Business interruption (BI) losses now account for a much higher proportion of large onshore energy claims, a trend that has been particularly evident over the past 12 months.
Of the five largest onshore claims seen by AGCS in the past year, BI accounted for at least 75% of the claims, and in two instances it accounted for 100% of the claim.
“The cost of large energy claims has been rising. Exposures have increased in the wake of larger refineries and petrochemical production facilities, growing interdependencies, and as companies make bigger profits,” explains David Wilson, Energy Claims Specialist at AGCS.
BI exposures have also been growing in relevance for the insurance market, as more companies seek to purchase this type of coverage. At the same time a number of new buyers are looking to purchase this insurance for the first
time – a recent big change in the energy sector has seen more Russian companies buying BI cover, due to changes in market conditions and improvements in risk quality.
At the same time, existing buyers of BI cover in the US and Europe are now purchasing higher limits. The increase in business interruption as a proportion
of energy claims also reflects higher property damage retention levels by energy companies.
In 2014 the energy industry mutual insurer OIL Insurance increased available limits to $400m from $300m for non-Atlantic windstorm damage. This is already resulting in fewer property damage claims for the insurance market, leaving insurers with the more complex BI element to manage.
BI claims are particularly complex for the onshore energy sector, where the cover is seen as essential for many onshore operators, like refineries and petrochemical plants. Quantification of claims can often be a lengthy task.
“The complexity of oil refining and the non-linear relation of profit to throughput (the volume of oil processed) is a notable characteristic of onshore energy claims, and something we do not see in other sectors to anywhere near the same degree,” says Wilson.
The wide range of products produced by the onshore energy sector, the high values involved, the interdependencies and the volatility of commodity prices and currency fluctuations creates a unique challenge, according to Wilson.
Profits at some large onshore operations can be as high as $6m per day, and indemnity periods purchased by energy companies are typically 12 to 24 months. Therefore, disruption of one year or more can lead to a significant loss, while even a small partial loss could generate a claim in the hundreds of millions of dollars.
“The biggest challenge for energy claims is the calculation of the loss of profits on a partial loss of production,” explains Wilson.
A small percentage loss of production can have a large impact on overall profits, particularly where higher value products are affected. For example, a refinery may be able to restore 75% of production in a short amount of time, but profits could still be 75% down if the remaining disruption hits the most valuable products, he explains.
Wilson recalls a claim in which a damaged refinery and petrochemical plant was able to quickly restore production of petroleum, but profits remained negligible because production of the more valuable polypropylene product was disrupted for many months.
Quantification is also complicated by fluctuations in exchange rates and commodity prices over the indemnity period. A recent loss at a Russian refinery saw the fall in oil price offset by the depreciation in the Russian ruble against the dollar.
The impact of a change in the price of oil on a BI claim is difficult to assess. “Refinery profit margins depend on the price of oil versus the price they achieve for their product, and both can vary,” explains Wilson.
The price of petrochemical products typically lags any movement in the price of oil. Potentially, a falling oil price may initially boost profits if the price of products remains high, which would mean more, not less, costly BI claims.
Interdependencies between companies are another contributing factor. For example, in the Middle East clusters of refineries and petrochemical plants often supply each other with products. So if one plant – such as one that produces an important fuel additive used by others – were to suffer a disruption, it would have a knock-on effect on neighboring plants.
Interdependencies can also result in complex contingent business interruption (CBI) claims. In 2008, a ruptured gas pipeline and subsequent explosion at a processing plant on Varanus Island, Western Australia, caused a major disruption to the region’s energy supply, affecting refineries, construction, mining and leisure industries.
“We have seen a number of energy CBI claims caused by a lack of supply due to damage at the supplier’s premises,” says Wilson.
More recently, insurers have been notified of potential CBI claims after damage to a gas plant disrupted supplies to a number of petrochemical plants in the Middle East.
“Knowing your customers and suppliers and ensuring that this information is passed to your insurer will ensure you have the appropriate cover. Many companies have filed a claim, only to find that they do not have adequate CBI cover,” Wilson adds.
The main causes of BI for onshore energy in recent years have been fire and explosions, often linked to a leak of hydrocarbons related to maintenance problems or faulty equipment.
Natural catastrophes are another major cause of BI claims in the energy sector. However, no major hurricane losses have significantly impacted the Gulf of Mexico since Hurricane Ike in 2008.
Cyber exposures are another potential cause of property damage and BI claims. Although an emerging peril, fears are that a malicious cyber-attack against a refinery or petrochemical facility could result in a fire or explosion.
“Compared with the past, BI claims are increasing in severity and as a proportion of the overall claim,” says Wilson, who predicts that such claims will continue to grow.
“There are still many mega-projects in construction, such as liquefied natural gas (LNG) plants in Australia, as well as aging refineries in the US and Europe. With fewer new refineries planned, there is a likelihood of increased wear and tear, and insurers are already seeing a number of losses due to aging equipment,” he concludes.
Offshore energy property damage losses overall over the past year have been relatively benign, reflecting the lack of natural catastrophes globally and absence of major hurricanes in the Gulf of Mexico.
At the same time, safety in the oil and gas sector has improved, and regulation increased, notes David Wilson, Energy Claims Specialist, AGCS. In particular, safety has been in sharp focus since the Deepwater Horizon fire of 2010. “Since operations in the Gulf of Mexico have been restored, the insurance market has seen a significant reduction in the numbers of accidents post-Deepwater Horizon,” says Wilson.
However, there have been a number of large property damage losses recently in the offshore energy construction sector.
Safety concerns led to the abandonment of the newly-constructed Yme oil platform in the North Sea, resulting in a reported claim1 against insurers of $1.3bn towards the end of 2014. Meanwhile insurance industry losses relating to mooring problems with Chevron’s Gulf of Mexico Big Foot oil platform have been estimated at being in the region of $300m+.
The increased relevance of business interruption (BI) claims in the energy sector in recent years has seen insurers and brokers take steps to improve clarity of cover and stronger definitions, according to David Wilson, Energy Claims Specialist, AGCS. There has also been a move to use forensic accountants that are energy specialists, he says.
AGCS, in particular, has increased its focus on pre-contract inception risk assessment, involving energy engineers to get a better understanding of the risk. There is also more information-sharing between the AGCS claims department and insureds.
“We have been placing more underwriting focus on BI with a view to learning from claims experience. Claims teams now get more involved in pre-risk assessment,” he says.
1. Upstream Online, September 24, 2014