Will BP Oil Spill Losses Turn Insurance Cycle?

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Includes: ACGL, AIG, BP, MCO, MRH, PRE, TRV, WRB, XL
by: Gloria Vogel, CFA

Moody’s recently estimated that total insured losses from the British Petroleum (NYSE:BP) oil spill in the Gulf of Mexico will run somewhere between $1.4 billion and $3.5 billion. The insured losses would run much higher if BP had purchased commercial liability insurance coverage instead of choosing to self-insure through a captive.

However, as Moody’s noted:

Many parties were involved in the drilling work, dozens of class action lawsuits have been filed, and the ultimate extent of environmental damage is unknown … It is possible that other parties found liable will exhaust the limits of their insurance policies.

According to the Insurance Information Institute (I.I.I.), other companies with exposure to the Deepwater Horizon oil rig are insured for losses up to $1.4 billion, with such losses spread throughout the global insurance market. The oil spill is likely to give rise to first-party and third-party claims. Dr. Robert Hartwig at the I.I.I. has a slide presentation that details announced Deepwater Horizon insured losses to date, and also looks at other oil rig blowouts for comparison.

One of those I.I.I. presentation slides shows announced insurer losses to the BP rig to date: Deepwater Horizon Insured Losses. These announcements suggest that insured losses from the BP rig will be more than manageable for the (re)insurance industry. Indeed, while the Deepwater Horizon spill has surpassed the Exxon (NYSE:XOM) Valdez disaster of 1989, there are several hurricanes that have cost the insurance industry more than appears to be the case to date with the BP oil spill.

Surely, this spill will still be an event for insurers, and it will most certainly have bearing on insurance rates for the offshore energy sector. Moody’s observes:

Early reports indicate that property rates are 15-25 percent higher for rigs operating in shallow waters and up to 50 percent higher for deepwater rigs ... Pricing for offshore energy liability insurance is sure to trend higher as insurers and reinsurers take stock of their losses and reevaluate the complex risks associated with drilling in deep waters.

One would expect premiums to soar after a catastrophe in a given line of business, much as homeowners’ rates jump after a major hurricane. But will these losses be enough to turn pricing in other lines? Is this event significant enough to turn the property-casualty underwriting cycle?

Many lines of business -- business interruption, pollution, workers’ compensation, etc. -- would likely be affected by the spill. Indeed, if a hurricane carries the toxic dispersants used for the spill into the air or water, claims could rise in many areas. However, given current capacity in the offshore energy insurance market, most analysts believe this event will not lead to a sustained hard market.

Typically, the property-casualty insurance cycle turns only when capacity is significantly depleted due to loss. It is the hit to capacity available rather than the loss event itself that turns the market. With ample overall capacity in place, and manageable losses from Deepwater Horizon, there is not likely to be any turn in the market due to this oil spill, unless losses begin to soar well above current estimates.

Property-casualty policyholders’ surplus, or its capital, at year-end 2009 stood at $511.5 billion, within 2% of its all-time record high, with the premiums-to-surplus ratio at a strong level. The weak economy slowed premium growth, while financial market recovery from the March 2009 lows provided ample capacity to keep rates very competitive. It will likely take another major event, not the BP spill, to change these market dynamics.

Disclosure: No positions