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November 2022 Exclusive Story

Several Factors Drive Growing Adoption of Creative Insurance Solutions

By Stuart Wallace and Morgan Moore

Rising inflation rates, an increase in the number of auto accidents, natural disasters, nuclear verdicts and the growing cost of insurance claims have created a hard insurance market for companies operating in the oil and gas sector. In other words, insurance premiums are rising, and carriers generally have a lower appetite for risk. Add in fluctuating commodity prices, federal regulatory pressure on hydraulic fracturing and offshore drilling, and the growing demand to meet environment, social and governance criteria, and the industry faced major hurdles long before COVID-19 emerged.

The pandemic reduced overall demand for oil and gas while exacerbating a shortage of highly skilled workers in the sector, particularly drivers in the Permian Basin as well as oil rig workers. Even after governments and businesses relaxed social distancing rules and energy prices soared partially in response to the Russian invasion of Ukraine, the oil and gas sector has struggled to recruit the skilled workers who left the workforce.

Many companies are paying higher compensation—in the form of recruiting bonuses, wages and retirement packages—to both retain the qualified workers who stayed, and to bring on workers who still need significant training or have suboptimal backgrounds. Losing large numbers of highly experienced workers and hiring smaller numbers of less experienced workers may increase the risk of accidents. An increase in liability claims and a hardening insurance market have created an environment where many oil and gas companies have found it difficult to obtain cost-efficient insurance coverage.

Nuclear Verdicts

One of the factors behind higher premiums is that during the past decade, a significant rise in automobile accident settlements has occurred across various sectors, including oil and gas, as plaintiffs’ attorneys have persuaded juries that companies committed negligence. Cases often involve evidence of drivers who became fatigued after long hours on the road, or drivers who became distracted while using mobile phones. So-called “nuclear verdicts” can result in huge payouts.

Whereas a settlement 10 years ago may have been in the range of $2 million to $10 million, a similar case with the same set of facts could settle for up to 10 times that amount today. “Social inflation” refers to the recent growth in liability risk and costs stemming from several trends and developments, including litigation funding, proliferation of class action lawsuits, juries’ increased sympathy toward plaintiffs, and the negative public sentiment toward the oil and gas industry. These verdicts can have an ever more pronounced impact on privately-held, small-to-medium-sized oil and gas businesses as they face unique insurance challenges.

For example, a service contractor may have more than 300 trucks on the road at any given time. Previously, insurance carriers could turn to loss stratification, peer analysis and balance sheet protection to determine an appropriate amount of insurance to purchase. However, nuclear verdicts—and the higher rates that insurers charge to protect against them—may drastically alter calculations on the maximum limit of liability that privately held small-to-medium-sized businesses choose to purchase. In 2019, U.S. jury verdicts of at least $20 million were over 300% more frequent than their average annual occurrence between 2001 and 2010.

Without careful planning, insuring against a potential nine-figure liability claim that never occurs may appear to be an unnecessary expense that hinders an oil and gas company from allocating capital to strategic growth initiatives. Some companies are seeing their insurance rates rise as much as 50% annually, substantially increasing the cost of maintaining sufficient insurance and tempting some companies to sacrifice coverage. On the other hand, businesses can go bankrupt over accidents that occur after failing to purchase enough insurance.

Environmental Concerns

Natural disasters have become more catastrophic, partly because of huge increases in property and facilities development in geographies more prone to be in the path of weather events. The oil and gas industry is no exception, given the often close proximity of oil fields, refineries and offshore rigs to severe weather (lightning, fire and hail in West Texas and hurricanes and flooding on the Gulf Coast). As much as $40 million worth of equipment may be at one well site, with dozens of workers in harm’s way. A limited number of carriers are willing to underwrite these hard-to-quantify risks, and only at a higher cost to the insured.

Many oil and gas companies have master service agreements that require them to possess coverage against environmental risks, including pollution. Such insurance is readily available and relatively easy to obtain at sufficient capacity. However, unproven negative perceptions among some demographics about oil and gas operations, especially hydraulic fracturing, have stigmatized the industry to a degree. These beliefs increase the risk that if companies do face environmental litigation, the results may be unfavorable verdicts and costly settlements.

Government policies related to environmental concerns also impact the oil and gas sector. These impacts can alter oil and gas companies’ financial prospects and the amount they can afford to spend on insurance. For example, President Biden has advocated more stringent federal policies toward the oil and gas sector than his predecessor, including his decision to halt the Keystone XL pipeline.

Innovative Solutions

In today’s hard insurance market, oil and gas companies are increasingly relying on more innovative insurance solutions to meet evolving needs. A full marketing effort may lead to better pricing, structure and coverage. This effort begins with reviewing the company’s current insurance program and how it ties into the company’s risk appetite to determine the best path forward. The company executive(s) responsible for overseeing risk (typically the chief financial officer) should evaluate the health of the balance sheet as it pertains to deductibles, retentions, self-insurance and lender stipulations that may put constraints on insurance programs, among other considerations.

It may be necessary to conduct a competitive process to find a new carrier, negotiate better terms with the current carrier, or establish a captive program. Multiyear rate commitments allow the company to achieve greater certainty on costs. In loss-sensitive programs, the company may assume liability for the first $300,000 to $1 million of losses before the carrier becomes responsible. Captive programs take the form of an insurance company owned and controlled by its insured, which may be its parent company or a group of related companies.

Also, it is worth conducting in-depth risk analysis of master service agreements to check whether an insured company has the proper insurance and mutual indemnification language in its contracts and to verify that the insurance component matches or complements the MSA language. These reviews must consider how the insurance requirements and indemnification sections work together to provide coverage.

Finally, oil and gas companies can invest in equipment to prevent or mitigate damages. Truck fleets may benefit from installing fleet monitoring systems for vehicles and drivers, giving the company real-time data on actions such as swerving out of lanes or hard braking so management can respond quickly with better training. Well sites may benefit from lightning protection systems that minimize the exposure of flammable and explosive materials. Although such equipment may cost hundreds of thousands of dollars, it can lower both insurance premiums and liabilities in the long term.

Rather than trying to navigate the insurance landscape alone, oil and gas companies may find it more efficient to seek objective guidance from experienced risk management experts. These professionals should possess a thorough risk analysis-based understanding of both the intricacies of the client’s business and how to effectively communicate the client’s unique story directly to carriers.

Editor’s Note: This article was adapted from a slightly longer piece posted on the website for Stephens Insurance.

Stuart Wallace

STUART WALLACE serves Stephens Insurance as president of the Houston office and a commercial property and casualty insurance adviser. He helps clients in the upstream, midstream, downstream and service sectors create insurance programs with efficient terms and conditions as well as pricing. Before Wallace joined Stephens in November 2015, he spent 15 years in sales production, service and management roles at Arthur J. Gallagher. Most recently, he led Gallagher’s energy practice as the managing director for the United States.

Morgan Moore

MORGAN MOORE is a senior vice president at Stephens Insurance’s Houston office and a commercial property and casualty insurance adviser. Her work includes designing creative program structures and negotiating terms and conditions for clients. Having entered the insurance industry in 2005, Moore has placed energy-related risks in the exploration and production, service contractor, midstream and manufacturing and distribution sectors. Before Stephens, Moore worked as an area vice president in the energy practice group at Arthur J. Gallagher. Earlier, she was a national accounts underwriter for American International Group (AIG) Global Marine and Energy’s primary casualty division. 

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