BENZENE AActual Maximum
From this detailed process flow map, a companys financial data is then integrated to generate a revenue map that can be used for the analysis. Source: Willis
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It partly depends on the coverage and the number of suppliers they want to consider, but we are being sensible and demonstrating good practice by looking for this information. The sooner we are on a journey where we are refining what we really need and working with the broker, the better. It isnt as onerous as some people suggest. Its just common sense.
Nick Wildgoose, Zurich
In order to produce this map, the brokers engineers will first carry out a desk analysis to build the preliminary model using our templates and any data provided to them from the clients operation under review. In our experience, the templates help to provide a quick start to the process which leverages the brokers in-house knowledge for the benefit of the client. It also optimises the time needed with clients at their operating facilities and seeks to minimise disruption to operations personnel. The final model needs to be endorsed by the client to ensure that both client and the broker agree on the basis for any future work.
Utility D
Facility 4
Utility A Utility B Supplier D Utility C
Product A
Feedstock 1
Facility 1
Facility 2
Facility 3
Product B
Supplier A
Level
Supplier B
Level
Supplier C
Level
Flow
Variance
Inventory Level
Variance
Price Movement
Variance
Each supplier input is turned off to assess the impact on the organisations financial standing Source: Willis
As part of the assessment scope discussions, it may be more appropriate to consider only the main feedstocks (both internal and external) in the initial analysis phase, with utility supplies (e.g. electricity) being saved for a later analysis in Phase 2 of the process.
26
The simulation work will allow each input to be priority-ranked, based on its impact to the company operation (revenue) according to the model output. Any available contingency or mitigation plans will be considered at this stage in the assessment process for a given input.
Dual or multiple source supplier strategies this could mean making sure that a company has a formal supply contract with more than one supplier of a given feedstock, with an assurance that each supplier can ramp up their deliveries given an agreed notice period. New or adjustments to existing trading strategies this could mean that hedging strategies may need adjusting to ensure that they are aligned with the prevailing supply chain exposures. This will very much depend on the base hedging strategy of the company. Introduction of CAPEX projects to reduce exposures this could mean that small capital projects could be implemented in order to remove a large potential loss. For example, if part of an operation is shut down it could result in an inefficient imbalance in the remaining production facilities. Part of this inefficiency might be the inability to handle intermediate products that are not normally produced. If new storage or export facilities are installed, this action this could effectively de-bottleneck the flow from a key supplier, greatly reducing the impact on the company. Supplier acquisition this could mean that following the analysis the only secure means of ensuring the supply of a critical feedstock would be to purchase an alternative supplier, either in-part or wholly. Assessment of potential risk transfer products as we have seen, these could be traditional Downstream CBI policies, a standalone SCI product or indeed an Alternative Risk Transfer product such as a catastrophe bond (although at present the cost-effectiveness of such a product may preclude this).
What we can say is that there is an increasing level of disruption out there. In making a rational decision about this, risk managers have to understand what is the potential cost of this disruption? Never mind about the catastrophe risk, just think of the day to day exposure. If you dont bring risk into your decision making process you are making suboptimal decisions, regardless of whether you buy insurance or not.
Nick Wildgoose, Zurich
27
for which the company has to consider strategies and determine appropriate alternatives.
A regular programme of review to ensure that all current business decisions have been included in the supply chain model
Once the BCP (including the geo-political risk assessment) is complete, the company should be in a much stronger position to: Instigate risk mitigation strategies in respect of key supply chain locations Involve a captive insurance company, if required, to take more of this risk off the parent balance sheet Present a comprehensive market submission to both the downstream market and, if required the stand alone SCI market Purchase external risk transfer products that maximise the cover available, both from the downstream insurance market and the SCI market (and possibly an ART solution) Provide firm evidence to the Board that the companys supply chain risk is being managed as effectively as possible, minimising any impact to the companys balance sheet
It is not the suppliers in the bottom right hand corner of this chart which the company should be looking at, which are normally the focus of the procurement department; its rather more the suppliers in the top left hand corner that may produce more of a problem to the company Source: Willis
In the model represented above, the x axis shows the relationship between the total amount spent on each supplier by the company annually while the y axis shows the potential business interruption loss should each supplier fail each of the dots represents a particular supplier. Because of the type of procurement systems that most organisations use, the normal approach is to relate the criticality of a particular supplier to the amount of money spent on it. However, by using this model, as plotting the results of the analysis in Phase 2, the company can ascertain the lost business that would result from the supplier ceasing to function. So it is not the suppliers in the bottom right hand corner of the chart which the company should be looking at, which are normally the focus of the procurement department; its rather more the suppliers in the top left hand corner that may produce more of a problem to the company. Annual spend may be at a minimum, but if these suppliers are knocked out for whatever reason and stop trading overnight, the business interruption consequences for the company would be massive. The company may not be spending much on them, but these are the suppliers
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When engineers go on surveys, in terms of CBI they dont necessarily talk to the right person. Sometimes the key person is from procurement, and these guys are not part of the normal survey. In some instances I think it would make sense to make sure that the engineers talk to the right person, because the person from the risk management department doesnt always have access to the right data.
Michel Krenzer, SCOR
29
Although dealing with geo-political risk is but one part of the overall Business Continuity Plan, the subject is sufficiently complex to warrant its own sub-section within this Feature. Just as the construction and maintenance of a cost effective and resilient global supply chain demands a broad view with local solutions, so too does the understanding and management of the political and security risks to which its components, including people, are exposed.
may be analysis of how the presence of a supply chain affects these divisions and connections through the resources associated with it. For example, do locals in the country in question currently expect a dividend from the energy industry activity currently underway? If so, what threats or opportunities might develop from this and how does it affect the local political landscape?
30
Brokers can now Assess if suppliers operate in areas of high security risk in relation to geo-political activities, terrorism and kidnap and ransom
Brokers now have the Ability to search local media close to supplier sites to understand severity of natural catastrophe events or establish an understanding of potential threat of strikes
Regular reviews and a mainstreaming of this approach to risk analysis require localised shifts in the skills and approaches of senior management akin to that of the diplomat in which contacts and dialogue are made and maintained with a multiplicity of actors and sources in order to identify causal factors, patterns and possible scenarios.
Tim Holt, Alert 24
31
Secondly, where there were plans, many relied too heavily on assumptions of assistance from embassies and consulates, which was either late or never appeared. Just as many foreign governments were overwhelmed by their contrasting, and often conflicting, military, humanitarian and consular objectives so too were corporate headquarters at country and global levels, seen in some cases in the dearth of communication, direction and coordination between them and their employees, both local and evacuee. What was strikingly absent from much planning during the Arab Spring was a set of sensible triggers based on solid scenario planning. Some generic examples might include: -- Is the country generally stable? -- Are the government/police/military in control? -- Does control extend across the country or are we in a bubble of control? -- What medical facilities are functioning? -- What routes out remain open? -- What are the attitudes of government/ armed non-state actors towards us? -- Is the country at war with a neighbour? -- Has a natural disaster or famine occurred? -- Can/will the government guarantee the safety of expatriates? -- Have there been any local government or embassy evacuation warnings or advice? The art, of course, is to judge the right moment to move the right people to the right place while maintaining business continuity or effective hibernation without threat to life this is no mean task and even a seemingly prepared business can incur costs by evacuating unnecessarily or risk death or injury by leaving it to late.
Phase 3 - Response
Timely information, prior planning and integrated response are extended into the core principles of the modus operandi required in response to a threat that comes to bear. Contingency planning based on intelligence driven scenarios has been emphasised. But responders the agencies actually serving the needs of the client on the ground must have a deep understanding of the arena, networks within it and access to local service providers such as hospitals, airlines, warehouses and transport companies. Such capacity should also be reflected in their relationships and permissions with local authorities or if possible with political or armed groups that are gaining legitimacy and control. What are the key attributes of the responder? They can perhaps be summarised as follows: The capacity to meet needs should a threat become reality The facility to ensure precision and agility The flexibility to meet timings The ability and willingness to coordinate or be coordinated with other agencies An integrated approach to political and security risk management
In the unstable world that has emerged since the implosion of the Soviet Union, accompanied by the backbeat of globalization, the by-products of uncertainty and confusion are seen in a multiplicity of threats to the interdependent networks that make up a supply chain beyond the ever-present spectre of natural hazards.
Tim Holt, Alert 24
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Part Seven: Time for Risk Management and Procurement to Kiss and Make Up?
In this Feature we have shown that although the risk to an energy companys supply chain continues to grow, fresh risk management solutions can be developed, providing the company acts with its broker to grab the nettle, instigate a BCP and evaluate the risk properly. However, if this exercise is really to be done effectively and an optimum risk management strategy maintained we would suggest that now is the time for Risk Managers and Procurement specialists to work together more effectively for the overall good of the company.
event, there can be little doubt that the Risk Management department has resources and skills that can be highly useful to the procurement department, and vice versa. With both departments working together with the backing of the company management, perhaps much more can now be done to address supply chain risk in the energy industry. With the proper work carried out, we at Willis believe that the insurance industry and maybe alternative sources of risk transfer such as the capital markets and catastrophe bonds will increasingly able to offer a wider and more useful risk transfer product in the years ahead.
