Deepwater Horizon Oil Spill Disaster: Risk,
Recovery, and Insurance Implications
Rawle O. King
Analyst in Financial Economics and Risk Assessment
July 12, 2010
Congressional Research Service
7-5700
www.crs.gov
R41320
CRS Report for Congress
P
repared for Members and Committees of Congress
Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
Summary
The April 2010 Deepwater Horizon oil spill disaster in the Gulf of Mexico is now being
characterized as the largest spill to have occurred in U.S. waters. As efforts to contain the current
spill proceed, the likely scale of clean-up costs and third-party damages has prompted
congressional review of clean-up and damage compensation mechanisms, as well as of ways to
facilitate future oil spill prevention, response, and recovery. A key element is the role of insurance
in ensuring that costs of spills can be financed, while at the same time enabling the continued
effective and responsible functioning of offshore energy exploration and production, as well as
protecting related economic interests.
The United States has an explicit oil spill liability and insurance mechanism to address the
Deepwater Horizon incident. In 1990, Congress enacted the Oil Pollution Act (OPA) to
strengthen the safety and environmental practices in the offshore energy exploration and
production business, to create a system of so-called “financial responsibility laws” and
compulsory liability insurance combined with strict liability standards, and to place limitations on
liability. Although liable for all removal costs, current law limits an offshore facility’s liability for
economic and natural resources damages to $75 million per incident. Damages in excess of the
cap could be paid by the Oil Spill Liability Trust Fund, which is financed primarily through a fee
on domestic and imported crude oil.
Lease holders of a covered offshore facility (COF) must demonstrate a minimum amount of oil
spill financial responsibility (OSFR) of $35 million per 35,000 barrels of “worst case oil-spill
discharge” up to a maximum of $150 million for COF located in the Outer Continental Shelf
(OCS) and $10 million in state waters. OSFR can be demonstrated in various ways including
surety bonds, guarantees, letters of credit, and in some cases self insurance, but the most common
method is by means of an insurance certificate.
Legislative measures (S. 3305, H.R. 5214, H.R. 5629) currently seek to raise the limit of
environmental liability on responsible parties from an oil spill from the current $75 million, in
some cases abolishing the limit altogether. Concerns have been expressed that higher limits of
liability will deter many smaller operators (in terms of net worth) and their investors, as they may
not be able to meet significantly higher financial responsibility requirements because of limited
offshore energy insurance capacity.
The offshore energy insurance market currently has a finite amount of liability insurance capacity,
including coverage for offshore oil pollution spills in U.S. waters, somewhere in the range of
$1.25 billion to $1.5 billion. Working capacity for OSFR certification is currently no more than
$200 million—an amount that is likely to be far less than what the market will demand should
Congress choose to increase the limit of liability on responsible parties to unlimited from the
current $75 million. Members of Congress might consider ways to assist the development of
alternative sources of insurance capacity for spreading oil spill financial risks. Some of the
alternative risk transfer mechanisms include “reinsurance sidecars,” catastrophe bonds, and
derivative financial instruments that securitize insurance risk. These alternative risk transfer
mechanisms turn an insurance policy or reinsurance contract into a financial security that is then
transferred to investors in the capital markets. These risk financing options could in theory
provide the added capital needed in the insurance marketplace to cover the higher liability and
associated OSFR limits.
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
Contents
Introduction ................................................................................................................................ 1
The Deepwater Horizon Oil Spill Incident ................................................................................... 3
The Offshore Energy Exploration and Production Business ......................................................... 5
Risk Management and the Demand for Insurance .................................................................. 6
Oil Spill Financial Responsibility and Insurance Requirements ............................................. 6
Offshore Energy Insurance Market .............................................................................................. 7
The Marine Insurance Industry.............................................................................................. 8
Structure and Performance of Offshore Energy Insurance Market .................................... 9
Typical Offshore Energy Insurance Coverage ...................................................................... 10
Compensating Oil Pollution Victims.......................................................................................... 12
Oil Pollution Compensation Funds ................................................................................ 13
Commercial Insurance .................................................................................................. 13
Federal Disaster Assistance ........................................................................................... 13
Tort Law ....................................................................................................................... 14
Policy Issue Considerations for Congress .................................................................................. 15
New Liability Limits and Insurance Capacity ...................................................................... 15
Future Insurability of Offshore Oil Spill Perils .................................................................... 15
Availability of Offshore Energy Insurance for Oil Spills ...................................................... 16
Potential Effects on Domestic Offshore Energy Production ................................................. 18
Figures
Figure 1. Illustration of Alternative Risk Transfer Instrument Using a Reinsurance
Sidecar Transaction................................................................................................................ 18
Tables
Table 1. Largest International Oil Well Blowouts by Volume ....................................................... 4
Table 2. Main Types of Oil and Gas Companies .......................................................................... 5
Table 3. Ocean Marine Global Insurance Premiums by Class..................................................... 10
Appendixes
Appendix. Total Number of Offshore Production Facilities in Federal Waters: 1959-2009 ......... 20
Contacts
Author Contact Information ...................................................................................................... 21
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
Introduction
The April 20, 2010, Deepwater Horizon oil spill disaster in the Gulf of Mexico is now considered
the largest spill within U.S. waters, eclipsing the 1989 Exxon Valdez spill several times over.1 As
efforts have proceeded to contain the current spill, the likely scale of clean-up costs and third-
party bodily injury and property damages has prompted congressional consideration of (1)
environmental damage; (2) the allocation of the cost of oil pollution clean-up; (3) disaster victim
compensation; and (4) future oil spill prevention, response, and recovery.
A key element is the limit on liability for operators of offshore energy facilities and the amount of
third-party liability insurance that is available from the commercial insurance market to meet
operators’ demand for coverage to satisfy existing governmental requirements. Without the ability
to spread risk broadly through risk diversification (e.g., insurance or alternative risk transfer
mechanisms such as risk securitization), the nation’s supply of oil and gas, as well as U.S.
government royalty payments from the sale of offshore oil and gas—an important source of
revenue for the U.S. Treasury—could become impaired.
By statute, modern environmental policy has sought to control oil pollution discharge into
navigable waters or upon adjoining shorelines.2 Federal agencies implement these statutes or laws
through regulations, rules, administrative orders, memoranda, and programs. Major oil spills in
the past, including the supertanker Torrey Canyon (1967), the Santa Barbara channel oil spill off
the California shore (1969), and the Exxon Valdez oil spill in Alaska (1989), have influenced the
development of ocean energy policy and ultimately prompted the enactment of the Oil Pollution
Act of 1990 (OPA).3 OPA was designed to cope with spills similar to what have occurred
historically, but is arguably not sufficient to address spills the size of Deepwater Horizon.
OPA established a comprehensive prevention, response, liability, and compensation regime to
deal with oil pollution caused by vessels and offshore energy exploration and production facilities
within U.S. navigable waters. The law strengthened the safety and environmental practices in the
offshore energy exploration and production business, created a system of so-called “financial
responsibility” requirements and compulsory liability insurance combined with strict liability
standards, and placed limitations on liability. Although liable for all removal costs, current law
limits an offshore facility’s liability for economic and natural resources damages to $75 million
per incident. Liability limits would not apply if the incident was “proximately caused by” the
“gross negligence or willful misconduct of” or “the violation of an applicable Federal safety,
construction, or operating regulation….”4 If one of these circumstances is determined to have
occurred, the liability would be unlimited.
