Energy companies’ exposures increase as commodity prices rise

Energy insurers and their clients have been warned that they could face bigger exposures as a result of sharp increases in commodity prices. In its Energy Market Review, Lloyd’s insurance broker Willis says that “superheated” prices for oil, steel, building material and contractor day rates is creating significantly increasing risks.

The spike in commodity prices has resulted in higher replacement cost valuations and much bigger potential for longer and costlier delays in the event of an accident, heightening business interruption exposures. The potential for more severe losses in the energy industry has therefore been enhanced at a time when many asset values remain unrevised for insurance purposes, Willis warns.

But following another benign hurricane season in the Gulf, energy insurance capacity has continued to grow. Willis expects that capacity for 2008 will grow by 10%-15% as a result of new start-ups entering the market, as well as increased lines being made available by existing energy insurers.

Willis says that energy insurance business is still profitable because rates are still relatively high by historical standards. That means that further rate reductions are a real possibility. For buyers, for the time being at least, energy insurance products are better value for money than at any time since 9/11, the broker says.

Phillip Ellis, chairman of Willis Energy says that although loss levels in the energy insurance sector have been low for two years, the situation could change rapidly. “While some [energy] companies are operating their assets in ways that are far superior to the past, for others the run of good luck is just that. It is very hard for us to accept that this run of low loss activity will continue indefinitely. Ultimately, something will break,” he warned the market.

Willis says that the energy industry is operating “at full tilt” with existing infrastructure being pushed to the limit and project activity at record levels. In addition, energy companies are increasingly investing in more risky, hostile territory, deploying sophisticated untested technology.

The Willis report points out that business interruption is an increasingly critical element in the energy insurance portfolio. A recent incident in the Middle East, which resulted in a physical damage loss of around US$100 million would have resulted in a claim for BI of as much as US$600 million had the exposure been insured. From an insurer’s point of view, they may not be receiving adequate premium for the actual exposure; from the client’s perspective, they are may be underinsured.

Looking to the future, Willis predicts that oil and commodity prices are unlikely to fall so far that levels of high investment can’t be sustained, and pressure taken off supply chains.

In the meantime, Ellis urged clients to continue to re-examine their risk exposures and asset valuations, in order to make sure that they remain in a position to be properly indemnified by insurers in the event of more severe losses in the future. He also urged brokers and underwriters to “innovate and improve our offerings to such an extent that our clients’ appetite for them continues to grow.”