Aon’s 11th Energy Insurance Training Seminar
Property Damage – Physical Damage and Business Interruption
John Swann and Kevin Knight
Why do companies insure their risks?
Production Facility Explosion
Hurricane
Offshore Blowout
Onshore Blowout
Refinery Explosion
Refinery Explosion
Pipeline Explosion
Insurance
•
The pooling of fortuitous losses by transfer of such risks to
insurers, who agree to indemnify Insureds for such losses.
•
So it is the premiums of the many paying the losses of the few.
Insurance
Legal Principles
When a company insures an individual entity, there are basic legal
requirements. Several commonly cited legal principles of insurance
include:
•Indemnity
•Insurable interest
•Utmost good faith
•Contribution
•Subrogation
•Proximate Cause
Insurance
Insurability
Risk which can be insured by private companies typically share
seven common characteristics.
•Large number of similar exposure units
•Definite Loss
•Accidental Loss
•Large Loss
•Affordable Premium
•Calculable Loss
•Limited risk of catastrophically large losses
Why Insure Operating risks?
What drives companies to purchase insurance ?
•
Size of your company / its Financial Strength
•
Largest oil companies are bigger than any insurance Co. so
often buy insurance as a purely financial transaction.
•
Medium / Smaller size oil companies benefit from access to
capital for specified risks releasing funds for investment / access
to finance.
Why Insure Operating risks?
Risk management philosophy / Impact of loss on the business
• Focus on company’s expertise not random hazard loss
• Could a single insured event reduce earnings in one year or
damage the company’s viability ?
• Interdependency vs alternate production / revenue sources
What losses are we concerned about?
• Aggregate value of all losses small or large?
Larger losses only that could damage our revenue / share
value?
Why insure operating risks?
Market opportunity
•
Is insurance cheaper than retained cost of transferable risks?
•
Is your insurance philosophy considered integral to business risk
management or one of many tools?
•
A company may buy opportunistically or be a committed long
term buyer and have a relationship with Insurers through hard
and soft cycles
Key Features of Insurance Contracts
•
Indemnification
•
Deductibles / Excess / Retention
•
Valuation of Insured Property
– Replacement Cost
– Actual Cash Value (ACV)
– Agreed-upon Value
Physical Damage - Valuation of property
Traditional Method
Full replacement value - ‘like for like’ / ‘new for old’ - early years
a) Building risk completed value
Historic incurred costs
b) Agreed value for operating ‘Off the shelf’ value
inflation adjusted
‘money of the day’
c) Increased costs of repair or Maximum envisaged
replacement (ICRR all risks) repair cost
d) Uplifted value (All Risks)
Future inflation
e) Total loss only interests (TLO)
Additional incurred costs
well abandonment /
pipe re-routing
Named Perils or All Risks
Named Perils
As the words imply underwriters will only pay claims in the event that
the claim was caused by a named peril – it is the insured’s
responsibility to prove that the claim was covered under a named
peril.
“All Risks”
This is a misnomer as there is in insurance terms no way that
underwriters will offer an all risks policy. These have a lot of
exclusions and it is the underwriter’s responsibility to prove that a
claim was caused by one of the many policy exclusions.
Where does Offshore end and Onshore begin?
In the Insurance world, Offshore and Onshore don’t mean what
they say!
•
Offshore - Upstream Operations:
E&P Production Facilities
Drilling Contractor’s Equipment
Well Control / Pollution / Redrill
•
Onshore - Downstream Operations: Refineries
Petrochemical Plants
LPG Plants
Terminals
Types of Offshore Structures
Definitions of structures
•
Fixed Platform - Rigid structure fixed in the sea bed
•
Compliant Tower – Platform capable of “swaying” to absorb sea
forces
•
Sea Star – Mini tension leg platform
•
Floating Production Systems – Floating tank system used to
take oil/gas produced by nearby wells, process it and store it
until it is unloaded
•
Tension Leg Platform – Semi-submersible platform moored
vertically to anchor points on the sea bed
•
Sub Sea System – Well(s) with wellhead(s) set on sea bed
•
Spar Platform – A very large manned single buoy mooring
incorporating oil storage
Definitions of structures
Jack up Rig
Floated to location and
raises itself clear of the
water by “jacking” itself
up its legs. Their stability
/ load capacity depends
on strength / stability of
the sea bed.
