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Spill May Force Long-term Rise in Insurance Cost

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Deepwater Horizon Gulf of Mexico Oil Spill

NEW YORK (Dow Jones Newswires), May 21, 2010

In the wake of last month's Deepwater Horizon disaster in the Gulf of Mexico, insurers that had focused in recent years on the possibility of a hurricane sinking an offshore platform are reconsidering the risk of drilling even when the skies are clear.

The price to insure offshore rigs will almost certainly rise as the accident's cost to the insurance industry becomes clearer. Premiums may remain permanently higher if the investigation of the disaster reveals previously unknown dangers, or if the inevitable legal wrangling breaks new ground in assigning blame more broadly than insurers expected.

The cost of insuring a rig against a so-called physical loss--damage to the rig itself--can easily surpass $3 million a year, and could reach $9 million depending on the deductible and whether the owner opted to waive the right to file a claim if it were damaged by a windstorm, said Richard Kerr, chief executive of MarketScout, the Dallas-based electronic insurance exchange. Other variables make it impossible to estimate the premium on the rest of the coverage, which would include liability, pollution cleanup, and the mounting price tag to stop the leak, which insurers call control-of-well costs.

The loss of the Deepwater Horizon rig itself has cost insurers $560 million, but that expense is just the start. The still-growing spill will likely require insurers to shoulder part of the cost of cleaning up the beaches, compensating coastal business owners and fighting the inevitable wave of litigation.

Two weeks ago, Swiss Re estimated insurers would incur $1.5 billion to $3.5 billion in claims. At the higher end, that would surpass the $2.2 billion to $2.5 billion that is generally believed to represent the annual premiums collected globally from companies involved with pulling oil and gas out of the ground.

And the spill has only grown since then.

"Two billion? Three billion? Nine billion? Nobody knows," said Kerr. "They can't get the damn thing stopped."

The insurers who sold protection on the Deepwater Horizon are many--possibly dozens will share the cost of the disaster. They include American International Group, Swiss Reinsurance and Munich Re. The loss is unlikely to cripple any one company, but carriers have pledged to re-evaluate the new equipment and novel techniques used to drill for crude a mile or more beneath the sea.

"The science and engineering involved were believed to be quite advanced, and you have to rethink those assumptions," said George Stratts, the head of marine and energy coverage at Chartis, the property-casualty arm of AIG. "Are these types of drilling methods and techniques as sophisticated as we thought, and are the risk mechanisms in place as sophisticated as they need to be?"

Lawsuits are seeking to pin blame on BP, the primary leaseholder of the well; Anadarko Petroleum and Matsui Oil Exploration, the minority partners; rig operator Transocean; Halliburton, the company responsible for cementing the well; and Cameron International, the maker of the so-called blowout preventer, which appears to have failed to operate properly.

If the contract between the leaseholders and their operators was typical, BP, Anadarko and Matsui would have agreed to bear the cost of the cleanup. But the lawsuits could spread the blame--and increase the costs--"to a degree much larger than anticipated" when insurers priced and sold the coverage to the operators, warned John Lloyd, the chairman and chief executive of insurance broker Lloyd & Partners Ltd., in a letter to U.S. senators last week. Insurers will bear much of the cost of fighting the lawsuits; liability policies typically include no cap on the cost of mounting a legal defense.

Coastal hotels, beachfront resorts, fishermen and many others will have grounds to seek reimbursement from their insurers, predicted Marshall Gilinsky, an attorney at Anderson Kill & Olick. "People who are harmed can go directly to their insurance companies and let the insurance companies work out how to get money from BP or Transocean or whomever."

Other insurers acknowledging they face losses from the sunken rig and resulting spill, include Hannover, Ace, Transatlantic, Flagstone Reinsurance, Arch Capital and Lloyd's of London carriers including Amlin and Chaucer Holdings. Insurers typically prefer to share large risks.

"Even if this particular case doesn't become a large liability event for the insurance market, it surely shows the potential of such claims arising," said Axil Brohm, the head of Swiss Re's energy and power unit. The potential alone may push offshore insurance rates higher.

A handful of insurance companies, including Warren Buffett's Berkshire Hathaway, attempted to capitalize on an earlier increase in prices following hurricanes in 2004, 2005 and 2008, but the higher rates instead caused operators to forego some of the coverage they'd purchased in earlier years. BP, for example, was self-insured.

Now, insurers may become less willing to back policies just as the companies working in the Gulf rediscover their appetite for insurance, said Richard Kern, the head of energy and environmental coverage at James River Insurance in Richmond, Va.

Some of the new entrants who did manage to sell coverage "are going to step back and look at what's taking place, look at what their results are and realize we're not doing restaurants," said Kern. "These aren't slip-and-fall cases. These are big claims."

Copyright (c) 2010 Dow Jones & Company, Inc.

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