The Risk Management and Procurement departments can have fun working together. Both can contribute to performance. Both can justify their existence. All functions in a company fight for the attention of their COO and say this is why we should have extra resource. In this scenario, both of them win, and both are stronger in the group as a whole. Its a marriage where there are two sets of skills coming together to help each other out. All of this surely presents a better value picture for the COO.
Nick Wildgoose, Zurich
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34
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WE Lars, how has the role of the Risk Manager at Maersk changed over the course of the last six years? LH If you go back five or six years our function was called Group Insurance, so perhaps its not so surprising that our department was very much focused on risk transfer. Since then we have opened up the remit of what we do by assimilating a number of functions under an Enterprise Risk Management (ERM) umbrella. So we have now changed our departments name to Risk Management; this means that our role encompasses more than simply transacting energy insurance programmes with the insurance market. Our ERM umbrella now includes operational, strategic, financial, and compliance risks, all from an enterprise perspective. It also means that within this umbrella sits not only our insurance strategy but also our risk finance strategy, which includes elements such as loss prevention, retention management and risk transfer to the external insurance markets. We have found that we now work more closely in this regard with individual business units; they have a significant input as to the amounts they wish to retain. Having considered this, we then take a view at Group level as to how much risk we want to retain overall, given our risk appetite and the strength of our balance sheet. WE What have been the immediate results of this change of approach? LH First of all, the fact that we started retaining more risk, both at Group level and also at business unit level, led to a strengthened focus on the risk itself rather than simply transfer and insurance. We realised we needed to understand the risk more and make sure that the risks we retained would not get out of control under any scenario. WE Is the insurance market still just as important to Maersk, given your recent focus on risk retention? LH We of course continue to recognise that external insurers are important for us; indeed, recently the market has shown that it plays a significant role in financing our losses. Given that they remain important stakeholders, we are keen to discuss loss prevention matters with the market; we want to open up our operations to them,
making sure that they are comfortable with the risk, that we have been transparent about what we are doing. We want to listen to their concerns and ideas as to how to improve the risk, and then take these on board as far as possible. So ensuring that our insurers understand the risk is a very important part of our stakeholder management strategy. On the other hand we recognise that insurers have a broad experience of what can go wrong in the energy business from their other clients and can often offer a broader perspective on certain issues. In the regions where Maersk does most business, for example the North Sea, they have certainly passed on their knowledge of this region to us. Indeed in many instances, we are able to learn from our insurers, and this transfer of knowledge contributes significantly to our overall risk improvement and loss prevention strategy. WE In terms of knowledge sharing, what was the outcome when you came to London last year to give a market presentation on the lessons learned from the Gryphon A loss? LH It turned out well we wanted to approach this from a number of different perspectives. Following the loss we felt there were a number of lessons that could be applied across the industry, so we wanted to share our lessons with our peer group. We also wanted to share this with our insurers, so that they understood exactly what the cause of the loss was, what the lessons learned were and what action was being taken in the aftermath. It turned out to be a much appreciated exercise, because insurers learned a great deal about what to look for with regard to FPSO risks, especially as there
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remains only a small amount of statistical data available around the world for these units they had only been around for some 20 years or so. So insurers were very interested in learning more about how FPSO exposures differ from other offshore oil and gas risks. I think our presentation contributed very well to this, but it was first and foremost designed to make insurers comfortable that we had conducted a thorough investigation process, that we had extracted the lessons learned and that we were implementing these lessons across our businesses. That was I think something that was very important to insurers; it was good to increase insurers understanding of the risk so that they could have a better understanding of how to price it properly. WE In what other ways does a modern risk management department such as Maersks manage your relationship with the insurance market? LH First of all, although we of course continue to work with brokers such as Willis we need to have a direct relationship with our insurers, we want to get to know and understand them and vice versa. We want to be open and transparent with them and show them what we are doing not only with regard to our operational risks, but also our business as a whole. For example, when we have our Bankers Day, we invite a number of insurers along so that they can get to know our business activities and our strategy for the future. So its really a true business partnership; from a risk perspective we want each insurer that we have identified as a strategic partner to broaden the relationship, so that its about more than just providing the capacity to insure: we want them to be involved in our risk engineering and loss prevention programmes, and we have derived a significant benefit from doing this during the last 12 months. We have had some very good constructive dialogue with both insurers and their risk engineers; we want to engage them on risk profiling and helping us to understand our maximum loss for our various installations, while we help them understand our production configurations, our risk simulations, our modelling systems and all those kind of things. Since we operate a captive, we also want them to work with us as co-insurers and support us in setting the right price; as well as being the claims lead we also want them to provide fronting services for the captive where we
We have opened up the remit of what we do by assimilating a number of functions under an Enterprise Risk Management (ERM) umbrella.
In many instances, we are able to learn from our insurers, and this transfer of knowledge contributes significantly to our overall risk improvement and loss prevention strategy.
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cannot write on a direct basis, as well as issuing policy documentation. So our strategic partners in the market add value on a whole range of issues, not just a question of providing capacity. WE How does this affect you in terms of your choice of leaders? Presumably this means you have selected your key leads for the long term what would have to happen, in very general terms, for you to change your leadership panel? LH One of the factors on which we place a good deal of emphasis is risk engineering, so our partners must continue to assist and co-operate with us on loss prevention. Other factors which are important include maintaining a global network, so that they can continue to front for our captive across the world; they must continue to offer a credible, solid and robust underwriting authority in the market so that they continue to attract sufficient following in the market to lead business. We like to see risk based underwriting, and we like to see insurers that offer a broader range of services than we have seen in the past. WE We notice you have not mentioned the price of the insurance product? LH Of course that remains a very important parameter for us! It obviously remains a vital part of our total cost of risk. Clearly we need to keep that at a reasonable level thats also why we want to offer them significant premium volume and diversity of risk, in return for attractive prices. WE How has the development of your captive shaped your risk transfer strategy? LH Our risk transfer strategy is part of our overall risk financing strategy, which is to fully optimise the overall cost of risk. Other elements, notably retention management and loss prevention, help us make sure that the losses we retain are controlled at a minimum level, while risk transfer remains an important element as well. The way we use our captive is to help us find the right balance between risks that we are comfortable to retain at Group level and risks that we wish to transfer; its about balancing risk and reward. The creation of our captive has made the retention element of our risk financing strategy much more active and significant than was previously the case its formed a critical part of our overall objective of optimising our overall total cost of risk. WE How has Maersk responded to manage risks in different geopolitical environments, such as China, over the last few years? LH Doing business in different geo-political environments involves a number of risks, ranging from political and environmental risks to compliance risks and foreign exchange risks, as well as many others. We actively strive to manage those risks through stakeholder mapping and liaison with authorities, by having robust compliance processes and an awareness in place throughout the Group, as well as taking out insurance against oil spills and hedging currency risks
on contracts made in local currencies. While we are certainly focussing on the growth opportunities that are out there, we are also very well aware of the risks associated with them. WE How does Maersk manage its supply chain risk? LH At a group level, we manage the supply chain risk as part of our business continuity planning. We do that at a strategic level; we have launched a business continuity process throughout the Group to make sure we have a coherent planning process in place. So we start off by asking the different business units to define the critical processes and put some planning in place for how we would deal with these critical processes, how we would deal with any disruption, and then also roll out that business continuity process through the supply chain. To the extent that our business units rely on suppliers, they will co-operate with Group Procurement on getting an exact picture of what suppliers they are relying on. First, we have to define the critical processes and then the critical suppliers only then can we start dealing with the mitigation, how we reduce our vulnerability towards those suppliers. There has been a great deal of business continuity planning within the individual business units; now at a Group level we have tried to co-ordinate it by means of a process whereby we set certain standards in terms of what business units have to do to make certain that they have a reliable and resilient BCP, supporting their operations. WE How does the Risk Management Department communicate and co-operate with Maersk Procurement specialists, and has this relationship changed significantly over the last 10 years? LH We have not been liaising with them at Group level but at the business unit level they have certainly done so, because that is where they manage their supply chain. Most of our business units have their procurement with their suppliers managed through the Procurement Department this is where we get the information from about critical suppliers, and so on.
