Oil-Rig Insurers Brace for Test as Gustav Bears Down

By Erik Holm

Aug. 29 (Bloomberg) -- Tropical Storm Gustav, projected to reach the Gulf of Mexico by Sunday, may reveal whether insurers have done enough to limit risks of covering offshore oil rigs in the wake of hurricanes Katrina and Rita.

American International Group Inc., Zurich Financial Services Group AG and Liberty Mutual Group Inc. were among insurers that raised prices fivefold and capped losses after the two hurricanes caused record offshore claims estimated at $8 billion in 2005.

Insurers are betting on a better outcome this time as Gustav threatens to become a hurricane and blow across the gulf anywhere from Texas to Alabama. Crude oil headed for the biggest weekly gain in almost two months, up 2 percent since Monday, on forecasts that Gustav may enter the region, home to more than 5,000 oil-drilling sites and one-fifth of U.S. production.

``We won't know if the changes we made are valid until they're tested by another storm,'' Christopher Pluchino, vice president at the Liberty Mutual unit that sells coverage for the platforms, said in an interview yesterday. ``We tend to stay glued to the Weather Channel this time of year.''

Katrina and Rita destroyed 113 platforms and damaged 457 pipelines, according to a 2006 report from the U.S. Minerals Management Service. They forced oil companies to redrill thousands of wells, said Frank Costa, president of AIG's rig- insurance division.

Billions in Damage

Insurers are trying to curtail their losses by putting limits for the first time on how much they'll pay out for storm damage over the course of the entire hurricane season. They're also repricing coverage based on studies of what kinds of oil- drilling equipment held up best when Katrina and Rita struck.

Insurers typically now limit coverage to $500 million in storm losses for all of a company's offshore assets over the six-month season, said Pluchino. Just one of the largest platforms can cost over $1 billion.

``It was estimated the premium in the Gulf of Mexico was $300 million a year'' before Katrina and Rita hit, Costa said. ``If you looked at the sum of those two losses to the industry versus the premium generated in the Gulf of Mexico, it was obvious that the formula was broken, that the exposures were a lot larger than anyone anticipated.''

Including expenses shouldered by the oil-drilling companies, the storms caused as much as $30 billion in damage before they ever made landfall on the Gulf Coast, said Paolo Bazzurro, director of engineering analysis for AIR Worldwide, the Boston-based catastrophe modeling firm that advises insurers.

Cat-in-a-Box

With insurers paring risk in the Gulf, ``the percentage that's insured now compared to before Katrina is lower than it used to be,'' Bazzurro said.

Gustav packed maximum sustained winds of 65 miles (105 kilometers) per hour at 8 a.m. Miami time and may reach hurricane strength of at least 74 mph today, the National Hurricane Center said. It was west of Kingston, Jamaica, and is expected to reach the Cayman Islands overnight before cutting across the eastern tip of Cuba and entering the Gulf of Mexico.

Owners of offshore platforms are responding to Gustav by seeking out a new type of coverage that protects them from a single storm, said Pat Gonnelli, a senior vice president for the capital-markets division at reinsurance brokerage Carvill Group. The coverage is known as the ``cat-in-a-box'' option, a name derived from the industry term for catastrophes and a rectangular area from Galveston, Texas, to Mobile, Alabama.

No Takers

The sellers of such options agree to pay the buyer if a hurricane enters the box at a size and intensity agreed upon in advance. Sellers can include hedge funds, insurance companies and so-called weather traders, who look to profit in part by swapping securities tied to disasters.

No buyers and sellers had agreed on a price and completed a transaction related to Gustav as of late yesterday, Gonnelli said. Still, the interest has grown, compared with the six other storms that reached tropical-storm status this year, he said.

``It will really pick up'' starting today, said Al Selius, the head of the insurance-linked securities desk at Swiss Re Capital Markets. ``There are people out there who could probably use some more protection.''

To contact the reporter on this story: Erik Holm in New York at eholm2@bloomberg.net.