Energy risk insurance shortfall presents opportunity for ILS

According to Willis Towers Watson the energy industry faces a huge insurance shortfall, leaving many of the world’s largest energy companies exposed as they often find it hard to secure the level of insurance protection they really require.

Insurance and reinsurance broker, consultancy and advisory Willis Towers Watson (WTW) explained that while energy companies are facing increasing levels of risk in their day-to-day operations, the insurance and reinsurance industry has not responded to the sectors’ needs and is not supplying enough capacity.

In fact, WTW suggests in a report on the shortfall in energy insurance, that there are a number of key areas where energy companies are massively over-exposed to risk, including supply chain risk, cyber risk, Gulf of Mexico tropical storm and hurricane risk and drilling risks.

For supply chain risk alone, a single energy company could require as much as $1 billion of cover, Nick Dussuyer, Global Head of Natural Resources Industry at Willis Towers Watson, expects. However, the insurance markets are currently unlikely to provide much more than $150m of cover for this risk at present.

Cyber risk is almost totally unprotected against in the energy sector. Dussuyer said; “Despite a high level of cyber risk, neither the upstream nor downstream energy insurance markets provide cover at present. The majority of energy companies remain inadequately protected.”

On tropical storm, hurricane and windstorm risks, which are most prevalent in the Gulf of Mexico of course, despite this being a key peril for the reinsurance and insurance markets, there remains a lack of capacity.

Dussuyer believes that there is around $750m of capacity available for hurricanes in the Gulf of Mexico but that total GoM windstorm exposure is over $20 billion, which is quite the shortfall.

Finally on drilling risk, which brings back memories of the Deepwater Horizon incident and the size of that event of course, underwriters using inadequate risk models is an issue and could mean they are storing up problems for the future.

WTW questions why, in a market where insurance and reinsurance capacity is abundant and companies are looking for new opportunities, they aren’t focusing on providing coverage to close these shortfalls in the energy insurance sector.

The report states that “In some key areas where energy companies are exposed, the insurance products on offer fail to provide the protection they need.”

A major factor in how the energy industry accesses insurance or risk transfer can come down to its profitability and with the oil price having plummeted this year there is a need for companies to look to the most efficient risk transfer solutions they can find, WTW says.

With the biggest insurance or risk transfer shortfall being Gulf of Mexico wind and hurricane coverage, WTW explains this as being due to the uncertainty caused by hurricane Ike losses, which were far above insurers expectations.

However capacity has expanded, with insurance and reinsurance devoted to upstream energy has almost doubled from $4 billion to $7 billion since 2010, but WTW notes that more work is needed to increase this further.

“Often it will mean finding innovative ways to ensure energy companies get the cover they need,” WTW writes, warning that it is not just energy companies that are at risk here, the insurers are also at risk by not providing what the sector needs.

And here lies a potential opportunity for the capital markets and ILS managers, with the Gulf of Mexico a peak windstorm zone and also one where the cat-in-a-box and industry loss warranty (ILW) has been prevalent in the past, perhaps the capital markets could look to bring innovative products to help energy companies gain greater insurance coverage.

Wind anemometers could provide an effective way to create parametric triggers for energy companies with Gulf of Mexico exposure, reducing the basis-risk by placing them as near to the exposed hardware as possible.

Then ILS capacity could be structured to provide the insurance coverage, as we see with ILS capital working with parametric insurance MGA New Paradigm Underwriters in Florida and other coastal hurricane hotspots.

Energy company risk managers and CFO’s may be open to discussions about innovations such as parametric insurance today, having gained a greater appreciation for the dynamics of the insurance and reinsurance market in recent years.

The WTW report doesn’t even go into other risks that the energy sector faces, such as storm surge around the Gulf area, earthquake exposure to pipelines and other types of physical damage which are also likely under-insured (compared to the potential size of exposures).

Supply chain risk, which is discussed in the report as another area of insurance shortfall by WTW, is also a risk that ILS and the capital markets, as well as innovative contract triggers, could help to cover.

Supply chain business interruption from weather and storm events could be covered with parametric triggers, or weather indices, which would at least provide energy companies with some contingent capital to help them minimise financial impact from major events.

Other supply chain risks which could be identified with metrics, could also potentially have protection structured around a parametric trigger of sorts. Think production values, wells operational, volumes transported, volumes sold etc, all of which could be hedged against using traditional or alternative risk transfer structures.

However, opportunities for the ILS market to deploy capacity and technology to help cover these risks aside, the real issue here could be a lack of innovation in an insurance and reinsurance market that could really do with the premiums at this time.

Some of these are prime risks, which would pay good rates-on-line, for coverage at prices commensurate with the exposures assumed. While there are issues surrounding energy companies willingness to protect themselves, there are also issues surrounding insurers willingness to offer a product that is both effective and cost-efficient at the same time.

Also read:

– Re/insurance, ILS key for energy sector extreme weather risks.

– No reason ILS can’t expand to energy all-risk property coverage: Willis.

– Speedwell launches platform to facilitate weather hedging for energy.

– New Paradigm’s parametric hurricane cover, with ILS credentials.

– Energy insurance buyers to benefit from new reinsurance capital: Marsh.

– As global energy exposures grow opportunities emerge for reinsurance and weather risk transfer.