Climate Change, The Offshore Industry,

And The (Re)Insurance Industry

Richard J. MurnaneBermuda Institute of Ocean Sciences

DHS Brown-Bag Talk Washington, D.C.

November 26, 2007

OGP/JCOMM/WCRP Workshop on Climate Change and the Offshore Industry

27-29 May 2008WMO Headquarters

Geneva, Switzerland

Phoenix, HiRISE, NASA, JPL-Caltech, Univ. Arizona

Phoenix Lander On Mars…

Full Disclosure…

• Senior Vice President, Baseline Management Company– Working to develop US

hurricane and earthquake catastrophe risk models

• Senior Research Scientist at BIOS– Manage RPI

The Main Points…• Reinsurers are aware of, and care

about, climate change• They operate in an environment that is

constrained by past losses• Even if they were certain climate

change would cause losses to increase in the future, they couldn’t price for it until losses started to increase

Overview• I don’t write offshore risk, why am I

talking about this?

• Primer on insurance and reinsurance

• The insurance industry and offshore business in the Gulf of Mexico

• Reinsurer’s views of climate change and the offshore industry

RPI Corporate Sponsors• XL Re Ltd.

• PartnerRe

• Arch Re

• Renaissance Reinsurance Corporation

• Axis Specialty

• Platinum Underwriters

• Nephila Capital

• State Farm

• Aspen Insurance

• Risk Management Solutions

• FlagstoneRe

RPI Information Flow

Risk Prediction Initiative

Academia

InsurersCommercial

Risk Modelers

Government

RPI Structure

RPI CoreWorkshops

In-house Products

RPI Research GroupForecasts

RPI Research GroupBenchmark Development

RPI Research GroupEmerging Markets

Overview• I don’t write offshore risk, why am I

talking about this?

• Primer on insurance and reinsurance

• The insurance industry and offshore business in the Gulf of Mexico

• Insurer’s views of climate change and the offshore industry

Top 40 Property Cat Losses 1970-2006

US Hurricane61%

Tsunami1%

US Quake6%

Man-Made9%

Japanese Typhoon

6%

US Tornado/Hail2%

European Wind

European Flood

US Wildfire1%

Caribbean Hurricane

1%

Japanese Quake1%

7%

Losses total $294 billion (2006 dollars)

Swiss Re Sigma, 2/2007

9/11 Piper Alpha

Katrina/Rita offshore losses

Major Losses In 2006

Swiss Re Sigma, 2/2007

Very similar distribution in 2007…

Victims Victims Insured Loss Insured Loss% Total (US$ m) % Total

Natural Hazards 22400 72 12,000 75Earthquakes 5900 80 Meteorological 8400 9,500

Man-made 8,677 28 4,000 25Oil, gas 500 330

Top 30 For Victims (1970-2006)Number of Victims

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

Weather Earthquake Man-Made Volcano

Hazard

Swiss Re Sigma, 2/2007

Top 30 For Victims (1970-2006)

Number of Victims

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

Subco

ntinen

t

Chin

a

Mid

east

Indones

ia/P

hili

ppin

es

Cen

tral

/South

Am

eric

a

Japan

(Q

uak

e)

Japan

(Typ

hoon)

US

Euro

pe

Location of Catastrophe

Swiss Re Sigma, 2/2007

2006 Non-life Premium Volume

Swiss Re, Sigma 4/2007

United States42%

Germany+France+UK19%

Europe (Other)17%

Canada3%

Latin America and

Caribbean

Japan6%

South Korea

PR China2%

Asia (other)2%

Taiwan1%

New Zealand0%

Australia2%

Africa1%

The US and Europe account for ~80% of premium

Event Intensity

Even

t Fre

quen

cy

Primary Insurer’s Retention

Reinsurance Layer 1Reinsurance Layer 2

PrimaryInsurer’s Retention

Reinsurance Layer 4

Reinsurance For A Single Event

Reinsurance Layer 3

Example CatXL Reinsurance ProgramM

illion

s of

$U

S

Primary InsurerLayer 1, Reinsurer ALayer 2, Reinsurer BLayer 3, Reinsurer C

Layer 4, Reinsurer D

Primary Insurer300

250

200

150

100

50

0

Layer 4, Reinsurer E

0 25 50 75 100% of Layer

12

34

5

67

89

A B

Aggregate sites and apply subarea limits and deductibles to each subarea

Layer 1 LossAggregate subareas and sites not in subareas and apply layer limits and deductibles