1 Based on estimates from the National Incident Command’s Flow Rate Technical Group (FRTG), which is led by the
U.S. Geological Survey, the 2010 Gulf spill has become the largest oil spill in U.S. waters. See Deepwater Horizon
Unified Command, “U.S. Scientific Team Draws on New Data, Multiple Scientific Methodologies to Reach Updated
Estimate of Oil Flows from BP’s Well,” June 15, 2010, located at http://www.deepwaterhorizonresponse.com/go/doc/
2931/661583.
2 Some of the other water programs that are not addressed in this report include the regulation of the containment of
wastes, covered by the Solid Waste Disposal and CERCLA Acts; the Federal Land Policy and Management Act; the
Surface Mining Control and Reclamation Act; the Forest and Rangeland Renewable Resources Planning Act; the
Coastal Zone Management Act; and the Marine Mammal Protection Act.
3 P.L. 101-380; 104 Stat. 484.
4 33 U.S.C. § 2704(c).
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
Lease holders of a covered offshore facility (COF) must demonstrate a minimum amount of oil
spill financial responsibility (OSFR) of $35 million per 35,000 barrels of “worst case oil-spill
discharge” up to a maximum of $150 million for COF located in the OCS and $10 million in state
waters. The OSFR is demonstrated in various ways, including surety bonds, guarantees, letters of
credit, and self insurance, but the most common method is by means of an insurance certificate.
Damages in excess of the cap could be paid by the Oil Spill Liability Trust Fund, which is
financed primarily through a fee on domestic and imported crude oil.
One aspect of the public policy response to the Gulf oil spill incident has been the introduction of
legislative measures (S. 3305, H.R. 5214, H.R. 5629) to remove the limit of oil pollution liability
on responsible parties. But is there sufficient offshore energy insurance globally to allow
operators to purchase sufficient amounts of insurance to meet their financial responsibility
requirements associated with the higher liability limits for oil spills? Concerns have been
expressed that higher limits of liability and corresponding higher financial responsibility
(insurance) requirements in an environment of limited offshore energy insurance capacity will
deter smaller companies from offshore oil and gas exploration and production.
The offshore energy insurance market currently has a finite amount of liability insurance capacity,
including coverage for offshore oil pollution spills in U.S. waters, somewhere in the range of
$1.25 billion to $1.5 billion.5 Working capacity for OSFR insurance certification is no more than
$200 million—an amount that is likely to be far less than what the market will demand should
Congress choose to remove the limit of oil pollution liability.
Congress may wish to consider the feasibility of alternative sources of insurance capacity for
spreading oil spill financial risks. Some of the alternative risk transfer mechanisms include
“reinsurance sidecars,” catastrophe bonds and derivative financial instruments that securitize
insurance risk. These alternative risk transfer mechanisms turn an insurance policy or reinsurance
contract into a financial security that is then transferred to investors in the capital markets. These
risk financing options could in theory provide the added capital needed in the insurance
marketplace to cover the higher liability and associated OSFR limits.
This report begins with a review of the Deepwater Horizon incident and identifies the limits of
liability facing the operators of offshore oil rigs. The next two sections of the report examine risk
management in the offshore energy exploration and production business, the scope of the oil spill
financial responsibility and insurance requirements, and the marine insurance industry that offers
specialized coverage for offshore oil and gas firms. The fourth section outlines the various
approaches to compensating oil pollution victims, including compensation funds, commercial
insurance, federal disaster assistance, and tort law. The report concludes with a discussion of four
specific policy issue consideration for Congress, including new liability limits and insurance
capacity, future insurability of offshore oil spill perils, availability of insurance, and the potential
effects on domestic offshore energy production.
5 Testimony of Ron Baron, executive vice president, Willis, Global Energy Practice, before the Senate Committee on
Environment and Public Works, S. 3305, The Big Oil Bailout Prevention Liability Act of 2010, June 9, 2010, at
http://epw.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=304d3142-8460-40e8-abd7-
2f129285946b.
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
The Deepwater Horizon Oil Spill Incident
On April 20, 2010, the ultra-deepwater, semi-submersible mobile offshore oil rig Deepwater
Horizon experienced an explosion and fire and sank in the Gulf of Mexico off the shores of
Louisiana. The rig was owned and operated by Transocean, a Switzerland-based offshore drilling
contractor, and leased to BP plc (BP), one of the world’s largest oil companies. The explosion and
fire, which resulted in 11 fatalities and several injuries, occurred in spite of specialized oil spill
prevention equipment called a blowout preventer (BOP), designed to avert this type of disaster.6
The failure of the BOP left the well unsecured and leaking from the marine riser. The amount of
oil and gas escaping from the subsurface well is a matter of dispute, but an interagency federal
panel of scientists led by the U.S. Geological Survey estimated the spill’s size in the range of
35,000-60,000 barrels of oil a day, making the recent incident the largest oil spill in U.S. history.7
According to the American Petroleum Institute (API), there have been 17 marine well blowouts in
the United Stated since 1964 for a total of 248,963 barrels spilled prior to April 2010.8 The largest
of these incidents occurred in January 1969 from Alpha Well 21 off Santa Barbara, California,
which spilled an estimated 100,000 barrels. Two blowouts have occurred in state waters and
account for 5% of the total spillage. The total amount of oil spilled into the Gulf of Mexico from
the Deepwater Horizon incident is thought to exceed the total amount of oil spilled from
blowouts in U.S. waters since 1964. The API reports further that the volume of U.S. well
blowouts tends to be small, that is, 50% of the well blowouts involved 400 barrels of oil or less.9
Based on data shown in Table 1, the Deepwater Horizon oil spill incident would be the largest
offshore platform oil spill in U.S. history, ahead of the Alpha Well 21, and the 1989 Exxon Valdez
oil spill disaster when the ship ran aground in Prince William Sound in Alaska.10 Prior to the
Deepwater Horizon incident, the 1979 Ixtoc I oil spill, which released 3.5 million barrels into the
Bay of Campeche in Mexico, was recognized as the largest offshore oil spill in the world. That
incident did not result in significant onshore oil pollution damages.
6 Blowouts occur during offshore drilling operations when pressure exceeds the weight of the drilling fluid in the well,
which results in an uncontrolled flow of oil. The oil flow could result in loss of the property at the drill site.
7 Deepwater Horizon Unified Command, “U.S. Scientific Team Draws on New Data, Multiple Scientific
Methodologies to Reach Updated Estimate of Oil Flows from BP’s Well,” June 15, 2010, at
http://www.deepwaterhorizonresponse.com/go/doc/2931/661583; see also Allison Winter, “USGS Director Quietly
Wages Fearless War on Oil Spill,” The New York Times, June 16, 2010, at http://www.nytimes.com/gwire/2010/06/16/
16greenwire-usgs-director-quietly-wages-fearless-war-on-oi-83792.html.
8 Dagmar Schmidt Etkin, Analysis of U.S. Oil Spillage, American Petroleum Institute, August 2009, p. 25, at
http://www.api.org/Newsroom/safetyresponse/upload/Analysis_us_oil_spillage.pdf.