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WE From your experience of the last five years, do you still think that the insurance market still offers value for money to Maersk? LH I think the insurance market has been very worthwhile for us, they have not only been flexible and innovative, but have also been competitive. So I think they have been good value for us to work with. We have received excellent service in terms of payment of claims and they have expressed a strong interest in continuing to work with us. We certainly see the insurance market as a business enabler; it means that when we make business decisions we also consider the commercial risks involved in making those decisions insurance is a way to control that risk. WE Finally Lars, in your opinion, what are the areas where there is there still room for improvement in terms of the value that the market provides? LH I think the product that we receive has responded very well when we have needed it insurers have been innovative, they have made sure that the product has responded to our requirements. But there is still definitely room for improvement on the process side. There is a great deal of frictional cost in the insurance market compared to other financial markets, and the market needs to be a more straightforward environment in which to do business. For example, right now there are significant issues with regard to documentation and contract certainty, as well as compliance with local territories and similar issues. The market needs to be able to offer strength of coverage, a proper allocation of premium for bigger corporations, and it needs to increase the speed and efficiency of conducting business. I find that the process of obtaining quotes and getting the coverage bound is still a relatively cumbersome process, compared for instance to how other financial markets deal with these things in some other markets you get the whole transaction completed in as little as 90 minutes. I know that insurance remains a people business and there are many good reasons why it should remain like that - but I think a certain automation of the current processes would benefit the market significantly and would reduce the frictional cost of doing business.
There is a great deal of frictional cost in the insurance market compared to other financial markets, and the market needs to be a more straightforward environment in which to do business.
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Upstream
In April 2012 we said: The market direction remained in the balance, as insurers waited on the situation at the Elgin platform to be resolved Capacity levels rose to a further record high Despite this, modest rating increases were the norm as a spate of losses late in 2011/early in 2012 was to a certain extent offset by a modest reinsurance renewal season The market showed a growing concern with the FPSO class following the Gryphon A incident The Gulf of Mexico windstorm model remained untested, following another benign season The market was increasingly using AFE rating methodology for OEE business The Upstream liability market continued to harden
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In last Aprils Energy Market Review, we showed how the mood of the Upstream market remained somewhat apprehensive as the situation at the Elgin platform in the North Sea had yet to be resolved. As most readers will now be aware, the Elgin platform has now resumed production following the successful cessation of the leak in May last year by means of an operation which pumped heavy mud and cement into the affected underwater well. When it became clear that there would be no explosion, Upstream insurers breathed a huge sigh of relief; although the control of well/relief well costs came to some USD400 million, this was a small price to pay considering the potential ramifications had the leaked gas exploded. Furthermore, we understand that no meaningful Business Interruption insurance was purchased by the Joint Venturers in this project; had they done so then the cost to the upstream market would likely to have been much more significant. It is interesting to note that the magnitude of this loss was also further reduced from a commercial market perspective as most of the Joint Venturers recovered a significant portion of the loss from their captives and/or OIL entries; this perhaps reflects a growing trend of the effect of major upstream losses, as very often these losses will involve the participation of the major energy companies, who have increasingly absorbed their Upstream risks into their captives and OIL entries rather than transfer them to the commercial insurance market. Following the resolution of this incident, life has certainly become more bearable for the Upstream market. Indeed, 2012 has not produced anything like as severe a loss record as 2011, which in itself still produced a profitable underwriting result. At the same time, the modest upswing in rates that we reported last year has continued to maintain and indeed enhance insurers revenue streams for much of last year. To date, no significant losses have been reported in 2013, despite the fact that we are nearly through the first quarter of the year. Although we may have articulated this sentiment in previous Reviews, its perhaps worth repeating that in previous years this combination of buoyant capacity combined with an improved loss record would be the catalyst for us to predict a wholesale market softening, as insurers begin to compete more fiercely among themselves for larger shares of what is proving to be a profitable portfolio. So to what extent might we expect this to materialise in the Upstream market during the remainder of 2013?
Hurricane Sandy, which caused approximately USD2.5 billion of marine losses within the overall estimated total of USD25 billion as we explained in the Newsletter, the magnitude of the Superstorm Sandy loss to the Marine market took many reinsurers by surprise as Lloyds declared their loss numbers on December 8 The USD400 million deterioration of the Costa Concordia loss the P&I element of the loss was much more severe than was first expected The deterioration of the quantum of the Macondo well loss of 2010, following various US court rulings - this was further exacerbated by further rulings only last month The fact that all of this happened at the beginning of December right in the middle of the reinsurance season created what some inevitably described as a Perfect Storm of alarming news, and reinsurers responded by increasing both rates and retention levels. It was reported that several insurers were hit by reinsurance treaty rating increases of up to 25%, with several programmes only being completed at the eleventh hour before the turn of the year, leaving no time for the usual negotiating process to alleviate the situation. With reinsurance buyers effectively pushed into a corner, they had little choice but to accept the terms offered. Macondo aside, why did the Sandy and Costa Concordia losses have such a significant impact on the Upstream market? In our January Newsletter we intimated that Lloyds Syndicates energy reinsurance programmes were purchased on a Whole Account basis, packaging the Energy & Marine portfolios. The impact was largely twofold in character: Those direct insurers who purchased general Marine & Energy treaty reinsurance were impacted by the highly adverse loss record in the marine sector Those fortunate enough to purchase coverage on a stand alone basis for Upstream Energy reinsurance were more fortunate, but not immune from the overall reinsurance market backlash
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Upstream
One important general trend that we observed is that many direct Upstream insurers elected to mitigate the reinsurance price rises by purchasing less reinsurance at the bottom end of the risk spectrum, deciding instead to focus their attention on excess layers in the form of higher retentions. This is certainly a developing trend and forces the market to rely more and more on reinsuring catastrophe loss. So from a direct market perspective, insurers must now ensure that their own rating methodologies take care of the attritional element of a risk to secure an underwriting profit, with a sufficient cushion to finance reinsurance treaties and operating costs. As a result, the softening process which we had predicted in the second half of 2012 and which had started to become evident in December had generally fizzled out by the turn of the year, with generally flat market conditions holding sway for the January 1 renewal season. However, as we explained in our newsletter, we anticipated that capacity levels would remain buoyant during 2013 and that has certainly proved to be the case.
Estimated realistic market capacities Stated 2013 upstream capacity is at another record high - but this hasnt really changed what can realistically be obtained from the market Source: Willis
The chart above shows that overall Upstream market capacity has once more increased, for the seventh year in succession. Since a low point following the hurricanes of 2005, official capacities now total in excess of USD5 billion for the first time; it is now astonishing to think that 20 years ago, when Willis first started to compile this data, the market offered a mere USD1.6 billion of capacity to its clients. However as we often remind readers of the Energy Market Review, these stated capacity figures are based on the maximum figure that an insurer is theoretically able to commit to, bearing in mind reinsurance and management restraints; they do not reflect what can realistically be obtained in the market, even for the most attractive business. Because there have been few new entrants to the market this year with the exception of the Apollo Syndicate and Ironshore, which have recently recruited Simon Mason and Paul Calnan respectively, both highly experienced upstream underwriters and because the number of insurers involved in upstream business predominantly remains essentially the same as last year, we have calculated that the maximum that buyers can reasonably expect to purchase in this market has only increased modestly since last year, from circa USD4 billion to USD4.2 billion.
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This virtually static realistic capacity means that, for the largest Upstream risks featuring perhaps FPSO or FLNG units which are due to go operational in the next few years, there may still not enough capacity to cover these potential exposures in the event of a total loss of one of these units. This means that for these risks, buyers would remain at the mercy of the market, at least in theory in reality, most joint venture partners involved in these large projects tend to have OIL entries and are likely to deploy their captive insurance companies to absorb a large percentage of these risks, leaving the upstream market with perhaps rather less leverage that might be imagined. However, for the majority of the Upstream portfolio that features lower programme limits and a wide spread of risk for example, areas such as onshore Exploration & Production operations and shallow water, conventional production platforms capacity remains abundant. Indeed, it remains possible to generate significant competition for programmes featuring policy limits of as high as USD2 billion, provided that the risk profile in question (supported by good underwriting information) remains attractive to the market.
Cause
Heavy weather Heavy weather Capsize Unknown Blowout Mechanical failure Corrosion Faulty design Subsidence/ landslide Unknown Heavy weather Faulty design Mechanical failure Unknown Collision
Country
UK UK Mexico Nigeria Israel USA Nigeria Norway Israel China Russia Singapore Nigeria Brazil Venezuela
PD USD
534,000,000 193,000,000 230,000,000 230,000,000
OEE USD
BI USD
500,000,000 227,000,000
200,000,000 150,000,000 120,000,000 115,000,000 115,000,000 106,000,000 100,000,000 8,500,000 82,000,000 80,000,000 25,000,000 47,250,000 80,840,000
200,000,000 150,000,000 120,000,000 115,000,000 115,000,000 106,000,000 100,000,000 89,340,000 82,000,000 80,000,000 72,250,000 3,143,590,000
Last year we reported a number of significant losses excess of USD 100m Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
Insurers must now ensure that their own rating methodologies take care of the attritional element of a risk to secure an underwriting profit, with a sufficient cushion to finance reinsurance treaties and operating costs.
