OCS Study 

BOEM 2011-054 

Coastal Marine Institute 

Diversifying Energy Industry Risk 

in the Gulf of Mexico: Post-2004 Changes 

in Offshore Oil and Gas Insurance Markets 

U.S. Department of the Interior

Bureau of Ocean Energy Management 

Gulf of Mexico OCS Region 

Cooperative Agreement

Coastal Marine Institute 

Louisiana State University 
U.S. Department of the Interior Cooperative Agreement 

Bureau of Ocean Energy Management Coastal Marine Institute 

Gulf of Mexico OCS Region Louisiana State University 

OCS Study 

BOEM 2011-054 

Coastal Marine Institute 

Diversifying Energy Industry Risk 

in the Gulf of Mexico: Post-2004 Changes 

in Offshore Oil and Gas Insurance Markets 

Authors 

David E. Dismukes 

Christopher P. Peters 

November 2011 

Prepared under BOEM Cooperative Agreement 

1435-01-04-CA-32806-39899 (M08AX12687) 

by 

Louisiana State University 

Center for Energy Studies 

Baton Rouge, Louisiana 70803 

Published by 
iii

DISCLAIMER

This report was prepared under contract between the Bureau of Ocean Energy Management 

(BOEM) and Louisiana State University’s Center for Energy Studies. This report has been 

technically reviewed by the BOEM, and it has been approved for publication. Approval does not 

signify that the contents necessarily reflect the views and policies of the BOEM, nor does 

mention of trade names or commercial products constitute endorsement or recommendation for 

use. It is, however, exempt from review and compliance with the BOEM editorial standards. 

REPORT AVAILABILITY 

This report is available only in compact disc format from the Bureau of Ocean Energy 

Management, Gulf of Mexico OCS Region, at a charge of $15.00, by referencing OCS Study 

BOEM 2011-054. The report may be downloaded from the BOEM website through the 

Environmental Studies Program Information System (ESPIS). You will be able to obtain this 

report also from the National Technical Information Service in the near future. Here are the 

addresses. You may also inspect copies at selected Federal Depository Libraries. 

 U.S. Department of the Interior U.S. Department of Commerce 

 Bureau of Ocean Energy Management National Technical Information Service 

 Gulf of Mexico OCS Region 5285 Port Royal Road 

 Public Information Office (MS 5034) Springfield, Virginia 22161 

 1201 Elmwood Park Boulevard Phone: (703) 605-6040 

 New Orleans, Louisiana 70123-2394 Fax: (703) 605-6900 

 Telephone requests may be placed at Email: bookstore@ntis.gov

 (504) 736-2519, 1-800-200-GULF, or 

Rush Orders: 1-800-553-6847 

 Fax: (504) 736-2620 

CITATION 

Dismukes, D.E. and C. Peters. 2011. Diversifying energy industry risk in the GOM: Post-2004 

changes in offshore oil and gas insurance markets. U.S. Dept. of the Interior, Bureau of 

Ocean Energy Management, Gulf of Mexico OCS Region, New Orleans, LA. OCS 

Study BOEM 2011-054. 95 pp. 
v

ACKNOWLEDGMENTS

The authors wish to acknowledge the financial assistance of the Bureau of Ocean Energy 

Management in funding a portion of this study through the Coastal Marine Institute program at 

the Louisiana State University. Additional matching financial support for this study was 

provided by the Center for Energy Studies, Louisiana State University and its Industry 

Associates Advisory Board. 

During the course of this investigation, the authors received important and helpful input from 

several industry experts including: David Sharp, author of Upstream and Offshore Energy 

Insurance; Richard Martin, broker with J.H. Blades; James Granger, underwriter of Watkins 

Syndicate; and Riley Winchester, producer with Ross and Yerger. 
vii 

ABSTRACT

Hurricanes Ivan, Katrina, Rita, and Ike had significant implications for offshore oil and gas 

activities in the Gulf of Mexico (GOM). These “Big Four” hurricanes significantly changed the 

perception of oil and gas industry’s exposure to weather-related risks. This project surveys 

historic (pre-storm) offshore insurance markets and investigates insurance-related changes 

occurring after the advent of the Big Four storms. Each major offshore insurance type has been 

examined including commercial insurance coverage, mutualization coverage, insurance-linked 

securities, and self-insurance. The research finds that, while considerable offshore insurance 

changes have been made, post-storm insurance markets reacted in relatively expected ways by 

changing total coverage limitations, coverage terms, risk-sharing terms, and premiums. The 

more significant unexpected change rests with the higher annual informational requirements for 

insuring offshore assets and the greater degree of asset risk assessment and modeling that is now 

commonplace in the industry. 
ix

TABLE OF CONTENTS

Page

LIST OF FIGURES ....................................................................................................................... xi 

LIST OF TABLES.......................................................................................................................xiii 

EXECUTIVE SUMMARY ............................................................................................................ 1

1. INTRODUCTION................................................................................................................... 3

 1.1. Purpose of the Proposed Research .................................................................................... 3

 1.2. Organization of the Report............................................................................................... 3

2. FACTORS IMPACTING OFFSHORE INSURANCE RATES AND COVERAGE ............ 5 

2.1. Overview .......................................................................................................................... 5 

 2.2. Transportation-Related Risks........................................................................................... 5 

 2.3. Operator-Related Risks .................................................................................................... 6 

 2.4. Equipment-Related Risks................................................................................................. 6 

 2.5. Environmental-Related Risks........................................................................................... 6 

 2.6. Weather-Related Risks..................................................................................................... 9 

 2.7. The Role of Insurance in Mitigating Weather-Related Risks ........................................ 10 

3. FORMS OF OFFSHORE ENERGY INSURANCE............................................................. 15

 3.1. Self-Insurance and Captives........................................................................................... 15

 3.2. Private Insurance............................................................................................................ 17

 3.2.1. Types of Insurance Affected by Hurricanes ........................................................ 18

 3.2.1.1. Control of Well and Operator’s Extra Expense...................................... 19

 3.2.1.2. Offshore Drilling Insurance.................................................................... 19

 3.2.1.3. Offshore Liability Coverage................................................................... 20

 3.2.1.4. Repair or Replacement (Property Damage) ........................................... 20

 3.2.1.5. Offshore Removal of Wreck Insurance.................................................. 21

 3.2.1.6. Business Interruption.............................................................................. 22

 3.3. Mutualization ................................................................................................................. 23

 3.3.1. OIL Formation..................................................................................................... 24

 3.3.2. Original OIL Membership and Coverage ............................................................ 25

 3.4. Reinsurance .................................................................................................................... 29

 3.4.1. General Overview................................................................................................ 29

 3.4.2. Reinsurance Functions......................................................................................... 30

 3.5. Insurance-Linked Financial Instruments........................................................................ 31

 3.5.1. General Overview of Catastrophe Bonds ............................................................ 32

 3.5.2. General Overview of Contingent Capital ............................................................ 36

4. IMPACTS OF THE BIG FOUR HURRICANES ON OFFSHORE OPERATIONS........... 37

 4.1. Hurricane Ivan................................................................................................................ 38

 4.2. Hurricane Katrina........................................................................................................... 42

 4.3. Hurricane Rita ................................................................................................................ 47

 4.4. Hurricane Ike.................................................................................................................. 51
x

TABLE OF CONTENTS 

(continued) 

Page 

5. POST-HURRICANE OFFSHORE INSURANCE MARKETS ........................................... 57

 5.1. Private Insurance............................................................................................................ 57

 5.1.1. General Market Reaction..................................................................................... 57

 5.1.2. Offshore Insurance Cycles and Tropical Activity ............................................... 59

 5.1.3. Insurance Market Reaction: Hurricane Ivan........................................................ 60

 5.1.4. Insurance Market Reaction: Katrina and Rita ..................................................... 60

 5.1.4.1. Business Interruption.............................................................................. 61

 5.1.5. Insurance Market Reaction: Hurricane Ike.......................................................... 61

 5.1.6. Insurance Industry Reaction: Aggregate Limits.................................................. 61

 5.1.7. Insurance Industry Reaction: Lloyd’s Realistic Disaster Scenario..................... 62

 5.1.8. Insurance Industry Reaction: Hurricane Forecasting ......................................... 63

 5.1.9. Insurance Industry Reaction: Market Recovery ................................................. 63

 5.2. Mutualization Impacts and OIL ..................................................................................... 64

 5.3. Changes in Self-Insurance.............................................................................................. 73

 5.4. Reinsurance .................................................................................................................... 73

 5.5. Insurance-Linked Financial Instruments........................................................................ 76

 5.5.1. Parametric Bond Triggers.................................................................................... 77

6. CONCLUSIONS ................................................................................................................... 79

REFERENCES ............................................................................................................................. 83 

APPENDIX A............................................................................................................................... 93

APPENDIX B ............................................................................................................................... 95
xi

LIST OF FIGURES 

Page

Figure 1. Oil spills in the Gulf of Mexico.................................................................................. 8 

Figure 2. Transocean Ltd.’s Deepwater Horizon drilling rig fire .............................................. 9 

Figure 3. Timeline of API RP2A major milestones................................................................. 12

Figure 4. Steel commodity price changes, 2002 to 2010......................................................... 21

Figure 5. Crude oil and natural gas prices ............................................................................... 23

Figure 6. Annual OIL membership levels, 2001 to 2009 ........................................................ 26

Figure 7. OIL membership, unweighted gross assets by industry sector................................. 28

Figure 8. Total catastrophe bond issues................................................................................... 32

Figure 9. Total outstanding catastrophe bond contracts .......................................................... 33

Figure 10. A common catastrophe bond mechanism structure.................................................. 34

Figure 11. GOM OCS production and hurricanes ..................................................................... 37

Figure 12. GOM OCS active structures and hurricanes ............................................................ 38

Figure 13. Path of Hurricane Ivan.............................................................................................. 39

Figure 14. Ensco 64 drilling rig after Hurricane Ivan struck..................................................... 40

Figure 15. Hurricane Ivan maximum wind field and damaged/destroyed structures ................ 41

Figure 16. Hurricane Ivan, percent of crude oil and natural gas shut-in after peak 

shut-in....................................................................................................................... 42

Figure 17. Path of Hurricane Katrina......................................................................................... 43

Figure 18. Hurricane Katrina maximum wind field and damaged/destroyed structures ........... 44

Figure 19. Post-Katrina damage to the Ocean Warwick drilling rig ......................................... 46

Figure 20. Hurricanes Katrina/Rita, daily percentage shut-in, crude oil and natural gas .......... 47

Figure 21. Path of Hurricane Rita .............................................................................................. 48

Figure 22. Hurricane Rita wind fields and damaged/destroyed structures ................................ 49

Figure 23. Chevron’s Typhoon Mini-TLP after Hurricane Rita................................................ 50

Figure 24. Hurricane Ike storm path .......................................................................................... 52

Figure 25. Hurricane Ike wind fields and major damaged/destroyed structures ....................... 53

Figure 26. Hurricane Ike: shut-in percentages; crude oil and natural gas.................................. 55

Figure 27. Energy insurance market GOM premium versus claim (estimates)......................... 58

Figure 28. Lloyd’s of London 2009 Realistic Disaster Scenario............................................... 63
xii

LIST OF FIGURES 

(continued) 

Page

Figure 29. World energy total losses vs. estimated world energy premium.............................. 64 

Figure 30. OIL’s cumulative reported net incurred losses by geographic region (1972 

to 2008, million $) .................................................................................................... 65

Figure 31. OIL cumulative net incurred losses by geographic region (1972 to 2008) .............. 66

Figure 32. OIL cumulative reported net incurred losses by sector ............................................ 67

Figure 33. Estimated OIL incremental reported net incurred losses by sector.......................... 68

Figure 34. OIL annual balance sheet figures ............................................................................. 69

Figure 35. OIL net incurred losses and rates ............................................................................. 70

Figure 36. OIL member gross assets (OIL-insured value) ........................................................ 72

Figure 37. Annual catastrophe reinsurance rates (property reinsurance) .................................. 74

Figure 38. Guy Carpenter world rate on line index ................................................................... 75

Figure 39. Year-over-year reinsurance rates by region ............................................................. 76

Figure 40. Catastrophe bond issues ........................................................................................... 77

Figure 41. Willis Hurricane Index (WHI).................................................................................. 78
xiii

LIST OF TABLES 

Page

Table 1. Sample Information Compiled in BOEM OSTS Inspection and Assessment 

Reports...................................................................................................................... 13

Table 2. Vermont-Domiciled Energy Company Captives by Premium Issued as of 

December 31, 2008................................................................................................... 16

Table 3. OIL Membership by Country ................................................................................... 27

Table 4. Number of Platforms Destroyed and Damaged by Hurricane Katrina..................... 45

Table 5. Number of Platforms Destroyed and Damaged by Hurricane Rita.......................... 50

Table 6. Comparison of Damage and Costs of Recent Major GOM Hurricanes ................... 54

Table 7. Hurricane Loss Metrics ............................................................................................ 59 

Table 8. OIL Estimated Hurricane Claims ............................................................................. 65

Table 9. 2006 Reinsurance Market Entrants .......................................................................... 75
1

EXECUTIVE SUMMARY

Prior to 2004, offshore oil and gas operators tended to insure against hurricane-related risk in one 

of three different manners: traditional commercial insurance; mutualization; or self-insurance. 

Commercial insurance for the offshore oil and gas industry has tended to be structured in a 

fashion comparable to other types of high-cost energy assets: a level of coverage is defined, and 

a premium level and structure is assessed on that requested coverage. A deductible is typically 

defined that establishes a certain degree of risk-sharing between the oil and gas company seeking 

insurance, and the insuring company or parties. Like other forms of commercial insurance, a 

higher deductible can lead to lower premiums (insurance costs), given the higher share of risk 

assumption held by the insuring party. Lloyd’s of London, a form of international insurance 

exchange, is a commonly-recognized source of commercial insurance for the offshore oil and gas 

industry. 

Mutualization is another important form of insurance that can serve as competition or as a 

supplement to traditional commercial insurance for offshore oil and gas operators. Mutual 

insurance is often referred to as “club” or “pool” insurance and, as the name suggests, refers to a 

form of insurance where individual companies form a collective pool in order to “mutually” 

insure one another’s assets. The largest and most common form of mutual insurance in the 

energy business is Oil Insurance, Ltd. or “OIL.” 

Self-insurance is not necessarily a specific “form” of insurance that companies purchase, but 

rather a practice in which larger energy companies, typically those with a relatively large and 

diverse set of assets, diversify their exposure to external risks, including hurricanes. Selfinsurance is usually secured by the creation of some form or type of deferred account, the 

balances of which are allowed to accumulate to pay for potential losses from unforeseen events. 

Most integrated major oil companies have some significant levels of self-insurance, usually 

conducted through the creation of a special purpose affiliate that is dedicated to the task of 

insuring the parent’s, and often other subsidiaries’ assets. 

While hurricane exposure has been an ongoing threat to offshore operations since its earliest 

days, offshore oil and gas insurance experienced a period of significant duress starting with the 

tropical storm season of 2004, and continuing up to as recently as 2008. During this period, four 

major hurricanes leveled a swath of destruction across virtually the entire Gulf of Mexico 

(GOM) and all of the major sets of assets supporting energy exploration, production, 

transportation, and processing. The “Big Four,” including Hurricanes Ivan, Katrina, Rita, and 

Ike, imposed an inflation-adjusted total of some $25.25 billion in damages to energy 

infrastructure along the GOM: a combined level of destruction never before experienced over a 

relatively short period of time. 

A number of important lessons were learned by all parties during and after the Big Four 

hurricanes. The first, and primary lesson learned during this period is that, while the industry 

was significantly challenged, from both a logistical and financial perspective, insurance 

providers, and most all forms of insurance, were preserved. The logistical challenges during this 

period included the significant number of claims made by individual companies and the industry 

as a whole. The financial challenges during this period included the extreme stress placed on the 
2

balance sheet of a number of insurance companies and individual self-insurance subsidiaries 

between 2004 to 2008: insurance claims, on an individual and industry-level basis, reached totals 

not seen in the history of the oil and gas industry. 

The second important lesson learned during this period is the important role of reinsurance in 

diversifying the risk associated with high-cost assets such as deepwater oil and gas platforms and 

wells. Reinsurance can be thought of as insurance coverage for insurance companies. 

Reinsuring companies “purchase” a share of the risk portfolio held by traditional commercial 

insurance companies in return for some claim on the coverage premiums, in an attempt to profit 

from further risk diversification. Reinsurance companies were relatively newer players in the 

offshore oil and gas insurance market prior to the 2004 hurricanes, and have increased their 

presence in the market since that time. 

The third important lesson learned during this period is the role of information. Prior to 

Hurricane Ivan, the use of general industry standards and common understanding of asset types 

governed premium levels and coverage structures. The diverse nature of the destruction after 

Hurricane Ivan, and particularly after Hurricanes Katrina and Rita, forced commercial insurance 

providers to reassess this generalized approach. Today, commercial coverage is much more 

customized, and reflects a “richer” collection of asset-specific information and analysis than was 

common in years past. 

Prior to 2004, hurricane coverage tended to follow more discrete patterns that ebbed and flowed 

with tropical and weather-related events typically leading to claims. This practice was 

acceptable in prior years since individual storm-related events were typically not large enough to 

create dramatic changes in overall premiums and coverage terms. The last and perhaps most 

important lesson learned during and after the Big Four hurricanes is that offshore insurance 

coverage should be evaluated on a more continuous, evolutionary basis than the discrete 

practices of the past. Continuous evaluation and exposure modeling approaches have led to a 

greater degree of resilience for all types of offshore insurance, and, as consequence, preserved 

risk-adjusted affordability and availability for most types of offshore assets. 
3

1. INTRODUCTION 

1.1. Purpose of the Proposed Research 

Hurricanes Katrina and Rita inflicted considerable economic damage on the Gulf Coast 

economy. The impacts associated with oil and gas supply interruptions created by the hurricanes 

went beyond the region’s economy by impacting both national and international energy markets. 

These oil and gas supply interruptions occurred during perhaps one of the most inopportune 

times in the recent history of energy markets and underscored the need for diversifying energy 

industry risk in the Gulf of Mexico (GOM). 

This project investigates how the energy industry diversifies its risk exposure in general in the 

GOM, with a particular emphasis on insurance-related issues. Risk mitigation is secured through 

the use of various strategies, including but not limited to the following: the private insurance 

market, energy supply portfolio management, alternative resource development, and nontraditional markets such as hedge funds. All strategies, but most notably the private insurance 

market, have undergone significant changes in recent years. 

For example, the estimated insured losses to on/offshore energy industry infrastructure in the 

GOM due to hurricanes in the 2004 and 2005 season is approximately $9.4 billion. Wave action 

was the principal source of damage, followed by sea-floor instability, and wind. Immediately 

following Katrina and Rita, an expert panel estimated that the energy industry would see 

property damage premium increases in excess of 400 percent on offshore property and 

equipment, and 25 percent to 50 percent increases on onshore coastal property. Business 

interruption insurance, the availability of which was questioned at one time, was also expected to 

increase by 300 to 400 percent. Yet, as this report will show, while rates did increase 

considerably in the aftermath of 2005 tropical season, the offshore insurance industry did adapt 

and change in manners that reduced the potential premium increases to operators by requiring 

them to share in greater levels of weather-related risk. 

1.2. Organization of the Report 

This report is organized into six sections including the introduction and conclusion. Section 2 

investigates the factors impacting offshore energy insurance rates and coverage. Section 3 

describes the various forms and methods of offshore energy insurance including a description of 

self-insurance, private insurance, mutualization, reinsurance, and insurance-linked securities. 

