Energy market on the edge

Energy insurance buyers have been spared large price hikes following last year’s hurricanes, but questions remain about the sustainability of current market conditions. Hurricanes Harvey, Irma and Maria were predicted to prompt meaningful energy rate increases but have resulted in only “modest” price rises, according to a recent Willis Towers Watson 2018 report on the sector. The limited impact was said to be the result of a continued “glut” of insurance capital and lower than expected energy losses from the three storms. According to Willis, the downstream market saw hurricane losses in excess of $1bn, a much lower figure than for previous events, while the direct impact on the upstream industry was “virtually negligible”. Capacity has crept up in both the upstream and downstream property markets to $7.95bn and $6.8bn respectively, Willis’ numbers show. “It is fair to say that there has not been a dramatic hardening of the market. Hurricanes have arrested the fall in pricing, rate reductions have stopped and are heading back the other way. But on balance rate increases have been disappointing,” said Richard Palengat, head of marine and energy at AEGIS London. While rate increases have been limited in the energy insurance market, the hurricanes have brought an end to the period of year-on-year rate increases for most buyers, according to Willis. “The market seems to be levelling off in terms of pricing and terms and conditions. There has been some correction but it is difficult to say if there is a consistent global change,” according to Paul O’Neill, chief underwriting officer of specialty lines – which includes energy, marine, aviation and entertainment – at AGCS, and board member. While limited rate increases make good news for buyers, it leaves energy underwriters in a quandary. According to Willis, energy insurers face the choice of either scaling back to wait for better conditions to materialise, or accepting that today’s modest rate rises will not be enough to sustain long-term profits. According to Mr O’Neill, the energy market had a tough year in 2017 even though hurricane losses were less than initially feared. The downstream market was hit by hurricane losses, but large and attritional losses, coinciding with a low premium base eroded by more than a decade of soft market conditions, really took their toll. According to Willis, downstream losses were in excess of $5.5bn, its worst loss year for almost a decade. “The downstream market is currently a difficult market in which to make margin, but we are here to be a long-term sustainable partner and provide a sustainable product,” said Mr O’Neill. In contrast, the upstream market had one of its most benign loss years on record at less than $1.3bn, according to Willis. However, while the upstream market was not heavily impacted by last year’s hurricanes, it is suffering from the effects of the low oil price and a reduced premium base. “Last year was a benign year for upstream losses, but our market shouldn’t be complacent and should be appropriately concerned by the scale of business interruption losses,” said Mr Palengat. “A single incident in the Jubilee Field in 2016 is set to cost the upstream energy market well in excess of $1bn in respect of a combination of property damage and contingent business interruption. Yet total annual income for the upstream market is probably just $1.5bn,” he said. According to Mr O’Neill, the numbers no longer add up for the energy market. Global working capacity has been quoted at $6bn in the upstream market and $4bn to $5bn for downstream, with premium bases in downstream of about $2bn and upstream just short of $2bn. The market saw losses of about $1bn from hurricanes Harvey, Irma and Maria alone. “The math does not add up. There are a lot of people chasing an eroded premium base and there have been some large losses. It is not a good equation,” warned Mr O’Neill. The low premium base and slim margins being earned by underwriters in the current market could make for some tough choices ahead. “Underwriters have been hurt by the performance of their accounts and have to consider the cost base they have to work from and premium levels. There will be decisions on strategy to make going forward and how the energy product can be offered sustainably and under the right terms,” said Mr O’Neill. Despite losses, few insurers have pulled out of the energy market, but there has been a change in behaviour since last year’s hurricanes. Some insurers insist on double-digit rate increases or are now less willing to take large shares of small risks, explained Mr Palengat. Consolidation in the insurance market has yet to play out, with several players in the energy space halfway through mergers and acquisitions. Willis said the recent withdrawal of Partner Re from the upstream portfolio, together with the XL Catlin/Axa merger and AIG’s acquisition of Validus/Talbot, may signal an end to the trend of year-on-year capacity increases. In addition, there are unlikely to be new entrants waiting in the wings to snap up underwriters and replace energy capacity, noted Mr Palengat. It is also possible that MGA capacity and market facilities could lose the support of underwriters if they underperform. This could reduce capacity, said Mr Palengat. The increasing oil price may offer energy underwriters a glimmer of hope. The higher the cost of oil, the more exploration and drilling activity, which in turn drives premium growth. “As the oil price rebuilds, it increases confidence and activity levels. Laid-up rigs are being reactivated and we see more demand for control-of-well cover as more wells are drilled,” said Mr Palengat. “With more activity we will see a rise in premium volume. While we will benefit from this, we should have concerns about the inevitable increase in claims however,” he said. The increase in oil price is a mixed blessing for energy underwriters. It brings the opportunity to write more business, but also raises the spectre of increased losses. “For upstream, in particular, the increase in oil price is correlated with increased activity, and we already see this with some contractors. But with the opportunity is also risk, such as with the reactivation of drilling rigs,” said Mr O’Neill. Hundreds of drilling rigs were mothballed as the oil price fell but some are now being brought back into operation. “Reactivation of a rig can be a dangerous time and how this process is managed is key to reducing the risk,” he said.

Energy market on the edge

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