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Upstream
Cause
Blowout Blowout Blowout Blowout Grounding Unknown Blowout Blowout Faulty Design Fire/lightning/ explosion
Country
Nigeria UK Nigeria India USA Venezuela USA Canada Brazil Mexico
PD USD
175,000,000
OEE USD
277,000,000 400,000,000 200,000,000 150,000,000
BI USD
Total USD
452,000,000 400,000,000 200,000,000 150,000,000 90,000,000 65,300,000
What a difference a year makes. The 2012 upstream major loss record has improved significantly on that of 2011 at a time when premium income levels continue to rise. Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
However, the chart above shows the major loss record for the Upstream industry in 2012, compared to 2011 is very encouraging. While in 2011 the Gryphon A loss was supplemented by 10 further losses excess of USD100 million, in 2012 there was no such run of major losses. Indeed, only four losses were reported excess of USD100 million, all of which were caused by blowouts (including the incident at the Elgin platform)*.
2012 premium income set to exceed overall loss total Upstream losses in excess of USD1 million, 2000-2012 (adjusted for inflation)
USD billions 20 18 16 14 12 10 8 6 4 2 0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
On a gross basis, 2010/11 were the worst non-windstorm affected underwriting years in the upstream markets history. However, the market still made overall profits, as so many of these losses were not picked up by insurers. Meanwhile 2012 premium income looks like it is going to exceed all upstream losses, both insured and uninsured making 2012 potentially one of the best years of the last decade. Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)/Willis
*It should be noted that the Willis Energy Loss Database only records Business Interruption losses which have been quantified by Loss Adjusters i.e. usually when such losses have been insured. As we have intimated, there was no need for the adjusters involved in the Elgin incident to report any Business Interruption figures to our database, although the actual uninsured Business Interruption loss to the co-venturers will undoubtedly have been significant. 45
This improving loss picture is also borne out in the chart on the previous page, which shows the total Upstream insured and uninsured losses recorded by our database over the last 12 years, adjusted for inflation. As usual, this chart shows the huge spikes caused by the Gulf of Mexico windstorm seasons of 2005 and 2008 but also shows something just as significant the Upstream loss record for 2012 in comparison to the last seven years or so. While of course there is still plenty of time for the figures to deteriorate further, it seems possible that the total for 2012 may turn out to be the lowest since 2003, in itself one of the lowest totals in recent years. If we then look at the estimated worldwide Upstream market premium income for 2012*, we can see what effect this may be having on upstream market profitability. For the first time in the last 12 years, there is a noticeable gap between global premium income and overall insured and uninsured losses. Should there be no significant deterioration in these figures, it will be reasonable to suggest that significant profits are likely to be recorded by the Upstream market in 2012.
Lloyds upstream incurred ratios for 2009-2012 remain resolutely under the magic 80% figure. Since Hurricane Ike in 2008, we can conclude that in general terms this has been a profitable portfolio for the market. Source: Lloyds NB: Upstream Property combination of ET/EC/EM/EN Audit Codes OEE combination of EW, EY and EZ Audit Codes
For a final commentary on the profitability of the market, we must have a look at Lloyds own Incurred Ratios (premiums received compared to paid & outstanding claims) for upstream energy business, for which we now have figures going back nearly twenty years. The chart above shows how often these Incurred Ratio figures come in at under 80% for each year; it is generally accepted in the market that should an insurer secure a ratio below this figure then it is likely to have generated an overall profit, even allowing for administrative expenses and reinsurance costs. (Just like the previous diagram, this chart underlines the relatively small percentage of overall losses insured by the market). From our chart we can see that, since the collapse of the old soft market in 2000, Lloyds Incurred Ratios for both Upstream Property and OEE classes of business have come in under the critical 80% figure on no less than 9 of the last 12 years. Whats more, its not difficult to
*At Willis Energy we estimate worldwide premium income for a class of business by taking Lloyds premium figures and grossing them up by the percentage of Lloyds capacity compared to overall market capacity. So for example, if Lloyds were to have a 55% share of global market capacity, and the respective Lloyds premium income for the year was USD1 billion, then we can estimate a total global premium income of USD 1.818 billion. This is not obviously an exact science, but gives an approximate picture for comparison purposes. 46
Upstream
spot which years have been the problem; they are of course the Gulf of Mexico hurricane-affected years of 2004 (Ivan), 2005 (Katrina and Rita) and 2008 (Ike). Since 2008, not only have prices risen, aggregate limits imposed and deductibles increased for Gulf of Mexico windstorm cover (see our 2009 Energy Market Review) but our database has recorded only some USD9 million of energy losses relating to this exposure in the years 2009-2012.
apply aggregate to specific areas such as certain South Korean shipyards and other locations where there is a concentration of Upstream infrastructure, but to date have been generally unable to enforce this on buyers because of current market forces; to insist on this would generally mean that the business would be lost. As far as the commercial insurance market is concerned, there is therefore certainly a great deal more awareness of their risk outside the Gulf, but no uniformity of approach to underwriting as yet. It remains to be seen whether or not the more conservative underwriting approach to aggregate exposures wherever possible, thereby reducing the overall capacity available will eventually hold sway, or whether a more entrepreneurial approach, involving the possibility of increased premium income, will prove more popular. Meanwhile for some time now Oil Insurance Limited have pre-empted the issue of non-Gulf of Mexico natural catastrophe risk. Members that have windstorm exposed assets in regions outside of the Atlantic Named Windstorm (ANWS) zone (e.g. South China Sea, North Sea, Australia) are entitled to the usual maximum USD300 million Limit and USD900 million Aggregation Limit; however, once that region suffers a loss trigger event (i.e. a USD750 million single loss event or USD1 billion of losses over five years), their limits will revert to the ANWS limits in the following year.
Recent Developments
Increased focus on non Gulf of Mexico natural catastrophe risk Energy Natural Catastrophe Losses, 2009-2012 (EXCESS USD 1M)
USD174m USD256m
Although the Upstream market has yet to apply aggregate limitations on windstorm cover from outside the Gulf of Mexico region, there is no doubt that insurers are looking more closely at their natural catastrophe exposure, particularly in the Asia Pacific region (see chart above). As well as windstorm aggregate exposure in both the Timor Sea and the South China Sea, there are certainly various parts of this region, such as Sakhalin Island, where there is a significant concentration of Upstream assets in four separate locations which feature a notable earthquake risk. The difficulty for Upstream insurers is to determine whether or not they should aggregate all these exposures together, or whether they can be safely underwritten separately, on the basis that they could not all be lost in the same event. Detailed information to determine the correct underwriting strategy is difficult to come by in this region; using other earthquake regions as a guide also poses problems because of differing geological formations around the world. Insurers are also attempting to
In both the Upstream Operating and Offshore Construction markets, the trend that we reported last year of buyers purchasing increased programme limits certainly appears to have continued into 2013. Yards are full, replacement costs continue to increase, as have re-drilling costs, both fuelled mainly by supply and demand for contractors. Buyers are therefore continuing to re-assess the replacement values of their units; in addition, many are also re-evaluating their Business Interruption/Loss of Production Income (BI/ LOPI) requirements, a process that is often translating into increased programme limits. To a large extent the market is accommodating this drive, so long as BI cover is purchased in combination with a significant Physical Damage programme.
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Upstream insurers writing Gulf of Mexico windstorm business have therefore been the beneficiaries of a double whammy of receiving increased income from the Gulf of Mexico windstorm cover purchased during these years while having to pay out next to nothing in terms of claims.
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Upstream
Gulf of Mexico windstorm remains of particular concern for all insurers, with wind considerations and Removal of Wreck of specific third party property being highly scrutinised. Furthermore, insurers remain focused on deep water operations and drilling, with high pressure/ high temperature wells and contract integrity continuing to come under intense scrutiny.
Improved loss record Innate profitability of the class Less attention from Lloyds PMD More capacity Threat of cross class underwriting OIL drive to attract fresh membership Reluctance to lose business
Future increase in losses Impact of reinsurance renewal season Lack of fresh leadership Market discipline Easy pickings for excess layer specialists Management attention Long memories
HARDENING FACTORS
SOFTENING FACTORS
?
It will be interesting to see to what extent the market softens during 2013
Notwithstanding and accepting the historical volatility of this class of business, it is now generally accepted that the Upstream market is a good place for insurers to invest, now that its exposure of Gulf of Mexico windstorm risk has been managed and reduced. So the next question is this: why have we not seen a softening of rating levels during the course of the last 12 months?
