2010 Gulf Oil Spill: Impact on the Insurance Industry & Why Oil Companies Need to COPE

COPE: Consortium of Oil, Petroleum & Energy Insurers

The explosion and subsequent fire on the semi-submersible Mobile Offshore Drilling Unit (MODU) led to the bursting of an oil rig that has devastated the lives of people across the gulf. The long term implications of the oil spill are unknown. Scientists believe that the spill is going to have a profound impact on the gulf ecosystem. People’s lives in the gulf have been tremendously impacted, and it could perhaps take years for them to recover. Moreover, investors including both institutional and small households have taken enormous hits on their holdings in the companies that have been named responsible for the spill. Pension funds and teacher association unions are just some examples of groups that have lost a significant amount of their portfolio holdings.

The Impact

The oil spill has threatened the very foundations of BP. Its total equity is worth $104 billion. One of the most extreme estimates suggests that BP could end up paying $90 billion for the cleanup and compensation for businesses, workers and households in the region. If this turns out to be true, BP could find itself in a difficult spot and on the brink of bankruptcy. Federal prosecutors have named BP (owned 65 % of the well), Halliburton (installed & cemented production casing), Transocean (responsible for drilling the well), Cameron (built the well), Anadarko (owned 25 % of the well), and Mitsui (owned 10 % of the well) as being responsible for this spill. Some experts suggest that Smith International (supplied products for well exploration) & National Oil Well Varco (provided major mechanical components for drilling the offshore rig) could also be held responsible.

It’s important to understand what kinds of liabilities exist for BP & the environmental implications of this spill. The list includes Property Liability, General Liability, Workers’ Compensation, US Longshore & Harbor liability, Directors & Officers, Clean Up Workers Exposure (occupational hazards: heat strokes, sun exposure, noise, fumes from burning oil, rashes, lung issues and impacts from huge cloud of toxic components of oil), Tainted food (this has restricted catches of fish) , Disturbance of Ecosystem (long term impact, changes in balance of nature, could be fatal for species and could affect overall counts of individual species), Negligence & Criminal Wrongdoing, long term effect of crude oil & dispersants (long term impacts of interaction between crude oil and dispersants are largely unknown) & perhaps the biggest one would be Environmental Liability exposure and would impact sea life, birds, shoreline life, turtles, seafood etc (NOAA).

Some of these cases overlap. In addition, this pie chart only represents the different types of cases. Hence, this explains the lower proportion of cases against BP. Over ¾ of the pending court cases have been filed against BP (Griffitt).

Environmental & Securities litigation exposures (D & O) are bound to increase going forward. The other category, which includes business interruption & economic loss, will also grow bigger moving forward. Prior to the Gulf Oil Spill, Exxon Valdez was the biggest environmental disaster. Exxon recently settled the incident for $7 billion and this payout was much bigger than initially estimated in 1989 when the incident had taken place (FPN Advisen).

Laws Involved & Impact on the Insurance Companies

Insurance companies should expect to see claims due to exposure related to Oil Pollution Act, General Maritime laws, Response Effort Liability, First Property Party, Directors & Officers & Event & Cancellations coverage. The insurance policies that were in place before the crisis happened were underpriced. Nearly all insurance companies that issued any coverage policy did not consider such a big disaster in their product pricing. There was a mismatch between exposed limit and what firms would put up in the market if they were aware of the potential claims. Such a disaster will have a big impact on the industry. It provides opportunity for insurance companies to include riders or exclude coverage. It presents them with an opportunity to create new products for consumers, businesses & the oil industry. After 9/11, the industry provided terrorism coverage to its policyholders. The mold problem in early 2000’s led to creation of environmental liability policy which provided relief to the commercial real estate market. Similarly, the Gulf Spill could provide the opportunity to develop products for restaurants and hotels. There could be newer types of business interruption (BI) coverage & environmental policies to meet increased needs.

The insurance industry may be able to recoup some of its loss payouts from the BP trust fund. The companies could request subrogation of funds. This could act as collateral to source and is usually covered as a contractual right of insured and the carrier. Additionally, it is important to note that before Congress agreed to retroactively remove the $75 million cap on damages, BP could have refused to pay a single penny above that threshold. Such a decision was probably made to improve its relations with the consumers, regulators and environmental activists as a way to mitigate the crisis (Stupak 5).

Going Forward: Forming the COPE Consortium

After this spill, it shouldn't be difficult to underscore the importance of prudent risk management in the oil industry. Not only will BP have to fight environmental liability lawsuits for several years but it will also take a long term hit to its reputation. Some activists are already referring to BP as British Polluters. This disaster has undermined investor confidence in BP's ability to prevent big spills from happening. BP was still recovering and rebranding itself as a company that prioritizes risk management after the 2005 Texas City refinery explosion & 2006 Prudhoe Bay Oil Spill. Even as per BP's estimates, which seem to be extremely conservative, the current oil spill is already 20 times as big as the Exxon Valdez tanker disaster. Exxon is still recovering from the aftermath of the spill that happened almost 21 years ago. It seems that BP similarly will be on the hook for a long time to come (BP internal documents). Deepwater drilling is an inherently dangerous undertaking (EPA). The need for such kind of drilling will become greater as we continue to run out of oil exploration sites close to our shores. This is going to be a great challenge for all risk management professionals who are in the oil, gas and petroleum industry. Yet, we don't see close collaboration amongst the experts, scientists, geologists, engineers and others who seem to have a broader understanding of the associated risks. The industry not only needs closer collaboration but also needs to form an industry wide task force that can prevent, mitigate & minimize disasters from happening.

English naturalist Charles Darwin (1809 – 1882) once said:

“In the long history of humankind (and animal kind, too) those who learned to collaborate and improvise the most effectively have prevailed.”

The failure to warn, act & respond effectively has damaged BP’s reputation severely. The company will be hit with this crisis for a long time to come. This involves billions of dollars in losses and hundreds of lawsuits that will drag on for many years to come. Therefore, I propose creating an industry wide consortium. I would like to call it COPE which stands for Consortium of Oil, Petroleum and Energy Producers.

The insurance industry can lend its expertise with risk retention groups, captives & mutual companies to help the oil industry better manage & make the consortium effective. We can also provide specialized products through the Primary, E &S, Treaty Reinsurance & Facultative markets. We could offer specialized catastrophe & per risk excess of loss products in addition to the existing quota & surplus share treaties. This would ensure that we play our part to prevent, mitigate & minimize the extent and scope of future disasters. This would lend credibility, improve our industry’s reputation & ensure future financial stability for the oil companies and their employees, management, investors & stockholders. The insurance & reinsurance industry can support this consortium by providing our financial support & protection services. This is the right thing to do for our industry, people of the Gulf region and the environment.

Thanks to Flickr for the photo. For sources or questions, feel free to email.