Layer 2 Loss

Layer and Subarea Example

Individual sites(or rigs)in a subarea

Aggre- gated subareas

Aggregated layers

How Does A Company Determine:

• Their risk of experiencing a catastrophic loss?– They use (multiple) risk models

Catastrophe Risk Model

physical damage repair costs

Damage

terms of coverageInsured Loss

Probability Location

Intensity, Wave Height Duration

HazardLocation

Construction Age

Building Code

Exposure

Types Of Offshore Modeled Losses

• Physical damage• Operator extra expenses• Well control• Debris removal• Business Interruption• Contingent business interruption

How Does A Company Determine:

• Their risk of experiencing a catastrophic loss?– They use multiple risk models

• How much should they charge/pay?– “Market forces”

Cat Market Price Cycle

1992 1994 1996 1998 2000 2002

100

80

60

40

20

0Pric

e cy

cle

rela

tive

to 1

994 50

40

30

20

10

0 Insu

red

Loss

es, b

illio

ns 2

002

US

$

Man-made catastrophes

Natural catastrophes

Swiss Re Camares, 2002; Sigma 2/2003

Underwriting Vs. Investment Returns

QuickTime™ and aTIFF (LZW) decompressor

are needed to see this picture.

Swiss Re, Sigma 2/2005

Overview• I don’t write offshore risk, why am I

talking about this?

• Primer on insurance and reinsurance

• The insurance industry and offshore business in the Gulf of Mexico

• Insurer’s views of climate change and the offshore industry

Deepwater Rigs

MMS, 2008

Offshore Industry In Gulf Of Mexico

Offshore structures: >4000Length of pipeline: >56,000 kmProperty Value: ~$150 Billion

MMS, 2008 MMS, 2008

Gulf Hurricanes And Insurance

• Flossie was first hurricane to cause widespread production halt in Gulf

• Instigated formation of API committee on Fundamental Research on Weather Forecasting (industry, academia, consultants)

Flossie, 1956

Clinton, 2008

Pre-Piper Alpha Disaster• Hilda (1964), Betsy (1965), Camille (1969)

– All but one platform destroyed by Hilda designed for 25y event.– Two 100y storms, one 400y storm in 6 years forced operators to

design for 100y event.– 75 foot waves in Camille higher than expected.– Mudslides and currents increased water depth so that some rigs

needed to be raised to increase air gap

• London Master Drilling Rig Cover formed after these storms, no use of engineers by insurers

• Move into North Sea increased insured values, but rates still supported profits

• Oil Insurance Ltd (OIL) formed in mid-70s, prided itself on not analyzing exposure, premiums based on assets and adjusted according to losses

Post-Piper Alpha• Piper Alpha loss in 1988 made insurers start to focus on

engineering– Reinsurers demanded more engineering information– Insurers started to monitor aggregation of offshore exposure

• Hurricane Ivan (2004) had ~$2.5 billion insured loss– Some of largest waves ever recorded, ~30m wave hit Chevron

Petronius platform, caused significant damage, and a production halt of nearly 6 months

– Classed by NHC as 2,500y event (current design parameters were for 100y storms)

– Caused small “hardening” in rates and increase in deductibles

Post Katrina And Rita (2005)

• Katrina/Rita (2005) had ~$20 billion insured loss– Damaged over 3000 platforms– 113 platforms destroyed, of these 108 were designed

to pre-1988 standards– Rates more than doubled, deductibles increased,

limits lowered

Overview• I don’t write offshore risk, why am I

talking about this?

