On Insurance and Managing Risk in the Arctic

from Lloyd’s Report 2012: Arctic Opening – Opportunity and Risk in the High North

 

Given the complex and often unique risk challenges of the Arctic described above, all interested parties need to adopt a cautious and highly risk-aware approach to Arctic development.

Governments – singly and together – have an essential role in setting acceptable risk thresholds, monitoring activity and ensuring that knowledge gaps are sufficiently addressed. They will need to ensure that an integrated ecosystem-based approach is taken to development, to avoid the impacts of one activity harming and displacing others. They will also need to take full account of the cumulative impacts of development, as opposed to the impacts of a single project. Governments should insist upon a safety-case, rather than a prescriptive, approach to risk management (liii).

Where activity takes place, corporate risk management is fundamental for companies to work safely, sustainably and successfully. As this report has emphasised, there is a wide range of Arctic operating environments that present greater or lesser operational and other risks, but many parts of the Arctic remain extreme. Practices and technologies will need to be continuously updated to reflect a rapidly changing situation, and to ensure that best practice is constantly improved and consistently applied.

Though much research is ongoing and experience from outside the Arctic region may prove useful to operations within it, considerable further research and analysis are required to fully assess the range of hazards of Arctic operations and the vulnerabilities of technical systems, equipment and the Arctic environment to disruption and harm.

Below we consider the main risk management approaches – risk governance, risk mitigation and risk transfer – principally from a corporate perspective, and principally with relevance to the oil, gas, mining and logistics sectors (liv).

Risk Governance

Firms arguably do not need to recreate their risk management frameworks for the Arctic context. They will need to ensure, however, that these frameworks take account of the complex and fast-changing nature of the Arctic risk environment.

Company boards need to be fully engaged in the risk management process and to ensure that a risk culture is embedded across the organisation, from business planning to clear communication of risk issues. Governance frameworks should include clear procedures for risk identification, assessment and analysis, and control, as well as action planning and reporting.

Companies also need to think through possible worst case scenarios and develop plans both to prevent these occurring, and to respond if the worst did happen. These plans should include clear and robust action plans for crisis management as well as strategies and approaches to manage any reputational damage.

While management of reputational risk necessarily remains the exclusive responsibility of companies themselves, crisis-management plans for Arctic operations should be either available to public authorities or published to ensure public oversight, maintain public trust, and make companies fully accountable for their actions.

Risk Mitigation

There are a number of ways in which companies can mitigate some of the risks of operating in the Arctic. Many of these will be techniques and approaches adapted from other regions, particularly those where extreme cold conditions are the norm. However, some will be unique to Arctic conditions.

The development and implementation of best-in-class safety and operational standards at both corporate and industry-wide level are crucial. The development of ISO standards – such as ISO 19906: 2010 covering Arctic offshore structures for the oil and gas industry, and the development of an IMO polar shipping code – are good examples of this. While learning from experience elsewhere, these reflect the complexity and sensitivity of the Arctic risk environment.

Offshore, there are a number of practical operational steps and actions that companies operating in the Arctic can take to mitigate risk. Ice preparedness and ice management – from ice-drift maps to satellite tracking – are key. There are also various practical actions that energy and shipping companies can take once operations are under way, including detection of icebergs by radar, aerial and vessel reconnaissance, icebreaker support and physical management in the form of towing vessels out of danger or using water cannons.

Companies can also mitigate risks by adopting the latest, Arctic-specific technologies, materials and processes, including drill rigs and the latest ice-class vessels. Indeed, some of the extreme environmental factors experienced in the Arctic can be mitigated through the design process.

Finally, as mentioned earlier, if all the above fails, companies must develop response plans for the full range of hazard events, including under-ice blowout and pollution.

The Role of Risk Transfer

While corporate risk management in the Arctic should focus on risk mitigation, any robust and comprehensive risk management strategy should also consider transferring some risks to a third party through insurance. A number of specialist insurers have provided insurance cover in extreme conditions, including the Arctic. Insurance should not only be seen as financial protection. Rigorous insurance processes can promote improved risk management within a company, reducing risk before the event as well as managing the cost of actual risk events to a company.

We briefly outline the current outlook for insurance in three main areas – marine insurance, energy industry insurance and political risk.