Definitions of structures
Process/Receiving Plant
-Onshore or Offshore
(Semi, FPSO, Spar, TLP etc)
Well
-valves and well control at Christmas Tree
Wellhead (single well or multi slot template)
Flowline Oil/gas/condensate, water or gas injection
Riser -vertical section of flowline between seabed and offshore
platform
Umbilical -well control and monitoring, power supply, hydraulic
fluid, electric power
Manifold (subsea hubs)
Export Facility (Export Pipeline, Loading Buoy, etc)
Offshore Hazards
Environmental
•
Storm - hurricane / sub-hurricane storm / typhoon Earthquake Tsunami
Ice - Beaufort Sea
Seabed Subsidence - Ekofisk Field, Norway
Deliberate
•
War and Political Risks - Persian Gulf
Terrorism / environmental activists
Deliberate Damage - Torrey Canyon spill
Offshore Hazards
Accidental
•
Fire / explosion - during maintenance “hot work” / gas leaks /
work procedure
– Piper Alpha 1988 $1.4bn
– Petrobras ‘36’ 2001 $500m
•
Blowout
– Macondo 2010 $20bn
– Montara 2009 $350m
•
Impact - supply boats / drill rigs / helicopters
– Ekofisk 2/4 W 2009 $750m
•
Anchor damage to sub-sea facilities
•
Load / discharge accidents - crane drops
Offshore Hazards
Construction Defects
•
Physical damage following faulty design
•
Fatigue / corrosion
•
Mechanical breakdown
•
Faulty work / materials NOT covered during operating phase
Key Exclusions.
•
Windstorm (can be bought back)
•
Earthquake (can be bought back)
•
Loss, expense resulting from delay, detention or loss of use.
•
Wear and tear, gradual deterioration, metal fatigue, machinery
breakdown, corrosion, rusting, error in design.
•
Liabilities to third parties.
•
Well(s) and / or hole(s) whilst being drilled or otherwise.
•
Drilling mud, cement, chemicals and fuel actually in use, and casing
and tubing in the well.
•
Unrefined oil, gas or other crude product, except whilst in storage or
in transit in pipeline.
•
In respect of pipelines only: subsidence, scouring, abrasive action
of sea and shingle.
Typical Offshore gathering operation
Standard Offshore Forms
•
Offshore Rigs:
London Standard Drilling Barge Form
•
Supply Vessels/Tankers:
FPSO’s
Institute Time Clauses Hulls or FSO’s,
American Time Clauses
•
Production Units:
London Standard Platform Form
•
Pipelines
London Standard Pipeline Form
Onshore hazards
•
Fire
•
Explosion
•
Lightning
•
Aircraft
•
Storm
•
Flood
•
Earthquake
•
Machinery Breakdown
•
Sabotage, riots, strikes, civil commotion,
malicious damage…
•
War, terrorism
Insurance Considerations for Onshore Energy
•
High values / loss potential
– No single insurer will underwrite whole risk
•
Brokers act for many using their leverage / expertise to help
insured obtain best deal.
•
Complex subject matter / insuring conditions / tailored policy.