• Primer on insurance and reinsurance

• The insurance industry and offshore business in the Gulf of Mexico

• Insurer’s views of climate change and the offshore industry

I queried people in over 12 companies and received only 2 substantive responses…

Climate Change And Insurance• Reinsurer A

“The questions on off-shore oil industry are not very different than the general questions about the impact of climate changes on extreme events.”

“In particular for the Gulf region, the debate on whether hurricanes will increase in intensity and frequency is still a hot topic of debate.”

“For the North Sea, the evidence is strong that the northward movement of North Atlantic storms will result in more frequent storms in this region.”

“Concerns more specific to the oil industry but less related to climate changes is the disruption of oil supply/pipelines that major hurricanes can cause in the Gulf region.”

“Although some modeling agencies are approaching this issue, it is still very questionable how far it can be quantified.”

• My interpretation…– they are aware of the issues, but don’t seem able to act because of

uncertainties

Climate Change And Insurance (2)• Reinsurer B (who actually writes offshore risk)

– Situation analogous to Florida, but offshore insurance “behind the curve”

– Prior to 2004/2005 there was complacency• people were happy with Mineral Management Service (MMS)

standards• North Sea was the worry for severe storms - Gulf was in

shallower water and a more “benign” environment– Past 3 years focus on construction, anchoring, age, design,

and orientation of rig– Deeper water rigs in Gulf will be more like North Sea - wind

not as important as wave height and air-gap

• My interpretation…– Focused on engineering and its suitability for the current

environment and associated natural variability

Minerals Management Service• Deepwater Gulf of Mexico 2008: America’s

Offshore Energy Future (U.S. Department of the Interior, Minerals Management Service, Gulf of Mexico OCS Region, 102 pages, New Orleans, May 2008)

“The MMS is a responsible steward of U.S. offshore resources by ensuring the receipt of fair market value for the sale of leases, encouraging conservation, evaluating and approving new technology, and regulating the drilling and production of fields in ever-deepening water depths.”

“This Deepwater Gulf of Mexico 2008 Report is the latest edition of the biennial publication produced by MMS that highlights the activities and offers trend analyses and technological advancements in this important portion of the Gulf.”

In The 102 Page MMS Report…

• Environmental issues covered (in 3.5 pages) are:– Deep-sea currents– Deepwater shipwrecks (finding them is a benefit)– Environmental impacts, mainly on biology

• The word– “hurricane” occurs 5 times, mainly in conjunction with an

explanation of a drop in production– “weather” occurs 2 times (in a single paragraph)– “climate” does not rate a single mention…

Each Company Is Different• In response to the large number of US landfalls in 2004

numerous reports released by insurance companies• Munich Re:

“The year 2004 was marked not only by an increase in the windstorm exposure of areas that were already known to be at risk but also by individual exceptional meteorological events which provided further evidence of change processes in the atmosphere.” (in Topics GEO Natural Catastrophes: 2004 Annual Review)

• Swiss Re:“The generally high cyclonic activity of 2004 was unusual, but not unexpected….This, however, lies within the range of natural climatic variation and is not necessarily indicative of global warming” (in Hurricane season 2004: Unusual, but not unexpected)

European Storm PerspectiveDecember, 1999: December, 1999: AnatolAnatol, , LotharLothar, and Martin, and Martin

ERC Frankona Munich Re

LotharLothar

MartinMartin

AnatolAnatol Also, Benfield, Swiss Re, RMS (and others?)

Climate mentioned by insurer’s reports:– ERC Frankona: 1 time/28 pages– Munich Re: 28 times/76 pages

In Summary…• Climate change is on reinsurers’ minds, but that

is about as far as it goes• Natural variability driving variance in past losses

is focus of business• Market forces are bigger influence on pricing than

interannual fluctuations in risk due to natural modes of climate variability

• Can’t really price for future climate change, must wait for change in losses