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August 2012 Exclusive Story

Evolving Liabilities Impact Coverage

By Thomas Jenkins

DALLAS–The oil and gas industry has seen enough boom-and-bust cycles to know that the pendulum eventually swings back. What is unusual these days is the feeling that the pendulum is moving in both directions at once, making it difficult for prudent owners and operators to prepare for whatever is coming next.

On the positive “boom” side of the pendulum’s swing, rapid development continues to drive demand for energy products around the world. At the same time, new technologies are opening opportunities to extract resources in areas that were once thought barren or impossible to exploit. Purely from a supply-and-demand perspective, the prospects for oil and gas businesses to thrive have never been so bright.

However, the dark and challenging backswing is that the industry is under intense scrutiny and faces increasing regulatory pressure at every level. The 2010 oil well blowout in the Gulf of Mexico created widespread mistrust that has reached beyond those involved in offshore drilling. Since then, contamination from oil pipeline spills and questions about whether earth tremors might be linked to hydraulic fracturing have added to a public perception that the industry as a whole is not as careful as it should be regarding its environmental impact.

Altogether, these factors create an uncertain playing field that poses new exposure to liabilities piled on top of the well-known risks oil and gas businesses always have faced. That makes it more important than ever for owners and operators to work closely with an insurance broker that understands the industry and can help them identify the right coverage at the best price. By paying attention to a number of potential exposures, any oil and gas business can put an effective plan in place to manage risk.

Avenues For Liability

When rules are well established, a business has the information it needs to make decisions and carry on with operations. But when the old rules have been thrown out and new ones are not yet in place, businesses can be caught in limbo, uncertain about what is required and what must be avoided.

When it comes to rules, the situation for oil and gas companies today is quite fluid. Legislatures, local officials and policymakers are questioning the effectiveness of current regulations and are considering changes that include more rigorous oversight, more onerous restrictions, and greater liability limits.

A series of incidents and concerns has contributed to the unrest that is driving the movement toward strict regulations. These include:

  • The 2010 deepwater blowout and oil spill dumped an estimated 200 million gallons of oil into the Gulf of Mexico. The three-month process of capping the well and stemming the flow of oil fed a public perception that oil companies could not be trusted to operate safely.
  • The 2010 Enbridge pipeline rupture spilled more than 800,000 gallons of oil into a Michigan river. The incident brought public attention to the problem of corroded pipelines and their potential for contaminating the environment.
  • Small earthquakes in a number of states where fracturing is used have raised a red flag. The technology also has led to concerns about groundwater pollution and radiation exposure.

In reaction to these concerns, officials at federal, state and local agencies are rolling out tougher regulations and more stringent laws. For example, in the wake of the Gulf oil spill, Congress considered raising the maximum legal liability for economic damages from $75 million to $1 billion. At the state level, Pennsylvania policymakers increased the distance around an unconventional well for which the operator is presumed liable for any groundwater contamination from 1,000 to 2,500 feet.

“Not in my backyard” protests have influenced local restrictions on where pipelines can be constructed and how drilling operations are permitted. Often, drilling operations now require extra permits, new procedures, and more coordination with local authorities. Some operators have seen an increase in lawsuits by area residents for inconveniences such as road closures, increased dust, and noise.

Issues Beyond Pollution

While pervasive, environmental concerns are not the only cause for new liability issues that oil and gas operators need to stay on top of. One example is the U.S. Supreme Court’s decision in Pacific Operators Offshore LLP v Valladolid, which has made it more likely that onshore employees will have access to funds designated to address injuries and fatalities for offshore workers. The case involves a worker who spent 95 percent of his time with Pacific Operators offshore, but who was killed in a forklift accident while assigned to one of the company’s onshore facilities.

Instead of settling for state workers’ compensation coverage, the employee’s wife made a claim under the more generous Longshore and Harbor Workers Compensation Act. The coverage under that act has been extended to offshore oil rigs through the Outer Continental Shelf Lands Act.

The Supreme Court stepped in to resolve conflicting rulings by lower courts regarding who was eligible for the offshore coverage. Rather than requiring that an employee be offshore when the incident occurs, the court ruled a claim could be made if employees could establish a nexus between their work and the employer’s offshore operations.

The ruling has the potential to increase a company’s workers’ comp costs. In addition, it may lead companies to reconsider whether it is worthwhile to have employees split their work time between offshore and onshore operations.

Familiar Risks

While new liability exposures are emerging, oil and gas companies need to continue to address the risks that always have been present in their operations. Workers’ comp and contractual risk transfer are two areas that can strongly impact both the availability and pricing of insurance, if a company has not managed its risks well.