9 Ibid.
10 According to the International Tank Owners Pollution Federation (ITOPF), the clean-up costs alone totaled $2.5
billion, with fines and penalties adding at least another $1 billion. The ITOPF is an organization established on behalf
of the world’s shipowners to promote an effective response to marine spills oil, chemicals and other hazardous
substances.
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
Table 1. Largest International Oil Well Blowouts by Volume
(as of May 5, 2010)
Volume of Oil Released
Date
Name of Platform
Location
(Barrels)
June 1979 - April 1980
Ixtoc I
Bay of Campeche, Mexico
3,500,000
October 1986
Abkatun 91
Bay of Campeche, Mexico
247,000
April 1977
Ekofisk Bravo
North Sea, Norway
202,381
January 1980
Funiwa 5
Forcados, Nigeria
200,000
October 1980
Hasbah 6
Persian Gulf, Saudi Arabia
105,000
December 1971
Iran Marine intl.
Persian Gulf, Iran
100,000
January 1969
Alpha Wel 21
Pacific, California, U.S.A.
100,000
March 1970
Main Pass Block 41
Gulf of Mexico
65,000
October 1987
Yum II/Zapoteca
Bay of Campeche, Mexico
58,643
December 1970
South Timbalier B-26
Gulf of Mexico, USA
53,095
Source: American Petroleum Institute, Analysis of U.S. Oil Spillage, August 2009, p. 26, at http://www.api.org/
Newsroom/safetyresponse/upload/Analysis_us_oil_spillage.pdf.
Many expect the Deepwater Horizon offshore oil spill to cause unprecedented losses in the
commercial fishing and tourism industries along the Gulf of Mexico, and seriously damage some
of the delicate wetlands and intertidal zones along the coasts of Louisiana, Mississippi, Alabama,
and Florida.11 The final cost of the oil spill incident will depend on many factors, including the
distance between the oil spill location and the potential impact sites along the Gulf Coast, the sea
conditions, the sensitivity of affected locations to damage from oil and cleanup techniques, the
availability and cost of cleanup labor, the ecosystem value attributed to the location,
socioeconomic factors such as the economic value of activities affected by the spill, and the
acceptability of residual level oil contamination.12
According to various media reports, BP has pledged to clean up the Deepwater Horizon oil spill
in the Gulf of Mexico and to pay “all legitimate claims” arising from the spill. Limitations on
liability for damages under OPA are determined on a per-responsible party and per-incident basis
and the type of vessel or facility from which the discharge of oil flows. BP’s liability is currently
capped at $75 million and Transocean’s at $65 million, but those limits of liability could be
increased if the companies are ultimately found to have acted with gross negligence or to have
broken the OPA rules, leading to the oil spill.13
BP is also potentially exposed to statutory liability pursuant to the Louisiana Oil Spill Prevention
and Response Act (LOSPRA) that could hold parties responsible for up to $350 million in
damages arising from the discharge and must pay all pollution removal costs and damages
regardless of any defenses it may assert. Much of the BP’s losses, however, will likely be paid
11 Douglas Hanks, “Gulf Oil Spill’s Economic Impact Will Be Long Term,” The Miami Herald, June 17, 2010, at
http://www.mcclatchydc.com/2010/05/28/94982/gulf-oil-spills-economic-impact.html.
12 For more information on estimating the cost of offshore oil spills, see Franklin E. Giles, “Factors in Estimating
Potential Response Costs of Spills and Releases,” Environmental Claims Journal, vol. 22, iss. 1 (January 2010), p. 29.
13 For more information on this issue, see CRS Report R41262, Deepwater Horizon Oil Spill: Selected Issues for
Congress, coordinated by Curry L. Hagerty and Jonathan L. Ramseur.
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
through self-insurance with high retention (deductible) reinsurance because BP does not purchase
insurance. BP’s two non-operating partners of the Deepwater Horizon project, however, are
reportedly covered under various insurance policies and these insurers and their reinsurers have
pollution liability cleanup exposures totaling about $1.4 billion in potential losses under business
interruption, general liability, pollution liability, control-of-well, property and workers
compensation coverage.
The next two major sections of this report examine the offshore energy exploration and
production business in which the Deepwater Horizon operated and the offshore energy insurance
market that offers protection against the various risks these firms face.
The Offshore Energy Exploration and Production
Business
The oil and natural gas exploration and production industry plays an important role in the U.S.
economy by providing energy sources for transportation and the production of other goods and
services. The oil and gas business consists of three major segments:
• Exploration and production of oil and natural gas (the upstream);
• Transportation, storage, and trading of crude oil, refined products, and natural gas
(the midstream); and
• Refining and marketing of crude oil (the downstream).
Table 2 shows the main types of oil and gas companies and what they do. 14
Table 2. Main Types of Oil and Gas Companies
Types of Companies
What They Do?
International Integrated Companies
Involved in almost every aspect of the oil and natural gas
business and also make and sell petrochemicals.
Major Integrated Companies
Firms with at lease $100 billion in market capitalization
that engage in worldwide exploration but whose
upstream and downstream operations are not integrated.
Independent Exploration and Production Companies
Engage in exploration, development, refining and
marketing but whose upstream and downstream
operations are not integrated.
Midstream Services Companies
Engage in the transportation, storage, and trading of oil,
natural gas, and refined products.
Refining and Marketing Companies
Engage in the refining and selling of crude oil products
such activities as gasoline, jet fuel, heating oil, motor oil,
and various lubricants.
Source: Congressional Research Service.
14 For more information on how the oil and gas industry is structured and operates, see Standard & Poor’s Industry
Surveys, “Oil & Gas: Production & Marketing,” at http://www.netadvantage.standardandpoors.com/docs/indsur///
ogp_0310/ogp30310.htm.
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
The Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE)—the new
name, as of June 18, for the U.S. Mineral Management Services (MMS)—uses auctions to
allocate rights or leases for oil and gas exploration, drilling, and production on federally owned
lands on the Outer Continental Shelf (OCS). Oil companies may enter into a joint venture or
partnership with other firms for the purpose of applying for a license to explore for and develop
oil and gas tracts on the seabed.
Risk Management and the Demand for Insurance
Offshore oil and gas exploration and production companies face a wide range of complex
maritime perils and exposures, such as environmental uncertainty (e.g., hurricanes), adverse
exposures in drilling and construction of offshore oil wells, performance of equipment, and
defects in plans and specifications. Although these risks may not generally result in significant
offshore oil spills, they do have the potential to generate significant first-and third-party claims
for cleanup costs under state and federal laws. In the early 1960s, a specialty niche offshore
energy insurance market emerged to offer pollution liability coverage for third-party property
claims and cleanup and containment risks, oil well blowouts, and redrilling.
In the aftermath of the 1989 Exxon Valdez oil spill, Congress passed the Oil Pollution Act of 1990
(OPA) to shift the cost of oil pollution to the ledger of the polluter (“polluter pays”), establish
statutory limitations concerning liability and liability insurance, and set in motion the Oil Spill
Liability Trust Fund (OSLTF) as the explicit mechanism for compensating oil spill victims. The
imposition of pollution liabilities meant oil and gas exploration and production firms would, in
theory, have incentives to manage risks cost-effectively, inducing the polluter to take measures to
reduce the probability of accidents or to reduce consequent damages at least up to the point where
the marginal cost is equal to the expected marginal recovery paid to victims. Moreover, the
insurance industry would play a major role in oil pollution risk analysis by applying its skills in
actuarial science and safety engineering.