Physical Damage
•
Covers:
– All Physical onshore assets, including:
• Plant (Refinery, Petrochemical, LPG etc)
• Pipelines
• Jetty
• Storage tanks
• Vehicles
• Unprocessed Oil and its products
•
Premium setting:
– Insurers will apply a rate to the Total Values to reach the premium
and not the Loss Limit
Processing and storage facility
Downstream - Refining, Petrochemical etc
•
Operating:
– Physical Damage
– Machinery Breakdown
– Business Interruption
– Third Party Liabilities
– Terrorist & Political Risks
Extent of Cover
Core non-marine cover
•
Physical Damage following
– All Risks
– Machinery Breakdown
•
Business Interruption following PD
Can be arranged “stand alone” or as part of a wider package
depending on
•
Risk profile
•
Client’s needs
Extent of Cover
Loss destruction of damage must be:
•
Sudden and unforeseen /accidental
•
Physical
•
Resulting from insured cause/not resulting from an
excluded cause
Physical Damage Cover
•
Fire, lightning, Explosion, Aircraft (Flexa)
•
Added Perils
– Natural e.g.
• Earthquake, Seismic Risks
• Storm/Windstorm
• Flood
– Manmade e.g.
• Riot/Strike/Civil Commotion
• Impact
• Malicious Damage
– Accidental Damage
•
This Coverage is provided either by
– Fire and Perils Insurance
– All Risks Insurance
All Risk Coverage
“All” Risks except those excluded in the Policy
•
Exclusion Types
– Absolute
• War/Nuclear
• Wear and Tear
• Gradual Cause
• Deliberate Acts
– Other Policies
• Sabotage/Terrorism
• Marine
• Liability
• Construction
–Buy Backs
• Natural Perils
• Land Transits
• Machinery Breakdown
Coverage Issues
Incidence of natural perils
•
Type of plant
– Inherent risks
•
Risk retention
– Limiting coverage
– Deductibles
•
Market availability
– Natural catastrophe
Risk Considerations
•
Assumption that correct PD and BI values declared
•
PD values either reinstatement as new or indemnity.
•
Additional cost factors to be considered e.g.
– Fire Fighting Expenses
– Removal of Debris
– Architects Fees
– Expediting Expenses
– Transport Costs
– Testing Costs
Risk Considerations
•
Current Technology
– New plants cheaper BUT most losses are repairs
•
Age of plant
– Is the same equipment available today?
•
Influence of external factors
– Affecting delivery time and costs (material & labour)
•
Contractual advantage
– Ongoing agreements with manufacturers
Risk Considerations
THE CLIENTS OPTION
Risk retention strategies adopted for multiple location
risks
•
Insuring the catastrophic loss only
•
Insuring first loss only.
•
Aggregate limits.
Estimated Maximum Loss
•
Methodology
– Broker or market assessment
•
Including Business Interruption scenarios
•
Assessing normal risk as well as catastrophe
•
Including Machinery Breakdown
•
Accuracy
– Known scenarios or the unexpected
Deductibles
•
The decision of the client or the will of the market depending on:
– loss history
– risk quality
– financial advantage
– ability to retain risk
Property - Interests not Covered
•
Wells or holes whilst being drilled or otherwise (see OEE)
•
Drill mud, cement, consumables actually in use / tubing /
casing
•
Unrefined oil / gas in the ground
•
Plans / specifications / records
•
Employees personal effects
Property Exclusions
•
Consequential loss (see B.I.)
•
Inherent vice / wear & tear / gradual deterioration / Metal fatigue
/ machinery breakdown ( can buyback) / expansion or
contraction due to temperature / corrosion / rusting & electrolytic
action
•
Latent defect / faulty design
•
Electrical / mechanical derangement
•
Third Party Liability (see Liabilities)
•
War Risks / Terrorism - subject to possible terrorist buyback
•
Radio-active contamination
Should an Insured buy their own policy?
Operator arranged policy vs separate partner policies
•
Common valuation
•
Common loss adjusters / surveyors
•
Common wording
•
Ensuring philosophy freedom / control of own destiny & costs
•
‘Fleet’ interests / bulk purchase
•
Retention / deductibles
Coverage Issues:
Property including Machinery Breakdown
Cover can be provided on an indemnity or reinstatement basis:18
Indemnity:
This means that the property at the time of loss is valued on the
new value of the property, less deductions for wear and tear I.e. the
actual cash value will be the basis of settlement under the policy
Reinstatement: This means that following an accident, the property lost will be
replaced by equipment in a condition equal to but no better
than its condition when new. This is the most common form of
property coverage
Average:
Whichever option of cover is chosen, the insured must pay particular
attention to the sums insured under the policy and ensure that they
keep pace with inflation and in respect of reinsurance policies, the
increasing cost of new equipment. If the insured does not do this, he
runs the risk of being under insured and, if there is an Average
condition in the policy, then he will be penalised by underwriters for
underinsurance and will be unable to recover the full amount of the
loss.