Section 4 details the impacts that each of the major post-2004 hurricanes had on offshore oil and 

gas operations. Section 5 examines the post-hurricane reaction of insurance companies and 

offshore operators and how coverage rates, terms, and conditions changed as a result of the post2004 storm seasons. Section 6 presents the research conclusions and findings. 
5

2. FACTORS IMPACTING OFFSHORE INSURANCE RATES AND 

COVERAGE 

2.1. Overview 

Given the risky nature of offshore activities, it should come as no surprise that insuring against 

these risks is no trivial matter. Yet understanding the nature of “risk” is difficult without some 

further context including: (1) defining “risk;” (2) identifying the various types of risk facing 

offshore operations; and (3) examining how risk and insurance are related. 

Risk is a commonplace term that is used colloquially on an everyday basis in a fashion that tends 

to differ from the more theoretic and formal definition used in economics, finance, and the 

development of insurance products. For instance, a colloquial definition of risk suggests that risk 

is associated with unforeseen events. 

However, the more formal definition of risk is the combination of the likelihood (i.e., 

probability) of a harmful event and the severity of the damage created by that event when it 

occurs. This differs from uncertainty which is used more formally to connote the occurrence of 

events that cannot be measured. Frank Knight, an early twentieth century economist, considered 

the father of risk and uncertainty analysis in economics, noted this apparent dichotomy in the use 

of the term “risk” in practice and theory (Spiegel, 1983). 

In standard probability theory, risk is simply measured as the probability of an event occurring 

times the damage created by the occurrence of that event. Offshore oil and gas operations, for 

instance, have a number of relatively broad categories of “risks” each of which are measurable in 

terms of their frequency (i.e., number of occurrences) and their damage (the historically-report 

costs of the various types of incidents). As a general matter, offshore oil and gas operational 

risks can be categorized into those that are transportation-related, operator-related, equipmentrelated, environmental-related, and weather-related risks. 

2.2. Transportation-Related Risks 

Transportation risk arises in a number of forms, from vessels supplying offshore platforms to the 

transportation of mobile offshore drilling units. Transportation risk is a major concern within the 

offshore oil and gas industry (Fowler and Sorgard, 2000). Mobile offshore drilling units and 

offshore platforms are constantly tended by a number of vessels with specific duties. Crewboats 

are made specficially to shuttle workers from shore to rigs and platforms, while offshore supply 

vessels (OSVs) handle both shuttle crew and supplies. OSVs shuttle drilling fluids, cement, fuel, 

water, bulk cargo, and chemicals to rigs and platforms. The nature of handling fuel itself 

introduces a special risk to operating an OSV (Antonsen, 2009). Bulk cargo, especially that 

which is loaded and unloaded by crane, can introduce additional risk to personnel and the vessel 

itself. 

The Gulf of Mexico operating region averaged 24 vessel collision accidents per year from 2006 

through 2009. About two-thirds of those accidents caused more than $25,000 of damage 

(USDOI, MMS, 2010a). 
6

2.3. Operator-Related Risks 

Offshore oil and gas exploration and production is an inherently dangerous process fraught with 

risk that requires a significant amount of human labor to carry out. The nature of offshore rigs 

and platforms put humans in close proximity to volatile substances and chemicals. While 

processes and procedures have been developed to mitigate all types of risks, frequently the 

human condition of offshore workers (and also design flaws in the technology they use) can 

expose those risks. While the offshore oil and gas industry has spent significant sums of money 

in the name of creating a safety conscious culture on offshore rigs and platforms, operatorrelated risks due to error and negligence still exist. 

The federal Gulf of Mexico oil and gas producing region averaged 7.5 fatalities per year due to 

exploration and production activities (USDOI, MMS, 2010b). The majority of GOM fatalities 

on average during the period were drowning events. Further, in 2009, there were 133 operatorrelated fire or explosion events in the GOM rigs and/or producing platforms, though almost all of 

the events could be considered incidental. No fatalities were reported, but several injuries did 

occur. The Gulf of Mexico operating region averaged 128 fire or explosion events from 2006 

through 2009 (USDOI, MMS, 2010c). 

2.4. Equipment-Related Risks 

Equipment-related risks are also an important factor of offshore oil and gas activity and the 

insurance industry associated with it. Crane accidents and equipment defects and malfunctions 

create hazards for operating crews as well as the insurance companies that insure oil and gas 

companies against those risks. 

Operators work alongside regulators, standards organizations, and insurers to mitigate risk. 

Standards organizations such as the American Petroleum Institute analyze common preventable 

risks to determine best practices for risk mitigation. Through workshops and meetings with 

operators, the organizations formulate recommended practices that are often coopted as rules by 

regulators. Insurers act as a mechanism of indirect enforcement through insurance contract 

clauses that except coverage in the case that regulations and certain specified recommended 

practices are not followed (Aven and Vinnem, 2005). The Bureau of Safety and Environmental 

Enforcement (BSEE) regulates cranes by requiring lessees and operators to comply with the 

American Petroleum Institute’s Recommended Practice for the Operation and Maintenance of 

Offshore Cranes (API RP 2D), 5th Edition, June 2003; API RP 2A-WSD, Recommended 

Practice for Planning, Designing and Constructing Fixed Offshore Platforms – Working Stress 

Design, Twenty-first Edition, December 2000; and API Spec 2C, Specification for Offshore 

Cranes, API revised API SPEC 2C, 6th Edition, March 2004 (USDOI, MMS, 2010e). 

2.5. Environmental-Related Risks 

The environmental-related risks facing offshore drilling rigs and platforms are the most serious 

of all risks. Environmental risks include blowouts, fires and explosions, spills, unintentional 

discharges, pipeline strikes and failures, and platform strikes and failures. Environmental-related 

risks can be considered the most serious due to the interaction of consequences and the 

probability of an event. Three specific offshore environmental accidents help define the extreme 
7

environmental and financial damages that can result from accidental discharges from offshore 

accidents. These bellwether offshore environmental events include: (1) the 1969 Santa Barbara 

oil spill in California (discussed further in section 3.3.1); (2) the 1979-1980 IXTOC I spill off the 

Mexican coast on the GOM; and (3) the 1989 Exxon Valdez tanker-related accident in Alaska.

The Santa Barbara oil spill of 1969 is commonly attributed as the catalyst for the modern 

environmentalist movement. The oil spill resulted in 80,000 to 100,000 barrels (Bbls) of crude 

oil washing up along the beaches of Santa Barbara County (County of Santa Barbara, 2010). 

The public reaction to the spill resulted in at least two new major laws being passed to ensure 

greater protection for the environment. On January 1, 1970, the National Environmental Policy 

Act (NEPA) was signed into law. The law created requirements for federal government agencies 

to prepare Environmental Assessments (EAs) and Environmental Impact Statements (EIS) for 

actions they propose to take “significantly affecting the quality of the human environment 

(NEPA, 1969).” A second policy innovation as a result of the spill was the Coastal Zone 

Management Act (CZMA). The Act was the first step towards the creation of a governmental 

mechanism to systematically manage the nation’s coastlines. The Act encouraged states to work 

in conjunction with the federal government to establish subset zones within each states’ waters 

(CZMA, 2006). 

Prior to the Deepwater Horizon oil spill, the record holder as the largest oil spill in the Gulf of 

Mexico offshore oil and gas industry’s history was the IXTOC I oil spill which occurred on June 

3, 1979. Estimates place the amount of oil spilled per day between 10,000 and 30,000 barrels 

until March 23, 1980, when the well was finally capped (USDOC, NOAA, 1979).

The third historic offshore environmental accident to influence the oil and gas industry was 

actually a transportation-related event and occurred when the oil supertanker Exxon Valdez ran 

aground on Bligh Reef in Prince William Sound, Alaska (USDOC, NOAA, 1989). The spill 

would ultimately result in about 264,000 Bbls of oil being spilled in Prince William Sound 

(USDOC, NOAA, 1989). The spill would usher in the Oil Pollution Act of 1990 (OPA 90), that 

would govern the formal response to an oil spill designated as one of “National Significance.” 

The Act required oil companies to plan to prevent spills that may occur and to have a detailed 

containment and cleanup plan on file (Center for Wildlife Law, 2009). 
8

Figure 1. Oil spills in the Gulf of Mexico. 

Figure 1 shows the historic trend in GOM oil spills since 1964. The chart generally shows that 

spill performance has improved significantly since the historic highs experienced during the 

decade between 1964 to 1974. While total spills are down relative to the historic highs, there 

have been a few years where small, but stubborn, spills have increased including 2004, 2005, and 

2008. These years, however, correspond to each of the Big Four hurricanes (2004-Ivan, 2005-

Katrina/Rita, 2008-Ike) and highlight the “compound” events (risks) that can occur on the GOM. 

The environmental and safety performance of offshore oil and gas operators in the GOM has 

been studied in considerable detail by Pulsipher et al. (1998 and 1999) and will not be belabored 

here. Despite what has been a relatively stellar past oil spill performance history, accidents can 

and do happen. The single most notable reminder of the severity of offshore environmentalrelated accidents has been the BP-Deepwater Horizon accident (Figure 2). 

Source: USDOI, MMS, 2010d. 
9

 Figure 2. Transocean Ltd.’s Deepwater Horizon drilling rig fire. 

On April 20th, 2010 the Deepwater Horizon, a semi-submersible drilling rig owned by 

Transocean Ltd., and operating in 5,000 feet of water, exploded in an accident of unparalleled 

magnitude in North America. The rig was under contract by BP and drilling in the Macondo 

field to a sub-surface depth of approximately 18,000 feet. To date, about 5 million barrels of 

crude oil have been spilled or released as a result of the accident. Early estimates of the total 

damage of the event are in the range of $30 billion (Upstreamonline.com, 2010). While the 

purpose of this research focuses on offshore weather-related risks and changes in insurance 

resulting from the Big Four hurricanes, it is likely that the BP-Deepwater Horizon accident will 

have at least equally-significant ramifications and likely be the subject of future research. 

2.6. Weather-Related Risks 

Few industries are as susceptible to weather-related risks as the offshore oil and gas industry. 

Offshore structures, located entirely in a marine environment, are typically fixed or moored to a 

fixed location with little ability to physically move to avoid inclement weather. Even on a 

“good” weather day, offshore structures and equipment are exposed to waves, wind, sun, heat, 

salt, water spouts, and lightning strikes. These factors can create a range of damage that may 

seem as minor as accelerated equipment and structure “wear and tear” to complete destruction 

and potential loss of life. 

Source: USDHS, USCG, 2010. 
10

Perhaps the biggest weather-related risk and the primary purpose of the instant research are those 

created by catastrophic hurricane activity. Hurricane-related risks have existed since the 

beginning of offshore oil and gas activities along the GOM in the late 1940s. What differs, and 

will be discussed in greater detail in Section 4 of this report, has been the significant increase in 

the destructive capability of these storms over the past several years. 

2.7. The Role of Insurance in Mitigating Weather-Related Risks 

The general purpose of insurance is to mitigate risks. In their simplest form, insurance markets 

are comprised of buyers and sellers of risk mitigation products. For the offshore oil and gas 

industry, insurance is secured for a variety of different risks that go beyond just physical damage 

to structures and equipment and can include insuring against a wide range of liabilities and 

business interruptions and contingencies. These types of products are explained in greater detail 

in Section 3 of this report. 

Since risks have some degree of measurability, both in terms of frequency and damages, the 

value of “fair” insurance is simply the expected value of a negative outcome, where “fair,” in this 

instance, is simply insurance with no economic “profit.” Sellers offer insurance to buyers 

because these sellers have the ability to manage risks in a more efficient (i.e., lower cost) manner 

than buyers. Gains from mutually-beneficial trade occur between these two parties since a seller 

can make a certain degree of profit by mitigating the risk of a buyer at a rate lower than the 

buyer’s opportunity cost of mitigating that risk himself. 

The degree of that profit (seller) or benefit (buyer) retained by either party in an insurance 

transaction is a function of a variety of factors that include market structure (i.e., number of 

buyers and sellers) and the degree of information available about the insurance purchaser’s 

actions and past performance. The system works well so long as competitive market conditions 

exist on both sides of the market (buyer and seller): when these fail, prices (premiums) can 

increase or coverage can become restrictive, resulting in less than optimal market outcomes. 

On the seller side of the market, market power and market concentration can lead to potential 

market failures if there are barriers to entry limiting the number of offshore insurers. Longer 

term market concentration can lead to outcomes where a few companies have the opportunity to 

raise prices and to artificially restrict coverage to levels that are not supported by changes in 

overall operating risks (i.e., costs). Such an outcome would prejudice offshore insurance 

purchasers, leading to unfair and unreasonable premiums and coverage terms. 

Market failures can also arise on the buyer’s side of the market also leading to market failures 

and inefficiencies. Insurance, for instance, can suffer from “moral hazard” problems that arise in 

instances where an economic agent facing a certain degree of risk behaves differently when it is 

insulated from that risk than it would if the risk were not insured (Nicholson, 1990). Moral 

hazard is, in effect, the behavioral difference that results from the presence or introduction of 

insurance. Moral hazard results in a “market failure” or inefficiency because the agent receiving 

the insurance does not have to bear the full responsibility for its actions. 

An example of potential moral hazard problem in public policy has been the 2009 – 2010 

banking and financial crisis that led to policies bailing out banks and other financial institutions 
11

considered “too big to fail.” Many financial institutions were given billions of dollars in bailouts and other forms of financial support to buttress their financial positions devastated by past 

risky lending actions. Some analysts have argued that these policy actions have done nothing to 

correct the underlying problem leading to the 2009 financial crisis and in fact, in the long run, 

may have exacerbated these problems since in the future banks may use this policy precedent as 

support for future rescue actions from continued risky practices (Wilson and Wu, 2010; Hakenes 

and Schnabel, 2010; Helwege, 2010). 

Moral hazard problems are created by informational asymmetries or instances when the insuring 

party does not have complete information about the buyer’s willingness and efforts to avoid, or 

mitigate risk. Often, insurers have to turn to other means of acquiring information that provides 

“signals” about the types of risk to which buyers are potentially exposed. As will be shown in 

later sections of this report, the informational requirements for offshore oil and gas insurance 

coverage have increased exponentially since the Big Four hurricanes. 

Historically, offshore insurance providers have mitigated potential moral hazard problem by 

relying upon an examination of offshore operators’ compliance with a combination of standards, 

common practices, and regulatory oversight to mitigate financial risks created by offshore 

weather-related events, including hurricanes. Standards included in such guidelines as the 

American Petroleum Institute’s (API) Recommended Practice 2a (RP2A) publications, and the 

International Standards Organization’s 1990X-X, serve as the basis for modern offshore structure 

design in the GOM (Laurendine, 2007). These standards specifically address the meteorological 

and oceanographic challenges created by hurricanes and provide physical recommendations that 

are designed to mitigate the structural damages created by these weather-related events. 

Mandatory compliance with these standards, as well as other government-created standards and 

guidelines, are commonplace. 

API issued its first set of RP2A standards in 1969 after hurricanes Hilda and Camille created 

considerable structure/structural damage. Since that time the RP2A standards have undergone a 

number of revisions and are currently on their 22nd edition. Figure 3 provides a timeline for the 

major developments and revisions in the RP2A structural regulations and guidelines. 
12

 Figure 3. Timeline of API RP2A major milestones. 

Insurance companies continue to rely heavily on standards and regulatory oversight in 

determining exposure to financial risk from structure damage to offshore assets. However, as 

will be shown later in this report, standards and guidelines are simply not enough. The tropical 

storm seasons beginning in 2004 created a new environment for insuring against weather-related 

risk. These storms highlighted the structural diversity of the industry, as well as the implications 

that significant storms could have on very large and diverse assets that range from underwater 

gathering systems, to traditional fixed platform structures in shallow waters of the Gulf of 

Mexico (GOM), to massive deepwater production and processing facilities. The key to 

providing insurance for these assets is understanding their diversity and potential exposure, and 

the key to understanding this diversity is through information. 

Thus, today’s offshore insurers conduct considerable analyses and have considerable information 

requirements prior to covering offshore operating companies and/or their assets. Specific asset 

information is always required prior to entering into a traditional insurance agreement that 

includes platform deck height (air gap), age of structure, wave height, historical levels of 

subsidence, proneness to mud slides, environmental impacts, existing corrosion, and damage 

from previous hurricanes. One basic set of information utilized by these insurance companies 

includes the Bureau of Ocean Energy Management (BOEM) Office of Structure and Technical 

25 – 100 year criteria?

Quality 

Joint 

Equations

Modern 

Design 

Code

Reassessment 

Activities 

(AIM)

MMS 

Inspection 

Program 

Begins 

Updated 

Wave 

Load 

Recipe

Existing 

Platform 

Assessment

Pre – RP 2A

Early –

RP 2A Modern – RP 2A

Hurricanes Industry 

Standards

DesignPractice

1950 1960 1970 1980 1990 2000

‘48 ‘64 ‘69 ‘72 ’78 ‘82 ‘84 ‘89 ‘91 ‘92 ‘93 ’97

Hilda 

Failures

Camille 

Failures

Juan 

Failures

(manned)

Andrew 

Failures

API RP 2A 

1st 

Edition

API RP 2A 

9th Edition

API RP 2A

Supplement 1 

Section 17

API RP 2A 

19th Edition

API RP 2A 

20th edition

Source: API, 2009; Versowsky, 2006. 
13

Support (OSTS) Inspection Reports as well as their Annual Platform Assessment Reports. A 

sample of the information provided in these reports is summarized in Table 1. 

Table 1 

 Sample Information Compiled in BOEM OSTS Inspection and 

Assessment Reports 

Platform Identification Platform Type Platform Design

Area code Structure type Exposure category

Block number Water depth Deck height

Structure name Longitudinal framing Soil data

Complex ID number Transverse framing Number of decks

Structure number Number of Well conductors

Field

Installation Date

Authority type

Authority number

Authority Status

 Source: Laurendine, 2007. 

One of the more obvious and important types of information considered in the development of 

insurance premiums and coverage terms for an individual structure is its age or vintage. The age 

of a facility provides important information on the likely structural stresses the platform can 

withstand, the potential wear and depreciation of the asset, and the replacement or insurance 

value should the structure become completely destroyed.1 Another important factor influencing 

offshore coverage and premiums includes the measured distance between the sea level and deck 

structure (air gap). Recent experience supports the perception that older structures are more 

prone to hurricane wave damage due to antiquated design, along with seabed subsidence that in 

many cases reduces an already deficient air gap (Det Norske Veritas, 2006). Hurricane wave 

heights are the most important factors that affect offshore structures and influence design 

standards. Prior to Hurricanes Katrina and Rita, air gap information was not generally required 

by insurers (Slanis and Shockley, 2010). 

Potential mudslide exposure is a new insurance coverage consideration arising from the 

experiences of Hurricane Ivan in 2004. During Ivan, and to a lesser extent after Katrina, a 

significant number of important pipelines were exposed to damages create by underwater 

mudslides along the seafloor. During Ivan, 16 underwater pipelines (part of larger gathering 

systems) were damaged by underwater mudslides. These mudslides created two insurance 

 

1Most policies reimburse coverage holders for the fair market value of damaged or destroyed asset. Fair 

market value is typically defined as replacement value less depreciation, which is commonly a function of age 

(Sharp, 2009). 
14

challenges since (1) pipelines were damaged and had to be replaced and (2) the 

damage/destruction associated with these pipelines interrupted considerable energy supplies 

from reaching the beach during a high market price period, resulting in considerable business 

interruption (BI) claims not only for pipelines, but operators as well. In today’s offshore 

insurance market, operators are required to provide more information on localized gathering 

systems and interconnection opportunities associated with the insured structure (Slanis and 

Shockley, 2010). 
15

3. FORMS OF OFFSHORE ENERGY INSURANCE

3.1. Self-Insurance and Captives 

Most major oil and gas companies, particularly those referred to as “super majors,”2

 have 

balance sheets, and asset bases, that are larger than the insurance companies that it contracts with 

for coverage. For instance, seven of the top twenty companies in the world, as valued by market 

capitalization, are energy companies, while only one is associated with insurance (Financial 

Times, 2009). Thus, many oil and gas companies have asset bases they can leverage themselves, 

in order to protect (or insure) against certain types of isolated events such as hurricane damage in 

the GOM. While many upstream oil and gas companies engage in a multi-pronged approach to 

risk management, the largest companies typically rely on a strategy of either mutualization 

and/or self-insurance. 