Oil Spill Financial Responsibility and Insurance Requirements
Congress passed the OPA to strengthen the safety and environmental practices in the oil and gas
exploration and production business and to create a system of financial responsibility laws and
compulsory liability insurance combined with strict liability standards. The financial
responsibility and compulsory insurance requirements provide funds to pay for damages; the
strict liability rules allow third-party claims to be made directly against the insurer, irrespective of
negligence. This regulatory structure was designed to avoid time-consuming and costly litigation
and the need for oil spill victims to prove negligence as the primary test of liability for oil
pollution damage. Operators of offshore energy facilities are held strictly liable and thus cannot
argue that disaster victims contributed to the injury by their own negligence. Strict liability
theories eliminate the necessity of establishing intent. The presumption is that oil pollution
victims are incapable of protecting themselves against exposure to oil pollution. Strict liability is
therefore intended to distribute the economic burden of environmental-related damages while
enhancing the speedy compensation of third-party oil pollution damages, property losses, and
bodily injury irrespective of fault or the defendant’s solvency.
Under Section 1016 of the OPA, oil and gas exploration and production (E&P) leases issued by
the BOEMRE for operation in the Gulf of Mexico must establish and maintain OSFR capability
to meet their liabilities for removal costs and damages caused by oil discharges from an offshore
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
facility and associated pipelines.15 For offshore facilities, OPA established a $75 million cap on
the responsible party(s) for economic and natural resource damages unless the damages were the
result of acts of gross negligence or willful misconduct.16 (Responsible parties of offshore
facilities must pay for all cleanup costs.)
Lease holders of a covered offshore facility (COF) must demonstrate a minimum amount of
OSFR of $35 million per 35,000 barrels of “worst case oil-spill discharge” up to a maximum of
$150 million for COF located in the OCS and $10 million in state waters. As an illustration, a
worst case oil-spill discharge volume of 35,000 barrels requires $35 million in OSFR while a
volume of 35,001 barrels requires $70 million. The BOEMRE calculates the worst case oil-spill
discharge volume for a facility. An exemption to the OSFR is provided for persons responsible for
facilities having a potential worst case oil-spill discharge of 1,000 barrels or less. The OSFR is
demonstrated in various ways including surety bonds, guarantees, letters of credit, and self
insurance, but the most common method is by means of an insurance certificate. Claims above
the current liability cap can be made to the Oil Spill Liability Trust Fund, which has about $1.6
billion that can be used for cleanup costs and bodily injuries and property damage to third parties.
The fund is capitalized by a $.08 excise tax on every barrel of domestic and imported crude oil
and petroleum products. The Fund is limited to payouts of $1 billion per incident and $500
million for natural resource damages.
Offshore Energy Insurance Market
Prior to 1969, liability insurance was an internal matter of the companies that owned shipping
vessels, including offshore energy facilities (oil rigs). Insuring potential liabilities facing mobile
offshore drilling units (MODUs), a type of vessel, was not made compulsory until the advent of
the 1969 International Convention on Civil Liability for Oil Pollution Damage.17 The triggering
event was the 1967 Torrey Canyon incident after which shipowners’ liability insurance for oil
pollution damage became commonplace. At about the same time, a specialty niche offshore oil
and gas insurance market began offering insurance coverage for risks usually retained by the
operator. Offshore international underwriting syndicates began offering expanded coverage for
pollution liability resulting from blowouts, costs of well control, damage to underground
resources, liability to the employees of the operator, loss or damage to equipment lost while
actively in use, and loss to drilling and servicing equipment from corrosive elements.
The emergence of OSFR requirements and compulsory liability insurance combined with strict
liability statutes occurred after the 1989 Exxon Valdez oil spill and the enactment of the OPA. The
imposition of strict liability for large-scale oil spills dramatically increased demand for offshore
energy facility liability insurance protection. Today, the offshore energy insurance market is well-
syndicated, with the insured losses spread across a broad spectrum of global insurers and
reinsurers based principally in London and Bermuda.
15 This requirement applies to the Outer Continental Shelf (OCS), state waters, and certain coastal inland waters.
16 CRS Report R41266, Oil Pollution Act of 1990 (OPA): Liability of Responsible Parties, by James E. Nichols.
17 See International Convention on Civil Liability for Oil Pollution Damage, 1969, at http://www.imo.org/conventions/
contents.asp?doc_id=660&topic_id=256.
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
The Marine Insurance Industry
The offshore energy insurance market is the generic name for a broad segment of the insurance
market that provides coverage for offshore oil and gas exploration and production business
operations. Because the offshore exploration business is conducted in bodies of water, the
offshore energy insurance market is closely associated with the marine insurance industry. Marine
insurance is therefore a component of the offshore energy insurance market.
Operators of vessels, including MODUs, like the Deepwater Horizon oil rig, face multiple
property and liability loss exposures for which they use marine insurance to cover.
Marine insurance covers vessels and their cargoes for both property and liability risk exposures.
In the United States, marine insurance consists of two distinct branches: (1) inland (or “dry”)
marine that includes exposures related to properties in transit such as mobile equipment and
jewelry; and (2) ocean (or “wet”) marine that includes hull and cargo coverage. Ocean marine
means the same as marine insurance in the global insurance market. Because of their unique loss
exposures, both ocean and inland marine insurance are exempt from state insurance rate and
policy form filing requirements and state insurance premium tax. This allows a high degree of
flexibility in modifying forms and rates to cover unique loss exposures. A vessel owner’s legal
liability is subject to a specialized branch of federal law known as admiralty or general maritime
law.18 This favorable regulatory treatment was designed to encourage the development of the U.S.
ocean marine insurance industry that was being outcompeted by British marine insurers.
Marine insurance covers:
• Liability for bodily injury, illness, or death of
• members of the vessel’s crew
• shore workers, passengers, or other persons on board
• persons not on board the vessel
• Liability for property damage to (and resulting loss of use of)
• other vessels, resulting from collision with the vessel
• vessel owners’ own vessel
• cargo or other property on board other vessels
• cargo or other property of others on board the at-fault vessel
• bridges, piers, docks, navigational locks, and other structures
• Liability for environmental impairment resulting from oil spills or other pollution
incidents.
18 Admiralty law can be distinguished from common law that governs disputes and claims for other lines of business in
that a marine dispute is tried before judges only rather than involving juries.
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Deepwater Horizon Oil Spill Disaster: Risk, Recovery, and Insurance Implications
Structure and Performance of Offshore Energy Insurance Market
The offshore energy insurance market is one class of business (or subline) within the ocean
marine insurance market. The sublines within ocean marine are cargo, hull, war, primary marine
liabilities, excess liabilities, yacht, protection and indemnity (P&I), and offshore energy. Ocean
marine insurance is typically purchased to cover risk exposures of shipowners (cargo and hull),
marinas, wharves, ports, offshore oil and gas exploration and production firms, and onshore
warehouse and retail establishments. Operators of offshore energy facilities typically self insure
or purchase pollution liability coverage and excess liability limits in the surplus market or the
international marine insurance market. Insurance sold in the surplus market is handled through
specialized brokers.
