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Self-insurance a tricky option in costly energy insurance market

Posted on 15 October 2010

Skyrocketing insurance costs for Gulf of Mexico development are driving some to consider self-insurance. But self-insurance is more complex than it first appears, said an expert speaking at the 2010 IADC Contracts & Risk Management Conference, 13-14 October, Houston.

“Self-insurance is on many people’s minds because people fear an inability to buy insurance due to the spill,” said Stephen P Pate, Partner at Fulbright & Jaworski LLP, the event’s opening speaker. “Unfortunately, I’m here to tell you … I’m not sure it will be (a solution).” Insurance litigation forms a large part of Mr Pate’s practice.

Ironically, insurance premiums in other industries are decreasing in what Mr Pate termed a “soft market.” Conversely, though, premiums are up 10%-30% for energy, he said, citing insurance giant Lancashire Group.

Ballooning energy-insurance costs are driven by two major factors. First is governmental, beginning with the US House of Representatives’ vote to lift the $75 million liability cap imposed under the Oil Pollution Act of 1990. The US Senate has yet to act on this proposal. Further, Congress is considering raising Certificate of Financial Responsibility requirements, as well. And irrespective of Congressional action, insurer eyebrows are sky high over BP’s startling to-date Macondo expenses of $4 billion. BP has estimated that direct civil costs could reach $32 billion.

“Self-insurance is not a good idea for catastrophic events,” Mr Pate said.

Mr Pate defined self-insurance as a risk-management method where a calculated amount of money is set aside to compensate for a potential future loss. The key to self-insurance, under this definition, is the ability to accurately calculate and predict risk, such as employee benefit situations. When used properly, self-insurance can save by eliminating carrying costs of a commercial insurer.

Self-insured retention is a variant on this theme, in which a company pays up to a certain amount before an insurance policy pays out. “This is similar to a deductible,” Mr Pate said, “a very, very high deductible.”

On a $300 million policy, for example, the company might be responsible for as much as $100 million. “The retention makes the insurance much less expensive, and makes it palatable to the insurance carrier.”

“Captive” insurance is a more realistic option, he suggested. A “single parent” captive is an insurance company formed to insure the risks of a single company, such as Jupiter Insurance for BP. A “group captive” is an insurance carrier owned by several companies.

Benefits of a captive insurance include coverage unavailable through traditional insurance, direct entry to re-insurance and tax benefits. However, caveats exist. Jupiter, for example, offered a $700 million benefit, far less than BP’s ultimate payout. The savings on premiums, Mr Pate said, were far outweighed by costs of the disaster.

“This has cast doubt on self-insurance and captive insurance programs,” he said.

Still, Mr Pate indicated that group captives will be the only way to meet increased liability requirements.

“The bottom line, I think, is that everyone is going to be self-insured in this industry,” he predicted.

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