Self-insurance is more of a strategy of insuring against risk rather than an explicit form of 

insurance that is purchased in the market. Companies pursuing self-insurance typically create 

what is referred to as a “reserve fund,” or “affiliate reserve fund,” to protect against 

unanticipated events. A reserve fund can be generally described as a relatively large savings 

account into which the self-insuring company deposits an amount of money (capital) to serve as 

a financial base to call upon during an adverse event. The capital, or contributions, made to the 

reserve fund are comparable to the premiums that would be made to a private insurance 

company. The primary difference between traditional insurance and self-insurance is that the 

self-insuring company actual pays the premiums (or makes contributions) to itself rather than a 

third party. Companies will evaluate the merits of self-insurance at the margin: meaning that if 

the self-insuring company can insure itself cheaper than what is being offered in the market it 

will do so; otherwise, it will purchase traditional insurance. Thus, if large profit premiums, or 

cost inefficiencies, start to become embedded in overall coverage premiums, larger companies 

may find that providing its own insurance is more cost-effective (Bawcutt, 1987). Given the size 

and scope of many super majors, and their diversified asset bases (and earnings streams), many 

can secure capital to fund insurance operations at a cost considerably lower than insurance 

companies themselves (Bawcutt, 1987). 

An “affiliate reserve fund” is simply a reserve fund that has been created, and booked for 

financial reporting purposes, to an affiliate, or subsidiary company of a larger energy company. 

These affiliate reserve funds typically become stand-alone affiliates or operating companies 

themselves, and their sole function is to internally insure (or finance risk) for the parent 

company, other operating affiliates, and sometimes partners, joint venture or special purpose 

projects, and in some instances other project contractors. Affiliate reserve funds created by super 

majors and other energy companies are referred to as “captive insurance companies” given their 

specialized function (Bawcutt, 1987). 

The rationale for self-insurance can extend beyond the simple economics of comparative costs 

with more traditional forms of insurance. For instance, one benefit offered by self-insurance is 

the general financial insulation from market cycle swings in the insurance business. Selfinsuring companies with operations in the GOM, for instance, were likely to have received 

 

2

Super Majors: ExxonMobil, Royal Dutch Shell, BP, Chevron Corporation, ConocoPhillips, Total S. A. 
16

considerable benefits during the period between 2004 and 2008 when premiums leaped in the 

aftermath of several damaging hurricane seasons (Willis Group Holdings, 2008). Self-insuring 

companies are also likely to reduce its overall transactional costs of insurance and in many 

instances, can create greater flexibilities for coverage that may not be available in the market. 

There can also be a number of additional tax benefits created by self-insurance depending upon 

the nature, format, and structure that self-insurance takes (Adkisson, 2006). 

Another benefit of captives is that they allow the parent company to internalize the knowledge 

associated with brokering insurance. The company learns intimate knowledge of its risks and 

losses, this in turn, allows the company to avoid paying external brokers a markup when 

negotiating with reinsurers through its captive. The company also has the benefit of having an 

insurance company whose interests are completely in line with the parent company’s interests. 

Usually companies take advantage of this knowledge by making the captive an integral part of 

their risk management teams (Adkisson, 2006). 

Many captive companies are located offshore, or in specific states of the U.S., for competitive 

reasons centering on taxation and regulation (Adkisson, 2006). Bermuda, Vermont, and Utah, 

for instance, have become major centers of domicile for captives. Utah has ramped up an 

economic development program with the purpose of attracting captive insurance companies 

beyond the 148 companies already domiciled within the state.3

Vermont manages a website with the specific purpose of wooing potential captives to establish 

headquarters/domicile within the state (Vermont Captive, 2010). Vermont was home to 26 

energy industry captives in 2008 with the top six provided in Table 2. 

Table 2 

 Vermont-Domiciled Energy Company Captives by Premium Issued 

as of December 31, 2008 

Captive Name Parent

Ancon Insurance Company ExxonMobil Corporation

Sooner Insurance Company ConocoPhillips

Noble Assurance Company Royal Dutch/Shell Group

Colonnade Vermont Insurance Company Valero Energy Corporation

Iron Horse Insurance Company Chevron Corporation

AES Global Insurance Company AES Corporation

Yorktown Assurance Corporation Marathon Oil Company

National Grid Insurance Company Keyspan Corporation

Ashmont Insurance Company Ashland, Inc.

Energy Risk Assurance Company Ameren Corporation

 Source: Risk and Insurance Magazine, 2009. 

 

3Utah also has its own website with the purpose of reaching out to potential captive insurance companies.
17

3.2. Private Insurance 

The private insurance market for offshore oil and gas insurance is comprised of two primary 

parts: (1) mutualization (pooling of risk between similarly-situated companies) and (2) 

traditional or “commercial” private insurance. While there are two components to this industry, 

it is rarely the case that they operate entirely independently of one another and, in fact, typically 

tend to work in ways that mutually assist, or reinforce, their various risk mitigation services. For 

instance, in some cases, particularly for large oil and gas companies, the commercial market will 

write policies that “wrap” primary mutualization coverage.4

 For companies not participating in 

some form of mutualization, the commercial market may write those companies’ entire GOM 

asset base. 

Increasing platform cost and complexity, particularly for deepwater operations, has led to the 

emergence of a number of new players in commercial insurance market that are commonly 

referred to collectively as “reinsurers” or the “reinsurance market.” Reinsurers help diversify the 

risk of primary commercial insurance companies: in other words, reinsurance companies are 

insurance companies for insurance companies. 

Reinsurers frequently purchase the “excess” capacity

5

 in addition to capacity offered by direct 

market insurers. For example, if a direct market insurer’s capacity to write an individual risk 

was limited to two billion dollars, but the total single site value that the client wished to have 

insured was three billion dollars, the direct market insurer may turn to a reinsurer to assist in 

covering the difference. In the case of a claimable catastrophe, the direct insurer would be liable 

for the entire three billion dollar policy, but could turn to a reinsurer for any losses beyond his 

two billion dollar capacity. 

Interactions between mutualization pools, commercial insurance companies, and reinsurers help 

spread the risk of increasingly large deepwater assets, and require a large amount of 

understanding and coordination, especially between direct insurers and reinsurers. Brokers are 

largely those who help facilitate these interactions between each of these major players, as well 

as the companies seeking insurance themselves. Typically an oil company interested in offshore 

energy insurance will solicit a broker, who will develop an insurance package that is shopped to 

direct insurers. While some insurance companies can write smaller risks without the help of one 

or more reinsurers, it is becoming increasingly uncommon, especially for high value deepwater 

platforms and large platform fleets. 

Much of the commercial insurance market is physically located in London. Lloyd’s of London 

(Lloyd’s), a type of insurance exchange, with a physical location similar to the New York Stock 

Exchange, serves as a meeting place for insurers and brokers. Underwriters are employees of an 

insurance company who negotiate and write policies and define the terms of insurance contracts 

that assign risk to various parties in return for financial payment (profit) and assurances. An 

underwriter’s seal must be affixed to each commercial policy. At Lloyd’s, underwriters work in 

what are called “syndicates” that represent a group of underwriters serving as gate keepers for 

 

4To “wrap” an insurance policy is to use a separate additional insurance policy to cover risks not insured by that 

policy.

5Capacity is defined as the value of the largest single-site asset to be insured.
18

participating companies signing new policies. The members6 of Lloyd’s provide capital, and the 

syndicates7 exercise that capital based on their best professional judgment. Lloyd’s brokers work 

with the syndicates employed by direct and reinsurance companies to find a solution for offshore 

oil and gas companies. In some instances, a direct insurance and reinsurance company may exist 

under the same roof, as in the case of the Watkins Syndicate, the largest GOM direct insurer 

(Granger), and Munich Re, the world’s largest reinsurer (Aglionby, 2009). 

In addition to direct market participants such as brokers, direct insurers, and reinsurers, there are 

several boards and associations influencing the underwriting of offshore oil and gas risks. For 

example, the London Market Association’s Joint Rig Committee is a group of industry experts 

that produces recommendations for the industry, including many standard policy wordings.

(London Market Association, 2010). While the Committee is non-binding, their 

recommendations are near-universally accepted by the industry (Sharp, 2009). 

The Lloyd’s Franchise Board is another important member of the Lloyd’s exchange and 

supervises syndicate accountability for the risks they have underwritten since each Lloyd’s 

syndicate is collectively backed up by all Lloyd’s members. The “Realistic Disaster Scenarios” is 

a recent tool developed in 2006, after Hurricanes Katrina and Rita, that assists the Franchise 

Board in quantifying syndicate exposure to various types and degrees of risk. For instance, each 

year a specific hypothetical GOM hurricane will be created, and each syndicate is required to 

define and quantify their exposure according to pre-defined parameters such as gross insured 

losses, storm track, wind speed, wave heights, storm surge, and specific infrastructure affected. 

The process forces syndicates to follow their stated beginning-of-the-year underwriting goals in a 

strict manner. This approach is a prime example of the ways in which the commercial insurance 

market has adapted to changes in risks from the major hurricane events that began in 2004. 

3.2.1. Types of Insurance Affected by Hurricanes 

Offshore oil and gas insurance is typically sold as a package of individual policies all pooled 

together into one over-arching “umbrella” policy. Some of these individual, separate policies 

had little to nothing to do with weather-related risks created by hurricanes such as construction 

insurance or workers compensation. A large number of these individual policies, however, could 

be impacted, and impacted considerably by offshore weather-related events such as business 

interruption, removal of wreck, and liability coverage. Well control insurance, commonly 

written under what is referred to as a “making wells safe” rider, can also include weather-related 

considerations (Sharp, 2009). A number of these individual policies, their purposes, structure, and 

conditions, are described below. 

 

6The members of Lloyd’s are a group of participating insurance companies that individually and jointly employ 

syndicates. Each member is a franchise of Lloyd’s, independently owned, but subject to collectively decided rules 

administered by the Lloyd’s Franchise Board.

7A syndicate is a group of underwriters housed at Lloyd’s who are either individually or jointly employed by 

Lloyd’s members (insurance companies) to examine and decide which insurance policies to grant on behalf of 

members.
19

3.2.1.1. Control of Well and Operator’s Extra Expense 

Control of well (COW) insurance was the first form of offshore oil and gas insurance offered to 

offshore oil and gas companies. COW coverage was first offered in the 1940s by insurers located 

at Lloyd’s and has now evolved into what is called “operator’s extra expense” coverage (Hoare, 

2009). COW coverage now protects oil companies from the costs associated with re-drilling or 

well safety protection. COW insurance protects oil and gas companies from losses occurring 

from a blowout, cratering, or loss of well control created by an adverse weather event like a 

hurricane. Today, the London market combines COW and “extra expense” coverage under a 

standard form approach, call the “Energy Exploration and Development 8/86 Form” (EED 8/86) 

form (Granger, personal communication, 2009). 

COW insurance can also include a number of riders and amendments. Two common COW 

riders include a “making wells safe” (MWS) rider and an “extended re-drilling and restoration 

cost” (ERRC) amendment. A MWS rider protects operators from losses arising from well reentry requirements created by a damaged or destroyed rig or platform.8

 This type of coverage is 

common in the GOM and has incurred significant claims with each hurricane. An ERRC 

amendment provides financial protection to an operator seeking to rework a damaged well 

instead of plugging and abandonment. 

3.2.1.2. Offshore Drilling Insurance 

GOM offshore drilling insurance policies are typically based upon one of two standard policy 

wordings: (1) the “American Institute Hull Clauses” and (2) the “London Standard Drilling 

Barge Form” (and its derivatives) (Sharp, 2009). 

Colloquially called the “American Form,” the standard policy wording of the American Institute 

Hull Clauses (AIHC) was first published on June 2, 1977 (Sharp, 2009). Many GOM drilling 

rigs are insured by policies adopting the AIHC. The form is adaptable and can cover partial or 

total loss. The standard wording included in the AIHC includes a pre-defined list of events or 

accidents (called “named perils”). These “named perils” include events that can impact GOM 

offshore drilling rigs such as explosions, collisions, and pass-through “pilotage and towage” 

indemnity. Relatively few exclusions are individually listed on the AIHC, but war and strikes 

are two common exclusions that have been specifically identified. Drilling rigs are also 

restricted to certain pre-defined geographical location parameters. 

The London Standard Drilling Barge form (LSDBF), the most commonly used standard policy 

wording for GOM drilling insurance, was first published on March 9, 1972 (Sharp, 2009). The 

standard policy wording included in the LSDBF represented the first insurance form specific to 

offshore drilling. Prior to the LSDBF, drilling rigs were covered under definitions applicable to 

other forms of standard marine commercial insurance. The form has since been updated and is 

now referred to as the “London Market Offshore Mobile Unit” form (LMOMUF). The new 

LMOMUF is characterized as an “all risks” form indicating that damages from all forms of 

negative events can be claimed with the exception of those specifically listed. The LMOMUF 

also imposes geographical navigational limitations on insured drilling rigs much like the AIHC. 

 

8

See Appendix A.
20

Such limits are usually defined by contract parameters, and navigation beyond those parameters 

requires prior insuring company approval. 

3.2.1.3. Offshore Liability Coverage 

Many upstream and offshore oil and gas companies will sign policies insuring against 

operational liabilities with their offshore activities. These policies cover damages created by the 

destruction of another party’s property, injury, and loss of life. Since a single platform may have 

numerous contracted entities working in close proximity, a web of bilateral indemnity is 

typically created. That is, each company will reciprocally write indemnity for the operator and 

other contractors working on the platform. These series of indemnities are not formal insurance 

company policies or riders, but standard legal and contracting conventions that have the effect of 

allocating (or clearly defining) risk to each participating party. In the past such a web of 

indemnity, and in some cases a lack of it, has created contention among the parties when an 

accident occurs (Sharp, 2009). 

Liability insurance tends to be a very customized product in the offshore insurance industry. 

Coverage can be obtained specifically for environmental damage, risk assumed from already 

completed projects, directors’ and officers’ liability, injury by chemicals or other products, 

professional liability, risk arising from chartering vessels, towing liability, service contracts, 

helicopter and vessel liability, control of wild wells, removal of wreck or debris, to name a few 

examples (Sharp, 2009). Ultimately, oil and gas companies will work with brokers to assess the 

cost of purchasing insurance on each of these various types of risk and will make cost-benefit 

assessments on their purchase. 

Commercial liability insurance tends to seamlessly switch from a platform construction policy to 

an operating policy once construction is complete and a certain number of agreed upon 

contractual parameters are met. The same is true for wells that are covered under an AIHC and 

LMOMUF policy, but switch to an operating policy once completed. While construction policies 

are typically purchased jointly by partners in the case of a joint-venture (JV), separate policies 

will be purchased by each party with respect to operations (Sharp, 2009). The interaction of 

multiple policies create an additional complexity, but one that the market (and presumably the 

operators) prefers since multiple contracts arise on a regular basis. Generally, it is the project 

operator that assures the coordination of the partners’ policies should the project be part of a JV. 

Operating insurance policies are typically renewed every twelve months. Policy duration 

typically balances oil companies’ wish to minimize transaction costs with insurance companies’ 

desire for capital mobility. 

3.2.1.4. Repair or Replacement (Property Damage) 

There are three main types of offshore property insurance that reimburses owners for either 

repair or replacement costs resulting from an adverse event or peril. The first, and oldest, is 

commonly referred to as “off-the-shelf” or “like-for-like” replacement (Sharp, 2009). This type 

of policy reimburses an insured party for the replacement cost of an offshore platform or well. 

However, since the replacement process itself can span a period of over a year, offshore 

operators worked with insurers to develop an additional contingency deemed “increased cost of 

repair or replacement” coverage that includes inflationary adjustments (Sharp, 2009). Steel price 
21

increases as shown in Figure 4 during the 2007 through 2008 time period, in particular, created 

significant repair and replacement challenges for insurers in the aftermath of Hurricane Ike. 

Combined, both types of insurance cover the dual risks of (a) the repair or replacement of the 

platform and/or well, and (b) any inflation associated with equipment and materials costs for 

making repairs or replacements. 

0

50

100

150

200

250

300

2002 2003 2004 2005 2006 2007 2008 2009

Steel Prices (2002 = 100)

Ivan

Katrina

Rita

Ike

 Figure 4. Steel commodity price changes, 2002 to 2010. 

The third form of repair or replacement insurance is commonly referred to as “total loss only.” 

This form of insurance is especially important for companies in the GOM since it extends repair 

or replacement coverage to the additional cost that may be incurred after-hurricane, such as subsurface costs, like reconnecting pipelines and re-drilling wells. Total loss insurance will cover 

supplemental repair and replacement activities as an excess, typically at a lower marginal rate 

than the main repair or replacement policy (Sharp, 2009). However, like any other repair or 

replacement policy, total loss only insurance reimbursements will discount replacement costs for 

reservoir depletion and depreciation. 

3.2.1.5. Offshore Removal of Wreck Insurance 

Removal of wreck (ROW) coverage is typically written as part of property damage coverage. In 

its simplest form, ROW covers an operator’s legal obligation to remove a hurricane destroyed 

platform and its sub-components. Removal of risers, subsea Christmas trees, casing, and 

wellheads are covered under this type of policy. Wells are typically insured against hurricane 

damage, along with platforms, through an additional rider on a ROW policy. Another approach 

requires oil and gas companies to identify specific wells for ROW coverage with intention of 

either replacement or re-drilling in the event of weather-created damage. 

Some ROW reimbursement controversies have arisen in recent years over what constitutes a 

proper and fair claim for the removal of structures and equipment associated with non-producing 

or uneconomic wells. While insurance companies recognize that oil and gas companies are 

Source: USDOL, BLS, 2010. 
22

entitled, at least in some cases, to some measure of replacement value for these uneconomic 

platforms, such cases were likely to lead to what insurance companies viewed as a forwardlooking “moral hazard” problem.9

 

In other words, if insurance companies continue to make operators completely whole for 

hurricane-created losses associated with uneconomic structures, then operators will have lower 

incentives (to the extent allowed by regulations) to remove these structures on their own, and 

will wait for adverse weather related events to seek damages to cover for what should otherwise 

be a normal removal and abandonment cost. This moral hazard problem has been solved by the 

creation of a new assessment and replacement approach referred to as “dual value,” which limits 

recovery, on a percentage basis, to the remaining share of producible reserves associated with an 

insured structure. 

3.2.1.6. Business Interruption 

BI insurance is primarily designed to protect an oil and gas company from lost operating 

revenues resulting from a shutdown in operations. BI coverage may also include insuring 

against financial losses associated with post-storm reductions in energy production. BI insurance 

coverage is very important for many small to mid-size GOM operators that must seek to 

financially protect themselves from a hurricane-created shutdown. 

BI policies are typically issued with a waiting period that functions like a deductible. Once a 

shutdown or business interruption occurs, the company must wait a certain number of days 

before BI claims can be paid out (Willis Group Holdings, 2006). Recent tropical activity and 

high energy prices have significantly increased the waiting periods for BI reimbursements in the 

GOM insurance market. Prior to the 2004 tropical season, BI waiting periods averaged around 

30 days. This number has increased to sixty days post-Ivan (Geisel, 2007). 

BI policies are typically written to cover only net revenue. Factors used to “net out” revenue 

recovery amounts include the typical outage time for workover or routine maintenance, royalties 

or taxes, or other known factors created by planned production outages (Sharp, 2009). Some 

scaled-down BI policies only aim to cover interest on loans and overhead or forgone capital 

opportunity should an operator’s borrowing opportunities become more expensive. Many BI 

policies also contain an endorsement that covers extra expenditures incurred by an insured party 

in an attempt to mitigate production loss or shorten interruption periods (Sharp, 2009). Further, 

the coverage will be subject to an overall specified limit to length of coverage. 