Marine Insurance

The maritime insurance industry can play a critical role in reducing risk for shipping companies in the Arctic, as elsewhere. If insurers are unable to cover shipping through the Arctic, or if rates for insurance cover are exceptionally high, the economic viability of some Arctic shipping may be brought into question. This has broad implications for other industry sectors reliant on maritime logistics – including natural resource development.

Insurers are currently helping to improve the safety and raise awareness of the Arctic shipping routes, by providing information and encouraging effective risk-mitigation measures and safer vessels. The website of the London market’s Joint Hull Committee (JHC), Navigating Limits Sub-Committee is a good resource for shipping companies and insurers operating in the Arctic with wordings, recent incidents, links and ice maps¹ . Though commercial maritime interest in the Arctic is growing, the current take up of Arctic specific insurance is currently limited by the relatively small numbers of vessel voyages per year.

The key issues of concern for underwriters when considering the Arctic are: remoteness, lack of rescue and salvage facilities, whether a vessel to be insured is sufficiently ice-classed for expected conditions and whether it will receive icebreaker support. The JHC highlighted the need for underwriters to satisfy themselves on the following points, as a minimum:

• Voyage feasibility study, including ports of refuge.

• Suitability of the vessel for the intended voyage.

• Proposed route, dates and timing.

• Crewing arrangements including key personnel’s levels of experience in Arctic navigation (lv).

• Icebreaker and/or escort arrangements.

• Access to accurate and up-to-date weather/ice information during the voyage.

• Assessment of chart accuracy.

• Whether an ice pilot will be on board.

• Bunkering arrangements.

The main types of insurance for vessels in the Arctic are Hull (including Increased Value (lvi)), Cargo and P&I (Marine Liability):

• There is likely to be an additional Arctic premium for hull insurance and/or an additional voyage-specific ice deductible, based on a loading of the standard annual Navigating premium for a particular time period (such as the length of the voyage). The ability to insure will depend on how far the responses to the points above satisfy Hull underwriters.

• The market will not charge additional premiums for cargo for Arctic trade under a worldwide policy. For a specific cargo, perceived additional Arctic exposure is likely to be taken into account in the original rating.

• The potential costs of Marine Liability risks – wreck removal, pollution, and death and bodily injury to passengers and crew – will be enhanced and are likely to be much more severe events in the Arctic owing to the remote and harsh environment (lvii).

Insurance for the Energy Industry

Insurance is currently provided for a range of risks within the energy industry, from physical loss and damage to property, removal of wreck and evacuation expenses, business interruption and loss of production income, liabilities for death and bodily injury to employees, third parties and third party property damage and construction risks.

Insurance is also provided for Control of Well and a range of Operators’ Extra Expenses (OEE) with relevance to the Arctic offshore, in particular:

• Covering a blowout that requires control to be regained. This may include expenditures for hiring mobile drilling rigs to drill relief wells. In Canada, operators are required to have a second mobile drilling rig standing by, greatly increasing the cost.

• Re-drilling or extended re-drilling of wells, making them safe or plugging and abandoning them.

• Covering seepage and pollution, essentially from a blowout, though it has been possible to extend cover to include pollution from the production facility itself, provided the original cause of loss is a blowout. The agreement covers legal liability, the costs of cleanup (whether or not there is legal liability) and legal defense costs (lviii).

As with maritime cover, insurance capacity for the energy industry is not unlimited. Cover is offered for risks in return for appropriate premiums and on specified terms and conditions² . Areas of cover may clash, and insurers will have their own maximum limits for which they will offer capacity (lix). There may be many parties involved in a drilling operation, from the operator (and any joint operators) to the service companies, contractors and equipment providers (including the provider of a blowout preventer). Insurers may be covering several of these parties and will therefore need to manage any potential aggregations of risk. Geographic aggregation of risks can also occur if limited accessibility in the Arctic forces companies to focus operations in one place, for instance through the use of extended reach wells (lx). Managing risk in the offshore Arctic and insuring it is likely to be costly. Risk criteria will be set much higher than in other offshore areas, such as the North Sea, as the consequences of an event could be much worse. Lower risk criteria would reduce operational costs for energy companies, but increase the risk to insurers.

Cover Provided by a Typical OEE Policy

• Control of well: this is effectively a blowout, requiring regain of control, and may, at worst, include costs for hiring mobile drilling rigs to drill relief wells.

