The US National Commission's criticisms of the energy giant must heighten insurers' awareness of potential poor risk management
If BP thought $20bn (£12.8bn) would buy them any love, or even a little mercy, from the US government, they were wrong. Yesterday the National Commission, set up by President Barack Obama to investigate the Deepwater Horizon oil spill at BP’s Macondo rig, put the boot in to the already battered energy giant.
The Commission cited systemic management failure and concluded that cost-cutting and a lack of proper risk assessment were the biggest causes of the spill: “The most significant failure at Macondo – and the clear root of the blowout – was a failure of industry management.”
Damning stuff. And this not the first time poor management in the energy industry has proved catastrophic. Much of the damage and loss of life at Piper Alpha, owned by Occidental – where a platform fire in 1988 cost Lloyd’s £8bn – was due to poor management: a neighbouring platform kept pumping oil despite the blaze.
Other industries are equally vulnerable to poor management. Last year, supermarket Safeway sued its former chairman, directors and senior management after having to pay a multi-million-pound fine to the Office of Fair Trading for dairy price fixing.
Evaluating management failure
Given the risks of management failure, what are insurers doing to evaluate it?
“In reality, the degree of due diligence which insurers undertake will vary depending on the risks being underwritten,” says Lloyd’s Market Association (LMA) head of underwriting, Neil Smith. “There are, obviously, specific Directors & Officers and Errors & Omissions insurances where the quality and competence of individuals will be key, and insurers will investigate thoroughly.”
But are insurers doing enough?
“The problem is that insurers will have to rely on information given in the underwriting process,” explains James Roberts, Partner at law firm BLG. “And very often insurers will be essentially taking it on trust.” And by the very nature of D&O, Roberts says, senior people will not report systemic management failure by accident or design.
The big safety questions
The biggest risks are inevitably in the riskiest businesses. “Every company tells us they operate safely but do commercial pressures impinge upon their safety standards? What priority is safety given? Is it ingrained within the culture of the business?” says David Croom-Johnson, lead underwriter of the AEGIS London syndicate and deputy chair of the LMA’s marine committee. “These questions are often the most difficult for insurers to get a strong understanding of without having known the assured for a significant period of time.”
And yet, says Association of Insurance and Risk Managers (AIRMIC) chief executive, John Hurrell, many insurers are remarkably willing to take management at its word. “I’m surprised by how little work goes on by insurers,” he says. “Insurers don’t spend as much time on this as you’d expect. The energy comes from buyers rather than insurers.”
There is often a considerable incentive for management not to take too much interest in what risk managers are telling them, as the National Commission acknowledged: “Many of the decisions that BP, Halliburton, and Transocean made that increased the blowout clearly saved those companies significant time (and money).”
Understand the insured's incentives
The key, explains Aon Benfield's head of rating agency advisory, Chris Myers, is to know who you are dealing with. “Understanding the risk culture of any organisation starts with knowing the management team,” he says. It is not just who you know. Myers also recommends reviewing reports and procedures and understanding the incentives of management and junior staff. “It’s often when incentives are misaligned that communication failures surface,” he says.
Hurrell agrees that risk management must come from the top. Insurers should make sure that the board of a company is involved in risk management, find out who chairs and sits on risk committees, and that the risk committee reports to shareholders.
As a last resort insurers have what Roberts calls the “big stick”: refusing to pay claims. “In cases where failure is systemic the insurers would be interested to know why there was no mention of it in the underwriting process,” he says.
The National Commission’s evaluation of management in the Deepwater Horizon spill is particularly pertinent for British insurers with the Energy and Climate Change Committee yesterday recommending that the government consider making third-party insurance a necessary requirement for small exploration and production companies working in the North Sea. With conditions more perilous than the Gulf of Mexico, management will have to be up to scratch. Insurers should keep a close eye.
