Record Claim Rate in 2008 Weakens Insurance Carrier Interest in Mining Business

The global mining industry is caught in a “classic insurance market crunch” as mining companies, faced with declining commodity prices and profits, have less to spend on coverage while insurers raise prices and limit capacity as they deal with the fallout of the credit crisis and react to record property damage and business interruption claims from 2008, according to a new report from Willis Group Holdings, a global insurance broker.

Willis’ first annual Mining Market Review, released in February, reports that in 2008 the mining industry submitted an unprecedented $3.5 billion in property claims against a sector premium of $600 million, meaning mining underwriters lost nearly six dollars for every dollar of premium income. Under these conditions, at least 12 insurers had withdrawn or were considering withdrawing from the sector at this time, and those that remain are finding tighter limits on their own reinsurance arrangements. The report found that reinsurers will be restricting available capacity from a 2007 maximum of $1.75 billion to between $1 billion and $1.25 billion by the end of the first quarter of 2009.

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“The mining industry has been hit hard by the economic climate and profits are down…[Insurance company] clients are responding by looking into self-insurance and capital market solutions as alternatives to traditional insurance.”

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“In addition to record claims, the mining industry has been hit hard by the economic climate and commodity prices and profits are significantly down. This has created cash flow problems for many companies, with even the giants of the industry having to look very closely at every use of capital, including insurance,” said Steve Higginson, Willis mining co-practice leader. “Clients are responding by looking into self-insurance and capital market solutions as alternatives to traditional insurance.”

The report finds no pattern to the cause of the 2008 losses, which were spread between natural catastrophes, fire and machinery breakdown. Tellingly, however, 80% of claims arose from business interruption, as mining companies sought to recoup lost revenues at the peak of the commodity bull market when they experienced operational downtimes of even a few days. The problem was exacerbated by equipment manufacturers that were stretched to capacity and were unable to keep pace with the demand for new equipment and replacement parts.

[Insert figure “Insurance Pie Chart” nearby. Caption: A breakdown of 2008 mining industry property insurance claims by region and reason. Source: Willis Group Holdings, 2008.]

Andrew Wheeler, Willis mining co-practice leader, said, “The mining ‘super cycle’ drove mines to work to capacity and possibly beyond tolerance. When the very large risk losses hit at the end of 2007 and the beginning of 2008, they were consequently grossly underestimated by insurers, most of whom failed to fully appreciate the potential for such Business Interruption claims.”

An insufficient number of mining specialist adjusters to service all of these claims has led to an increase in claims disputes, the report said, noting that the volume and complexity of the operational claims has created a service “expectation gap” between many clients and the markets due to the perceived slow pace of the claims process. The report noted that “only a few markets have grasped the PR advantages available to them from differentiating their claims service against their peers’ in the shop window of the industry.”

The Willis Mining Market Review said that miners with deep knowledge of their risk profiles and good enterprise risk management strategies have been able to secure competitive terms by trading lower policy and peril sub-limits and/ or higher self-insured retentions to continue protecting their largest and most complex risk exposures. Alternative Risk Transfer mechanisms, however, have proven technically and commercially insufficient to draw clients away from traditional forms of cover, the report noted.

In an accompanying analysis focusing on the North American mining industry, Willis that with prices having spiked and are presently trending downward, companies are delaying or cancelling projects until the economic picture becomes clearer. Some are obtaining bridge loans while they restructure their debt. The recession is causing their Financial Assurance issues to become less pressing as companies struggle to obtain funding for operations.

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“[Mining] companies who are continuing with their projects now or in the near future in North America face unique challenges as insurance carriers are very cautious of mining risks.”

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Those companies who are continuing with their projects now or in the near future in North America face unique challenges as insurance carriers are very cautious of mining risks. As a result, over the last several years, it has become very difficult to transfer long-term closure risks to carriers. Willis said it has been actively involved in working with select carriers to develop innovative programs to address these challenges.

Among the most difficult issues facing hard rock mining companies in the U.S. are Financial Assurance issues for reclamation, closure and post closure. Mining companies must provide adequate Financial Assurance (FA) for mine reclamation and closure to obtain operating permits for mine development and expansion.

Financial Assurance is required by government agencies to ensure that money is available to complete the reclamation, regardless of the long-term stability and financial viability of the owner or operator. Federal and State agencies responsible for approving the permits often have differing or vague regulations related to acceptable forms ofFA. The regulations are difficult to change and can be onerous for many operators because of collateralization requirements of institutions guaranteeing the FA options. In some cases collateralization can be 100% of the estimated future reclamation costs, effectively eliminating the ability of many owner operators to secure permits.

Additionally, because of the constantly changing appetites of financial institutions, sureties and insurance underwriters to accept mining risks, regulators are often unaware of the types of FA options available in the marketplace, or how they have changed. As a result, regulatory agencies can inadvertently neglect or ignore other forms of FA which could offer viable alternatives for the owner operators and also provide the guarantees necessary to protect the public and prevent “unnecessary or undue degradation” of public lands and resources. Final, post-production reclamation costs are typically funded from established provisions such as dedicated trust funds. The magnitude of these reserves is based on engineering estimates and value judgments. Consequently, final closure costs may substantially exceed expectations and allocated funds may prove inadequate.

Historically, there has been pressure on companies to underestimate the ‘true cost’ of full life cycle reclamation in an attempt to reduce Financial Assurance requirements and balance sheet provisions. In response to a number of high-profile mine company failures (leaving abandoned mines with inadequate reclamation funds), the government has introduced more prescriptive accounting rules and increased Financial Assurance requirements to more accurately reflect the total cost of restoration and third party liability exposures.

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“Historically, there has been pressure on companies to underestimate the ‘true cost’ of full life cycle reclamation in an attempt to reduce Financial Assurance requirements and balance sheet provisions.”

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There are a variety of risk factors that can influence the final closure costs and potentially lead to unanticipated overrun. These risks include:

  • Changes in governmental requirements regarding the nature and scope of reclamation
  • Changes to the planned schedule of reclamation efforts (creating cash flow issues)
  • Direct project cost overrun (such as unanticipated failure or underperformance of reclamation scheme, discovery of unexpected contamination, cost basis variations, etc)
  • Changes to Financial Assurance requirements or associated costs.

In addition to the risks outlined above which directly relate to the scope of reclamation efforts, other environmental risks could also pose a significant cost impact such as:

  • Third party bodily injury / property damage claims (including diminution in property value),
  • Natural Resource Damage (NRD) claims
  • Spreading of existing contamination by contractors during reclamation activities.
  • The uncertainty associated with all these risk factors creates a variety of financial and business ramifications for
  • many mid-tier mining companies. These issues also pose a variety of complications to any transactions involving mining assets requiring reclamation including:
  • Potential purchaser demands to offset uncertainties through price discounts, difficult-to-negotiate indemnifications, or the use of a variety of deferred consideration or hold-back provisions involving escrows or trust funds.
  • Conservative overestimation of uncertainties by risk-averse purchasers or partners.
  • The availability and cost of Financial Assurance. In recent years, mining companies have had difficulty obtaining Financial Assurance bonds due to increasing collateral requirements and the market withdrawal of most surety providers. This has also happened with mine related insurance products as well.
  • Contingent liability to the mining company in the event of purchaser failure (for example where the government or other third party sought recovery for reclamation costs from a previous owner)

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