Upstream
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Upstream Capacities Average Composite Percentage of 1992 rates
Finally, the laws of supply and demand are beginning to exert themselves in 2013 as the anomaly of increasing capacities and rating levels disappears, at least for the moment. But by how much can rating levels soften, given the stability of the current market membership? Source: Willis
Our chart therefore predicts a modest reduction on overall rating levels for 2013, although we must stress that this is simply an average for guidance purposes; the rating levels outlined in our charts are our own estimate of average rating levels over the entire portfolio. By definition therefore, some programme rates are being renewed above this average, some below and so some rates and rating movements for some programmes are bound to defy the general trend. There is certainly evidence of selected softening in some areas during the first three months of 2013; this has coincided with a continuation of 2012s good loss record, with no significant events recorded. Depending on the historical loss record and how existing rating levels compare to an energy companys peer group, the controlled softening which has now reestablished itself seems likely to become the norm in 2013. The question that does remain is whether insurers will continue to differentiate different programmes to the same extent as they have done in the past, and to what extent.
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Offshore Construction
In April 2012 we said: The market proposal to introduce the WELCAR 2011 form had not been well received by buyers and brokers Capacity had increased, but insurers were more likely to deploy this capacity competitively for smaller projects featuring tried and tested technology 2011 had the largest Offshore Construction loss figures for the first year of reporting for the last six years More losses were expected to materialise from this portfolio in the coming 12 months
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From an insurance market perspective, this welcome increase in both spread of risk and premium income, coinciding with the introduction of the stricter underwriting models imposed during the course of the last five years or so, has certainly led to a change of image for this portfolio within the overall Upstream market.
Project values have also increased due to the continued stretching of technological boundaries. As fields in increasingly deeper water are developed, project infrastructure is focused on sub-sea completions and larger above surface facilities to support these operations. From an insurance market perspective, this welcome increase in both spread of risk and premium income, coinciding with the introduction of the stricter underwriting models imposed during the course of the last five years or so, has certainly led to a change of image for this portfolio within the overall Upstream market.
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Offshore Construction
2011 loss record misleading from an insurance market perspective? Offshore Construction Losses, 1990-2013 (Excess USD 1M, adjusted for inflation)
USD billions 1.2 1.0 0.8 0.6 0.4 0.2 0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13*
* To date The overall loss record from Upstream Construction risks has generally been improving since the late 1990s. Although 2011 seems to show a significant blip in this trend, it should be remembered that a significant proportion of these losses are likely to have been absorbed by a combination of OIL entries and captive insurance companies. Insurers are therefore looking at this class with renewed interest. Source: Willis Energy Loss Database as at April 1 2013
From the overall loss figures recorded by our database, the reader might be forgiven for wondering where this market enthusiasm has come from. The chart above certainly shows an improvement in the loss record from 2006 to 2010; however, we can see a significant blip for 2011, which is currently showing over USD700 million worth of Offshore Construction losses. However, our next chart shows that a large proportion of these losses come from three significant losses involving FPSOs and associated sub-sea completions systems (SSCS).
Sub Category
Well FPSO FPSO Pipeline Pipeline Cable (elec/ control) Pipeline
Cause
Unknown Mechanical failure Corrosion Pipelaying/trenching Anchor/jacking/trawl Pipelaying/trenching Flood Mechanical failure Anchor/jacking/trawl Faulty work/op error Heavy weather Contamination
Land/ Offshore
Offshore Offshore Offshore Offshore Offshore Offshore Land Offshore Offshore Land Offshore Offshore
Location
Rivers State GOMWR Rivers State Gujarat Akwa Ibom State Jindo El Tarf Province South China Sea Jindo Geoje Sarawak Queiroz Galvao
Country
Nigeria USA Nigeria India Nigeria South Korea Algeria China South Korea South Korea Malaysia Brazil
Total USD
230,000,000 150,000,000 120,000,000 30,500,000 26,500,000 24,790,000 23,000,000 15,000,000 12,210,000 12,000,000 10,000,000 10,000,000
Three losses involving FPSOs dominate the 2011 loss record Source: Willis Energy Loss Database as at April 1 2013
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We understand that a large proportion of these losses are not written by the commercial insurance market, as a majority of the Joint Venturers involved not only are due to have the benefit of their OIL entry but also to retain a large proportion of the balance of their exposures in their captive insurance companies. So although it is not possible accurately to split out the insured and uninsured losses on these two charts, it is reasonable to assume that the 2011 loss record from an insurance market perspective is not the alarming picture it might seem to be. Indeed, if this factor is taken into consideration, 2011 may turn out to be no worse than 2008; on this basis, we can still point to an overall improvement in Construction underwriters fortunes.
2008
2009
WELD advised 01/12/2008 WELD advised 01/03/2011
2010
WELD advised01/02/2009 WELD advised 01/02/2013
2011
2012
Although 2007 and 2008 suggest significant deteriorations after the second year of reporting, 2009 and 2010 suggest that the 2011 loss record may not deteriorate much further. Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
Will the 2011 figures deteriorate significantly in the coming years? The chart above is not really conclusive. For the calendar year 2007, the deterioration after two years was approximately 20%; for the 2008 calendar year this increased to 40% but for the calendar years 2009 and 2010, the figures actually show an improvement in the total from the second to the third year of reporting. As these figures are based on losses being reported within each calendar year (rather than on a risks attaching basis, unlike insurers own figures for each underwriting year), the likelihood of another major Offshore Construction loss being reported for the 2011 year is somewhat remote; it is therefore far from inevitable that the results for each year will deteriorate further. However, the accuracy of the figures behind each loss report will certainly be affected by contractor availability and costs, as well as factors such as the time it takes to repair the damaged item and the prevailing weather conditions.
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Offshore Construction
Cause
Faulty design Faulty work/op error Faulty design Faulty design Mechanical failure Impact Faulty work/op error Impact Unknown Pipelaying/trenching Pipelaying/trenching Faulty work/op error Mechanical failure Pipelaying/trenching Mechanical failure Mechanical failure Subsidence/landslide Heavy weather Contamination Heavy weather
Country
UK Malaysia Burma China India Brazil Netherlands Norway Brazil Turkmenistan UK Malaysia USA India Brazil Brazil Norway China Singapore India
Land / Offshore
Offshore Offshore Offshore Offshore Offshore Offshore Offshore Offshore Land Offshore Offshore Land Land Offshore Offshore Offshore Offshore Offshore Offshore Offshore
Total USD
14,000,000 11,000,000 10,000,000 10,000,000 7,350,000 7,000,000 6,613,000 6,500,000 5,900,000 5,648,296 5,552,400 4,000,000 3,500,000 3,000,000 3,000,000 2,700,000 2,500,000 2,000,000 1,500,000 1,400,000
The loss record for 2012 is highly encouraging for the market to date Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Estimated realistic market capacities As is the case for upstream operating underwriting capacity, the realistic market maximum hasnt increased significantly from last year Source: Willis
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As can be seen from the chart on the previous page, although maximum capacity levels have continued to increase in theory, for projects requiring maximum capacity, limits of just over USD3.5 billion are really the most that the market can offer at a realistic price. Certain projects scheduled to begin during 2013 will have Estimated Contract Values that exceed the realistic available commercial market capacity; however, captive involvement and a clear delineation between non-clashing items of insured property (such as sub-sea installations and platforms) should alleviate the pressure exerted on commercial market capacity by these next generation projects. Additional capacity is available for those Operators and Joint-Venture Partners who are members of the industry mutual OIL; indeed, OILs participation can significantly assist with capacity issues on extra-ordinarily large projects. Where the Estimated Contract Value (ECV) exceeds the available commercial market capacity, it is worth noting that the vast majority of major construction programmes are owned by Joint Ventures composed of the largest oil companies, mainly because of the capital requirements; most of these companies either have OIL entries or significant captive capacity. As a result, we are finding that even the largest Construction programmes are being completed in the market, as it is rare that brokers are required to place a 100% order. Meanwhile this increase in capacity, combined with the improved underwriting results we outlined earlier in this chapter, has certainly generated increased competitive pressures for smaller projects that do not require the participation of the more conservative market leaders.
encompass the risk of physical damage and the risk of loss of use. Specifically, the market has focused on strict liability for the loss of use of pipelines being crossed and platforms being tied into. Such strict liability exposure, incurred contractually by operators, continues to be exacerbated by the fact that the contractors carrying out the installation work expect to be held harmless for any losses sustained by the surrounding property. Recently, the trend for smaller energy companies to take over older fields from the super-majors, or develop smaller fields requiring to be tied into existing infrastructure, has continued, especially in the North Sea. If these older fields are to be developed/redeveloped, this will often involve the new owners infrastructure crossing or tying in to existing facilities owned by a third party. There is an established indemnity regime to address this issue, which stipulates that companies must show evidence of at least GBP50 million of cover if not more in order to proceed with the crossing or tie-in. While the super-majors can usually absorb this risk internally, the smaller energy companies generally have no such luxury. Meanwhile, despite an excellent loss record, the market for contractual liability cover for loss of use has contracted, which has reduced the availability of coverage and increased premium levels. In order to attract further capacity, the involvement of alternative markets and placement strategies has become necessary. In our view, it is therefore essential that in the future the London market steps up to the plate and offers a product that will truly protect the smaller energy company from this critical risk. Indeed, should these companies fail to secure the cover they need, the redevelopment of some of these fields in the North Sea could well be put at risk. Alternatively, current practice will need to change to take into account the lack of capacity for this particular cover.