Structure
The offshore energy insurance market is highly specialized and, because the limits of insurance
are usually in excess of $1 billion, there is no single insurer who covers the entire risk exposure.
Consequently, operators of offshore drilling units, production platforms, undersea pipelines and
systems for loading oil onto vessels at offshore mooring points typically insure their property and
liability risk exposures on a subscription basis through specialized brokers who negotiate with
underwriters in the energy field. Most subscription transactions are negotiated and placed in the
London and Bermuda insurance market through, for example, Lloyds of London and scores of
global reinsurance companies and intermediaries.
In the past decade, the formal organizational structure of the ocean marine industry underwent a
significant cultural and institutional transformation. According to Conning Research and
Consulting, the ocean marine insurance market has become more concentrated with fewer, larger
insurers due to overall insurance industry consolidation. In 2009, there were 106 groups
underwriting ocean marine coverage compared with 189 in 1986.19 Moreover, the size of the
ocean marine insurance industry, as a proportion of the overall property and casualty (P&C)
insurance industry, has declined from 3% of total P&C insurance premiums in 1989 to 0.7% of
overall writings in 2009.20
An industry once dominated by individual freestanding monoline underwriters (i.e., managing
agencies/pools) is reportedly now dominated by small marine underwriting units subsumed
within multiline insurers, either in the commercial or speciality lines divisions. In addition,
offshore energy insurers, who traditionally were defined by their willingness to assume risk
without relying on technical analysis, now require professional engineers to evaluate risk and
quantify exposures. Some claim that marine insurance underwriting is now guided not by
experienced and knowledgeable underwriters but by computer simulation models and estimates
of exposure promulgated by actuaries and quantitative approaches.21
19 Conning Research and Consulting Strategic Study Series, “Ocean Marine Insurance: Entering New Waters: 2009,”
Hartford, Connecticut, p. 9.
20 Ibid.
21 Ibid.
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Performance
Table 3 shows ocean marine global premiums by class for first-party physical damage coverage.
Importantly, these figures do not include third-party liability coverage for bodily injury and
property damages and clean up and containment of oil spills. These data are not readily available
because the main market players are based principally in London and Bermuda and beyond the
reach of state insurance regulators. Conversations with offshore energy insurance brokers suggest
that the estimated total offshore energy property insurance premium is in the range of $3 billion
to $3.5 billion annually. These sources estimate that there is an additional $500 million in third-
party liability capacity. Most operators of MODUs typically carry about $300 billion to $500
million of operator extra expense insurance.
Table 3. Ocean Marine Global Insurance Premiums by Class
($ in millions)
2006
2007
Global Hul
$5,282
$5,919
Transport/Cargo $10,724
$11,958
Marine Liability $1,381
$1,420
Offshore/Energy $2,736
$2,806
Total
$20,124
$22,103
Source: International Union of Marine Insurance.
In 2009, the offshore energy insurance market experienced surplus capacity due to two main
factors. First, MODUs rig utilization and, hence, demand for insurance declined sharply in all oil
and gas exploration and production areas of the world, but particularly in the Gulf of Mexico
because of heightened hurricane activity in 2004, 2005, and 2008. According to the International
Union of Marine Insurance (IUMI), the worldwide rig capacity utilization rate stood at 75% in
2009, down from 88% in 2008.22 The Gulf of Mexico rig utilization rate was 49%, off from 75%
in 2008. Second, the demand for ocean marine insurance has been adversely affected by the
global economic downturn and the decline in world trade and a decline in market price for oil and
natural gas.
Typical Offshore Energy Insurance Coverage
The main types of insurance coverage commonly used in the offshore energy insurance market
that are relevant to the Deepwater Horizon incident include (1) offshore physical damage
coverage for physical damage or loss to offshore fixed platforms, pipelines, and production and
accommodation facilities;23 (2) Operator’s Extra Expense (OEE); (3) Excess Liability insurance;
(4) business interruption; and (5) workers’ compensation. Another type of insurance coverage that
provides third-party liability protection for owners and operators of vessels is Protection and
22 International Union of Marine Insurance, “Sharp Drop in Offshore Rig Operation in 2009,” press release, March 31,
2010, at http://www.iumi.com/index.cfm?id=7198.
23 ISO Commercial Property, Causes of Loss – Special Form, CP 10 30 04 02, at http://www.endlar.com/Documents/
Policy_Forms/Arbella%20CP1030%20Special%20Cause%20of%20Loss%20Form.pdf.
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Indemnity (P&I) insurance sold by P&I clubs, which are mutual associations of vessel owners.
However, P&I policies sold by conventional insurers explicitly do not offer coverage to
indemnify offshore energy facilities for oil pollution damages and supplemental pollution liability
insurance must be obtained under a separate marine policy.24
• Offshore Physical Damage. This coverage provides post-loss financing for any direct
physical loss of or damage to fixed offshore drilling, production, and accommodation
facilities, including (1) offshore energy drilling, production, and accommodation
facilities;25 (2) pipelines; (3) subsea equipment; and (4) offshore loading. All risks are
covered unless specifically excluded, but such risks are covered in OEE policies. For
example, oil wells and regaining control of the well after a blowout and redrilling
expenses are typically excluded.
• Operator’s Extra Expense (OEE)/Energy Exploration and Development (EED)
Coverage. This covers the costs of well blowout and indemnifies the offshore facility
operator for third-party bodily injury claims, damage to and loss of third-party property,
and the cost of clean up and legal defense expenses as a result of a blowout. OEE covers
evacuation expenses, the removal of wreckage and making wells safe, and the property of
others in the insured’s care custody and control. Coverage may also include the redrilling
of a well after a blowout to the original depth and comparable condition prior to the loss,
as well as the legal expenses emanating from an incident such as the sinking of a rig or an
oil spill. The oil pollution incident must be sudden and accidental and the occurrence
must have taken place during the period when insurance coverage is in force. Also, the
incident must become known to the insured within 90 days and the insured must report
the claim to the underwriter within 180 days. OEE is sold as a “Combined Single Limit
of Liability” and covers actual costs or expenses incurred in regaining control of an
unintended subsurface flow of oil. The operator is responsible for damage to drilling
equipment as determined by the “Operating Agreement” between the operator of the rig
and the drilling contractor listing the risks the operator will cover. Under these
24 In the 19th century, shipowners banded together in mutual underwriting clubs to form shipowners’ Protection and
Indemnity (P&I) clubs to cover shipowners’ third-party liabilities and expenses arising from the owning or operation of
their ships. There are 13 separate and independent principal clubs that form the International Group of P&I Clubs.
Some of these clubs have affiliated and reinsured subsidiary associations. The American Steamship Owners Mutual
Protection and Indemnity Association, Inc., established in New York in 1917, is the only mutual P&I club domiciled in
the United States. It is a member of the International Group of P&I Clubs, a collective of 13 mutuals that together
provide P&I insurance for some 90% of all world shipping. Members of the clubs are generally levied an initial sum
that is used to purchase reinsurance to cover their mutual liability risks. If a club experiences unfavorable losses, the
members are assessed a supplementary premium. The club attempts to build up loss reserves.