Workers’ comp can be a particularly troublesome area during tight labor markets. When there is more demand for experienced workers than supply, companies often hire workers who have little training. In addition, companies may move employees to unfamiliar sites, send them to remote locations that don’t have the infrastructure to handle the influx of workers, or put them in harsh environments that may present dangers they are not used to.

Owners and operators can counteract these exposures by screening workers for experience, past performance, certifications for special equipment, and alcohol and drug use. Companies that focus on orienting new employees and that provide training with a strong safety emphasis are in a better position to reduce their workers’ comp incident records, which is a critical factor in determining future premiums.

Another sound practice for reducing exposure to liability is careful scrutiny of all contracts and joint operating agreements. Typically, these documents delineate who is responsible when things go wrong and spell out requirements for liability coverage. For example, a joint operating agreement may require each party to carry $1 million in general liability coverage and divide the expenses evenly for any liability incurred above that limit. To avoid costly problems, companies should consider whether the limits cited are high enough to cover potential claims.

On contracts with vendors that require insurance coverage, companies should be sure they receive proof of coverage before the vendor is allowed on site. They also should check for ongoing coverage if the contract stretches over a substantial time.

In addition, contracts that cities or counties may require before operations begin should be reviewed carefully. If a company agrees to maintain the road leading into a drilling site and the county requires the company to indemnify road upkeep, the company may become liable if a fissure, fault, or snow removal on the road causes an accident.

Each party to a contract is interested in protecting itself to the maximum extent possible, so no amount of review will produce a contract that completely favors the oil owner or operator. But by thoroughly reviewing each contract and understanding what is being agreed to, a company has a better chance to address potential problems before they become costly quagmires.

Coverage Factors

Just as the oil and gas industry is facing pressure from many directions, insurance carriers face a variety of factors that influence both pricing and the availability of coverage. Today, those factors are largely negative.

Oil and gas companies are part of most insurance companies’ energy books, which include mining companies, petrochemical plants, and other similar enterprises. The benefit is that risks are spread across a broader base of companies. Unfortunately, however, the recent history of claims for all of these types of companies has not been favorable. From refinery fires in Canada to typhoon, earthquake and flood damage, to Australian mines and the Gulf blowout, catastrophes have been costly.

One insurer’s experience illustrates the impact of these and other catastrophes throughout the insurance industry. In 2010, Lloyd’s of London reported paying $1.16 in claims for every $1.00 it received in premiums prior to 2009 reserve credit. Similarly, the top reinsurers reported that during the first nine months of 2011, payouts per $1.00 of premium were running at almost $1.09.

The effect going forward is that underwriters become much more stringent about what their companies are willing to cover, and pricing for coverage is pushed upward.

As a result of these pricing pressures, experts expect oil and gas companies with no or few losses to experience flat to 5 percent increases in premiums–unless they are in areas where catastrophic events are frequent, in which case, the increase may be as high as 15 percent.

Best Foot Forward

What can a company do to make sure it gets the right coverage at the best price?

Oil and gas owners and operators should approach purchasing insurance much as they do attracting investors. When a company wants new investors, it puts its best foot forward, telling the story of its operations, assets, potential for success, and much more.

Similarly, an underwriter needs to know all the positive information a company can compile. By working closely with the underwriter, a company has a much better chance to be viewed as a sound risk and deserving of the most competitive rates the insurer can offer.

Among the things companies should highlight when talking with underwriters are its procedures for hiring qualified, well-trained workers; safety training programs; equipment maintenance practices; the experience of managers and supervisors; and past performance in conducting claims-free operations. Companies also should demonstrate sound practices in reviewing contracts, and arrange for appropriate contractual risk transfer whenever possible.

In addition, companies should look for insurance carriers with solid financial ratings and long track records of insuring oil and gas businesses. Both indicate an ability to be there for an insured over the long haul.

Finally, working with a broker who understands the industry and has expertise can make a difference. For example, control-of-well insurance policies may either indemnify the oil operation or “pay on behalf of” when there are claims.

The difference is that in the first case, the insured pays the bill and then presents it to the carrier to be reimbursed. Insurers pay claims directly in pay-on-behalf-of policies. For oil businesses with tight cash flows, having a pay-on-behalf-of policy can be an advantage that is easily overlooked by anyone who is unfamiliar with oil and gas industry coverage.

With so much criticism and skepticism from different sources in today’s unsettled regulatory and economic environment, oil and gas businesses could be forgiven for feeling abandoned and on their own. When it comes to risk management, however, they do not have to go it alone.

By working with a broker that understands the industry’s special needs and emerging issues, oil and gas operators and owners can be assured that someone is in their corner, ready to help them manage risks and reduce their exposure to liability.

THOMAS JENKINS is senior vice president and director of technical international risk, specializing in energy at Wells Fargo Insurance, the largest bank-owned insurance brokerage in the United States, with experience in property, casualty, benefits, intern

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