Oil and Gas Industry Listen Closely – Five Keys to Buying the Right Insurance Coverage

Let’s say you just finished with the renewal of your company’s insurance policies for the year, but you still have some nagging questions or doubts. Why did we buy these policies, and not some others? Did we buy enough? What do our peer companies do? Why did we end up with that limit or deductible? If you take the steps below, it should help you anticipate and answer the most important questions during the process of the renewal. As a result you should have a lot more confidence that you’ve made the best decisions for your company.

So what are the key steps to building the right insurance program?

1. Envision losses. Get a working group together of your finance, legal, operational, and risk employees or advisors and talk through your operations to envision various scenarios and resultant losses. It may help organize the discussion by considering the following categories of potential losses: Loss of owned property, loss of revenue and margin, injury to employees, and liability to others.

Next, talk about the source of the potential damage, or the “perils” as we call them in the insurance business. These could be fairly obvious such as fire or blowout, or a bit more unconventional such as cyber, employment practices liability, environmental damage, and many others. Be sure to think not only about what can happen to you directly, but also to your key suppliers, vendors, clients, etc.

For example, let’s say that that you are sending 40% of your production through a gas plant which you do not own. What happens to your revenue if that gas plant suffers a loss of some kind and is shut down? This can be a very valuable project to explore the full range of financial and operational issues that can impact the firm. Think broadly and be creative. This exercise will help you identify the major risk exposures in your company so you can manage them as well as possible, whether with insurance or not.

2. Match up the perils with the insurance policies available to you. Of course there are many risks to an oil & gas company that cannot be insured, but you may find that the breadth of available coverage is surprising. For example, do you know that pollution coverage is available in at least three different types of policies, each insuring a different type of pollution whether it’s from the well bore, or some other type of sudden or gradual release of pollutants? Do you know that many risks within a typical acquisition or divestiture such as the Representations & Warranties or the possibility of adverse tax rulings can be separately insured with “transactional” insurance products?

Be sure you get proper advice to know the full range of policies which could apply to all of the scenarios you developed in the first step above. Do not get stuck in the rut of just considering those you have purchased in the past.

3. Understand the full range of coverage options within each policy. For any type of coverage you purchase, there are dozens of options or more about how to modify the policy to better fit your needs. There is a natural tendency to focus on the exclusions section of the policy, but many of the most critical policy provisions are elsewhere, such as in the insuring agreement itself, the definitions, or conditions.

Particularly for larger oil & gas companies, virtually every section of every policy has negotiable items within it. In the resource plays with multi-stage fracking, there are a number of important coverage issues regarding casing failure, multi-well pads, and batch completions, just to name a few. Be sure you work through these issues and options thoroughly with your agent or broker before you pull the trigger on the purchase.

4. Buy enough limit. While no one likes to buy insurance, it is often the most efficient means of transferring large amounts of risk from your income statement and balance sheet. This is particularly true for larger risks where the insurance rates might be a fraction of a percent of the very high values at risk. When deciding how much to buy, you have to first know how much you could lose, and then how much insurance you can afford.

Some risks are relatively easy to quantify, such as the replacement cost for a truck or a drilling rig. But how much coverage do you need for controlling and redrilling a well after a blowout? Old rules of thumb such as “5 times dry hole cost” might not be appropriate for wells in your schedule, particularly if they include everything from Mississippi Canyon to the Permian.

Other risks are even more uncertain in potential value, such as a lawsuit against your directors and officers. The potential for large auto liability claims is greater than ever as more trucks are on the road in high activity areas such as the Eagle Ford, Bakken, or Marcellus. Whether you have one pick-up truck or 1,000 18-wheelers, you can be faced with the same liability.

Particularly for those less certain or quantifiable risks, be sure to get good benchmarking information from your risk advisors. They can help you compare your limits and exposures against others in your peer group. Of course you may choose to do something completely different for all the right reasons, but the benchmarking can give you a useful reference point.

When deciding how much you can afford, I always recommend that you start at the top and buy your way down to your level of budget and comfort. In other words, protect against the bigger and more catastrophic risks as your first priority and then save money if necessary by purchasing less insurance on lower valued exposures which also carry the highest premium rates.

5. Don’t “trade dollars” with your insurance company. When making your decision on an efficient deductible level for each policy, it’s generally not wise to insure claims that you can reasonably expect and comfortably afford. The insurance companies, like Vegas, will win at that game over time. You will also consume a lot of administrative and management time and effort buying coverage and negotiating claim recoveries that are truly unimportant to your firm.

As one example, I find that some companies still purchase physical damage coverage on their auto and truck fleets even though they have hundreds of vehicles. Even a simple analysis of claims and premiums will show that this is a bad trade – it’s almost certainly a waste of your time and money. The good news is that it’s a perfect risk to self-insure since you typically have a wide spread of relatively low valued exposures.

Other decisions about taking higher deductibles can be more complex, and there are many sophisticated risk management tools to help in this analysis. Some of these include actuarial forecasting, dynamic financial modeling, and even the formation of owned or “captive” insurance companies.

With these steps you can be much more confident that you’ve done your homework to purchase the right type and amount of coverage for your company’s exposures. You will know on a more comprehensive basis why you bought the coverages you did, and hopefully you will have few if any of those nagging questions or doubts after the renewal process.

Even though you will have spent a lot of money for this protection, of course you still hope you don’t have to use it. Collecting claims is not fun or easy, but in next month’s article I’ll give you some tips on that important subject.