Oil and natural gas commodity price fluctuations, shown in Figure 5, have put pressure on BI 

insurance policies and rates. Many large companies have chosen to forgo business interruption 

post-Katrina/Rita, while many companies with annual revenues smaller than $100 million have 

continued to purchase BI insurance (Geisel, 2007; Willis Holding Group, 2006). 

 

9

 Moral hazard is defined as the change in behavior created by the presence of insurance. 
23

0

100

200

300

400

500

600

700

800

2002 2003 2004 2005 2006 2007 2008 2009

Commodity Prices (2002 = 100)

Petroleum Prices Natural Gas Prices

 Figure 5. Crude oil and natural gas prices. 

One variant of business interruption coverage, and one that has been contentious as a result of 

the recent hurricanes, is called “contingent business interruption” (CBI) coverage. This type of 

coverage protects offshore operators from production interruptions created by third parties. For 

instance, a shutdown in a third-party owned pipeline that prevents an otherwise active well from 

moving output to markets. A real-world variation of this example is a production interruption 

caused by an upstream pipeline interruption created by dragging anchors and mooring systems 

for jack-up rigs moved across the GOM by hurricane wind and wave activity. 

3.3. Mutualization 

Another important form of offshore oil and gas insurance can be generally referred to as 

“mutual,” “pool,” or “club” insurance. Mutualization is based upon the development of a 

common insurance “club,” comprised of similarly-situated companies that “mutually” insure one 

another against various types of adverse outcomes. What makes this form of insurance different 

from others is the fact that policyholders of the mutual insurance company are also the 

owners/shareholders thereby diversifying risks, and reducing overall costs. Mutualization, while 

common in the energy business, has its origins in the shipping and maritime industries (UK P&I 

Club, 2010). 

One of the factors leading to the use of mutual insurance in the energy and maritime industries is 

its ability to form a pool of similarly-situated policyholders meeting certain financial and/or 

operating characteristics. The breadth, size, scope, and common risk profile of participants in the 

mutual insurance club are thought to enhance insurance availability, expand the terms under 

Ivan

Katrina Rita

Ike

Source: USDOE, EIA, 2010a and b. 
24

which insurance is offered, diversify risk, and reduce the overall cost of insurance. Oil 

Insurance, Ltd., or “OIL” is the major energy industry example of a mutual insurance company. 

3.3.1. OIL Formation 

Prior to the mid-1960s, most petroleum companies secured property insurance under typical 

forms of private insurance that offered an energy company the ability to insure a set of assets at a 

given value with a corresponding deductible/premium trade-off (OIL, 2008a). Traditional 

insurance coverage allowed an energy company to increase its deductible (risk retention) in 

return for a lower premium, and vice versa. Until the 1960s, private insurance for energy assets, 

under a traditional premium/deductible form, was not difficult to obtain and premiums were 

considered reasonable (OIL, 2008a). 

Two events in the late 1960s, however, created significant changes for the energy industry in 

terms of insurance availability and price. The first incident was a 1967 explosion at the Cities 

Service Company (Cities) refinery in Lake Charles, Louisiana.10 The accident killed six people, 

injured another fourteen and led to over $17 million in damages and claims, a record amount for 

the industry at that time ($109 million in 2009 dollars) (CITGO, 2010). The accident caused the 

insurer of record, the Simmonds Group, to default and go bankrupt soon after paying out the 

claim (OIL, 2008a). 

The second accident included the now infamous 1969 Santa Barbara oil spill, often heralded as 

the beginning of the environmentalist movement. The accident, created by an explosion at a 

Union Oil company offshore crude oil well, resulted in over 54 Mbbls of crude oil spilled along 

the California coastline (Clarke and Hemphill, 2002). 

Both incidents, occurring within a relatively short amount of time of one another, revealed the 

potentially high costs and liability that could be placed upon the energy industry from a 

catastrophic environmental and safety-related event. The level and magnitude of both incidents 

challenged the traditional insurance market’s ability to absorb that level of risk, and created 

concerns about future potential liabilities that could surpass those recognized by the two 

accidents of the late 1960s. As a result, energy industry insurance coverage became considerably 

more expensive and more likely to have limitations that did not exist in the decades prior to the 

1960s. 

The Lake Charles and Santa Barbara accidents directly led to the formation of a new type of 

insurance company for the oil and gas industry, commonly referred to as “OIL,” which is one of 

the first major mutual insurance companies servicing the energy sector including offshore oil and 

gas drilling and production assets. OIL was formed in 1971, in the Bahamas, by a group of 15 

energy companies (OIL, 2008a). The original purpose of OIL was to develop an alternative to 

the high premium and limited coverage options that were emerging at that time in the private 

commercial insurance industry. Through mutualization, OIL’s members hoped to form a 

collective, lower-cost insurance pool for similar-situated energy companies. 

 

10Cities Service Company is now known as Citgo, and is owned by Petroleos de Venezuela. The refinery is still in 

operation in Lake Charles, Louisiana and has a distillation capacity of 440,000 barrels per day. 
25

OIL did not originally form as a true mutual insurance company. Its original design was based 

upon what is referred to as “a risk-financing facility.” Under this mechanism, insurance 

participants (members) were required to pay premiums in advance, which in turn, were deposited 

into separately identified reserves attributable to each participant (OIL, 2008a). For example, 

Citgo’s premiums were directly deposited into its account of record, while Phillips’s premiums 

were deposited into its own account of record. Funds at this time were not deposited, like many 

mutual insurance companies, into a common pool. 

Under the original formation terms, if a claim were made on OIL, any party making a claim in 

excess of its reserve balance would receive its full claimed amount, and be required to pay back 

any differences over a five-year basis. For instance, if Citgo had an ongoing account balance of 

$200 million, but made a claim for $300 million, the company would receive the full $300 

million. In this hypothetical, the balance in Citgo’s account of record would be used to fund the 

first $200 million, and the company would be required to amortize the additional $100 million on 

a five-year repayment schedule: hence, the term “risk financing” facility. The prior example 

shows that, at least under the original OIL organizational structure, the “insurance” provided to 

each of its members did not shift or reduce risk like traditional or “true” mutual insurance, but 

simply served as a financing mechanism (or loan) to pay for claims in excess of the self-insured 

amount (i.e., reserve). 

The original insurance structure for OIL, however, did not last very long. In the early 1970s, the 

U.S. Supreme Court issued a ruling requiring a considerable revision in the way members pooled 

their collective self-insurance resources and responsibilities (Commissioner, 1971). This 

Supreme Court decision, referred to as the Lincoln Loan Association decision, did not directly 

question OIL’s organizational and operational structure, but did question certain tax provisions 

of a similarly-situated insurance organization in the banking industry. The Supreme Court 

findings did not challenge the validity of mutualization as a form of insurance, but did question 

the tax status of reserve payments and found that these payments were not similar to insurance 

premiums that companies commonly pay to private insurance providers. The Court found that 

reserve payments were deposits (like a bank), and not expenses (like insurance premiums); as 

such, these reserve payments represented assets, which are taxable, as well as any returns on 

those balances (Commissioner, 1971). 

The Court’s decision in Lincoln Loan significantly changed many of the perceived economic 

benefits of mututalization, as OIL was originally created, leading members to reorganize the 

club’s insurance coverage structure (OIL, 2008a). Under the reorganization, OIL formed along 

traditional mutual insurance principles by pooling reserves, creating genuine premium structures, 

and offering various insurance and risk management services to share and spread risks across all 

of its members. The one difference between OIL’s revised structure and the private insurance 

market continued to be that OIL operates on a fee/cost basis for its services and not upon a profit 

basis like many private insurance companies (OIL, 2008a). 

3.3.2. Original OIL Membership and Coverage 

In the early 1970s, OIL started with 15 oil and gas company members (OIL, 2008a). Figure 6 

shows that by 2003, OIL membership had peaked to over 80 companies. By 2009, OIL 
26

membership had decreased to 55 companies due to mergers, acquisitions, industry consolidation, 

and, as will be discussed in Chapter 5, hurricane-related activity. 

 Figure 6. Annual OIL membership levels, 2001 to 2009. 

Today’s OIL membership is also broader than its simple “oil and gas” company origins, and 

includes a broad range of “energy” companies that operate in a number of different sectors, are 

comprised of a number of different financial structures, and operate in a broad range of 

geographic locations. OIL’s current membership includes a number of US-based energy 

companies as well as several located in Europe, Canada, Australia, and the Caribbean. 

A listing of OIL’s 2009 membership has been provided in Table 3 and includes a number of 

vertically integrated major oil companies (Chevron, ConocoPhillips), independent oil and gas 

companies (Apache, Noble Energy), petrochemical companies (Lyondell Bassell, Westlake), 

independent refineries (Sunoco, Tesoro) and electric companies (Sempra, Electricit de France). 

A breakdown of membership by unweighted gross assets by operations type is provided in

Figure 7. 

Source: OIL, 2010a. 
27

Table 3 

OIL Membership by Country 

Australia United States

BHP Billiton Petroleum (Americas) Inc. Apache Corporation

Caltex Australia Limited Chevron Phillips Chemical Company LLC

Santos Ltd. Chevron Corporation

Woodside Petroleum Limited CITGO Petroleum Corporation

ConocoPhillips

Canada Drummond Company Inc.

Canadian Natural Resources Ltd. DTE Energy

Husky Energy Inc. El Paso Corporation.

Nexen Inc. Forest Oil Corporation

NOVA Chemicals Corporation Hess Corporation

Paramount Resources LOOP LLC

Suncor Energy Inc. Marathon Oil Corporation

Talisman Energy Inc. Mariner Energy, Inc.

Murphy Oil Corporation

Europe Noble Energy, Inc.

ARKEMA Occidental Petroleum Corporation

BASF SE Puerto Rico Electric Power

BG Group plc Authority (PREPA)

Borealis A/S Sempra Energy

CEPSA Southern Union Company

DONG Energy A/S Sunoco, Inc.

Electricité de France (EDF) Tesoro Corporation

Eni S.p.A. The Sinclair Companies

Galp Energia SGPS, S.A. Valero Energy Corporation

LyondellBasell Industries Westlake Chemical Corporation

MOL Hungarian Oil and Gas Company XTO Energy Inc.

OMV Aktiengesellschaft

Repsol YPF, SA Latin America / Caribbean

Royal Vopak N.V. Hovensa L.L.C.

StatoilHydro ASA

TOTAL S.A.

Yara International ASA

Country / Company

 Source: OIL, 2010b. 
28

E&P Offshore

23%

E&P Onshore

22%

R&M/ 

Chemicals

22%

Electric Utilities

13%

Pipelines

6%

ANWS Onshore

6%

ANWS Offshore

4%

Mining

2%

Other

2%

 Figure 7. OIL membership, unweighted gross assets by industry sector.11

Membership in OIL is based upon four separate requirements. First, any prospective member 

must have at least $1 billion in gross assets. Second, members must use 50 percent of its assets, 

or derive 50 percent of its gross revenues, from energy operations. Third, members must be of 

investment grade credit rating from Standard and Poor’s (“S&P”) (i.e., equal or greater than a 

“BBB” rating) and Moody’s (equal or greater than a “Baa3” rating). Fourth, a prospective 

member must provide its ten-year loss history for review by the OIL Board. The Board 

subsequently meets to review the application for approval or rejection. OIL’s insurance structure 

is based upon a two-tiered system, with the first tier being comprised of a mandatory premium 

and the second tier comprised of a voluntary premium. 

OIL has three main insurance agreements. The property damage agreement covers damage to all 

physical assets the insured may have (subject to occurrence limits and other factors discussed 

later). The second form of coverage is broken into several sub-parts that includes what is 

referred to as “sue and labor,” “control of well,” and “removal of debris” coverage. Lastly, OIL 

provides liability coverage resulting from pollution including oil spills. Each form of coverage is 

packaged together to create the basic insurance policy each member acquires through a minimum 

 

11Unweighted gross assets are the total assets, by sector, for all of OIL’s members and are not weighted by size, but 

on total dollar amounts.

Source: OIL, 2008b. 
29

membership in OIL. There are, however, exclusions associated with each part of the coverage, 

as well as extra coverage that may be added with the payment of supplemental premiums. 

OIL’s coverage options are also broken into mandatory and optional components. Mandatory 

coverage is capped at the lesser of 10 percent of a company’s “unmodified gross assets” or $250 

million per incident/claim with no annual aggregate limit (OIL, 2009). If a company selects only 

the basic mandatory coverage level, its losses will only be paid at 60 percent of the claimed 

amount up to the $250 million incident/claimed limitation. The insured will retain the remaining 

40 percent of the loss. The 60 percent of the loss covered by OIL will be repaid by OIL 

members per a formula for the standard premium rate. Commonly, the 40 percent of exposure 

retained by an insured will be covered by the commercial market. OIL does not prohibit 

companies from “filling the gaps” of its mandatory coverage with other supplemental policies 

that may be provided by other parties. 

OIL’s voluntary coverage structure is based upon one of two different options from which an 

insuring company self-selects. The first option is referred to as an “individual retro” (IR) option 

and insures a policyholder (energy company) for an additional amount up to $250 million per 

occurrence. The same occurrence limit is in place for both the first and second tier. The IR 

electing member pays only the standard premium until it incurs and claims a loss. Once a claim 

occurs, the member is responsible for a sliding percentage of the IR claim. 

The sliding percentage associated with IR claims range from between 33.3 to 62.5 percent. The 

larger the loss, the smaller the percentage of risk retention: the smaller the loss, the larger the 

percentage of risk retention. Losses that result in a payback of less than 40 percent provides clear 

advantages over the simple standard premium option but an outcome of this nature is rare since 

the average formula retrospective premium percent tends to gravitate towards the 40 percent 

level. Generally, the percentage calculated by the formula determines the amount an insured 

company is liable for in terms of its whole claim. An example of the individual retrospective 

premium option formula has been provided in Appendix B of this report. 

The second voluntary premium structure is referred to as a “flat premium” option. If selected, 

this option insures an OIL policyholder for 100 percent of its losses in excess of the base $150 

million coverage level up to a cap of $250 million per claim. The higher coverage level comes at 

a cost since companies that choose this second voluntary option pay considerably higher 

premiums than the first voluntary option. 

3.4. Reinsurance 

3.4.1. General Overview 

Secondary market insurance companies, often referred to as “reinsurers,” play an important role 

in the diversification of hurricane risk and other risks arising in offshore oil and gas operations. 

Reinsurance companies can be thought of as “insurance companies for insurance companies” 

and, given their close interactions with brokers and underwriters, can often have considerable 

influence and input into the development of oil and gas industry insurance coverage and 

premiums. The reinsurance company’s product is not surprisingly referred to as “reinsurance,” 
30

and is an agreement with a ceding insurance company12 to assume a portion of risk in return for a 

portion of the premium. Reinsurance companies also reinsure each other in what is called 

retrocessional insurance (or treaties). Reinsurance contracts are commonly called treaties 

because the receiver of risk and premium responds by indemnifying the seller of risk, which can 

be another reinsurer or direct insurance company. 

3.4.2. Reinsurance Functions 

Reinsurance companies serve a number of market functions. Reinsurance companies’ first and 

primary function, however, is in providing risk mitigation services to direct insurers by 

effectively leveraging those insurance companies’ underlying risk. The availability of 

reinsurance gives the direct insurer the market option to shore up reserves due to variety of 

market and institutional changes and risks. For instance, should invested reserves decline in 

value, a reinsurer may be willing and able to take enough risk off the direct insurer’s books to 

maintain a safe risk-to-reserve ratio. In this way reinsurance can create profit stability and 

reduce the risk of financial distress and even insolvency. 

Capacity expansion13 represents a second and equally important benefit and market function 

served by reinsurance companies. Without reinsurance, a direct insurer may not be able to write 

new risks or renew existing contracts which would reduce the scope of the insurance market and 

drive up costs (and premiums) for all insurance buyers. 

This is particularly important for high cost, geographically concentrated assets, like deepwater 

oil and gas production facilities that may be so highly-valued that a single loss in that location 

would be unacceptable to the shareholders of a direct insurance company. By agreeing to sell 

some of the risk to a reinsurance company, the direct private insurer may be able to offer 

insurance to a high value risk that it otherwise would not have covered. 

Reinsurers play an important role in the GOM oil and gas insurance market, and their collective 

decisions can greatly influence prevailing premium prices. Overall market dynamics feed into 

this web of influence since the amount of reinsurance (or capacity) offered to any given sector 

(like the oil and gas industry) is part of a broader strategy of developing a diversified portfolio of

risk that hopefully results in broader gains to reinsurance investors (i.e., reinsurance revenues 

exceed claims on reinsurance assets). Approximately 50 percent of all U.S. risk exposures are 

reinsured and about 20 percent of all U.S. exposures are retroceded (reinsurance of reinsured 

risk)14 (Banks, 2005). 

Reinsurance can take two functional forms: facultative reinsurance and treaty reinsurance. 

“Facultative reinsurance” requires significant due diligence and a rich set of initial informational 

 

12A ceding company is the insurance company buying the insurance, which can also be thought of as the insurance 

company that is selling risk to another insurance provider.

13Capacity is defined as the market insurable value limit of a single location asset. For example, if an oil and gas 

company had a portfolio of assets valued at five billion dollars, with the largest single asset value at two billion 

dollars, then two billion dollars would be considered the necessary amount of capacity. In the insurance industry 

reference to capacity implies the maximum single risk.

14All risk including life, property, health, casualty, etc. All commonly insured risks in the United States.
31

data from which to draw a comprehensive prospective risk analysis. Facultative reinsurance is 

done on a per risk basis: in other words, each risk is evaluated and insured separately. 

“Treaty reinsurance”, on the other hand, involves an ex ante agreement between the reinsurer and 

private insurance company. The contract will involve a specified overall limit of capacity and 

policy size that the private insurer can automatically pass to the reinsurer. The contract will also 

specify the types of risks that are eligible for reinsurance under the policy. In this case, risks are 

not individually agreed upon by the reinsurance company but taken in aggregate, with some 

overall cap on policy size and capacity. While treaty reinsurance can considerably reduce 

overhead costs associated with analyzing individual risks, it also requires the reinsurance 

company to assume a considerably higher level of risk than under a facultative approach. Thus, 

treaty reinsurance places exceptional value on the trust built up from a long-term relationship 

between a reinsurer and a direct insurance company.

Reinsurance coverage options also take a variety of forms that rest primarily upon “proportionalto-loss” coverage and “excess of loss” coverage. Proportional-to-loss reinsurance can be thought 

of insuring risk with a direct insurer on a side-by-side basis. In other words, both the direct 

insurance company and the reinsurance company share losses (claims), as well as revenues, on a 

proportional basis with the shares of each (costs, revenues) being negotiated between the two 

parties. Excess of loss coverage, on the other hand, is based upon risks sharing beyond some 

negotiated/contracted limit that is referred to as an “attachment point” (Sharp, 2009). 

The relationship between reinsurers and direct insurance companies is symbiotic and based upon 

a number of market-based functions and arms length negotiations that typically result in fair and 

profitable outcomes for both parties. This relationship, however, requires direct insurers to 

carefully weigh the benefits of reinsurance versus its costs. While reinsurance can provide direct 

insurance companies with a valuable hedge against risk, particularly for high cost assets, these 

hedges do not come without costs that, in turn, can reduce overall direct insurance company 

profitability. Direct insurance companies have incentive to not “oversubscribe” to reinsurance 

coverage since in doing so they reduce their opportunities for growth and profits. 

Likewise, reinsurance companies must view their relationship with various direct insurance 

companies with some degree of scrutiny since there is a clear informational asymmetry between 

the two parties that can lead to a variety of moral hazard problems. If reinsurers unnecessarily 

assume too much risk and/or assume risk without pricing it accurately, they will be subject to 

unanticipated losses, forgone profit, and potentially insolvency. Reinsurance companies are 

clearly in a business that requires the assumption of a considerable degree of risk. But not all 

risk is created equally, and if not evaluated properly, can become a considerable business 

liability, particularly in the face of unanticipated catastrophic losses such as the impact of a 

destructive hurricane on a large, concentrated number of high value assets. 