25 It is important to distinguish between a mobile offshore drilling unit (MODU), such as the Deepwater Horizon, and a
well drilled from a MODU. A MODU is classified as a vessel and well drilling from a MODU is classified as a covered
offshore facility (COF) under the OPA. The Secretary of Transportation has authority for vessel oil pollution financial
responsibility and the U.S. Coast Guard regulates the oil-spill financial responsibility program for vessels. Offshore
drilling rigs are classified into two categories: mobile offshore drilling units and fixed units. MODUs are classified in
terms of bottom-supported (shallow water) rigs and floating (deepwater) rigs. In bottom-supported units, the rig is in
contact with the seafloor during drilling, while a floating rig floats over the site while it drills, held in position by
anchors or equipped with thrusters to be dynamically positioned. Both units float when moved from one site to another.
Bottom-supported units include jack ups, tenders, submersibles, and barges. Floating units include semi-submersibles
and drillships. Fixed units (or platform rigs) are drilling units that are placed upon a platform or other structures.
Subsea floating production systems are employed in deeper water. The Deepwater Horizon was a floating production
system (FPS) or vessel that was connected to a subsea pipeline, while a floating, production, storage, and offloading
vessel (FPSO) processed and stored oil on board a vessel prior to being offloaded into shuttle tankers.
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Agreements the drilling contractor is typically held harmless with respect to pollution
liability for underground resources and liability for damage to operator’s property or
injury to operator’s personnel arising out of the employee/employer relationship.
• Excess Liability Insurance. This coverage is purchased in layers that attach excess of a
certain dollar limit. A typical operator would have many layers of excess liability that
adds up to a certain aggregate level of protection. Although excess liability coverage is
purchased as an additional layer of coverage in excess of the OEE policy it is subject to
its own terms and conditions. Thus, whereas OEE covers pollution-related third-party
bodily injury and third-party property loss or damage or loss of use on a strict liability
basis, the excess liability insurance policy excludes pollution from wells. The policy
generally has a limited “buy back,” which requires the pollution event to be sudden,
accidental and unintended and subject to strict discovery and reporting requirements. The
offshore energy facility operator must purchase specific “pollution endorsements” that
overrides the pollution exclusion provision in the excess liability policy. A point of note is
that the use of pollution endorsements could have the effect of reducing overall insurance
capacity for clean up of pollution from wells because the insurer is potentially liable for
higher levels of third-party liability on each policy.
• Business Interruption (BI)/Loss of Production Income (LOPI). This coverage
indemnifies the insured for lost net income that would have been earned had the damage
not occurred, as well as for refunding fixed expenses incurred during the period of
indemnity. Contingent business insurance coverage provides payments for damages based
upon loss income due to damage to upstream facilities such as processing plants,
trunklines, and refineries owned by third parties but upon which the insured’s income
depended. This coverage is usually written in conjunction with offshore physical damage
coverage on standardized forms published by Insurance Services Office, Inc. or those that
resemble the ISO form.26 Because of the standardization in contract language there tends
to be more predictability in claim payments and, therefore, reduced potential litigation
over contract interpretation. Companies filing a business interruption insurance claim
must show that their business operation sustained actual direct physical loss of or damage
to the insured property. Without this proof, the BI claim could be denied because, as
many experts agree, the consequences of oil spill can be far reaching without any need
for the oil itself to actually reach those affected.
• Workers Compensation/Employers’ Liability. This provides coverage for claims
arising out of employee injuries or deaths incurred while the employees are in the line of
duty.
Compensating Oil Pollution Victims
The offshore oil and gas exploration and production industry faces many operating hazards, such
as blowouts, explosions, oil spills, and fires, as well as hazards associated with marine operation,
such as collision, grounding, and damage or loss from severe weather. These hazards can cause
personal injury and loss of life, damage to and destruction of property and equipment, pollution
26 ISO Form CP 0030.
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or environmental damage, and suspension of operation. Liability for marine oil pollution is
governed by the OPA and by any number of stricter statutes in individual states. The main sources
of funds for compensating victims of offshore oil pollution damages include (1) oil pollution
compensation funds, (2) commercial insurance, (3) federal disaster insurance, and (4) tort law.
Oil Pollution Compensation Funds
In the aftermath of the 1967 Torrey Canyon grounding and oil spill, the International Tanker
Owners Pollution Federation (ITOPF) was established to administer a voluntary fund that offers
compensation to parties affected by oil spills. The United States is not a party to the ITOPF. Oil
spills that occur in the United States are covered under the OPA. In the event claims for oil spill
and related damages are not paid by the responsible party the claimant may file a claim directly to
the Oil Spill Liability Trust Fund (OSLTF) or file a lawsuit in court. The fund is currently
authorized to provide up to $1 billion per oil pollution incident.
If offshore energy insurance capacity is scarce or expensive, the government could create
mandatory insurance pooling arrangements to which all participants in drilling activities
contributed in proportion to their involvement in drilling activities. Operators who benefit from
oil and gas exploration and production would bear risk and implement stronger safety and
environmental controls to reduce losses.
Commercial Insurance
The offshore oil and gas exploration and production business has the potential to affect third
parties who may be physically injured or whose property may be damaged or both. A third-party
(liability) insurance policy protects the insured (the first party) against being sued for negligence
brought in a lawsuit by another person or company (the third party) that alleges the covered
person caused an injury or financial loss. Liability insurance does not protect against liability
resulting from crimes or intentional torts committed by the insured.
The most prompt and effective compensation for pollution victims is thought to be compulsory
insurance on a strict liability basis. Given the high level of risk associated with oil and gas
exploration and limited insurance and reinsurance capacity for these risks, oil companies usually
join together, pool their financial resources, and establish a wholly owned affiliate company
called a captive insurance company that is establish to exclusively underwrite the risks of the
parent company or group of companies in an industry or trade association.
Federal Disaster Assistance
In theory, the Robert T. Stafford Disaster Relief and Emergency Assistance Act27 should offer
several options for compensating oil spill disaster victims. Pursuant to an emergency declaration
or a major disaster declaration under the Stafford Act, the Federal Emergency Management
Agency (FEMA) has the authority to provide disaster assistance to compensate disaster victims.
FEMA assistance can be rapid and flexible, but it is usually carefully delineated to avoid
duplication of benefits.
27 P.L. 93-288, 42 U.S.C. 5192.
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There is not, however, a precedent for providing federal disaster assistance under the Stafford Act
for oil spills. Following the 1989 Exxon Valdez oil spill incident, the President turned down two
requests from the governor of Alaska for an emergency declaration based on the rationale that a
declaration by the President would hinder the government’s litigation against Exxon that
promised substantial compensation for the incident.28
Tort Law
Another way to compensate for damage caused by offshore oil pollution is through state tort
liability—that is, through a private lawsuit brought by an injured part against the entity
proximately causing the injury. Torts that are potentially implicated by such damage include
negligence, trespass, private nuisance, and perhaps strict liability for abnormally dangerous
activities (breach of contract is a separate area of law; a breach of contract is not a tort). Liability
insurance may be used to distribute the costs imposed under the tort (or other) liability system
when a court determines that an entity is liable.
Although the compensation of an injured party pursuant to a court judgment may not reverse the
environmental damage done, or even completely redress the economic harm, it can play four
important roles in mitigation future offshore oil and gas pollution damages.