Basic underwriter considerations:
It has now becoming essential for all but the smallest risks to have a survey prior to
underwriters provide terms. This survey will include the following information:
Hardware:
details of the physical assets and process involved, their age
and conditions, layout and spacing
Software:
Management, systems of work, safety procedures,
housekeeping
Fixed Protections: means of fire extinguishment permanently in place, fire
prevention, fireproofing, fire/gas detection
Fire Fighting
Facilities
dedicated fire brigades, support and back up from local fire
services, availability of fire extinguishing media
Natural Hazards:
Assessment of exposure to hazards of nature, eg. Earthquake,
flood, windstorm, subsidence
Maximum Loss
Evaluation:
Noting the above factors, assessment of the potentiall for loss
and quantification for insurance purposes
The Loss Record and deductible level.
Machinery breakdown
Insurers normally require the following information
•
A list of key machinery items within the plant
•
The new replacement values of these items
•
A description of each item, eg. Its function, its capacity, its operating
parameters, mechanical details and the name of the manufacture
•
A list of spares kept
•
The time it is anticipated that it will take to replace the item
•
What the effect will be on the overall plant operation of a machinery
breakdown incident on each of the items
•
Details of Manufacturers’ guarantees in force at the
commencement of operation.
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Major Onshore losses in modern history
•
Flixborough (1974)
– 28 killed, 36 injured.
– Poor engineering planning.
– BIG loss at the time.
•
Phillips 66, Pasedena Chemical
Complex (1989)
– 23 killed, 130-300 injured.
– Including BI, loss over US$1,000,000,000.
•
Toulouse Fertiliser Plant (2001)
– 29 killed, 700 injured.
– Including BI, loss over US$1,000,000,000
All VAPOUR
CLOUD
EXPLOSIONS
Introducing Business Interruption
•
Losses from physical damage to our property are easy to identify
•
Consequential financial losses are harder to quantify.
•
Business Interruption (BI) insurance is one method of protecting the balance
sheet from unexpected financial loss.
– Phillips, Pasadena explosion
•
BI insurance is the most flexible of all insurances and is adjustable to suit
individual needs
•
Providing the financial loss results from insured loss or damage to property, the
Insured can select any sum of money to be insured under the policy
A Rose By Any Other Name……
Like all the best things in life, it has various names:
•
Business Interruption
•
Loss of Profits
•
Loss of Revenue
•
Loss of Hire
•
Delay in Start-up
•
Loss of Production Income
Origins of Business Interruption
•
Loss of Hire was bought by shipowners to maintain their income when their
vessels were unable to trade.
•
Loss of Profits can be traced back to 1797, becoming more widespread in
the nineteenth century during the industrial revolution.