Current leadership options remain limited, while Liability now has its own leaders
Leading Offshore Construction market capacity within the Lloyds market is often dictated by the size of the project in question. The main leadership panel is well established, and shows little sign to date of changing significantly. The norm is now for the Liability element of the risk to be placed separately, and consequently a new panel of markets has entered the Offshore Construction arena, a development that we have seen across both the Lloyds and company markets.
It is therefore essential that in the future the London market steps up to the plate and offers a product that will truly protect the smaller energy company from this critical risk.
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Offshore Construction
The chart below provides an overview of insured and uninsured Offshore Construction losses for the past six years based upon the subject matter of the loss and reflects a broader trend relating to subsea property. It can be seen that, notwithstanding the upswing in Construction underwriters fortunes, sub-sea incidents continue to dominate the overall loss record for the last six years. The frequency of sub-sea losses and the related remedial action costs therefore continues to see this aspect of the risk attract higher rating and deductible levels than the platform element of the project. This has meant that, while the capacity for the traditional jacket/ topside element of a construction programme remains robust and continues to grow, the growth in appetite for the sub-sea element has not matched these more proven areas of the portfolio. Consequently, while we have witnessed a mild softening on rating levels in the proven parts of the portfolio, sub-sea rating has remained robust; this is a trend that we expect to continue in the future.
17.36%
11.31%
46.46%
A significant percentage of recent offshore Car losses come from subsea - related incidents Source: Willis Energy Loss Database at April 1 2013
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60
Downstream
In 2012 we said: The sector continued to feel the impact of recent natural catastrophe and mining losses There had been a continued growth of regional insurance markets in the Middle East, Eastern Europe and the Asia Pacific rim Four dynamics were shaping the market the perception of the capacity available for a given programme, the extent to which that capacity could be accessed, the degree to which it was prepare to compete and the extent of any natural catastrophe exposure involved 2011 was by far the largest loss year ever recorded by our database, if windstorm losses are excluded There was a greater focus on Contingent Business Interruption following the recent floods in Thailand and the Japanese earthquake Rating levels were generally flat, despite an increase in capacity, suggesting a softer overall market environment in the absence of further losses To prevent a wholesale market withdrawal, buyers should focus on developing long term risk partnerships with key insurers
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No capacity increase for first time in eight years Downstream Operating Underwriting Capacities, 2000-2013 (Excluding Gulf Of Mexico Windstorm)
USD billions 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0
2000
2001
International
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
North America
Downstream market capacity is basically flat compared to last year Source: Willis
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Downstream
The theoretical underwriting capacities for Downstream energy business for the last 14 years are outlined in the chart above. It can be seen that, following a period of year-on-year increases beginning after the 2005 hurricane losses, capacity is basically flat for this year, both for North American business and for International (i.e. non-North American) business. However, additional capacity in excess of the standard market capacity referred to above can be accessed from the following sources: Oil Insurance Limited (OIL), where a for interest limit of USD300 million (USD900 million in the aggregate) continues to be available to its members Berkshire Hathaway, who continue to provide very significant capacity for specific programmes where they have forged long term risk partnerships with major Downstream clients AIG, who we understand have the ability to offer up to USD1 billion for selected Property programmes Given that we understand the capacity offered by both OIL and Berkshire Hathaway continues to be what these companies offered in 2012, we can certainly say that, for the vast majority of programmes, capacity remains very much what was provided by the market last year. In any event, it is one thing to have the potential to offer a maximum capacity level; it is quite another actually to deploy it. Last year we suggested that the maximum underwriting capacity that could be accessed at realistically commercial rates was USD2.5 billion; we see no reason to alter this approximation for 2013.
Another bad year for losses and a bad start to 2013 DOWNSTREAM LOSSES XS USD50M 2011 Type
Oil sands Refinery Chemical Chemical Gas plant Refinery Petrochemical Refinery Petrochemical Refinery Refinery Chemical Gas plant Petrochemical Petrochemical Refinery Petrochemical
Cause
Fire/lightning/explosion Earthquake Earthquake Earthquake Windstorm Fire/lightning/explosion Mechanical failure Earthquake Fire/lightning/explosion Fire + explosion/VCE Fire/lightning/explosion Earthquake Fire + explosion/VCE Fire/lightning/explosion Fire + explosion/VCE Ice/snow/freeze Supply interruption
Location
Alberta Miyagi Prefecture Kashima Various Oklahoma Singapore Ontario Chiba Prefecture Louisiana Saskatchewan Texas Soma Texas Rhineland-Palatinate Stavropol Krai Texas Bahia State
Country
Canada Japan Japan Japan USA Singapore Canada Japan USA Canada USA Japan USA Germany Russia USA Brazil
PD USD
385,000,000 590,000,000 11,000,000 25,000,000 47,500,000 150,000,000 27,500,000 120,000,000 24,000,000 50,000,000 95,000,000 45,000,000 65,000,000 7,800,000 60,000,000 10,900,000 26,000,000
BI USD
622,000,000
Total USD
1,007,000,000 590,000,000
108,000,000
135,500,000 120,000,000
80,000,000 50,000,000
48,000,000 25,000,000
58,900,000 51,000,000
Gulf of Mexico Windstorm losses aside, 2011 was one of the worst ever years for the Downstream market Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
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Cause
Fire/lightning/explosion Fire + explosion/VCE Fire/lightning/explosion Fire/lightning/explosion Supply interruption Fire + explosion/VCE Fire/lightning/explosion Fire + explosion/VCE Collapse Windstorm Fire/lightning/explosion Fire + explosion/VCE Fire no explosion
Location
N Rhine-Westphalia Punto Fijo Map Ta Phut Shuaiba Bahia State N Rhine-Westphalia Arkansas Hyogo Prefecture Bangkok New Jersey Cologne Oklahoma Alabama
Country
Germany Venezuela Thailand Kuwait Brazil Germany USA Japan Thailand USA Germany USA USA
PD USD
110,000,000 320,000,000 143,000,000 52,000,000 50,000,000 8,200,000 108,000,000 62,500,000 140,000,000 110,000,000 25,000,000 10,000,000 10,000,000
BI USD
325,000,000
Total USD
435,000,000 320,000,000
While 2012 has so far proved to be less damaging than 2011, there have still been a number of high profile losses in the downstream sector. Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
The charts shown above and on the previous page show the Downstream losses excess of USD50 million declared to the Willis Energy Loss Database during 2011 and 2012. It can be seen that there are almost as many losses for 2012 as there were for 2011 at this level, although the quantum of loss at this level has reduced. What is particularly striking is the overall quantum of Business Interruption losses compared to Physical Damage losses in both years. Furthermore, the regional spread across both years is particularly noticeable while in 2011 the Asia Pacific region was heavily impacted by major losses, in 2012 the geographic spread is somewhat more universal, covering such diverse additional locations as the United States, Kuwait, Venezuela, Brazil and Germany as well as Thailand and Japan. While none of the losses reported so far in 2012 have been truly catastrophic unlike several in 2011 that featured several events that occurred as a result of natural disasters most of them will have certainly had a major impact on theDownstream market as in most cases the quantum of loss has not quite been sufficient to be recoverable under the majority of reinsurance treaties taken out by the direct market. Indeed, the impact of the 2012 losses will be felt even more strongly by the market as several insurers had elected to take increased reinsurance retentions at the beginning of 2012. This depressing loss record has therefore continued to maintain the pressure on the downstream market from senior management either to find a way to increase rates or to increase premium revenues to compensate.
When some of the more proactive leaders have tried to react to these losses by instigating a push to drive rating levels up, capacity over-supply has stopped any significant market upswing from materialising.