• Compensate disaster victims (e.g., commercial fisherman, shrimpers, seafood
processors, property owners and tourism-related businesses);
• Cause the oil industry to improve their safety procedures;
• Reduce the risk of another costly oil spill that reduces company profits;
• Spur regulatory action, which can prevent these disasters from occurring in the
future.
Many lawsuits have been brought in connection with the Deepwater Horizon incident.29 Most
allege damage to real or personal property, but others are based on personal injury, economic
loss, products liability, or loss of stock value (in suits brought by investors in the company). The
fact that BP has taken responsibility for all “legitimate claims” (which it defines as those claims
recognized by the Oil Pollution Act) does not, however, mean that it has accepted liability for the
above torts. The investor’s lawsuits allege that company executives lobbied state and federal
agencies to remove or decrease the extent of safety and maintenance regulation of the company’s
Gulf operation, claiming that volunteer compliance would suffice to address safety and
environmental concerns.30 Meanwhile, officials for BP requested that all lawsuits over economic
and environmental damages as a result of the oil spill be combined in a federal court in Houston.
The multidistrict-litigation panel has agreed to hear arguments on this request in July 2010.
28 For more information, see CRS Report R41234, Potential Stafford Act Declarations for the Gulf Coast Oil Spill:
Issues for Congress, by Francis X. McCarthy.
29 For more information on legal activity surrounding the Deepwater Horizon incident, see Robert Meltz in American
Law Division of the Congressional Research Service. Also, see CRS Report R41266, Oil Pollution Act of 1990 (OPA):
Liability of Responsible Parties, by James E. Nichols.
30 Firpo v. Hayward et al, 2:10-cv-01430, U.S. District Court, Eastern District of Louisiana (New Orleans).
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Policy Issue Considerations for Congress
In the aftermath of the Deepwater Horizon incident, one issue that Congress may wish to consider
is the willingness of the global offshore energy insurance market to participate in the OSFR
program. Commercial insurance companies might be concerned about the proposed change to
remove the liability limits under OPA and also the proposal to increase the OSFR requirement to
some higher level that is yet to be determined. If insurers were willing to continue to participate,
another question might be whether the new limit of liability is supported by the availability of
insurance coverage on adequate terms and conditions in the global commercial insurance market
for offshore energy facilities given (1) the insurability of future offshore oil spill hazards; and (2)
the impact of the global financial market crisis on insurance market’s capacity for underwriting
“catastrophe” or “peak” risks, including oil spill damages.
New Liability Limits and Insurance Capacity
Congress has been called upon to reconcile two policy issues: (1) the desire to remove the
limitations of liability for operators of offshore energy facilities for economic losses caused by oil
pollution damage and raise the criteria for demonstrating OSFR; and (2) the limited capacity of
offshore energy insurance and reinsurance to cover loss of well control, cost to redrill a blowout
well, and pollution liability facing operators of offshore energy facilities.
Several congressional hearings were held to consider these issues and to determine whether
offshore energy facility operators of any size will be able to obtain sufficient amounts of
insurance at acceptable prices to demonstrate evidence of financial responsibility under new, yet
to be proposed, OPA insurance requirements. Concerns have been expressed that the higher limits
of liability on responsible parties for oil spills and the corresponding insurance requirement could
lead to the domination of drilling activity by major oil companies, if many smaller oil firms and
their investors are not able or willing to expose themselves to such liability.
It would appear that the energy insurance market currently has a finite amount of available
insurance, including coverage for offshore oil pollution spill in U.S. waters, which now stands in
the range of $1.25 billion to $1.5 billion.31 The “working capacity” or the dollar amount that an
insurer will typically commit to any single risk, for control of well (COW) risks is in the range of
$600 million to $750 million on a stand alone basis.32 The working capacity for Oil Spill
Financial Responsibility Certification is allegedly no more than $200 million.33
Future Insurability of Offshore Oil Spill Perils
Large-scale disasters, such as Hurricane Katrina, may prove instructive. As a major source of
post-disaster recovery financing, commercial insurance companies have been called upon to pay
31 Testimony of Ron Baron, executive vice president, Willis, Global Energy Practice, before the Senate Committee on
Environment and Public Works, S. 3305, The Big Oil Bailout Prevention Liability Act of 2010, June 9, 2010, at
http://epw.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=304d3142-8460-40e8-abd7-
2f129285946b.
32 Ibid.
33 Ibid.
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for catastrophe-related losses; in some cases, beyond their contractual policy obligation. For
example, after the September 11, 2001 terrorist attacks at the World Trade Center, insurers faced
pressure to interpret policy language liberally with respect to war risk coverage and the number of
occurrences. After some negotiation between private insurers and reinsurers, legislators, and other
industry participants, which led to the passage of the Terrorism Risk Insurance Act (a pre-disaster
risk financing scheme), insurers agreed to pay claims related to the 9/11 incident. Insurers did not
charge an additional premium to cover that risk. Other notable examples include asbestos,
Superfund environmental claims, and Hurricane Katrina. In particular, after Katrina, the courts
reinterpreted some water exclusion provisions in homeowners’ policies, resulting in expanded
coverage for water damage. Consideration of coverage expansion through the reinterpretation of
insurance contract language by the courts could affect the availability of insurance for offshore
energy facilities going forward.
Availability of Offshore Energy Insurance for Oil Spills
In the aftermath of the Deepwater Horizon incident, offshore energy insurance underwriters have
begun to reassess their risk exposures in response to newly perceived operational risks involving
blowouts, fires, explosions, lost control of well and other non-hurricane risks. Insurance experts
expect offshore energy insurance rates to increase in the short term as a result of the perception of
greater potential risk exposure. Changes in the insurance market will likely not be driven by the
operator’s exposure to windstorm damages; rather, they will be driven by reassessments of
operational risks. Coverage for drilling contractors and control-of-well expenses are the areas
most likely to be targeted by underwriters for rate increases.
The proposed increase in the limit of liability required under OPA carries at least four
consequences in the offshore energy insurance and reinsurance market. First, some insurance
market experts have asserted that the global commercial insurance capacity for third-party
liability insurance—Operators’ Extra Expense (OEE) and Excess Liabilities coverage—that is
currently available to meet OSFR requirements is approximately $1.5 billion. This amount is
likely to be far below the OSFR associated with the new unlimited liability limits.
Insurers have pointed out that the strict liability standard with direct access to the insurer serves to
further limit overall industry capacity. The reason is that the insurer cannot control claims
payment with contract terms and conditions. Moreover, the OEE coverage as currently structured
provides a combined single limit for well control, well redrilling after a blowout, and sudden and
accidental seepage and pollution cleanup. This means prioritizing the single limit, for example, by
first using the insurance proceeds to hire a well control expert to retake control of the well and, if
necessary and funds remain, drill a new well, with the balance of the OEE insurance limits used
for pollution cleanup and containment of oil spills.
Second, given basic economic supply-demand principles and the fallout from what may be
characterized as the largest oil spill in U.S. history, most insurance market experts expect the
supply of insurance coverage for the new OSFR to only be available at a high premium, if
coverage is available at all. The imposition of higher strict liability limits for large-scale oil
pollution could have the effect of greatly increasing the demand for liability insurance protection.