• Re-drill: typically this follows a blowout; when a well is brought under control it may need to be re-drilled, or restored to its condition prior to the blowout. The costs incurred are in respect of re-drilling to the depth at which control was lost.

• Extended re-drill: this covers costs to re-drill or restore wells that have been lost as a result of damage to production infrastructure.

• Making wells safe: this relates to a physical loss or damage to the platform and involves sub-surface activity to make the well safe

• P&A: the requirement to plug and abandon a well could result from physical loss or damage to the platform.

• Seepage and pollution: coverage under the policy is triggered by pollution from wells resulting from blowouts, and not pollution from other facilities and resulting from other causes. The insuring agreement is in three main parts:

1. Legal liability, or liability incurred under a lease block contract, for damages in respect of third party property damage and injury.

2. Costs incurred by the insured to clean up, or attempt to clean up, seeping, polluting and contaminating substances. This second part does not require legal liability. The insured has autonomy to act quickly to try to prevent pollution reaching the shore.

3. In addition the policy covers legal defense costs.

These coverage provisions are based on a pollution incident that is sudden and accidental and for which notice provisions are incorporated into the policy.

Political Risk

A company may invest in the Arctic economy only to find that its investment is threatened owing to changes in commercial interests, regulatory obstacles or political change. It may be possible to transfer these risks to the insurance market through specialist political risk products. Two main groupings back up this class; Contract Frustration and Confiscation, Expropriation and Nationalisation (CEN).

• Most standard commercial property covers exclude damage following government actions. CEN can fill this gap and protect companies from financial loss, perhaps following the passage of new laws that make the operating environment unviable, following destruction of assets by the state and confiscation, or following government expropriation and nationalisation. When there are a series of acts by the government that slowly ensures deterioration in the operating environment this can also be included in cover and is often referred to as “creeping expropriation”.

• In the Arctic, due to the geopolitical dynamics of the region, coverage for war, terrorism and forced abandonment can be added to a CEN policy. Forced abandonment cover ensures the insured is protected against a situation where the security environment deteriorates and it becomes no longer safe to operate with the Insured abandoning their property. A third party analyst is often required to confirm that this is the case and the property will have to be abandoned for a continuous period of 180 days for a claim to be paid.

• Some insurers offer contract frustration cover, which provides coverage for a loss under a contract or agreement following a political event beyond the control of the insured. A sovereignty dispute leading to the invalidation of a previously purchased offshore drilling licence would be considered an insurable risk under a contract frustration policy. Coverage could also extend to ensure an indemnity is paid if the royalties or taxes are amended. Environmental issues, however, might be excluded. Unfair and/or politically fair calling of bond cover is often added as an extension to contract frustration if the contract is especially large.

With all these products, it is usual for the insurer to require evidence from the insured that they have authorisation for their licenses to operate in the region. Political risk insurance also relies on clear ownership of assets and contracts. To the extent that there may be legal uncertainty around the final position of sovereignty over some parts of the Arctic, underwriters will likely be reluctant to offer cover.

Footnotes:

(liii) A safety-case approach involves management presenting information showing that it has considered all risks relevant to its specific operation and has detailed how it will avoid or manage these risks. This is in contrast to a prescriptive regime where regulators define what operators must do to comply and there is no requirement for management to do more than what is prescribed.

(liv) Much of the material in this section is derived from risk experts within the Lloyd’s market.

(lv) The JHC also advise that it can be helpful for ships using the Northern Sea Route to have a Russian-speaking desk officer on board.

(lvi) This is a separate product written in the hull market, which covers assets other than hull itself such as bunkers.

(lvii) The International Group of P & I clubs (IGA) are a pool that retains the first layer of marine liability losses (currently $60m), with the excess being placed as reinsurance in several insurance markets, and led in Lloyd’s. There is insurance in place for up to $1bn for pollution and $3bn for death and bodily injury to passengers and crew.

(lviii) The insured has autonomy to act quickly to try to prevent pollution reaching the shore.

(lix) Clashing exposures include physical loss and damage to assets such as platforms or mobile rigs, control of well, and operators’ extra expense and pollution liability.

(lx) Extended reach drilling refers to the directional drilling of very long horizontal wells.

Charles Emmerson, Glada Lahn, 2012, On Insurance and Managing Risk in the Arctic, Lloyd’s.©