3.5. Insurance-Linked Financial Instruments 

Catastrophic bonds, or “cat bonds,” are one of the more commonly known insurance-linked 

financial instruments associated with the oil and gas business. Cat bonds were first offered in 

1997 by USAA/Residential RE and have evolved over time, along with a number of other 

comparable financial instruments that are used to support insurers, reinsurers, and a wide array of 
32

companies exposed to catastrophe risk (Banks, 2005). Cat bonds, along with what is generally 

called “contingent capital,” provide GOM oil and gas companies with an additional risk 

management option that leverages capital markets for insurance purposes. Contingent capital 

instruments allow buyers and sellers of risk to transact to create mutually beneficial gains from 

trade. Purchasers of cat bonds, for instance, engage in transactions for the possibility of 

speculative gains made on the coupon price and interest payments associated with the contingent 

capital instrument. Energy companies, on the other hand, benefit from a relatively lower cost 

insurance instrument that has a fixed, market-based/market determined rate. 

3.5.1. General Overview of Catastrophe Bonds 

As seen in Figure 8, the cat bond market has been continually growing since its inception in the 

late 1990s when the industry issued $1 billion in securities, to a 2008-2009 level averaging in 

excess of $2 billion (Business Wire, 2009). Particularly impressive is the degree of market 

growth experiences in 2005, well over 70 percent. The two years following Hurricanes Katrina 

and Rita saw the largest amount of growth in cat bond issuances, with a 135 percent and 250 

percent increase in 2006 and 2007, respectively.15

 Figure 8. Total catastrophe bond issues. 

While annual issuances provide interesting information about the incremental demand for cat 

bonds, the scope of the market tends to be defined by the number of outstanding bonds in any 

given year since most of these financial instruments tend to be multi-year in nature. Total 

outstanding contracts for cat bonds totaled $11.8 billion at the year-end of 2008 (Guy Carpenter 

 

15For further discussion of the reasons behind the increases please see Section 1.13 of this report.

Source: Guy Carpenter & Company, LLC, 2010a. 

Note: *Fourth quarter 2009 numbers are not yet available. 
33

& Company, LLC, 2010a). The total outstanding contracts for years 2003 through 2008 are 

shown in Figure 9. The number of outstanding contracts steadily grew from 2003 through 2007 

when the market peaked. While the overall cat bond market has fallen considerably since its 

2008 peak, outstanding valuations still remain above years prior to the Big Four hurricanes.16

 Figure 9. Total outstanding catastrophe bond contracts. 

While cat bonds are an important finance tool for the GOM offshore oil and gas industry, the risk 

transfer mechanism usually happens at arm’s length and with the involvement of a number of 

intermediaries. The central organization in a cat bond deal is a special purpose entity (SPE) or a 

special purpose reinsurer (SPR) (Klein et al., 2000). A diagram outlining the SPE/SPR’s 

relationship with other market participants is provided in Figure 10. 

 

16The Big Four hurricanes are Hurricanes Ivan, Katrina, Rita, and Ike.

Source: Guy Carpenter & Company, LLC, 2010a. 
34

Upstream Oil and 

Gas Company 

Special Purpose 

Reinsurer / Entity 

Capital Market 

Investors 

Trustee 

(financial intermediary) 

Treasury 

Market 

Swap 

Bank 

Premium Proceeds 

Notes with P/I 

Principal and Interest (P/I) Premium Proceeds 

Fixed / 

Floating Swaps 

Proceeds 

P/I 

Insurance 

Figure 10. A common catastrophe bond mechanism structure. 

The SPR/SPE acts as the administrator and general contractor of the security issuance. Typically 

the SPR/SPE will hire a trustee, a financial institution, to prepare and analyze the financial 

aspects of administering and handling the proceeds of the bond sale. Bond proceeds are usually 

passed from investors to the SPR/SPE, and then passed to the trustee for reinvestment, usually in 

what are considered risk-free assets, such as U.S. Treasury Bills. In return for their involvement, 

the SPR/SPE and trustee will receive a portion of the premium income as a fee from the insured 

company. The premium (and interest) from the insured company is also passed back to investors 

in the form of a bond coupon payment. 

The main purpose of employing an SPR/SPE is to further insulate investors from relying on the 

credit rating of the insured company.17 This structure allows insured companies to obtain the 

best possible costs of credit with respect to the solvency of the bond backing organization. 

Given the complexity of modeling catastrophes, capital investors are mainly represented as 

institutional investors though consumer-level investors do have the ability to invest in 

catastrophe bonds in special exchange-traded funds.

Cat bonds come in many different forms to fit the many different types of risk and investors, but 

each has a specific form of trigger that is activated and induces a corresponding response after a 

catastrophe has occurred. The three main types of triggers are indemnity, parametric and index 

triggers: 

 

17The SPR/SPE will frequently work in conjunction with external organizations and engage in credit default swaps 

and fixed/floating currency swaps in order to obtain the highest credit ratings and lowest borrowing costs.

Source: Banks, 2005. 
35

• Indemnity triggers create a hold harmless provision that insulates the insured 

against any contractually agreed-upon catastrophe risk per a definition. If a 

catastrophe occurs according to the definition, then the principal and interest 

due to the bond holder are forfeited up to the level of insured losses or 

otherwise stated amount. 

• Parametric triggers are developed from models, or other formulas, that use 

storm inputs, such as a hurricane’s maximum wind speed or minimum 

barometric pressure, to determine payouts (can include withheld interest 

and/or principle depending upon conditions). Geographical considerations are 

also used in parametric triggers. Parametric triggers are becoming more 

commonplace in the market because they do not require investors to be 

experts in the company’s asset exposure to calculate potential risk. The Willis 

Hurricane Index is one such parametric trigger.18

• Index triggers tie payouts to industry-wide losses or other metrics not 

associated with the specific storm such as a parametric model would use 

(Klein et al., 2000). 

In addition to specific bond triggers, bonds can be differentiated by outcomes, and various 

different tranches, relative to a catastrophic occurrence such as a hurricane (Banks, 2005). 

Bonds can be split in a variety of pre-defined manners such that interest, loss of principle, or 

other combinations are withheld as payout. Tranches, on the other hand, may cover any 

combination of outcomes from requiring that more than one trigger occur before payout, to total 

loss of principal and interest regardless of company exposure. Each tranche is set according to 

commonly-recognized bond ratings, and given a label from A/AA to BB rating. 

Catastrophe bonds were rarely rated above BB+ (investment grade) before 2006, but beginning 

in 2007 some catastrophe bond structures changed to more closely resemble collateralized debt 

obligations (CDOs), thus achieving higher investment-grade ratings (A.M. Best, 2008). Factors 

that affect ratings include structural, regulatory, and legal documents, the granularity of exposure 

data available for risk modeling, the results of analyses done by catastrophe modeling firms, the 

results of stress testing (extreme scenario analysis), exposure to basis risk,19 the existence of 

multiple event triggers, and the credit risk of all parties concerned. 

The pricing of cat bonds follows insurance and reinsurance costs since these are competitive and 

alternative forms of insurance. The price/cost differential between insurance and reinsurance 

costs and catastrophe bonds is the largest market moving factor of catastrophe bonds. The 

hardening of commercial insurance markets tend to drive up catastrophe bond usage (Banks, 

2005), although this trend appears to have dampened in the post-2007 market. This trend is 

evidenced in Figure 8. Cat bond pricing can also be influenced by the administrative costs for 

the SPR/SPE, trustees, and others engaged in the counterparty research/coverage work. Tax 

considerations can also influence cat bond pricing since some may not have as attractive tax 

 

18This index is discussed in greater detail on page 77.

19Basis risk is the risk that the payout of the bonds will not equal company losses. This does not exist in indemnity 

trigger bonds, but can be a major risk of parametric and index trigger based bonds.
36

considerations for at-risk companies compared to insurance, which can be written down as an 

annual expense (Banks, 2005). 

The cat bond market continues to evolve since its inception in the late 1990s. One of the more 

important institutional innovations over the past several years includes the establishment of longrun SPR/SPEs (lifes defined “into perpetuity”) for the purpose of handling multiple simultaneous 

and frequent bond issues, multiple peril issues, and multiple trigger issues. This creates a certain 

degree of consistency, and signaling of institution knowledge, that markets prefer for higher risk 

securities like those associated with the cat bond market. 

3.5.2. General Overview of Contingent Capital 

Contingent capital is similar in nature to catastrophe bonds, since it is based upon the use of 

financial markets to protect an insuring company against perils while providing a profit 

opportunity for market-based counterparties. The primary difference between the two financial 

approaches (cat bonds and contingent capital) is in their use of intermediaries. Cat bonds, as 

noted earlier, facilitate the use of an SPE/SPR and other intermediaries in conducting various 

market transactions. Contingent capital, on the other hand, is financed directly by the insuring 

company without any intermediary. It thus, becomes a direct agreement between the company 

seeking insurance and financial markets. 

The insurance component of contingent capital takes on many of the same approaches as cat 

bonds. The first step in the process is that the at-risk company defines and creates a financial 

instrument that provides market-based financial compensation should a storm occur. The costs 

associated with issuing this instrument tend to be limited to the same types of underwriting fees 

common with other corporate debt instruments. The financier underwriting the financial 

instrument for the at-risk company receives a servicing payment regardless of whether there are 

any peril/catastrophe outcomes and claims. 

The form of the financial compensation extended by the financier should a storm occur can take 

many forms. At-risk companies can often have credit rating concerns that can be challenged by 

the issuance of large levels of debt, including contingent capital. Thus, contracting parties may 

agree that the financial compensation should be restricted to a small financial level relative to the 

potential loss of an asset, or the capital infusion could represent a fixed-rate loan call option. 

The compensation can also take the form of a direct capital infusion or an obligation to purchase 

newly issued stock shares (preferred or common). Like catastrophe bonds, contingent capital 

can take many forms given the needs of the at-risk company and concerns of the financial 

institution underwriting the transaction (Banks, 2005). 
37

4. IMPACTS OF THE BIG FOUR HURRICANES ON OFFSHORE 

OPERATIONS 

Tropical activity and weather-related events are one of the more obvious challenges associated 

with managing offshore oil and gas activities in the GOM. Several major hurricanes have 

occurred in the GOM region since offshore oil and gas activities began in the late 1940s. Figure 

11 for instance, shows the changes in GOM production on a MMBOE basis and compares that to 

the number of hurricanes arising in the Gulf since 1960. Offshore production levels common 

during historic catastrophic hurricanes, such as Betsy (1964) and Camille (1969), were 

considerably lower than today’s, and those associated with the Big Four post-2004 hurricanes. 

At the time of Betsy, the federal OCS produced less than 260 million BOE (9 percent of thencurrent total domestic production), and 630 million BOE at the time of Camille (18 percent of 

then-current total domestic production). 

 Figure 11. GOM OCS production and hurricanes. 

Structure exposure has also changed dramatically since the last round of major catastrophic 

hurricanes of the 1960s. Figure 12 compares hurricane activity from 1960 to current against the 

number of active structures in the GOM. During Hurricane Betsy, there were over 1,000 active 

structures and 469 active platforms operating in the GOM. By the time of Hurricane Camille, 

there were 710 active platforms. Today, there are some 3,770 active structures and 2,347 active 

platforms in the Gulf. New platforms cost in the tens of millions, and as much as billions for 

deepwater structures, leading to the potential for costly hurricane impacts. 

Source: LDNR, 2010; USDOC, NOAA, 2010. 
38

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1954195619581960196219641966196819701972197419761978198019821984198619881990199219941996199820002002200420062008

Federal GOM Structures

0

1

2

3

4

5

Number of GOM Hurricanes

Hurricane Activity Federal GOM Structures

 Figure 12. GOM OCS active structures and hurricanes. 

Over the past several decades, hurricane impacts on offshore oil and gas activities have tended to 

be somewhat manageable. The nature of hurricane impacts, however, changed dramatically in 

2004, with even greater implications in 2005, and again in 2008. Post-2004, four major 

hurricanes crossed the prolific oil and gas producing areas of the GOM: Ivan, Katrina, Rita, and 

Ike. A brief and limited survey of the scope and breadth of each of the “major four” storms is 

necessary in order to put insurance market changes resulting from these storms into perspective. 

4.1. Hurricane Ivan 

Hurricane Ivan entered the GOM after passing between the Yucatan Peninsula and Cuba in early 

September, 2004. Hurricane Ivan strengthened considerably upon entering the warm Gulf waters 

attaining Category 5 status20 before decreasing to a Category 4 storm prior to landfall. Ivan 

generally took a northerly path across the Gulf after passing through the Yucatan Straits. As 

shown in Figure 13, this path enabled Ivan to impact a number of outlying structures as it 

approached the Louisiana-Mississippi-Alabama coast. Ivan was a relatively slow paced storm 

moving at directional speed of about 8 to 11 miles per hour (Stewart, 2005). 

 

20Hurricane strength is typically defined by the Saffir–Simpson Hurricane Scale: a classification used for most 

Western Hemisphere tropical cyclones that exceed the intensities of tropical depressions and tropical storms. The 

scale divides hurricanes into five categories distinguished by the intensities of their sustained winds. The 

classifications are intended primarily for use in measuring the potential damage and flooding a hurricane will cause 

upon landfall. Officially, the Saffir–Simpson Hurricane Scale is used only to describe hurricanes forming in the 

Atlantic Ocean and northern Pacific Ocean east of the International Date Line. See: National Hurricane Center. 

 

Source: USDOI, MMS, 2010f; USDOC, NOAA, 2010. 
39

 Figure 13. Path of Hurricane Ivan. 

Ivan changed course approximately one day prior to landfall, taking a more northeasterly “hook” 

as the storm appeared to be approaching the Louisiana coast. This change of direction pulled the 

storm to a landfall just west of Gulf Shores, Alabama on September 16, 2004. 

As Ivan approached the GOM producing areas, 575 platforms and 69 rigs were evacuated 

(USDOI, MMS, 2004a). Ivan’s path swept across some of the Gulf’s most highly productive 

deepwater projects located in Mississippi Canyon, Main Pass, Mobile Area, and Viosca Knoll 

(Gaudet, 2006). Some of the structures suffering significant damage from Ivan’s path included 

the Petronius (compliant tower), Medusa (Spar) and the Ensco 64 drilling rig. An example of the 

damage sustained by the Ensco 64 is shown in Figure 14. 

Source: USDOC, NOAA, 2010. 
40

 Figure 14. Ensco 64 drilling rig after Hurricane Ivan struck.21

 

21Ensco, “ENSCO Jackup Rig Suffers Damage from Hurricane Ivan.” September 16, 2004. The Ensco 64 drilling 

rig after Hurricane Ivan. The rig was directly in the path of the storm. Notice that the right is missing its jack-up 

legs and its derrick is totally destroyed. The rig was found adrift 40 miles south of its last known location before the 

storm hit. The rig was insured for $65 million dollars and was declared a constructive total loss (Rigzone, 2004).

Source: Rigzone, 2010. 
41

Figure 15. Hurricane Ivan maximum wind field and damaged/destroyed structures. 

Figure 15 identifies Ivan’s sustained wind speed across the relevant producing areas of the 

GOM. Ivan’s sustained wind speed was between 120 and 130 miles per hour (mph) as it swept 

across the Central Planning Area (CPA) of the GOM (Stewart, 2005). The storm surge caused 

by Ivan was between 10 to 15 feet in the coastal areas between Mobile, Alabama and Destin, 

Florida (Stewart, 2005). Wave heights associated with Ivan were reported at 50 feet with a 

possible record observed wave height of 52.5 feet reported by the NOAA Buoy 42040 located in 

the north central Gulf of Mexico south of Alabama (Stewart, 2005). Seven platforms were 

destroyed and six damaged by Hurricane Ivan, most of which were located in the Main Pass area. 

One of the more unique impacts associated with Ivan that had not been experienced with prior 

hurricanes was the considerable subsea mudslides resulting in some 53 damaged pipelines 

(USDOI, MMS, 2004b). Additional offshore pipeline damage created by Ivan included: 103 

pipeline risers; 16 pipelines between the sizes of 16 inches and 36 inches; and 153 pipelines 

between the sizes of 2 inches and 14 inches (Gaudet, 2004).

Peak production outages created by Hurricane Ivan occurred on September 17, 2004, resulting in 

the shut-in of 82.9 percent of the GOM’s daily oil production and 52.8 percent of region’s daily 

natural gas production (USDOI, MMS, 2004a). By December 16, 2004, those shut-in 

percentages had decreased dramatically with BOEM reporting only 8.93 and 4.83 percent of oil 

Source: USDOI, MMS, 2004b and 2010g; National Weather Service, 2010. 
42

and natural gas production, respectively, continued to be shut-in as a result of Ivan (USDOI, 

MMS, 2004c). The sustained, and long-term production shut-ins created by Ivan were a unique 

consequence of the storm, and one that would prove to be repeated with other major hurricanes. 

The daily trends in oil and natural gas production shut-ins created by Hurricane Ivan are 

provided in Figure 16. 

Figure 16. Hurricane Ivan, percent of crude oil and natural gas shut-in after peak shut-in. 

Cumulative shut-in oil production associated with Hurricane Ivan was 43.84 MMbbls of oil, 

representing 7.2 percent of the yearly GOM production at that time (USDOI, MMS, 2005a). 

Ivan also created the cumulative shut-in of approximately 172 Bcf of natural gas, representing 

3.87 percent of annual GOM natural gas production at that time. 

4.2. Hurricane Katrina 

Hurricane Katrina originated in the western Atlantic, north of Cuba on August 23, 2005 as a 

tropical depression. As seen in Figure 17, the storm took a track across the southernmost portion 

of the Florida peninsula on August 25, 2005 as a tropical storm. 

Katrina then re-entered the GOM and was anticipated to hook into a northerly path and make 

landfall somewhere along the northeastern GOM between Pensacola, Florida and Apalachicola, 

Florida. However over the weekend, the storm took a slow west-southwesterly dip and after a 

few days of stalled forward movement, the storm’s direction changed dramatically. Most 

Source: USDOI, MMS, 2004a. 
43

households, businesses, and industries along the Central GOM went home on Friday (August 26, 

2005), expecting little to no threat from Katrina’s destructive force. This expectation changed 

dramatically by the end of the weekend. 

 Figure 17. Path of Hurricane Katrina. 

Throughout the weekend of August 27th and 28th, it became apparent to many along the GOM 

that Katrina was going to be a storm that would make landfall somewhere along the central Gulf 

Coast. A series of voluntary and mandatory evacuations began in earnest over the weekend 

including the evacuation of offshore oil and gas platforms and structures in the Gulf. Mandatory 

evacuation orders were put into place by most oil and gas companies and by Monday, August 29, 

2005, 75 percent of manned platforms and 72 percent of rigs had been evacuated (USDOI, 

MMS, 2005b). 

Hurricane Katrina took a sweeping path across the GOM and impacted a large number of 

production structures, including many still recovering from Hurricane Ivan’s wrath from the 

prior year. Katrina gained considerable strength as it moved across the warm waters of the Gulf 

where water temperatures, at that time, exceeded 89 degrees (NASA, 2007). Katrina gained 

strength from these warm waters, resulting in wind speeds that, at one time, reached 162 mph on 

a sustained basis. Barometric pressures for Katrina were the lowest ever recorded at that time at 

902 millibars (Knabb et al., 2005): a pressure level only to be exceeded by Hurricane Wilma 

occurring two months later (Pasch et al., 2006). 

Source: USDOC, NOAA, 2010. 
44

Katrina rapidly reached Category 5 status and remained at that level for a good portion of the 

time it crossed the GOM. Structures impacted by Katrina, and the wind speeds to which they 

were subjected, are provided in Figure 18. Katrina’s wind speeds slowed somewhat prior to 

landfall, being reported as a Category 4 storm at that time of land fall. Later, post-storm 

evaluation of landfall wind speeds revised Katrina’s landfall status to a strong Category 3 storm 

(Knabb et al., 2005). 