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Downstream
WELD Downstream Energy losses 19902013 (excess of USD 1m) versus estimated global Downstream premium income
USD billions 10 9 8 7 6 5 4 3 2 1 0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Losses excess USD1m Estimated Worldwide Premium (USD)
For the last three years, overall insured and uninsured losses have exceeded overall premium income for Downstream insurers indicating a lack of profitability for this sector. Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
This chart shows the historic correlation between global downstream premium income received by the market and the total losses recorded by our database excess of USD1 million (which includes both insured and non-insured losses). Although this chart is only a very vague guide to Downstream market profitability, it does perhaps demonstrate a trend which may be of some concern to the market. Before 2011, the only year to top an annual total of USD3 billion (excluding Gulf of Mexico windstorm-impacted years) was the exceptional year of 2001, which featured an unprecedented series of refinery losses in North America; now it seems that not only has the 2011 total nearly reached USD4 billion, but it also seems likely that the 2012 total may top USD3 billion as well. Is this trend likely to continue into 2013? Such is the inherent volatility of loss frequency and severity in this class that it would be a very brave person to take a position on such a question. However, the 2013 year has started out badly for the downstream market; the year was only 12 days old when there was a significant loss at a refinery in the UK. This was something of a shock for the market sustaining a loss so early in the underwriting year is never easy, especially bearing in mind the decision of a significant number of insurers to increase their net reinsurance retentions. We have also seen another major loss from Mexico already this year. Furthermore, other losses written by Downstream insurers but not strictly speaking oil and gas related, especially from the power generation and mining sectors, have only served to increase the mood of pessimism in some parts of the market. However, as so often there are some insurers that have missed these losses, so once again brokers can still look to other parts of the market to secure competitive lead terms.
Indeed, the impact of the 2012 losses will be felt even more strongly by the market as several insurers had elected to take increased reinsurance retentions at the beginning of 2012.
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Lloyds figures only tell half the story LLOYDS DOWNSTREAM PROPERTY INCURRED RATIOS, 1993-2012(AS AT Q4 2012)
250 200 150
IKE REINSURANCE-DRIVEN SOFT MARKET KATRINA/RITA
100 50 0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012*
Generally accepted level at which the energy portfolios remain profitable * To date
The 2011 Lloyds downstream incurred ratio has increased from 18% to nearly 50% in the course of the last 12 months. With 2012 already at 35%, it seems possible that both figures will nudge towards 80% as these years deteriorate Source: Lloyds
To try to discern a more accurate indicator of the innate profitability of the Downstream portfolio, it is perhaps worth having a look at the Lloyds Incurred Ratio statistics even though Lloyds as a whole plays a less significant part in the Downstream portfolio than it does in its Upstream counterpart. It can be seen that 2010 was the first non-windstorm affected year in recent times where the incurred ratio exceeded 80% (the usual benchmark where one can assume that the portfolio in general has made a profit). So far, despite the significant increases in overall insured/uninsured losses in 2011 over 2010 (see previous chart) the Lloyds Incurred Ratio seems to be holding firm at 49% (although this has increased from 18% at the time of last years Review). One can only therefore assume that this figure will deteriorate still further as 2013 progresses, and that the figure for 2012 already at 35%, nearly double the figure for 2011 at the same stage last year may also eventually reach the critical 80% mark, as losses for this year are also already in excess of the final total for 2010 (again, see previous chart for a comparison). Although using these statistics to measure overall profitability levels is somewhat akin to using a broadsword to carve a leg of lamb especially as of necessity they fail to take into account individual insurers reinsurance arrangements and associated claims recoveries and premiums they do perhaps support the notion that this is a difficult business environment for insurers to operate in. Raise prices too far, and others will step in, still keen to maximise premium income; attempt to stay competitive, and the recent loss record suggests that insufficient profits will be made to guarantee the survival of the portfolio.
Raise prices too far, and others will step in, still keen to maximise premium income; attempt to stay competitive, and the recent loss record suggests that insufficient profits will be made to guarantee the survival of the portfolio.
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Downstream
Stuck at the bottom of the underwriting cycle Downstream Capacities And Average Rating Levels, 1993-2012
USD billions 6 5 4 3 2 1 0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Downstream Capacities Average Composite Percentage of 1992 rates
Capacity levels for Downstream business are essentially flat given the poor recent loss record, it is little surprise to find the market attempting to increase rates, albeit with limited success. Source: Willis
So where in the underwriting cycle is the Downstream market in 2013? Our chart above provides the answer still just about at rock bottom, with near record capacity levels acting as an effective brake on any significant rating increases. As we pointed out in last years Review, on average rates have not been so low since the super-soft market of 1996-2001; given the recent surge in non-windstorm related losses, it is perhaps only a matter of time before something will have to give. Either the Downstream market will have to find other ways to supplement their income, or a wholesale withdrawal from this class may well become a reality.
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Year
Europe (USDm)
359 322 626 359 146 436 630 315 156 758
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
For the first time, Europes share of the 2012 Downstream market losses exceeds that of North America Source: Willis Energy Loss Database as at April 1 2013 (figures include both insured and uninsured losses)
To illustrate, our chart shows that although 2011 produced significant Downstream loses in North America, in 2012 this figure had reduced only 21%, compared to an average of 52% for the period 2003-11. In contrast, other regions, especially the Asia Pacific rim, has had more than its fair share of natural catastrophe loses while other regions such as Europe have been impacted by operational incidents unconnected to natural catastrophe events. Indeed, Europes percentage of the overall loss total for 2012 has never been higher; for the first time, total losses from this region exceeded those from North America. This changing regional share of the overall total suggests that as some of the plants built over the last 20 years or so in some previously well-regarded regions have begun to age, so the attritional loses have begun to mount. It is interesting to note that in some of the regions where losses have generally increased, such as the Asia Pacific rim, the global downstream market continues to face strong competition in the form of a buoyant local market. We have also seen other insurers who have previously adopted a generally conservative underwriting position and participated only on the well-known, well-engineered programmes moving into new areas such as Russia and other parts of the Former Soviet Union.
Europes percentage of the overall loss total for 2012 has never been higher; for the first time, total losses from this region exceeded those from North America.
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Downstream
Clearly a scenario whereby the composite markets start to challenge the established Upstream leaders for major upstream programmes is an utterly unrealistic one especially as most of these composite insurers already fully participate in the largest upstream programmes. However, we do sense that the Downstream market would perhaps be interested in competing on midstream and smaller Upstream business, either by packaging or by putting together smaller programmes where they feel that they have the measure of the risk. This part of the upstream portfolio may therefore present a window of opportunity for these insurers to grow their premium income without cutting rates on their own already somewhat threadbare book. Meanwhile, it is not perhaps too dramatic to suggest that several of these markets remain on the cusp of withdrawal. The one factor that is preserving the market dynamic where it is at present is the fact that the cost of capital remains relatively low, and relatively few options exist to relocate it elsewhere. If results continue to be poor, we will be but a hairs breadth away from major withdrawals, and a dramatic hardening; as we said last year, it may be that a precursor to that might be increased competition before the market melts down. We may see a temporary dip in rates, as markets are forced to compete for revenue to meet budgets; however, this is likely to be followed by a stronger market hardening if results deteriorate. In this scenario, and if the class becomes unviable for some insurers, they withdraw and the number of leadership options are reduced. We will continue to keep our clients regularly informed of developments.
If results continue to be poor, we will be but a hairs breadth away from major withdrawals
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70
Onshore Construction
In April 2012 we said: The recent natural catastrophes would not turn this market The potential for DSU losses during a projects testing/ commissioning phase was attracting market focus No capacity withdrawals so the market remained stable De-centralised underwriting philosophies were leading to the development of specific territorial expertise
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Too many cooks in the kitchen? Market delivers positive returns as capacity remains abundant
Despite these on-going considerations, the Construction market generally continues to deliver positive underwriting returns, and there remains an abundance of global underwriting capacity. Global Construction capacity has remained consistent during the latter part of 2012 and into 2013, with total capacity estimated to be approximately USD3 billion on a Probable Maximum Loss (PML) basis with insurers rated A- (S&P/A.M Best) or above; this increases to approximately USD3.6 billion (PML basis) if carriers rated at BBB (S&P/A.M Best) or above are included.* As a result of the escalating costs of investment in major onshore construction projects, new developments (normally by way of consortium) continue to become more and more complex with more parties being engaged, each with their own group philosophy of risk transfer, management and retention. This is of particular significance, as many of these projects are concerned with the replacement or renewal of existing assets. This means that they can be considered as scale up from previously utilised technology, where again risk engineering becomes a major consideration and focus for the global market.
*Copyright 2013, Standard & Poors Financial Services LLC. Reproduction of S&P Credit Ratings in any form is prohibited except with the prior written permission of Standard & Poors Financial Services LLC (together with its affiliates, S&P). S&P does not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and is not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of ratings. S&P GIVES NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. S&P shall not be liable for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or profits and opportunity costs or losses caused by negligence) in connection with any use of Ratings. S&Ps ratings are statements of opinions and are not statements of fact or recommendations to purchase, hold or sell securities. They do not address the market value of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice.
72
Onshore Construction
They continue to attract some of the worlds best construction underwriting talent, which previously was centred around the London and European marketplace. Consequently, co-ordination between key markets and their global hubs is fundamental in ensuring that access is maintained to the key decision makers for a particular construction project. Global hubs continue to increase their market share and product distribution capabilities, with all but the largest and most complex projects focused solely in the London market.
