CHAPTER 12 MAXIMIZING INSURANCE PROTECTION AS PART OF CONTRACTUAL RISK ALLOCATION
| Jurisdiction | United States |
(May 2004)
MAXIMIZING INSURANCE PROTECTION AS PART OF CONTRACTUAL RISK ALLOCATION
IMA of Colorado, Inc.
Denver, Colorado
Theresa M. Fadul is a Vice President and Account Executive at IMA, a regional insurance broker located in Denver, Colorado. She specializes in placing insurance and managing risk for both upstream and downstream energy business, but her primary focus is oil and gas lease operators. She handles all aspects of her clients' property and liability insurance programs, as well as environmental, executive protection, and M&A risks.
Prior to joining IMA in 1990 and building the company's energy practice in Denver, Theresa spent eight years in accounting and executive positions with small, independent oil lease operators in Denver where she was involved in contract negotiation in all aspects of the business. She has been involved with IPAMS and COGA through the years and has spoken on various insurance topics to the Colorado Chapter of COPAS, the Colorado Society of Certified Public Accountants, and the Association of Petroleum Landmen.
Theresa received a B.A. degree in 1975, graduating with highest honors from Fairleigh Dickinson University, and subsequently pursued continuing education in accounting and oil and gas finance and taxation.
Introduction
The oil and gas exploration and production industry has worked through the years to develop a contractual risk allocation structure that presumably is acceptable to both sides, reduces the cost of litigation that would be incurred in establishing negligence or degrees of negligence in the courts, and for which adequate insurance should be obtainable for the liabilities assumed. The presumption that these risks are insurable appears under most insurance clauses of industry contracts. For example, the IADC Drilling contract in Clause 13. Insurance, states:
"Operator will, as well, cause its insurer to waive subrogation against Contractor for liability it assumes and shall maintain, at Operator's expense, or shall self insure, insurance coverage .... insuring the liabilities specifically assumed by Operator in Paragraph 14 of this Contract." 1
This presentation will identify some of the pitfalls of insurance programs with respect to the contractual allocation of risk. It will focus on oil and gas lease operators and the insurance implications of the risk allocation provisions in standard onshore IADC Daywork Drilling contracts and onshore Master Service Agreements of the major service providers, and in particular the "Special Events" carve-outs from the mutual indemnity obligations of these MSA's. This presentation will also review the need for customized certificate of insurance forms to ensure operators are receiving the insurance protection that has been agreed to contractually.
Insurance for oil and gas lease operators is like a jigsaw puzzle where the pieces do not fit together perfectly; there are gaps between some of the pieces, overlap of others, and areas of the puzzle where the pieces are totally missing. Operators and working interest owners take on not only the geologic risk of drilling and completing wells, but more and more they are being asked to accept the operational risks through contractual risk allocation. Unfortunately, the operator has limited ability, and in some cases, no ability to insure certain of these risks. The reason for this limited insurability is that underwriters are either not aware of the extent of contractual risk transfer or are in disagreement with it, or they consider some risks to be business risks and thus uninsurable. This situation has been further exacerbated during the recent hard insurance market.
State of the Insurance Market
The worldwide insurance market had been hard for several years, beginning in 2001, as a result of various factors. The hard market conditions had the following impact: less capacity (supply) and thus less competition among insurance providers, tougher underwriter criteria, coverage restrictions, higher prices, higher deductibles or retentions, few long-term arrangements, and greater claims scrutiny. The Energy sector of the market was particularly hard hit due to very competitive pricing in the soft market leading up to 2001, significant losses which resulted in several years of underwriting losses, and widespread reinsurance arbitraging which decimated the reinsurance market thus forcing direct underwriters to take more risk in higher net lines.
Market conditions began to improve in mid-2003, following two years of significant premium increases which were further improved by benign loss experience, and we have begun to see smaller increases and some flattening of rates in the long-tail casualty lines and rate reductions in the short-tail property lines. Although capacity, and thus competition, is re-entering the market, especially in the first party coverage lines such as property and control of well, there is still a "hang-over" effect from the hard market that is reflected in certain restricted coverage forms about which clients need to be aware. There remains a relatively small number of liability carriers that service the energy industry and the policy forms have not had many improvements in the past couple years, other than the St. Paul companies who continue to respond to the evolving requirements of industry contracts. In fact, there have been some restrictions in coverage, terms and conditions about which clients need to be aware. As more and more liability is shifted to the operator contractually, the burden is on each operator and non-operator to carefully review their industry contracts and insurance policies to ensure they understand the extent of these coverage deficiencies.
Working with oil and gas insurance programs, especially given the contractual risk allocation environment, is like negotiating through a minefield. The review of a client's industry contracts is crucial for insurance brokers in order to properly design an insurance program for the operator. It is equally important for the operator to understand their insurance program and build into their financial and risk models their uninsured and underinsured exposures.
Insurance industry practitioners and insureds face the following challenges:
- Inconsistency among policy forms and endorsements especially in areas referred to as "blanket" protection. Insureds think they are protecting themselves through their contracts, then discover that insurance policies are deficient in important areas, e.g. Additional Insured endorsements.
- Limitations or gaps in coverage that can only be partially filled, or cannot be filled at all, because underwriters feel the exposure should remain with the contractor or feel it is a business risk, e.g. rig physical damage due to unsound location or environmental loss including removal of wreckage and debris.
- Contractual requirements that continue to appear in contracts, but which the majority of carriers will not agree to provide, e.g. additional insured status to service providers of the operator, and notice of material changes or alterations in coverage.
- Industry contracts being signed prior to being reviewed by the insurance broker and attorney, and/or not being sent to the insurance broker so that they can ensure coverage is in place, where available, for the liabilities assumed.
- Brokers who do not understand their clients' industry contracts or the intricacies of policy wordings, or more importantly, how they interact. A great deal of effort is required to review contracts and policy forms, to conduct discussions with underwriters and their claims teams, to review claims handling with oilfield adjusters, and case law with attorneys to get to the bottom of coverage interpretation.
- Brokers, not carriers, provide certificates of insurance. If the broker doesn't fully understand the insured's contracts and policy wording, certificates can be issued with incomplete or incorrect information.
- Insureds are at the mercy of the insurance carrier's interpretation of policy wording, especially in "gray" areas.
- When coverage is denied, the insured is in a difficult position; they need to think carefully before bringing suit against their carrier, as there are few alternatives in a hard insurance market.
New Model Form IADC Daywork Drilling Contract (Revised April 2003 version)
The operator is allocated a significant portion of the exposure under the April 2003 version of the IADC Daywork Drilling contract, but as will be explained, their insurance protection is limited in several areas. In some cases the operator might contractually agree to grant coverage that is not supported by the language in their insurance policies, which would seem to create the potential for a breach of contract claim against the operator by the contractor in the event of loss. An exposure matrix is provided in the supplemental materials section of this presentation.
Clause 13 - Insurance
Additional Insured Status provided by Operator for benefit of Drilling Contractor
The April 2003 form IADC Daywork Drilling Contract requires that the operator name the drilling contractor as an additionally insured under all policies shown in the insurance exhibit to the extent of the indemnification obligations assumed. This requirement presents a couple problems from the operator's perspective as follows:
1. Their Commercial General Liability, Umbrella/Excess Liability, and Operator's Extra Expense policies will most likely not allow the operator to name a service provider as an additional insured.
2. If the operator's insurance carrier does agree to name the drilling contractor, the grant of coverage will most likely be more restrictive than what is required under the drilling contract.
The operator should also have concerns about the additional insured status being provided to them by the...
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