Figure 18. Hurricane Katrina maximum wind field and damaged/destroyed structures. 

The storm surge created by Katrina was considerable and reported between 24 to 28 feet in the 

coastal areas between the Louisiana-Mississippi border and Pass Christian, Mississippi (Knapp et 

al., 2005). Wave heights associated with Katrina surpassed records set one year earlier with 

Hurricane Ivan, with many in excess of 55 feet (Stewart, 2005). An additional unique feature of 

Hurricane Katrina was the breadth of the storm. Hurricane force winds were reported to have 

spread some 28 to 34 miles to the west of the eye wall and up to 86 miles to the east of the eye 

wall (Knabb et al., 2005). Tropical force storm winds were reported as being felt an additional 

230 miles away from the eye wall (Knabb et al., 2005). 

Source: USDOI, MMS, 2006 and 2010g; National Weather Service, 2010. 
45

Hurricane Katrina destroyed 46 platforms and 4 jack-up rigs and damaged another six jack-ups 

(Cruz and Krausmann, 2008). The most notable platform damaged by Katrina was the Mars TLP 

owned by Shell and BP. Most of the platforms damaged by Katrina were located in the Main 

Pass, West Delta, Grand Isle, and South Timbalier areas. 

Pipeline destruction was also experienced during Katrina, but unlike Ivan, where pipelines were 

destroyed by underwater mudslides, pipeline damage created by Katrina was facilitated in large 

part by mooring lines and anchors being dragged across the sea floor as runaway jack-ups and 

semisubmersibles were tossed miles across the Gulf. Ocean Warwick, a jack-up rig owned by 

Diamond Offshore Drilling, was found 60 miles from its pre-storm position off the coast of 

Dauphin Island, Alabama (Figure 19). Katrina led to 61 reports of submerged pipeline damage, 

mostly due to drifting anchors and mooring lines (Cruz and Krausmann, 2008). The distribution 

of platforms destroyed by Hurricane Katrina was over relatively shallow water. Damage to 

platforms occurred over a larger distribution and stretched out to GOM deepwater (see Table 4). 

Table 4 

Number of Platforms Destroyed and 

Damaged by Hurricane Katrina 

Number of

Water Depth Platforms Destroyed

less than 90 ft 16

90 to 180 ft 14

180 to 360 ft 14

Number of

Water Depth Platforms Damaged

less than 180 ft 16

180 to 360 ft 14

260 to 720 ft 14

720 to 3,000 ft 4

 Source: Cruz and Krausmann, 2008. 
46

Figure 19. Post-Katrina damage to the Ocean Warwick drilling rig. 

Peak production outages associated with Katrina damage occurred on August 30, 2005, resulting 

in the shut-in of 95 percent of the GOM’s daily oil production, and 88 percent of the region’s 

daily natural gas production. Two weeks later, 57 percent of total GOM oil production and 37 

percent of all natural gas production continued to be shut-in as a result of Katrina’s damage 

(Figure 20). This differed considerably from the experience of Hurricane Ivan where 72 percent 

of all daily crude oil and 82 percent of all daily natural gas production were restored within two 

weeks of landfall. (USDOI, MMS, 2005b). 

By December 1, 2005, BOEM reported that 36 and 29 percent of all daily GOM crude oil and 

natural gas production continued to be shut-in as a result of Katrina (and Rita), respectively. The 

sustained, and long-term production shut-ins created by Katrina and Rita (discussed later), 

created one of the most challenging natural gas market conditions ever experienced in the U.S. 

Source: Rigzone, 2010. 
47

 Figure 20. Hurricanes Katrina/Rita, daily percentage shut-in, crude oil and natural gas. 

4.3. Hurricane Rita 

The most unique and devastating aspect of the 2005 tropical season was the landfall of not one, 

but two major and destructive hurricanes in an area closely approximate to one another, and one 

that supports over one-quarter of the total U.S. energy production infrastructure and one-third of 

the total U.S. energy processing and transportation infrastructure. Within one month of Katrina’s 

landfall, the GOM found itself bracing for the onslaught of another powerful storm, Hurricane 

Rita. As this occurred, the region was forced to suspend recovery and restoration activities, and 

rapidly prepare to defend itself against another catastrophic event. 

Hurricane Rita formed in almost the same area of the Western Atlantic as Katrina. Rita started 

out as a slow moving tropical depression before rapidly strengthening into a tropical storm as it 

cleared the Florida Straits and entered the GOM. Like Katrina, Rita passed an area in the lower 

southeastern corner of the GOM that was marked by exceptionally high water temperatures. 

These warm waters supercharged Rita’s strength, challenging virtually all of the hurricane 

development records set by Katrina one month earlier. 

As seen in Figure 21, Hurricane Rita took a north-northwesterly track across the GOM. Unlike 

Katrina, which hooked northwesterly as it approached the coast, Rita maintained a broad, nearly 

westerly track. This enabled Rita to expose its winds and storm surge to a large amount of the 

GOM’s offshore production infrastructure in both the BOEM Central Planning Area and the 

BOEM Western Planning Area. 

Source: USDOI, MMS, 2005b. 
48

 Figure 21. Path of Hurricane Rita. 

The advance of Rita forced most GOM personnel to be evacuated from production structures on 

September 20, 2005, one day before the storm approached the central GOM. This was an 

untimely event since many crews were working at break-neck speeds to repair offshore 

structures and equipment damaged one month earlier by Katrina. By September 25, 81 percent 

of the offshore production personnel, as well as several thousand repair crews, were evacuated 

(USDOI, MMS, 2005c). 

Rita gained considerable strength as it moved across the GOM, reaching Category 5 strength 

with sustained winds at one point topping 178 mph (Knabb et al., 2006). Rita reached a low 

barometric pressure of 895 millibars (Knabb et al., 2006). Figure 22 shows that, like Katrina, 

Rita had an exceptionally broad wind field stretching some 86 miles in either direction of the 

storm’s eye. 

Source: USDOC, NOAA, 2010. 
49

 Figure 22. Hurricane Rita wind fields and damaged/destroyed structures. 

Rita, like Katrina, created considerable wave heights and storm surge damaging both offshore 

structures (wave height) and onshore support bases (storm surge). Wave heights were reported 

as high as 38 feet offshore during Rita’s trek across the GOM (Stockdon et al., 2007). Storm 

surge was also considerably high and impacted a more westerly area of the GOM than Katrina. 

Storm surge measurements were hampered by the failure of a large number of gauges. The 

estimated average storm surge where the storm came ashore on the Louisiana-Texas border was 

10.4 feet (Stockdon et al., 2007). 

Rita destroyed 69 and damaged 32 oil and gas platforms in the western central GOM (USDOI, 

MMS, 2006). The storm also caused damage to 31 submerged pipelines, with much of this 

damage being created by rigs and platforms dragging anchors across the seafloor and over 

pipelines (Det Norske Veritas, 2007). In total, 542 pipeline damage reports were filed as a result 

of Katrina and Rita (Det Norske Veritas, 2007). Pipeline risers accounted for 378 of the total 

542 damage reports submitted to the BOEM, although BOEM does not technically count 

pipeline riser damage as pipeline damage (Det Norske Veritas, 2007). 

Source: USDOI, MMS, 2006 and 2010g; National Weather Service, 2010. 
50

Chevron Typhoon, a major GOM tension-leg platform, was found drifting 70 miles from its 

original mooring (Cruz and Krausmann, 2008). The platform’s topsides were found floating 

upside down in the water separated from its mounting unit (see Figure 23). 

 Figure 23. Chevron’s Typhoon Mini-TLP after Hurricane Rita. 

Table 5 

Number of Platforms Destroyed and 

Damaged by Hurricane Rita 

Number of

Water Depth Platforms Destroyed

less than 90 ft 30

90 to 180 ft 27

180 to 360 ft 11

greater than 360 ft 1

Number of

Water Depth Platforms Damaged

less than 90 ft 7

90 to 180 ft 18

180 to 360 ft 5

360 to 600 ft 2

 Source: Cruz and Krausmann, 2008. 

Source: Rigzone, 2010. 
51

Hurricane Rita left a path of destroyed platforms mostly in shallow water (see Table 5). Many of 

the structures destroyed by Katrina and Rita were older fixed leg structures with 66 percent of 

destroyed structures older than 31 years, and 21 percent older than 40 years (Cruz and 

Krausmann, 2008). 

Hurricane Rita created a peak production outage on September 25, 2005, resulting in the shut-in 

of 100 percent of the GOM’s daily oil production and 80 percent of region’s daily natural gas 

production. Amazingly, production shut-ins for both crude oil and natural gas production 

remained over 75 percent of total for 8 days: something never experienced with any prior GOM 

hurricane. One month after land fall, production shut-ins associated with Rita (and lingering 

effects of Katrina) were still well over 60 percent for crude oil and 50 percent for natural gas. 

By December 1, 2005, BOEM reported that 36 percent and 29 percent of all daily natural gas 

production continued to be shut-in as a result of Rita and Katrina, respectively. The cumulative 

shut-in oil production associated with Katrina and Rita has been estimated at 166,312 MMbbls of 

oil, or some 30 percent of GOM annual production at that time (USDOI, MMS, 2006). 

Approximately 803 Bcf of natural gas production was also shut-in on a cumulative basis, 

representing 22 percent of annual GOM production (USDOI, MMS, 2006). 

4.4. Hurricane Ike 

The 2008 tropical season came close to providing a repeat of the 2005 season with two major 

GOM hurricanes making landfall within one month of one another. On August 25, 2008, 

Hurricane Gustav formed in the lower Caribbean and crossed the GOM prior to making landfall 

as a Category 2 storm near Grand Isle, Louisiana. Less than one week later, Hurricane Ike 

formed as a Cape Verde storm off the African coast and began its long trek across the Atlantic, 

Caribbean, and GOM waters before making landfall as a Category 2 storm at Galveston, Texas. 

While both storms were powerful at their peak, reaching Category 4 status with winds in excess 

of 145 mph, both storms tended to peak relatively early, and unloaded a considerable amount of 

their energy on Cuba before entering the GOM. 

Of the two storms, Ike was the only one to attain “Big Four” status by insurers due to the 

relatively more significant damage created relative to Gustav. The larger degree of offshore 

damage created by Ike is attributable to the duration each of the two storms spent traveling 

across the GOM. Gustav, for instance, was a relatively fast-moving storm spending only two 

days (August 31 and September 1, 2008) crossing the GOM while Ike, spent four full days 

(September 10-13, 2008, inclusive). Ike also took a broad and more westerly track (like 

Hurricane Rita) exposing its winds, waves, and storm surge to a broader geographic area than 

Gustav (Figure 24). 
52

 Figure 24. Hurricane Ike storm path. 

Source: USDOC, NOAA, 2010. 
53

 Figure 25. Hurricane Ike wind fields and major damaged/destroyed structures.

Hurricane Ike spent four days subjecting offshore GOM production structures to high winds and 

waves (Figure 25). Average wave heights during Ike’s passing were recorded at 25 feet (Risk 

Management Solutions, 2008). Storm surge along the southwestern Louisiana coast were 

reported between 10 to 13 feet (Berg, 2009). Storm surges along the Texas coast, near Jefferson 

County, reached as high as 17 feet, while Galveston, the location of the storm’s landfall, 

recorded a surge of 10 to 15 feet (Berg, 2009).

The BOEM reported that Ike destroyed 60 oil and gas platforms, exceeding the number of 

destroyed platforms from Hurricane Katrina. Interestingly, Table 6 shows that while Hurricane 

Rita resulted in a high damage rate relative to structure exposure, Ike did not, even though both 

storms took relatively similar westerly paths across the GOM. 

Source: USDOI, MMS, 2006 and 2010g; National Weather Service, 2010. 
54

Table 6 

Comparison of Damage and Costs of Recent Major GOM Hurricanes 

Structures

Destroyed

Structures in or with Damage Physical

Hurricane Year Storm Path Major Damage Rate Damage

(%) (billion $)

Andrew 1992 700 87 12 0.9

Lili 2002 800 10 1 0.4

Ivan 2004 150 31 21 1.5

Katrina 2005 2,068 66 3 6.4

Rita 2005 793 101 13 3.7

Gustav 2008 677 6 1 n.a.

Ike 2008 1,450 54 4 3.9

 Note: “n.a.” is not available. 

 Source: USDOI, MMS, 2010g; National Weather Service, 2010; and Willis Group 

 Holdings, 2010.

Hurricane Ike created a peak production outage on September 15, 2008, resulting in the shut-in 

of 99 percent of the GOM’s daily oil production and 93.8 percent of region’s daily natural gas 

production. Production shut-ins for both crude oil and natural gas production remained over 75 

percent of total for four days, somewhat comparable to the experience from Katrina and Rita 

(Figure 26). These statistics, however, should be viewed with some caution since market 

conditions, which can significantly drive the speed of restoration activities, were considerably 

different in the early fall 2008 than they were in 2005. 
55

Figure 26. Hurricane Ike: shut-in percentages; crude oil and natural gas. 

By the time Ike made landfall, the U.S. was entering one of the worst economic recessions since 

the Great Depression, significantly dampening energy demand during this period. On the supply 

side, new production arising from the prolific Barnett Shale area of Texas was providing 

considerable supply to a market that needed little natural gas. In fact, Hurricane Ike likely 

removed more natural gas demand from the market in the greater Houston area and southwestern 

Louisiana than it did displace supply resources.22 This unique combination of factors started the 

process of declining natural gas prices that remained for the better part of 2009 and had 

considerable implications for how fast producers were inclined to commit investment dollars to 

rapidly restore energy production in an uncertain market. 

By December 3, 2008, BOEM reported that 14 and 20 percent of all daily GOM crude oil and 

natural gas production continued to be shut-in as a result of Ike. Total cumulative oil and natural 

gas shut-in numbers were not published. 

 

22The Louisiana and Texas Gulf Coast have some of the largest concentrations of industrial demand for natural gas 

usage in the world. Hurricane-related interruptions during this period, in combination with new supply sources of 

gas in the Barnett Shale, therefore, did not create market short-falls, and were likely to have contributed to excess 

net supply. 

Source: USDOI, MMS, 2008a. 
57

5. POST-HURRICANE OFFSHORE INSURANCE MARKETS

5.1. Private Insurance 

5.1.1. General Market Reaction 

The risks associated with tropical activity highlight an important difference between insurance 

coverage for the offshore oil and gas industry relative to other businesses and activities. An 

additional important difference in relative insurance coverage has been the dramatic and rapid 

change in assessing and pricing insurance associated with offshore risks since 2004. The 

commercial insurance industry, mutualization companies, and financial markets also modified 

the terms, conditions, and expectations of offshore coverage virtually every year, whereas in the 

past, these changes were much less common, and more discrete (Sharp, personal communication, 

2010). 

The Big Four hurricanes taught insurers a number of lessons, the most painful of which was that 

deductible levels were too low, coverage terms too broad, and premiums insufficient to cover the 

potential risk exposure a catastrophic storm could have in any given year (Marsh, 2009). Yet, 

despite these lessons, few insurance companies packed up their offices and left the Gulf and its 

offshore operators to their own devices. The offshore GOM insurance market is simply too large, 

and potentially too profitable for many companies to ignore (Marsh, 2009). 

Figure 27 highlights the consequences of the post-2004 storm environment for many GOM 

insurers. Estimates place total claims at 4.25 times collected premiums during the course of the 

post-2004 market. Consensus among insurers is that going forward the market must be able to 

handle an “Ike-size” hurricane every year and still make a profit (Lloyd & Partners Limited, 

2008; Granger, personal communication, 2009; Sharp, personal communication, 2010). In order 

to do this profitably, private insurance markets of all types are raising premiums, increasing 

deductibles, and requiring a considerable amount of asset-specific information in order to 

customize insurance to the potential risk of loss involved. The days of generic standardized 

coverage are long gone, and not likely to return in the future. 
58

 Figure 27. Energy insurance market GOM premium versus claim (estimates). 

Table 7 characterizes the losses by type (Commercial Insurance, OIL-insured, and uninsured 

losses) for each of the Big Four hurricanes and also states the percentage of total share that each 

category bore. This table also states the Saffir-Simpson scale rating of each storm. 

$0

$2

$4

$6

$8

$10

$12

2004 2005 2006 2007 2008 Total

Billions of Dollars

GOM Wind Premium GOM Wind Claims

Source: Willis Group Holdings, 2009. 
59

Table 7 

Hurricane Loss Metrics23

($ Millions) Ivan Katrina Rita Ike

Saffir-Simpson 2 5 4 2

Platforms Destroyed 7 46 69 54

Platforms Damaged 24 20 32 95

Total Loss Incidents 57 147 124 107

Total Loss (Incl. not insured) 1,859 $ 7,078 $ 5,557 $ 5,949 $ 

Infl-adjusted Total Loss ($ 2008) 2,592 $ 9,362 $ 7,350 $ 5,949 $ 

Infl-adjusted Average Total Loss 45 $ 64 $ 59 $ 56 $ 

Comm. Market Insured Losses 1,250 $ 3,000 $ 3,500 $ 3,000 $ 

Share of Lossses Insured by

Commercial Market 67% 42% 63% 50%

Total OIL Paid Claims 560 $ 810 $ 800 $ 600 $ 

Share of Losses Insured by OIL 30% 11% 14% 10%

Estimated Losses borne by Industry 49 $ 3,268 $ 1,257 $ 2,349 $ 

Share of Losses borne by Industry 3% 46% 23% 39%

 Source: Gaudet, 2006; Det Norske Veritas, 2007; USDOI, MMS, 2008b; USDOC, NOAA, 

2010; and Willis Group Holdings, 2010.

5.1.2. Offshore Insurance Cycles and Tropical Activity 

The offshore insurance business in the GOM tends to move in cycles closely related to tropical 

activity. For instance, rates will tend to be relatively low for long periods of time when tropical 

activity is relatively limited. Interestingly, profit margins for private insurance companies during 

relatively calm periods can be challenged and lead to some participants exiting the offshore 

coverage market for more lucrative returns elsewhere. These calm and relatively low-profit 

periods are referred to as a “soft market” by those providing offshore coverage. Premiums and 

coverage terms in these soft markets turn decidedly in favor of offshore companies. For 

instance, offshore energy insurance premiums decreased between 20 to 30 percent in the 2008 

renewal season after two years of relative tropical activity calm in the GOM (Gonzalez, 2008). 

While the 2008 renewal season cannot be considered a soft market by traditional terms, it is a 

clear example of how calm tropical periods affect the market. 

 

23The number of platforms damaged and destroyed comes from BOEM-reported statistics. The number of total 

incidents and total losses, both number and dollar figure, come from the Willis Energy Loss Database. The dollar 

figures of associated commercial market losses come from the 2009 Willis Energy Market Review. OIL loss figures 

come from OIL’s website. The estimated share of losses borne by industry is calculated as the difference between 

total losses, commercial market losses, and OIL losses.
60

The cycle can, however, move in the opposite direction during periods of busy tropical activity. 

These periods can be thought of as a “hard market” for insurance coverage where profitability 

increases, coverage terms become more stringent, premiums increase, and offshore operations 

find coverage expensive and limited. Market conditions during this period swing decidedly in 

favor of private insurance companies that can raise premiums and deductibles, provided overall 

energy markets are relatively strong and robust. These hard market periods can also be thought 

of as ones in which offshore operators will tend to absorb more risk associated with their actions 

than would be the case in a soft market. 

For instance, the post-2004 market found many offshore operators in the positions of having to 

reduce their portfolios and coverage (Granger, personal communication, 2009). Although 

exclusions are likely under hard market conditions, there is some anecdotal information 

indicating that there were not as many exclusions to coverage as there were greater tendencies 

for greater information, and more specialized coverage/premium terms than in years past. As a 

result, more companies, primarily those with larger balance sheets, moved to greater levels of 

self-insurance to avoid costly coverage (Granger, personal communication, 2009). 

