Oil price rise brings greater exposure and new risks for insurers
27 December 2007
As the oil price nears the $100 per barrel mark, lloyds.com examines the impact the hike in the price of crude oil has on the insurance market.
Despite the increase in the price insurers say they have learned the lessons of two years ago. When Hurricane Ivan caused serious damage to oil and gas drills, and refineries along the southern United States in 2004, insurers were inundated with business interruption claims as oil and gas production was badly affected. However, some insurers found that they faced significantly higher claims than expected as the price of oil had risen sharply in the aftermath of the storm.
Paul Dawson, Energy Underwriter at Beazley says “Commodity prices have risen sharply in recent years, with the crude oil price being 60% higher today than it was a year or so ago. And the price rise has both positive and negative effects upon the energy insurance market.
“On the positive side, higher prices coupled with the expectation that relatively high prices will be sustained, have increased confidence within the energy industry. The effect of this is that investment is high. For example, here in the UK sector of the North Sea, exploration and appraisal activity has increased to levels not seen since before the 1998 price crash. It is estimated that over 200 wells are in planning for drilling between now and 2010, requiring up to $4bn of investment.”
He adds that the rising prices increase the level of exposure.
“The tight energy market means that equipment and personnel are in great demand. These factors coupled with increased steel prices means that the cost to repair damage has increased considerably. For example, in some extreme cases, the cost to hire drilling equipment has increased some four to five times,” says Dawson.
“Oil and gas companies will want to insure on a basis that reflects these increased costs and so therefore we have seen a trend of increased sums insured and limits. This, on the one hand, means that additional premium is generated but on the other hand means that insurers are seeing considerable claims inflation.”
Lloyd’s led the market’s response to these issues with a new set of policy wordings in 2005 which helped to clarify the situation in terms of maintaining exposure and client expectations in relation to business interruption and loss of production claims.
He explains: “Following Hurricane Ivan in 2004 it became clear that many policy wordings had not explicitly set out how the value of lost production would be calculated.
“A new wording, the JRC 2005/003 form, was introduced during 2005 and was available for adoption by interested underwriters. In summary, the focus of the wording was to make clearer the basis of claim payment by requiring that the insured and underwriters agreed in advance the assets covered the expected volume of oil or gas produced for each asset and the commodity price agreed for each volume unit of production. The commodity price was fixed.
“Although other policy wordings were also available, the enhanced clarity of the JRC 2005/003 form has meant that it has quickly been established as a market standard."
Neil Roberts, Technical Executive MAT (Marine) at the Lloyd’s Market Association, said: “The issues for underwriters are the indirect impacts of the rising prices such as the increased costs to the aviation and marine industries and commerce in general.
“However, it will also see energy companies looking ever further afield for new oil resources which will see underwriters asked to cover risks in ever more inhospitable places and oil reserves which were previously seen as uneconomic to extract become viable.”
Roberts adds: “There is also a move to explore new energy sources such as wind power, bio fuels and solar energy. It provides new and specialist risks for the market to cover.”
Last updated on 27 Dec 2007