This situation could multiply the challenges insurers might have in evaluating risk exposures,
defining reasonable limits for the coverage and calculating insurance prices. Operators may find
themselves assuming or retaining higher levels of self-insurance, which might affect the
BOEMRE’s offshore oil and gas lease bidding and ultimately the royalties earned for the U.S.
Treasury.
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Third, if the past is an indication of the future, private commercial insurers may be reluctant to
commit financial capital in underwriting unknown new risks in the post-Deepwater Horizon
environment until there is greater clarity on the legislative and legal climate. Insurers would want
to collect the necessary data for evaluation of risks associated with certain severity of loss and
insurability, recalculate rates, policy terms and conditions, and set limitations. Conduct of these
normal activities, at least in the short term, will be affected by the uncertainty of the losses
associated with the recent Gulf of Mexico oil spill.
OPA’s oil spill financial responsibility rule is a pre-disaster risk financing strategy that, in the
wake of the Deepwater Horizon incident, could come under intense pressure because of capital
shortages in the offshore energy insurance and reinsurance market. From an insurer’s perspective,
one issue that may arise is the potential for future massive environmental-related (strict liability)
damages which leads to the question of whether offshore oil pollution will be insurable or
insurable only with government support. Given the magnitude of losses and the uncertainty about
future profitability in the energy insurance business, a “hard” energy insurance market—scarcity
of coverage and high prices—may emerge following the Deepwater Horizon incident. Prior to
this event, the third-party pollution liability market was thought to be in a “soft” phase where
rates were low as a result of oversupply of capacity.34
Fourth, many insurance market experts would likely support a more efficient pre-disaster risk
financing approach to managing and financing large-scale oil spill disasters. The availability of
alternative sources of insurance capacity for spreading financial risks associated with oil spills,
perhaps through “reinsurance sidecars,” catastrophe bonds or energy insurance financial futures
and options (i.e., derivative financial instruments that securitize insurance risk, turning an
insurance policy or reinsurance contract into a security), could provide the added capital needed
in the insurance marketplace to cover the higher liability and associated OSFR limits. For
example, a reinsurance sidecar is a limited-life reinsurance company that is established to provide
property catastrophe (quota-share) reinsurance for the upper layers of an insurance contract or the
worst-case-oil-spill scenario event.
Figure 1 illustrates a typical reinsurance sidecar transaction created after Hurricane Katrina in
2005 to meet the catastrophe insurance risk financing needs of operators of offshore energy
facilities. The sidecar allows a ceding insurer or reinsurer to transfer oil spill risks to a newly
licensed reinsurance company that assumes risk, collects premiums, and pays claims losses to the
ceding insurer or reinsurer via a reinsurance agreement.
34 Willis Limited, “Energy Market Review: On the Edge of an Abyss?,” March 2010, at http://www.willis.com/
Media_Room/Press_Releases_(Browse_All)/2010/20100324_Willis_Energy_Market_Review_24_March_2010.
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Figure 1. Illustration of Alternative Risk Transfer Instrument Using a Reinsurance
Sidecar Transaction
Source: Congressional Research Service.
The sidecar issues fully collateralized debt to its investors. Reinsurers typically create sidecars by
transferring policies and premiums to a special purpose reinsurer (SPR) that uses them as
collateral for bonds, loans, and equity. This allows the sidecar to diversify (or spread) individual
reinsurers’ risk among the global reinsurance marketplace. Proceeds from the security offering, as
well as premium and investment income, are transferred to a collateral trust, which invests the
proceeds and disburses funds to the ceding insurer or reinsurer on behalf of the sidecar to pay
claims. Funds are also disbursed to the holding company, via the sidecar, to pay interest on debt
and dividends, if any, to the shareholders. Sidecar payouts are determined via the reinsurance
agreement contract between the ceding company and the sidecar, and are triggered by the loss
experience of the ceding company.
Hedge funds, private equity investors, and other institutional investors provide the bulk of the
funds via equity and debt financing to capitalize these unusual insurance investment vehicles.
Thus, capital market investors were able to get into the lucrative post-Katrina reinsurance
business without having any underwriting experience. Investors agree to invest the funds for two
to three years and typically earned 20% to 30% or more return on their investment. The reinsurer
receives a commission. Investors get interest and dividend payments from the collateral trust
when the sidecar expires, assuming that all of the capital has not been used to meet claims.
Potential Effects on Domestic Offshore Energy Production35
The Appendix shows that there were a total of 3,583 offshore production facilities in federal
waters in 2009, and that since 1989, both the East and West Coasts of the United States have been
off limits to OCS leasing and development. The future of offshore oil and gas exploration and
35 This section is based on the author’s research and telephone discussions with economists Marshall Rose and Sam
Fraser at BOEMRE and Marc Humphrey, analyst in Energy Economics, at the Congressional Research Service, Library
of Congress, on May 21, 2010.
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production in the Gulf of Mexico, an important source of energy for the nation, could be affected
by the imposition of higher liability limits.
Some maintain that quantifying the impact of OPA’s higher liability limit requires a rigorous
analysis due to the many variables that affect the economics of offshore oil and gas development,
such as price/demand of oil and natural gas, rig availability, discoveries, regulatory requirements,
and capital availability for the Gulf of Mexico, among other things. Increasing the liability cap for
oil spills may change the landscape of offshore leasing activity.36 Arguments have been made that
if a new cap were applied retroactively, it might cause current operators who are unable or
unwilling to meet the new insurance requirements to relinquish their leases. This may cause a
sharp decline in shallow water production since smaller operators operate in such conditions. In
the deepwater regions that are already dominated by the majors or large-scale independents,
production could be affected if those lessees could not find buyers in the lease resale market after
they have optimized their production.37 If there are no qualified buyers, the initial lease holder
may relinquish the lease early.
With a higher oil spill liability cap, at the lease sale level, one would likely expect to have fewer
bidders and less competitive lease sales, which could result in lower “bonus bids” offered for the
leases, according to economists at the BOEMRE. Small independent involvement in the OCS
allegedly declined after the 2005 hurricane season because of the higher costs to operate in the
OCS.38 As costs get higher and as shallow water offers fewer opportunities, small-scale
independent involvement may continue to decline unless the small operators are willing and able
to take equity positions in the larger and more expensive deepwater operations.
36 According to BOEMRE, U.S. offshore production in 2009 accounted for 27% of all U.S. crude oil production and
11% of natural gas production. The Gulf of Mexico (GOM) accounts for about 95% of U.S. offshore production while
the deepwater regions (1,000 feet and above) of the GOM account for 74% of oil and 43% of natural gas production.
Out of the 6,619 offshore leases, 4,204 were in deepwater—about half of the deepwater leases are in water depths of
1,500-4,999 feet.
37 Discussion with BOEMRE economists, Marshall Rose and Sam Fraser, May 21, 2010.
38 Upstream Insight, Deepwater Horizon Tragedy: Near-Term and Long-Term Implications in Deepwater Gulf of
Mexico, Woods-Mackenzie, May, 2010.
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Appendix. Total Number of Offshore Production
Facilities in Federal Waters: 1959-2009
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Author Contact Information
Rawle O. King
Analyst in Financial Economics and Risk
Assessment
rking@crs.loc.gov, 7-5975
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