5.1.3. Insurance Market Reaction: Hurricane Ivan 

According to the Willis Energy Loss Database (WELD), Hurricane Ivan caused approximately 

$1.8 billion in energy asset damages. While large, the “soft” state of the market at the time 

cushioned the impact to rates, retentions, coverage, and capacity. Willis estimated the amount of 

available capacity for an upstream offshore single site risk to be around $1.1 billion from Lloyd’s 

insurers and about $1.2 billion for other insurance companies during this time period (Willis 

Group Holdings, 2005). Lloyd’s and Willis estimated the highest available economically viable 

capacity at $2.3 billion (Willis Group Holdings, 2005). Ivan-created losses resulted in premium 

increases of between 10 to 100 percent depending on each company’s loss history and required 

level of coverage. By comparison, insurance rates for non-GOM energy assets during this period 

were estimated to be flat to decreasing by as much as 10 percent from the prior year (Willis 

Group Holdings, 2005). 

5.1.4. Insurance Market Reaction: Katrina and Rita 

The 2005 tropical season, that included offshore destruction from two major hurricanes, proved 

to be the market defining event for the offshore insurance industry. Willis estimated total GOM 

energy losses at $7.08 billion and $5.56 billion for Katrina and Rita, respectively. Both numbers 

are still not finalized, and are likely to continue to rise as claims continue to be settled as late as 

2010. The 2006 Willis EMR described the market reaction as one resulting in “massive rate 

increases, incomplete reinsurance programs, general confusion and a (perhaps understandable) 

lack of underwriting consistency, as different underwriters develop their own solutions to trading 

in a new environment” (Willis Group Holdings, 2006). Willis also expressed the concern that, 

“there is doubt in some quarters as to whether upstream energy underwriting can ever again be 

profitable” (Willis Group Holdings, 2006). Some insurance suppliers discussed abandoning the 

GOM market to focus on international business (Sharp, personal communication, 2010). 
61

5.1.4.1. Business Interruption 

BI insurance claims constituted a significant portion of total claims for all Big Four hurricanes, 

but were especially significant after Hurricanes Ivan, Katrina and Rita. Available statistics 

indicate that offshore BI losses accounted for 15 and 21 percent of total claimed losses for 

Katrina and Rita, respectively. Pipeline damage caused by mudslides during Hurricanes Ivan 

and Katrina are thought to have created especially significant CBI insurance claims although the 

exact statistics are not publicly available. These CBI losses were especially challenging for 

many underwriters who failed to impose the down claim sub-limits that were common on the 

downstream portion of the industry during a similar time period (Willis Group Holdings, 2006). 

Since that time, offshore CBI underwriters now require defined sub-limits. In addition, CBI 

underwriters require significantly more information about physical infrastructure constraints 

potentially impacting contingencies in order to qualify for CBI coverage approval. This 

information includes, but is not limited to, a detailed schedule of all pipeline connections and 

downstream transportation choke points upstream from an insured structure and its associated 

production wells (Sharp, personal communication, 2010). 

The GOM was relatively quiet in the post-2005 tropical season period. This led to small 

reductions in premiums although technical factors defining insurance underwriting, such as 

retention levels and the level of coverage continued to change as a result of the earlier 

catastrophic hurricane seasons. The Lloyd and Partner’s Energy & Marine Insurance Newsletter, 

a leading industry publication, reported that, “despite calls from senior management of insurers 

(and from the Lloyd’s Franchise Directorate) to “kill-off” the insurance market cycle through 

disciplined underwriting, signs are that the cycle is in full health and speeding down the other 

side of the peak [in rates] almost as quickly as it climbed it following the rocket it was given by 

2005 losses (Lloyd & Partners Limited, 2008).” 

5.1.5. Insurance Market Reaction: Hurricane Ike 

The 2008 tropical season created a near repeat of the two-storm experiences of 2005, although 

the 2008 levels of destruction, and overall level of claims were considerably lower than the 

Katrina-Rita events. Hurricane Ike resulted in an estimated $5.95 billion in energy industry 

losses (not all offshore). Adjusted for inflation, Ike caused about 64 percent and 81 percent of 

the total dollar losses created by Katrina and Rita, respectively (Willis Group Holdings, 2009). 

In the 2009 annual Lillehammer Claims Conference, an important annual conference for energy 

insurance underwriters, Dominick Hoare, head of the Watkins Syndicate24 noted that, after Ike, 

2009 was likely to be the “last chance saloon” for the industry to learn how to make a profit in 

the face of a large tropical storm like Hurricane Ike (Hoare, 2009). The industry consensus is 

that premiums, coverage structure, and deductibles will have to be fashioned in such a manner to 

defend against a possible Ike every year for the foreseeable future. 

5.1.6. Insurance Industry Reaction: Aggregate Limits 

Prior to the 2004 tropical season, aggregate limits, while not uncommon, were not widely 

utilized. After 2004, and particularly after 2005, underwriters and reinsurers decided the 

 

24Watkins Syndicate is the largest Lloyd’s of London energy risk underwriter by insured asset value. 
62

uncertainty with open ended policies, and disputable asset values under dramatically changing 

market conditions, was simply too risky, particularly under current premium levels and 

structures. When Hurricanes Katrina and Rita struck, some offshore insurance providers, 

especially reinsurers, lacked proper assessments (i.e., information) regarding their total exposure. 

Insurers (direct and reinsurance) have reacted by a series of new aggregate limits as well as the 

imposition of retrocessional coverage which is simply a contract between reinsurers to mutually 

cover or “back up” each others’ exposure under certain conditions. This has the effect of shoring 

up stability and increasing the reliability of capacity over the short- and long-run by diversifying 

risk across a number of different parties, particularly in the reinsurance market (Willis Group 

Holdings, 2008; Sharp, personal communication, 2010). Retrocessional coverage, along with 

aggregate limits, has helped insert stability back into the direct market and especially the 

reinsurance market. The net result is greater capacity, greater stability, and lower premiums. 

5.1.7. Insurance Industry Reaction: Lloyd’s Realistic Disaster Scenario 

One important realization reached by all types of insurance providers post-2004 has been that no 

company can have too much information about the operators or the assets it is insuring. An 

additional realization reached in the period immediately following the 2004 storm season was 

how little information the insurance industry had about its clients’ business activities, assets, and 

interrelationships with other assets. Insurers’ bottom lines depend on a better understanding of 

how hurricanes can be predicted and, if possible, maintaining a constant awareness of their 

exposure to such storms through analyses, research, and empirical/financial/risk simulation and 

modeling. 

These are the reasons that led to the annual Lloyd’s Realistic Disaster Scenarios (RDS) exercise 

being created by London insurers. Each year, Lloyd’s develops a set of hypothetical scenarios it 

“unleashes” on syndicate insurers who report back exposures. A simulated GOM hurricane is 

always part of the exercise, and is labeled a “compulsory event scenario” for all underwriters. 

The results are shared with the Lloyd’s Franchise Board who, depending upon the results, can 

force a syndicate to take actions to conform to a previously submitted business plan. If the 

Board believes any one syndicate’s reactions and coverages are entirely out of line, it can, under 

a more extreme situation, censure the offending syndicate raising significant reputation 

challenges and embarrassment to that syndicate’s chief underwriter. Since each Lloyd’s member 

insures the whole, the Board’s annual RDS exercise is seen as an important self-enforcing 

component of keeping Lloyd’s a functioning and successful insurance marketplace. An example 

of this analysis/simulation, based upon the 2009 GOM hurricane and windstorm scenario, is 

pictured in Figure 28. 
63

Figure 28. Lloyd’s of London 2009 Realistic Disaster Scenario.25

5.1.8. Insurance Industry Reaction: Hurricane Forecasting 

Hurricane modeling and prediction (i.e., forecasting) has become an important aspect of the 

GOM offshore energy insurance industry. Third-party companies such as Risk Management 

Solutions Applied Insurance Research and Eqecat actively model hurricane activity for insurance 

clients. Investment banks investing in contingent capital and cat bonds tend to rely heavily on 

these private meteorological modeling services provided by a number of companies. 

5.1.9. Insurance Industry Reaction: Market Recovery 

High premiums and tight market conditions often create the makings of their own demise since 

they result in higher profitability, enticing new market participants and expanded competition. 

For instance, Berkshire Hathaway expanded its energy insurance position in February 2010 by 

covering 10 percent of Marsh Inc.’s London energy portfolio (Bradford, 2010). Willis EMR, for 

instance, noted in 2003 that: 

the energy insurance business has been very profitable for carriers over the last 12 

to 18 months. As a consequence, competition has started to increase. Onshore 

property premiums have been drifting downward, and offshore property rates 

appear to have peaked.26

 

25Assumed destruction: $5.5 billion offshore energy (insured by Lloyd’s of London syndicates).

26This is due to rising rates after the 9/11/2001 terrorist attack on the World Trade Center in New York City. After 

the attack rates rose and corresponded with three relatively low loss years.

Source: Lloyds of London, 2009. 
64

Willis, a leading insurance broker, keeps track of energy asset losses in its Willis Energy Loss 

Database (WELD). The database records all losses not specific to claims from insurance 

companies. The trends in offshore damages, as well as offshore premiums, are provided in 

Figure 29. 

 Figure 29. World energy total losses vs. estimated world energy premium.27

5.2. Mutualization Impacts and OIL 

OIL, the leading energy industry mutual insurer, suffered many of the same insuring and claims 

challenges as other private insurance companies in the aftermath of the 2004 and 2005 tropical 

seasons. Hurricane Ivan, for instance, represented one of the first significant claims made on 

OIL’s financial reserves. Table 8 provides the estimated claims made against OIL’s reserves by 

its member companies for the last four major hurricanes. The total estimated losses by OIL 

members for the Big Four hurricanes were reported to be $5.47 billion in 2008 inflation-adjusted 

dollars. However, due to aggregate limits imposed per OIL’s bylaws, the amount actually paid 

out was somewhere in the order of $2.77 billion in 2008 inflation-adjusted dollars. 

 

27Includes uninsured losses.

Source: Willis Group Holdings, 2010. 
65

Table 8 

OIL Estimated Hurricane Claims 

Total OIL Scaling Total OIL

Hurricane Losses Factor Paid Claims

(billion $) (billion $)

Ivan $ 0.79 0.71 $ 0.56

Katrina $ 2.02 0.40 $ 0.81

Rita $ 1.46 0.55 $ 0.80

Ike $ 1.20 0.50 $ 0.60

Total $ 5.47 $ 2.77

 Source: OIL, 2010c. 

Loss coverage on claims made for each of the Big Four GOM hurricanes was limited in order to 

proportion pay-outs among several members making claims. For instance, pay-outs for 

Hurricane Ivan-related claims were capped, on average, to 71 percent of total filed claims. 

Payouts for the other three storms were capped at lower amounts ranging from 40 percent 

(Katrina) to 55 percent (Rita). OIL imposes aggregate limits to ensure continuity and viability of 

its mutualization model. The scaling factor is basically used to ensure proportional payout until 

members can efficiently and correctly be paid for the whole aggregate limit (OIL, 2010c). 

United 

States, 

$3,087

Europe, 

$1,283

Canada, 

$372

Gulf of 

Mexico, 

$3,573

North Sea, 

$505

Other Areas, 

$1,395

Figure 30. OIL’s cumulative reported net incurred losses 

by geographic region (1972 to 2008, million $). 

Source: OIL, 2008b. 

Total: 

$11,802 
66

Figure 30 provides a chart examining OIL’s reported net incurred losses by geographic region on 

a cumulative basis for the period of 1972 to 2008. The cumulative losses reported for the GOM 

region are considerable. Out of the $11 billion in total incurred losses over the past 26 years, 

some $3.6 billion (32 percent) were in the GOM region alone. An estimate of the hurricane and 

non-hurricane related losses can be developed by subtracting the $2.77 billion (25 percent) in 

Big Four-related claims provided in Table 8 from the cumulative claims identified in Figure 31. 

An estimate of the annual incremental losses per region can also be estimated by examining the 

changes in OIL’s cumulative reports on a year-by-year basis. Figure 31 examines these 

estimated losses by OIL members by region, over time, and shows the considerable spike created 

by the post-2004 tropical activity along the GOM. 

 Figure 31. OIL cumulative net incurred losses by geographic region (1972 to 2008).28

Figure 32 presents OIL’s estimated cumulative net incurred losses on an industry sector basis for 

the period 1972 to 2008. Offshore E&P activities account for $4.8 billion in cumulative losses 

from 1972 to 2008, or some 40 percent of OIL’s $11.1 billion in cumulative losses. Refining and 

marketing losses account for the second largest cumulative sectional losses at $2.8 billion. Prior 

 

28INBR stands for ‘incurred but not reported’ and INBE stands for ‘incurred but not expensed’.

Source: OIL, 2008b. 
67

to the hurricanes, E&P reported losses were below those reported in the refining and marketing 

sectors on several occasions.

 Figure 32. OIL cumulative reported net incurred losses by sector. 

An estimate of the annual (incremental) losses by sector can also be derived by examining the 

annual differences in OIL’s cumulative reported net losses. Figure 33 provides those estimates 

and highlights the fact that prior to 2004, offshore losses were actually smaller than claims made 

in the refining and marketing sector. 

Source: OIL, 2008b. 
68

 Figure 33. Estimated OIL incremental reported net incurred losses by sector. 

OIL’s balance sheet has seen a number of changes over the past decade in reaction to changes 

created by the post-2004 tropical activity along the GOM. Figure 34 presents a summary graph 

of some of the main components of OIL’s balance sheet over the past decade including total 

assets, loans payable, outstanding losses, and shareholder equity.

Source: OIL, 2008b. 
69

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Millions ($)

Loans Payable Outstanding Losses Shareholder's Equity Preference Shares Total Assets

 Figure 34. OIL annual balance sheet figures. 

A number of trends are discernable from Figure 34. First, the period prior to 2003 was marked 

by relative stability in OIL asset growth and claims. OIL’s outstanding losses,29 for instance, 

were less than $1 billion prior to 2003. These losses increased significantly on a percentage 

basis in 2001, but were relatively small in absolute value, and small as a share of total assets (32 

percent). Loans payable, or the outstanding loans used by OIL to make claims payments and 

fund other business operations, remained at a relatively constant level ($250 million) from 1999 

to 2002. 

OIL saw another significant annual increase in outstanding losses in 2004, in part from the 

claims resulting from Hurricane Ivan. Loans payable used to support business operation 

activities increased in 2003, but remained relatively constant all the way through to 2005. Assets 

during this period increased from $2.4 billion in 2002 to over $6.6 billion in 2005. 

OIL saw a significant shift in its balance sheet in 2005. Total assets leaped from a 2004 level of 

over $4.4 billion to a 2005 level of over $6.6 billion, a 50 percent increase driven in large part by 

a substantial increase in reserve fund investments and booked accounts receivable due to 

hurricane-related losses. Outstanding losses in 2005 increased dramatically, due in large part to 

the combined impact of Katrina and Rita in that same year. Loans payable increased only 

slightly to $1.3 billion as OIL appears to have relied more on collected premiums to pay off 

claims than the use of loans from other financial institutions and the market. 

 

29Outstanding losses represent the estimated amount necessary to settle all outstanding claims, including claims 

which are incurred but not reported, as of the balance sheet date. 

Source: OIL 2001, 2002, 2003 2004, 2005, 2006, 2007, and 2008b. 
70

The last several years (2006-2008) continue to reveal many of the same trends that materialized 

for the first time in 2005. Total assets have remained well in excess of $6.0 billion, and actually 

approached $8.0 billion in 2006 before declining over the past two years. Outstanding losses 

remain over $3.5 billion, increasing slightly in 2008 with the landfall of Hurricane Ike on the 

Texas Gulf Coast. Loans payable ceases to exist at any significant level and appears to have 

been replaced with a new component in OIL’s capital structure. Now, OIL appears to rely more 

on preferred equity and reserves for financing as opposed to debt (loans).

One of the most significant changes experienced by OIL membership resulting from 2005 

tropical activity has been a substantial increase in rates. Figure 35 charts the annual changes in 

net incurred losses from 2002 to 2008 and compares those to changes in OIL insurance rates for 

a similar period. Between 2002 and 2004, both standard (first tier mandatory coverage) and flat 

premium (second tier voluntary coverage) rates remain less than $0.10 per dollar insured. In 

2005, these rates increased by over 450 percent for standard rates and over 350 percent for flat 

premium rates. The increases however, have been relatively short-lived and by 2008, have 

returned to levels comparable to 2002. 

 Figure 35. OIL net incurred losses and rates. 

While OIL’s post-2005 insurance rates have returned to near normal levels, a number of new 

coverage limits and conditions have been adopted changing the nature of insurance for some 

policyholders/members. One of the initial steps taken by OIL immediately after Hurricane 

Katrina (September 23, 2005) was to resort to “extraordinary” measures to convert $800 million, 

Source: OIL 2001, 2002, 2003, 2004, 2005, 2006, 2007, and 2008b. 
71

or the “vast majority” of its “incurred but not evolved”30 (IBNE) reserves, to premiums (Willis 

Group Holdings, 2006). This action was reported to have been taken to circumvent a potential 

credit downgrade by S&P. 

Seven days later, however, S&P downgraded OIL’s credit status from “A+” to “A-”. Since OIL 

shares risk across its members, this downgrade translated directly into an increased cost. OIL is 

reported to have responded further to this downgrade by collecting close to $900 million in 

supplemental payments (premiums) from shareholders.

One of the more significant post-2005 changes made by OIL, that has had a lasting impact on 

how members’ assets are insured, has been through the creation of what is referred to as the 

“Atlantic Named Windstorm Sector” or “ANWS.” This categorization segments assets based 

upon their potential exposure to tropical cyclone activity. The categorization is further 

differentiated by onshore and offshore assets. This new ANWS categorization was adopted by 

the OIL Board in June 2007. 

Under the new ANWS, OIL’s gross insurable assets will be categorized for each member as 

being either: (a) not eligible; (b) onshore ANWS eligible; or (c) offshore ANWS eligible. 

Different discount factors will be applied to the gross insurable onshore and offshore assets. 

These discount factors will be determined on what appears to be a subjective basis by an 

individual OIL underwriter. The purpose of the discount factors is to reduce the insured value of 

assets subjected to tropical cyclone risk. 

 

30OIL collects payments from shareholders which it holds in a fund called, “Incurred but not evolved.” The fund is 

a reserve fund for claims that have not yet occurred.
72

 Figure 36. OIL member gross assets (OIL-insured value). 

Figure 36 provides an estimate developed by OIL, which shows the discount that the ANWS 

classification has caused from unmodified gross assets. For most years, these factors would have 

discounted OIL gross insurable assets by as much as 50 percent. 

The last major policy change by OIL in the aftermath of the 2005 storms has been the 2007 

adoption of a new “theoretical withdrawal premium” or “TWP.” The TWP was reportedly 

adopted by OIL to stem unnecessary withdrawals from OIL’s membership (Willis Group 

Holdings, 2006). While industry consolidation has contributed to membership contraction since 

the late 1990’s, the 33 percent reduction in membership since 2005 appears to go beyond 

industry trends and could represent attempts by members to shirk on their longer-term 

commitments to the insurance mutual in the face of challenging exogenous events (i.e., 

hurricanes). 

The TWP was adopted recently as a contractual premium obligation made by members wishing 

to disassociate themselves from OIL. The TWP is calculated as a company’s annual historical 

pool percentage applied against specific historical loss years (Willis Group Holdings, 2008). In 

order to withdraw from OIL, a member must provide 90 days’ notice, in addition to booking a 

TWP liability (OIL, 2009). This balances a member’s need to shop for competitive insurance 

coverage against the need for long-term commitments needed for mutualization-based insurance 

companies. 

