Insurance in the oil & gas industry: risks, values and coverage
Source: https://www.lexology.com, July 31, 2019
By: Angela Flaherty, Clyde & Co LLP
Typical policies for the sector
Oil and gas companies have a wide range of exposures in respect of which they seek to buy insurance. There are some liabilities which are compulsory liabilities in respect of which oil and gas companies must buy insurance, either by law or as a condition of their licence. Some typical liabilities are employers’ liability or third-party liability for bodily injury and property damage, which are common to many industries. However, there are also some additional liabilities, in particular pollution liability, which is very specific to the hazardous oil and gas industry. Separate to liabilities, there is a very specific type of insurance that relates to wells, and this is in relation to operator’s extra expense incurred in both drilling or operational wells. The key exposure under an operator’s extra expense policy is the costs of bringing a well under control if there is a blowout. More broadly, in both the upstream and downstream sector, first-party losses are a serious exposure which oil and gas companies wish to buy insurance against in order to protect their balance sheet. This is first-party property damage and business interruption or loss of production resulting from accidental losses. It is these accidental losses, which is broadly agreed, form the basis of coverage in the energy insurance market. It is generally accepted that insurers will not pay for the costs of losses arising out of wear and tear or gradual deterioration, the type of inevitable loss that generally ought to be dealt with through an operator’s maintenance program. Similarly, insurers don’t generally have an appetite to pay for claims resulting from defective property. Energy insurance is not in place in order to respond as a product guarantee for equipment or assets that may be being used in the oil and gas sector, rather it responds to accidental fortuitous losses, and generally that does also extend to subsequent damage resulting from an accident caused by defective property even if they will not generally cover the cost of repairing the defective property itself.
Tailoring of policies
In terms of the policy wordings, oil and gas companies tend to be sophisticated buyers of insurance and they also use the services of specialist brokers. Similarly, they have long-standing relationships with commercial market insurers. This combination of factors tends to lead to policies being bespoke which are tailored to the specific needs of each buyer of insurance. However, there is a general practice in the market to use standard-form wordings or clauses and then such wordings and clauses are amended to the specific needs of that insured.
Policy coverage, limits and deductibles
Subject to any specific legal requirements, liability policies and operator’s extra expense policies tend to have set agreed limits in the tens or hundreds of millions which are set at a level that the insured, with the benefit of specialist advice from their brokers, consider to be adequate to protect their exposures excess of specifically agreed deductibles.
In relation to business interruption coverages, the sums insured are much more closely linked to the specific trading history and production forecasts of the insured and the insured can, based on that information, then decide whether to buy full protection which would protect it in respect of a total outage, or partial protection in acknowledgement of the fact that were there to be a full outage it would not receive a full indemnity from insurers.
Business interruption coverages will also be subject to a maximum recovery period which may be 12 months or 36 months and, before the policy is engaged, there will usually be a waiting period which operates as a time deductible of, say, 30 days or 45 days and perhaps also additionally there may be a quantum deductible where production losses must exceed that amount before the policy is engaged.
In terms of property exposures, assets under construction will usually have specific sub-limits in the construction policy that are calculated by reference to the estimated contract values for that specific part of the project and they may be phased for different stages of the construction projects. Final contract values are often then used for the operational policy after handover of a construction project as the sums insured for the assets once they have gone into operation.
One very interesting aspect of energy insurance is that irrespective of the age of the property in question, where there is damage to that insured property, it will almost always be subject to a basis of recovery clause which states that the property will be replaced on a new-for-old basis rather than, for example, on a depreciated basis. The logic for this is that there is not really a second-hand market for many of these oil and gas assets, particularly if one considers an offshore scenario where the biggest cost of doing a repair or replacement is actually the mobilisation of the vessel and the crew in order to do the installation or repair works. So the effect of this is that irrespective of the age of the property or if the asset is coming, for example, to the end of its useful life, if it becomes damaged by an accidental cause which is covered under the policy, the insured will be entitled to a brand-new equivalent asset rather than an asset of the same age as the one that has been damaged.