Oil and gas: changing attitudes

Downstream oil and gas companies have faced steep premium rate increases in the past couple of years, with underwriters regularly demanding spikes of more than 30% at renewals. Now, insurers are also implementing new clauses to their policies that cap business interruption payments as the sector goes through high levels of volatility. Rodrigo Amaral reports

The oil and gas industry faces a transitional period as many companies are investing in the diversification of their activities towards greener energy sources, which is creating challenges for their insurance programmes as a result.

But downstream energy firms, which include those in sectors like petrochemicals and refineries, constitute the trickiest segment of the industry for buyers and their brokers at the moment.

Even before the Covid-19 pandemic, the segment was struggling with a high volume of operational losses that baffled insurers due to their lack of predictability.

Losses have remained significant, reaching more than $3.5bn in 2020, and $2.3bn in the first nine months of 2021, according to Alesco, a London-based broker. Respectively, $2.5bn and $2.1bn were due to operational causes, rather than nat cat events.

Brokers say that as a result of the high losses, underwriters have reduced their appetite for downstream risks, with some withdrawing capacity in the past couple of years. Buyers have faced rate increases of up to 35% in recent renewals.

Improving situation?
The situation has improved somewhat for buyers of late, however, with forecasts for future rate rises dropping to a maximum of 10%.

“In the past 12 months, we have seen a definite tampering in rate increases. Underwriters are still pushing to get rises but it is a very modest pressure now, even in the downstream market,” says Jon Smith, a managing partner at Alesco. “We are seeing some of those prices come down because underwriters are looking to write bigger lines in the downstream market next year.”

This constitutes an important change of attitude as one of the main characteristics of the market during the pandemic was an effort by underwriters to reduce their exposure to large risks.

“In 2019 and 2020, some of the largest carriers in the downstream sector became much more conservative. We would normally see big insurers taking 10% of the risk, but leading up to 2020, they would take 7.5% or 5%. If several carriers did that at the same time, clients struggled to get their programmes completed,” says Nicholas Little, chief broking officer of energy GBC at Aon in London.

“As we moved into 2021 and now enter 2022, the market has stabilised and there has not been any major withdrawal of capacity in the past six months. And some of that cautious underwriting has started to retreat. A number of very large players are now seeking to write larger lines in the downstream market,” he adds.

Oil and gas companies have reacted to the price increases by making more use of captives or the capacity offered by mutualist insurer OIL. The insurer announced that it will increase its limit from $400m to $450m next year, with the aggregation limit reaching $1.35bn, up from $1.2bn.

Business interruption cap clauses
But rate increases are not the only way the hard market is hitting the downstream sector. One of the noticeable developments to take place in recent times, and which is set to remain a feature in the near future, is the application of business interruption (BI) cap clauses in downstream oil and gas packages.

Insurers have expressed worries about turnover volatility at some downstream companies, especially refineries, which have suffered from the reduction of fuel consumption during Covid-19 lockdowns around the world.

“The insurance market has been pushing BI volatility clauses in the downstream sector. If a company declares to the market an annual revenue value, but in reality, at some point that year, it experiences a lower value, and then later on a higher value, it is very difficult for insurers to charge the correct premium,” Little explains. “Volatility clauses apply a cap to the BI values the client declares, either on a monthly or annual basis, or sometimes a combination of both, and establishes that, say, 120% or 130% is the maximum recovery that the client can make.”

He adds: “Clients need to think very carefully about what they declare as values. In the old days, if a company declared €10, and the loss was €20, on many BI forms they would still be able to recover the actual loss sustained. With BI volatility clauses this is not always the case and going forward, buyers need to work with their brokers to have a clear understanding of their BI risks.”

Upstream risks
In the upstream market, however, the situation has been much less dramatic. Capacity has remained plentiful and price increases have been much less painful than among refineries and petrochemical firms.

“Increases in rates have been very modest, ranging between 5% and 15%, usually around 7.5%,” Smith says.

Alesco pointed out in a recent report that the construction part of the market, which is also usually covered by upstream insurers, has seen tighter conditions, with increases reaching between 10% and 15%, and limited appetite for subsea elements. But capacity concerns in the upstream segment are mostly restricted to a few areas such as fracking, which has been afflicted by higher levels of claims.

“Fracking claims can reach up to tens of millions of dollars. So it is difficult to find capacity for that sector in the current climate,” Smith says.

Even then, Alesco estimates that upstream losses amounted to $864m last year, and in the first nine months of 2021 they reached $325m.

“There is plenty of capacity in the upstream market but premium volumes have been low in historical terms. Many of the production companies are not investing in production or new wells, and activity levels are quite low,” Little says.

In the midstream market, which encompasses pipelines and other intermediary activities, trends vary according to where the covers are purchased. As there is no specific midstream insurance market, both upstream and downstream underwriters can provide capacity to the sector.

Price increases are expected to range between 8% and 10% in forthcoming renewals, according to Alesco, which has however diagnosed a tendency among underwriters to impose minimum premiums on midstream businesses. The values demanded by insurers range from $50,000 to $75,000 and seem to have stabilised, according to the London broker.

Even though the situation is different in the three segments of the oil and gas industry, some of the challenges faced by the market today are shared among all companies. For instance, communicable-disease clauses have become commonplace in policies. And oil and gas insurers have increasingly striven to remove cyber risk covers from oil and gas packages, driving buyers towards the purchase of standalone policies from dedicated cyber teams.

Smith stresses that a few underwriters, such as Munich Re, offer a cyber facility for energy companies and they have gained some traction in the market. Other than that, most policies contain some kind of cyber exclusions.

“Not many energy companies are looking for traditional coverage, due to the limits available and the level of information required,” he says. “And also because some companies believe that they have excellent IT departments that provide good defences for them.”

Sustainability challenge
Other challenges come from the pressure for a sustainable economy that is gaining momentum both in the energy and insurance industries.

“There have been very specific areas so far where capacity has been withdrawn, such as Arctic drilling, due to ESG concerns. It is critical for brokers to understand the changes in underwriters’ appetites,” Little says. “It is very likely that insurers will adopt additional decision-making parameters, other than just profitability.”

Smith warns that insurers have an important role to play as energy companies go through a period of transition towards greener energy sources. Simply denying cover for companies that are deemed not immediately compliant with ESG standards is not going to cut it.

“We will not see oil and gas companies, and their insurers, disappear overnight. They will be around for a long time. But there is definitely a move towards renewables, and renewables are increasingly going offshore,” he says. “The industry is moving to much deeper and hostile waters, which will require much bigger capacities. This is where the upstream insurance market can step up and help, as it is much familiar with offshore structures and deep water. Working together with the renewables market, they can put together long-term solutions for our clients.”

Little adds: “Clients are getting involved with biodiesel, solar power, hydroelectric generation, or hydrogen. It is a big challenge for insurers to adapt their policy terms to provide programmes that cover all those different activities in addition to traditional energy market exposures.”

He concludes by noting that, even as the hard market fades, some of the approaches adopted by the insurance industry in the past couple of years are unlikely to go away.

“From now on, different subsectors in the oil and gas industry will have different insurance experiences,” Little says. “Some may have difficult nat cat profiles, others may have a more challenging ESG story. Rather than having a broad brush, insurers are increasingly differentiating clients, and there could potentially be a significant disparity in the results each client obtains at renewals.”

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