In addition to creating membership equity, the TWP has resulted in a positive impact on the 

company’s balance sheet. After adopting the TWP, OIL petitioned Standard and Poor’s to 

recognize the TWP as outstanding capital. S&P, in addition to other rating agencies, 

subsequently recognized this potential source of capital, allowing OIL to book over $1 billion in 

TWP capital credit to its balance sheet (OIL, 2006).

Source: OIL 2001, 2002, 2003, 2004, 2005, 2006, 2007, and 2008b. 
73

5.3. Changes in Self-Insurance 

One major outcome of the higher premium prices in the wake of Hurricanes Katrina and Rita has 

been the increase in the number of companies deciding to self-insure all or an increasing share of 

their assets. While the exact number of companies that decided to self-insure or increase the 

level of their self-insurance coverage since the storms is unknown, anecdotal evidence suggest 

the numbers are significant (Benning, 2009; Martin, personal communication, 2009; Winchester, 

personal communication, 2010). Estimates place the number of firms choosing to increase 

exposure at one-third, with another one-third choosing to entirely self-insure (Phillips, 2009). 

Another form of “self-insurance” that is becoming more common is the tendency for some 

companies to choose to incur more risk (and possibly more savings) by increasing their 

deductibles “across-the-board” since the first of the Big Four hurricanes hit. Significant 

increases in deductibles represent another form of self-insurance. 

The super major oil and gas companies continue to self-insure through captive programs and 

mutuals post-Big Four hurricanes. The pressure (and the possibility of choice) to move to selfinsurance is greater for mid-size companies, as small cap companies are often forced by lenders 

to maintain insurance (Martin, personal communication, 2009). 

5.4. Reinsurance 

The availability of reinsurance is crucial to the functioning of the GOM offshore energy 

insurance market. The supply and demand of reinsurance, and the extent to which hurricanes 

affect both factors, determines the availability of direct insurance to GOM offshore energy 

companies. The Big Four hurricanes had the effect of increasing demand, yet reducing the 

supply of reinsurance. This created a number of negative outcomes for direct insurance 

companies including paying higher reinsurance premiums, general reinsurance scarcity, and 

higher attachment levels (deductibles to direct insurers). 

There are accounts of the lack of retrocessional insurance in the wake of Hurricanes Katrina and 

Rita (Bradford, 2005). The lack of retrocessional insurance further compounds the impact of a 

hard insurance market on purchasers and limits the overall availability of reinsurance and thus 

direct insurance available to energy companies. The Benfield Group, now a part of Aon 

Corporation, a leading reinsurance brokerage firm, estimated the price increase of catastrophe 

reinsurance for property renewals at 10 percent to 115 percent. Figure 37 shows a comparison of 

year-over-year estimated price changes for property catastrophe renewals in reinsurance. 
74

Figure 37. Annual catastrophe reinsurance rates (property reinsurance). 

The increase in rates in 2007 is especially interesting given that 2006 was a quiet year for natural 

disasters and likely reflected the anticipation of a difficult 2007 for GOM hurricane activity. 

Indeed, the Department of Atmospheric Science at Colorado State University predicted an 

“above-average Atlantic basin tropical cyclone season in 2007” and an “above-average 

probability of United States major hurricane landfall” (Klotzbach et al., 2006). Another reason 

why rates remained high for offshore energy insurance is that reinsurers began significantly 

differentiating GOM offshore energy risk from other energy and catastrophe risk coverage in 

2006 in reaction to Hurricanes Katrina and Rita (Willis Group Holdings, 2007). 

In reaction to high rates in the wake of Katrina and Rita, reinsurance “sidecars” became 

increasingly popular. Reinsurance sidecars are deals between investors (usually investment 

banks) to assume a portion of reinsurance risk in return for an amount of premium. An estimated 

$2.4 billion of capital for reinsurance was made available by sidecars in 2006 (Benfield Group 

Limited, 2007). In addition to sidecars, high rates offered for reinsurance attracted a number of 

new reinsurance companies to enter the market (Table 9). 

Source: Benfield Group Limited, 2007. 
75

Table 9 

2006 Reinsurance Market Entrants 

Name Capital

(million $)

Aeolus Re $ 500

Advent Re $ 38

Alba Syndicate 4455 $ 18

Asia Capital Re $ 625

Empyrean Re $ 150

New Point Re $ 250

Norton Re $ 108

Syndicate 1919 $ 98

Syndicate 3334 $ 16

Syndicate 4242 $ 148

Syndicate 3820 $ 128

Total $ 2,079

Source: Benfield Group Limited, 2007.

The energy reinsurance market entered 2008 having experienced two years of outstanding 

profitability. Benign hurricane seasons and relatively high rates of premium were the largest 

contributing factors to the market’s success. Evidence suggests that GOM energy rates were 

softening and that competition was increasing throughout the 2007 and 2008 renewal seasons 

(Willis Group Holdings, 2008; Guy Carpenter & Company, LLC, 2010b). 

 Figure 38. Guy Carpenter world rate on line index.

Source: Guy Carpenter & Company, LLC, 2010b. 
76

As shown in Figure 38, reinsurance rates spiked in 2006, but began to marginally retreat in 2007 

and 2008 with 5.7 and 11.3 percent year-over-year reductions, respectively. 

As GOM hurricanes largely drove reinsurance rates between the years of 2005 and 2009, the 

worldwide reinsurance market rates are reflective of the rates and factors determining GOM 

energy company premiums. The fact that GOM hurricane activity has largely driven worldwide 

reinsurance rates is reflected in the rate reductions presented in Figure 39. 

 Figure 39. Year-over-year reinsurance rates by region. 

U.S. reinsurance rates were up 12 percent in 2009, 4 percent higher than worldwide increases, 

mostly due to 2008 GOM claims related to Hurricanes Ike and Gustav and the financial crisis 

(Guy Carpenter & Company, LLC, 2009). The Big Four hurricanes had a lasting effect on the 

reinsurance market. The main difference being premium price differentials and aggregate limits 

applied specifically to GOM offshore energy insurance policies. 

5.5. Insurance-Linked Financial Instruments 

Financial instruments used to capitalize GOM offshore energy insurance became a central focus 

of the market after Hurricanes Katrina and Rita. At that time the perceived risk (and rates) for 

GOM offshore energy assets was at an all-time high. The market for insuring such assets was 

hard and reflected a shortage of supply of capital for issuing policies. During this time the dollar 

value of catastrophe bond issues exploded, increasing from $2 billion in 2005 to over $4.7 billion 

in 2006 and $7 billion in 2007. Along with the overall softening of the market in 2008, 

catastrophe bond issues fell to over $2.7 billion, still higher than pre-Big Four as evidenced in 

Figure 40. 

Source: Guy Carpenter & Company, LLC, 2010b. 
77

 Figure 40. Catastrophe bond issues. 

Hurricane Katrina was the first storm to deliver a total principal loss to catastrophe bond 

investors when a KAMP Re company parametric-triggered bond was triggered. Post-Katrina 

bond issues were at higher yields-to-maturity, reflecting the greater perception of risk affecting 

GOM offshore energy assets. Despite the increased risk, the high returns made possible by 

catastrophe bonds attracted a significant amount of capital post-Katrina and Rita and continue to 

deliver capacity to GOM offshore energy insurers that did not previously exist. 

5.5.1. Parametric Bond Triggers 

The Willis Research Network (WRN), the world’s largest partnership between academia and the 

insurance industry, seeks to understand how hurricanes can be predicted among other 

catastrophes (Willis Research Network, 2010). Started in 2006, the WRN includes a number of 

top university programs and employs meteorologists, seismologists, hydrologists, engineers, 

actuaries, and statisticians. WRN research is one significant example of how brokers, mutuals, 

insurers, and reinsurers are adapting to the hurricane energy risk market. Some stakeholders 

choose to rely on a combination of in-house research as well as consulting firm research. A 

number of risk modeling firms, such as Risk Management Solutions, Eqecat, and Tropical Storm 

Risk, work with insurers to quantify risk exposure.

One interesting outcome related to catastrophe bonds has been the Willis Hurricane Index 

(Figure 41). Noting the disparity between the Saffir-Simpson scale of Hurricane Ike (Cat 2) and 

the dollar amount of its damage (~$6 billion in energy losses), Willis Research Network and 

National Center for Atmospheric Research set out to create an index that would better 

Source: Guy Carpenter & Company, LLC, 2010b. 

Note: * Fourth quarter 2009 numbers not available. 
78

statistically define hurricane damage. These partners used a set of commonly published 

parameters to build the model. The parameters include: the amount of energy dissipated at the 

surface by the maximum winds, the radial extent and character of the surface wind field, and the 

translational speed of the hurricane. The result of the model was an average of 96 percent 

explanation of the variation on dollar-value energy industry hurricane losses over all major Gulf 

of Mexico hurricanes from Andrew through Ike. 

 Figure 41. Willis Hurricane Index (WHI).

Indices such as the Willis Hurricane Index are poised to assist in the standardization of 

parametric-trigger bond issues. Parametric-trigger catastrophe bonds are particularly vulnerable 

to basis risk, that is, the risk that the issuer of the bond will suffer a loss without triggering 

parameters. The WHI and other indices is a step-forward for the industry in terms of minimizing 

basis risk while attracting investors with transparent and easy to understand triggers. 

Despite recent successful efforts in creating such an index, the ability to predict energy industry 

hurricane damage from models used to examine existing hurricanes still remains a young field. 

Source: Holland, 2010. 
79

6. CONCLUSIONS 

This report addresses a number of key issues associated with the offshore oil and gas industry’s 

ability to insure against hurricane-related risks in the GOM. Historically, insurance coverage for 

the offshore industry was based upon a structure not too dissimilar from other energy industry 

sectors. Prior to 2004, a significant share of offshore insurance coverage was provided on a 

commercial basis by private companies, mitigating storm-related and other risks in return for a 

fee (premium). These services were not limited to physical damages created by weather-related 

events alone, but included insurance against financial losses for business interruption, as well as 

asset replacement inflation. 

Prior to 2004, and even to the current period, the offshore industry had a number of competitive 

insurance alternatives including mutualization and self-insurance. The destruction created by the 

Big Four hurricanes forced all three insurances types (commercial, mutualization, and selfinsurance) to make a number of important changes that included: new aggregated policy limits; 

increased deductibles and waiting periods; more stringent informational requirements; and a new 

and increasingly more important role for reinsurance coverage and insurance-linked securities. 

New aggregate limits imposed by commercial insurance markets, as well as mutual insurance 

companies like OIL, reflect the reality of operating in today’s high cost energy environment, 

where the consequences of asset destruction and business interruption are considerable. Consider 

that the gross revenues lost from the interruption of a 300,000 barrel per day deepwater well 

could run as high as $30.0 million per day at a $100/Bbl oil price. This, coupled with the 

destruction of a production structure with a replacement value of close to $1 billion like 

Chevron’s Typhoon TLP, creates significant financial challenges for any kind of insurance, 

regardless of type. 

Aggregate limits shift the structure and nature of offshore energy insurance coverage by 

requiring operators to assume a larger financial share of extreme events. In many ways, 

aggregated coverage limits can be thought of as another form of self-insurance, since individual 

operations now have to assume some share of the “upper bounds” of those potential losses. The 

imposition of these aggregate limits has been seen as necessary during and after the advent of the 

Big Four hurricanes. The overall solvency of many individual commercial insurance companies, 

mutuals, and even self-insuring affiliates, would become challenged without some limitations on 

massive claims. Aggregate limits are seen as a means by which coverage capacity in the market 

can be maintained by requiring part of that capacity to be held by individual operators. Over 

time, as claims and catastrophic incidents decrease, commercial coverage capacity can begin to 

expand as more investment capital, seeking to earn a return on financing this offshore risk, enters 

the market. 

Changes in deductibles, and the impositions of waiting periods (primarily for business 

interruption claims), are additional coverage modifications developed to secure a relatively 

healthy and robust offshore insurance market. Both coverage limitations are additional examples 

of the increasing share of risk being assumed by offshore operators. Both restrictions (higher 

deductibles, longer waiting periods) require operators to assume risk on the “lower bound” of a 

potential catastrophic weather-related accident. Coupled with aggregate limits, these restrictions 
80

put operators firmly in the position of having to share risk, almost on an equal basis, with 

commercial or mutual insurance types. 

Higher deductibles, for instance, require operators to assume a larger initial share of weatherrelated damages than a lower deductible level. Waiting periods create similar risk profiles for 

offshore operators: the longer the waiting period, the greater the share of initial (and total) 

financial losses borne by an offshore operator. Operators can attempt to reduce both deductibles 

and waiting periods, but must do so at a cost: higher premiums. 

One of the more dramatic and significant changes created the Big Four hurricanes has been in the 

area of risk assessment and evaluation. Prior to 2004, offshore insurance providers (commercial 

as well as mutual providers) were making some, albeit limited, movements at expanding and 

improving their asset risk evaluation and risk management practices. Part of this initiative was 

driven by overall trends in the financial and energy sectors placing greater emphasis on the use 

of risk management tools and methods during the mid- to late-1990’s. The Big Four hurricanes 

rapidly accelerated the industry to adopt more detailed, sophisticated, and rigorous methods of 

risk evaluation. 

The ability to conduct a thorough and rigorous risk exposure analysis falls upon one key input: 

information. Prior to 2004, most aspects of the offshore insurance industry relied upon a 

standardized approach of evaluating policies based upon compliance, or asset categorization, 

within a set of uniform industry engineering standards. Post-storms, the evaluation process 

becomes more diverse, requiring a significantly broader and more extensive set of asset-specific 

information from offshore operations. This detailed information was used with a new set of 

modeling approaches and independent third party analysis, to develop new asset/ insurance 

analyses, classes, and categorizations such as Lloyd’s “Realistic Disaster Scenarios” and Oil’s 

“Atlantic Named Windstorm Sector.” 

An additional, ongoing change to offshore insurance markets created by the Big Four hurricanes 

has been the increasingly important role of reinsurance and insurance-based securities such as 

“cat bonds” and contingent capital. Both represent various forms of additional insurance, or risk 

diversification, for primary forms of insurance including commercially-provided insurance, selfinsurance, and mutualization. Reinsurance firms raise capital from markets, and in turn, invest 

this capital in risk held by commercial insurance companies for some share of its premium 

revenues. Insurance-based securities fund risk directly like corporate debt. Underwriters issue 

bonds that can be used (redeemed) if a catastrophic event occurs. Otherwise, the principal and 

some return is paid to the cat bond holder for the assumption of risk during the posted term of the 

bond. 

Both reinsurance and insurance-based securities are based upon the premise of efficient 

arbitrage: that markets for risk, if freely traded, can find the most efficient sources of capital to 

mitigate damages from extreme events. This efficiency creates two benefits. First, it reduces 

overall insurance cost by allowing more efficient insurance providers to assume various shares of 

offshore operating risk for a mutually beneficial fee: a fee high enough to encourage the 

reinsurance company to assume the risk, but lower than the insurance cost or alternatives for the 

primary commercial provider. Second, reinsurance and insurance-based securities expand the 

scope of the insurance markets, create competitive alternatives, and generally expand capacity 
81

that would otherwise be lacking in the aftermath of such catastrophic events such as a hurricane 

of the magnitude of Katrina or Rita. 

Offshore insurance is a competitive market and competitive forces work to both align the 

interests of market participants and keep prices (premiums) commiserate with the degree of 

perceived offshore operations risk. The presence of such market forces does not suggest that 

insurance rates for offshore operations will be low: it simply suggests the premiums will not rise 

above unnecessary levels. Premiums are said to be competitive or efficient when they reflect the 

risk-adjusted cost of insuring a particular offshore asset class or business activity with a 

reasonable return or profit. 

As noted earlier, high premiums and restrictive coverage conditions are reflective of what is 

considered a “hard market” for offshore energy insurance. Short-term supernormal profits may 

be possible during hard market conditions as the market searches for an understanding of the true 

degree of risk (cost) and appropriate degree of compensation (profit) for insuring offshore risk: 

particularly in the aftermath of sudden and unexpected events. Insurance providers that believe 

they can provide insurance at rates or under coverage terms that are more favorable than 

prevailing market conditions will enter the market to capture market share from other less 

efficient (more costly) providers. 

Likewise, when markets for offshore insurance become restrictive, individual operators will face 

greater incentives to pool together in mutual insurance companies/organizations to avoid 

unnecessarily costly premium structures, administrative and service fees, or even profits being 

assessed by commercial providers in a hard market. The same holds true with self-insurance: if 

large companies have the financial breadth and wherewithal to assume increasing degrees of risk 

by self-insuring, they will do so if the costs of assuming this risk are lower than the benefits. 

Therefore, the over-arching conclusion that can be reached from the post-2004 tropical storm 

season is that offshore insurance markets, while tested considerably, work and adapt to rapidly 

changing risk exposures in the GOM. Clearly, limits were imposed, premiums increased, and 

deductibles and other claims restrictions were implemented. These structural and market changes 

led, however, to the expansion of existing insurance providers, as well as the emergence of new 

players, all supported by expanded capital resources provided by reinsurance and other 

insurance-based financial instruments. The result of this experience has been a much tested but 

more resilient and robust offshore insurance market that continues to provide support and 

capacity for current and projected offshore oil and gas activities. 
83

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93

APPENDIX A 

ENERGY EXPLORATION AND DEVELOPMENT INSURANCE 

MAKING WELLS SAFE ENDORSEMENT 

In respect of wells insured hereunder and subject to all terms and conditions and exclusions 

stated therein and the Combined Single Limit of Liability applicable thereto, Section A of this 

policy is endorsed to cover reimbursement to the Assured for the actual costs and expenses 

incurred in preventing the occurrence of a loss insured hereunder when the drilling and/or 

workover and/or production equipment has been directly lost or damaged by lightning; fire; 

explosion; or implosion above the surface of the ground or water bottom; collision with land, sea 

or air conveyance or vehicle; windstorm, collapse of derrick or mast; collision or impact of 

anchors, chains, trawl boards or fishing nets; flood; strikes; riots; civil commotions or malicious 

damage; but only when in accordance with all regulations, requirements, and normal and 

customary practices in the industry, it is necessary to re-enter the original well(s) in order to 

continue operations or restore production from or plug and abandon such well(s). 

Underwriters' liability for costs and expenses incurred by reason of this endorsement shall cease 

at the time that: 

1) operations or production can be safely resumed, or 

2) the well is or can be safely plugged and abandoned, or 

3) whichever shall first occur. 
95

APPENDIX B

Oil Insurance Limited 

Retrospective Premium Determination Schedule (OIL, 2009) 

Maximum Factor Slope Factor Minimum Factor 

 ("MaxF") ("SF") ("MinF") 

 62.5 33.33 33.33 

For Incurred Losses less than $150,000,000, the Modifier is determined according to the 

following formula: 

Modifier = 1/500 x (MaxF - ((Incurred Losses / 150,000,000) x (MaxF - SF))) 

For Incurred Losses equal to or greater than $150,000,000, the Modifier is determined according 

to the following formula: 

Modifier = MinF / 500 
The Department of the Interior Mission

As the Nation’s principal conservation agency, the Department of the Interior has 

responsibility for most of our nationally owned public lands and natural 

resources. This includes fostering the sound use of our land and water 

resources, protecting our fish, wildlife and biological diversity; preserving the 

environmental and cultural values of our national parks and historical places; and 

providing for the enjoyment of life through outdoor recreation. The Department 

assesses our energy and mineral resources and works to ensure that their 

development is in the best interests of all our people by encouraging stewardship 

and citizen participation in their care. The Department also has a major 

responsibility for American Indian reservation communities and for people who 

live in island communities. 

The Bureau of Ocean Energy Management 

The Bureau of Ocean Energy Management (BOEM) works to manage the 

exploration and development of the nation's offshore resources in a way that 

appropriately balances economic development, energy independence, and 

environmental protection through oil and gas leases, renewable energy 

development and environmental reviews and studies.