SCOR recruited civil engineering underwriter from Allianz Korean carriers continue to show unrelenting interest in the construction sector, recruiting senior Partner Re underwriter to head office in Seoul Chaucer senior Construction underwriter moves to SOMPO, offering new Japanese capacity construction capacity in London
ANV Syndicate at Lloyds underwriting manager has moved to AIG in the USA WRB Berkeley senior underwriter to new market yet to be published Zurich senior Middle East Construction underwriter to Liberty International CV Starr London construction underwriter moves to Munich Re London to focus on power generation sector Munich Re London Head of Construction and Engineering returns to Munich and replacement is now fully in place in London HDI Gerling continues to recruit new underwriting talent, with the arrival of new Construction underwriting manager based in London
As other classes continue to soften, by comparison the construction sector is considered by many markets to be a sustainable class, where terms remain attractive.
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74
Terrorism
In 2012 we said: The Arab Spring became the buzzword for uprisings against oppressive regimes throughout the Middle East and North Africa The Terrorism market stepped in to provide standalone wider coverage which ensured there were no gaps in cover between the All Risks policy and the Terrorism Sabotage policy All Risks insurers either restricted the cover provided for SRCC perils with sub-limits or excluded them completely Political Violence market insurers became more restrictive in the way they offered capacity to certain territories; Lloyds reclassified Political Violence perils together with War, thereby reducing the aggregate capacity available for each syndicate
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Recent developments
The risk of terrorist activity is now no longer restricted to suicide bombers, car bombs or truck bombs; Osama Bin Laden may be gone, but the seeds of dissent sown by Al-Qaeda and its supporters continue to ferment violence around the world.
hostage at the facility; one of Belmokhtars senior lieutenants, Abdul al Nigeri, led the attack and was among the terrorists killed. After four days, the Algerian special-forces raided the site, in an effort to free the hostages; however, as was widely reported in the global media, at least 39 foreign hostages were killed, along with an Algerian security guard, as were 29 militants. A total of 685 Algerian workers and 107 foreigners were freed, while three militants were captured.
The biggest market move in the Political Violence (PV) arena is the introduction of the XL Syndicate in Lloyds, which will start writing PV risks with effect from May 1 2013. Stephen Ashwell, who used to be at Hiscox, is heading up this unit and has managed to pull off a minor coup by recruiting fellow Hiscox underwriters such as David Guest (who will be based in XLs Singapore office) as well as Daniel OConnell and Adam McGrath who will be based in Lloyds alongside him. David James formerly in charge of running the PV outfit at Ascot is the new active underwriter at ANV Syndicate, which will start writing PV business in the second quarter of 2013. Chris Kirby formerly Class Underwriter for Terrorism and Political Violence at Inter Hannovers London office has joined International General Insurance (IGI), bringing in Craig Curtis (also previously at Inter Hannnover) as his deputy. IGI, who were not previously a significant PV market, are also introducing USD15 million of new capacity, which is due to increase to USD30 million later in the year.
Some of the attacks during the last 18 months throughout the world involving the energy industry are outlined below: The Turkish company Botas, which operates oil pipelines between Turkey and Iraq, has been a target of the Kurdistan Worker Party for a number of years. In the period between February 3 and October 20 2012, the operator suffered 16 different losses due to acts of terrorism, amounting to losses of approximately USD31 million. Between January and June 2012, the FARC rebels in Colombia have launched around 80 attacks on oil pipelines, electrical towers and other energy infrastructure. On October 15 2012, the Azito Thermal power plant in the Yopougon district of western Abidjan in the Ivory Coast was attacked - around 30 armed elements tried to take over the plant. They disarmed the guards protecting the facility and managed to damage one of the turbines that was responsible for 15% of the Ivory Coasts total electricity production. On January 16 2013, the Tigantourine gas facility, south-west of In Amenas, Algeria, was attacked. Al-Qaeda-linked terrorists, affiliated with a brigade led by Mokhtar Belmokhtar, took over 800 people
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Terrorism
Clean renewal business can expect flat rates - or in some cases a slight reduction as market conditions remain stable. However, loss-impacted business is now attracting heavy rate increases with a possibility of reduction in coverage and imposition of sub-limits. Market appetite for risks in the energy sector remains healthy, and programmes emanating from regions that do not have a reason for concern enjoy a high level of competition in the market examples include Qatar, Oman and Norway.
Insurers now want to understand the companys workermanagement relationships, the trade union activity related to the company, their Corporate Social Responsibility culture as well as other related information.
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The story of the energy liability market has become a tale of two cities - two cities which, while sharing much in common in terms of the type of insurance products offered, have seen their respective fortunes become increasingly polarised: The International Onshore Energy Liability market (IOEL), being for the most part a subsection of the wider International Liability market, has experienced relative prosperity from its book of onshore non-USA domiciled business. In contrast, the Marine and Offshore Energy Liability (MOEL) market has continued to experience significant losses from its portfolio of predominantly offshore and marine risks. As such, the year has been one of increasing downward pressure on rates and new entrants into the IOEL market, contrasted with a continued upward pressure on rates and withdrawal of capacity from the MOEL market.
The last five years have produced little or no change in available liability market capacity Source: Willis
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While, with good levels of information and risk management details, most buyers will pass the check-points to enter the cities, there are certain characters of risk which can almost be described as social pariahs. Exploration and production operations in the Gulf of Mexico inevitably undergo a higher level of security check but the most extreme demands are made of those in the hydraulic fracturing industry. These greater levels of scrutiny, inevitably, lead to a lower (sometimes drastically so) level of capacity being available.
How will the relative fortunes of these three cities fare during the next 12 months? Increasing rates in the Offshore Market and the restrictions in cover are forcing many buyers to seek solutions elsewhere. Solutions cannot always be found, but where they can, the traditional Lloyds Marine market is losing more market share than most. Whether the leaders of this market and their followers will hold their nerve and not chase this business will depend on the perceived volumes of lost business/opportunities. The mariners will expect the non-mariners to get their fingers burnt the longer they experiment in an area in which the former feel the latter lack experience and knowledge. The mariners may not be prepared to stand back and watch others pick up this business should the forecast losses fail to materialise. The future of the composite market is less clear. There have been withdrawals of capacity and considering the extreme competition in the non-marine market, the cost benefit margin between capacity provided on a combined basis and the sum of rates offered by the two separate markets is getting narrower. In summary, we find a complex environment of different paths being taken by different parts of the market. The ultimate response is heavily dependent on the nature of the operation, the information required and, critically, the limit sought. As such, the experience of the populations of each city can still vary alarmingly.
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European markets start to consider the portfolio - but watch out for the patchwork quilt effect!
Recently, some Lloyds, London Company and European insurers who have not been seen to be taking on North America domiciled Energy Liability risks have started to assess the
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opportunity of increasing their profile in this class. They have seen over three years of rating increases in the Bermuda market, which in many instances have been sizeable. These carriers are now determining if the premium levels are high enough to enter the market on a testing basis; they have intimated that they have no desire to create a softer marketplace, noting that as some established insurers cut capacity or vacate layers with lower attachment points there is now an opportunity to replace capacity rather than generate meaningful competition. This is certainly an interesting dynamic. As this capacity emerges, there may be some additional conditions and exclusions to consider, including: Refinery Exclusion Clause (REC) Removal of Wreck For Gulf of Mexico Named Windstorms Any Removal of Wreck/Debris cover clarified to apply to true third party property Scaled JV limits Cyber Liability Exclusions. Furthermore, London markets still prefer the Claims Made policy to the Occurrences Reported wording. Since there are divergent views among insurers as to what constitutes acceptable pricing, completing programs has become more difficult in some instances because there are times when overlying and/or quota share insurers will not support underlying and/or another insurers quota share pricing. When this occurs, it can significantly increase the cost of completing programs.
Even though Excess Liability insurers are requiring and achieving premium increases especially where their capacity is in demand these same insurers still do not believe that they are generating sufficient premium income to pay for these losses and to support the higher program limits increasingly sought by buyers.
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The following Willis Associates contributed to this edition of the Energy Market Review: Justin Blackmore Jerry Garner Alan McShane Jack Camillo Steve Gillespie Mark Moore Mark Chambers David Hallows Alistair Rivers David Clarke Ben Hunt Neil Smith David Griffith Andrew Jackson Rahul Shah Chris Dear Mark Peacock James Sudbury James Excell Patrick Miller Tom Teixeira With special thanks to: Lars Henneberg, Maersk Michel Krenzer, SCOR Steve Sykes, Talbot Validus Nick Wildgoose, Zurich Tim Holt, Alert 24 Editor: Robin Somerville This Review is published for the benefit of clients and prospective clients of Willis. It is intended to highlight general issues relating to the subject matter which may be of interest and does not necessarily deal with every important subject nor cover every aspect of the subjects contained herein. If you intend to take any action or make any decision on the basis of the content of this Review, you should first seek specific professional advice and verify its content. Copyright Willis 2013. All rights reserved.
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