•
In the insurance markets BI insurance has always had an aura of mystique
•
This is wrong because in fact the Insurers’ end of the contract is simple – it
is the Insured’s who has to make all the tough decisions……the type of
exposure to insure and what sums to insure
Types of Financial Loss That Can Be Insured
•
Profit
•
Loan interest and principal repayments
•
Ongoing standing charges
•
Contract penalties
•
Contract fulfilment costs
•
Demurrage on chartered tankers
•
Increased Cost of working to reduce loss
What To Insure
• Indemnity Period
• Waiting Period
• Direct cause / contingent cause
• Customers & Suppliers
• Dependency Premises – the value chain
Basic Information Requirements
•
Volume of production and value
•
Volume of sales and value
•
Cost to company of production and sales
•
Estimated period of shut-down
•
Continuing Costs during shut down
•
Dependency premises exposure
Basic Information Requirements
NET
PROFIT
FIXED
COSTS
Debt Service
Wages
Maintenance
TURNOVER
i.e. sales price
VARIABLE
COSTS
Feedstock
Utilities
Transport
Wages
GROSS PROFIT
i.e. the bit that could be insured
Business Interruption
Product For Sale
Production Costs
Sales Revenue
Working Capital
Loans for interest
Finance Institutions
Loan capital for dividends
Shareholders
Loss of Margin – Financial Consequences
•
Interruption to the money cycle
•
Unable to realise cash from the sale of products
•
Ongoing “standing charges” to be paid from reduced sales
revenue
•
Reduction in working capital
•
Loss of investment income on capital reserves
Long term consequences
•
Shareholder dissatisfaction
•
Lender dissatisfaction
•
Loss of continuity of market
•
Potential for sale & take-over of the business
•
Deferral of expansions
Benefits of Business Interruption Insurance
•
•
•
Protection of the bottom-line budgeted profit
•
Provide working capital to pay on-going operational costs
•
Maintain the budgeted return (dividend) to the shareholders
Enabling continuity of business planning
•
Maintenance of reserve for long-term plans/projects
•
Reduced requirement to obtain injection of loan capital
Maintenance of market position
•
Retaining customer loyalty and market share
Insurance Coverage Issues
•
•
•
•
•
•
•
•
Loss and/or damage to assets by an insured event.
Differed basis of protection – Revenue, Process fee, Standing
charges, Debt servicing or extra expense
Coverage to reflect business.
Loss limit and sum insured to reflect future business risk.
Extensions to third party facilities.
Time limitation based on business recovery.
Extra expenses based on business recovery.
Uninsured waiting period.
Coverage Designed to Protect
•
•
•
•
•
•
Reduction in profit
Revenue required to pay for standing charges and payroll
expenses
Revenue required to pay for debt servicing costs
Business disruption costs – extra expense
Cost of acceleration of the repair (expediting expenses)
Penalties under contract
Business Interruption
•
Commercial rationale
– Damage to our asset or others may interrupt production hence income
– Extra Expenses of operating may be incurred to maintain production
– BI insurance can provide financial compensation for these costs
•
Basis of measurement
– losses must be capable of quantification by the insured
– If no P&L account then no BI cover
– Offshore this is an agreed amount = projected production / revenue
– “OPEX + Net profit” or in UK “Sales less variable costs”
– “variable cost” = one which varies in direct proportion to production
Business Interruption
•
Indemnity period
– re-build or repair period 12, 18, 24, 36 months
•
Deductible (waiting period)
– 60 days or more
•
Cause
– Resulting from physical damage to property
•
Contingent B.I. Extension
– suppliers / customers
– Partial interruption
– Modest take up due to cost, alternate revenue sources
Business Interruption - Exclusions
•
Strikes / workforce
•
Where there is no damage - latent defect requires repair and field shut
down - thus no PD or BI claim
•
Insolvency of any party
•
Withdrawl / non-issuance of licence excl PLOD
•
Under insurance for PLOD
Loss of Production Income (LOPI)
Coverage Basics
•
Measure of Recover = Loss of Production x Unit Price
•
•
Follows losses covered by Property or OEE Section
Fixed Indemnity
– Fixed Declared Volumes
– Fixed Unit prices
Standard Indemnity Period 180 days
Waiting Period 45 / 60 days
“Contingent” LOPI sub-limited to $250k unless locations named
•
•
•
Loss of Production Income (LOPI)
Exclusions
• Strikes / Lockouts / Political disturbance / Riots
• Following Abandonment of Insured’s Premises
• Suspension / lapse of any licence or lease
• Fines / Damages
• Dishonesty / Fraud
• Loss of Market
• Drilling Wells unless Specifically agreed
• Unnamed “Contingent” locations
Questions?