An event occurring in the waters of the North Sea on 6th July 1988, is recognised by many in the insurance profession as the largest loss faced by the insurance market, in terms of lives lost and industry impact.
Some years before this date, major oil and gas reserves were discovered in the North Sea. From the 1960s major oil and gas producers began to extract these natural resources from under the sea. This was made possible by the construction of production platforms in the area.
One such platform was Piper Alpha, constructed around 120 miles northeast of Aberdeen in Scotland. This platform was operated by Occidental Petroleum Ltd and began producing oil in 1976 with approximately 250,000 barrels per day. Shortly after, this was to increase to around 300,000 barrels per day.
By 1980 it had been converted into producing gas as well as oil. By 1980 the normal operating state of this platform was the production of North Sea Gas. During the 1980s production of oil and gas in the North Sea generated colossal incomes for the United Kingdom in terms of revenue from taxation. Up until the events of 6th July 1988, the Piper Alpha platform alone was said to be responsible for around 10% of the United Kingdom’s oil and gas production.
During the 6th of July 1988, routine maintenance work was taking place on one of two pumps vital to the production of gas. This resulted in the pump being taken out of action with a safety valve removed for inspection and a metal cap fixed loosely over the open pipe. So that production may continue during this work a second pump was used. Unfortunately, the second pump failed during the evening of 6th July, and gas was diverted to the out-of-action pipe. The temporary arrangement in place awaiting the return of the removed safety valve failed and a series of catastrophic explosions and fire ensued. Of the 226 men working on board the platform at the time of this event 165 lost their lives. A further two people died whilst attempting a rescue and their vessel became entangled with the falling superstructure of the platform.
It took a further three weeks to fully extinguish the blazing remains. This work was led by the world-renowned firefighter, Red Adair.
Needless to say, once the initial shock of the extent of this tragedy, including loss of life and injuries involved, the insurance community began coming to terms with what was the largest man-made loss experienced up to that point in the history of insurance.
Insurance losses amounted to USD 1.4 billion in total. Insurance for the structure of the platform and cover providing compensation for workers was placed with a major Norwegian underwriting organisation. However, as is common in the insurance industry, the risk was reinsured. In this instance, the majority of reinsurance arrangements were placed through Lloyd’s of London.
At the time of the Piper Alpha disaster, Lloyd’s was a self-governing market that comprised personal investors or ‘Names’. Lloyd’s Names were organised into syndicates with each syndicate led by an underwriter. Each name would put up his or her personal wealth and assets to back the insurance policies written by the underwriter. In doing so, they accepted unlimited individual liability for losses. During the fifteen or so years before Piper Alpha there had been an expansion of Lloyd’s Names from around 6,000 persons to over 32,000. As a consequence of this expansion, there was more underwriting capacity in the market of Lloyd’s.
Increased capacity allowed underwriters to compete in writing catastrophe business in the form of excess of loss reinsurance arrangements. In other words, the reinsurer agreed to indemnify the reinsured (original underwriter) in the event they sustained a loss in excess of a pre-determined figure. In turn, the underwriter that accepted the reinsured risk then reinsured some of it to another reinsurer in a process known as “retroceding”. These arrangements allowed the risk to be spread widely across the market.
Through these reinsurance and retroceding arrangements, much of the Piper Alpha business became reinsured between Lloyd’s syndicates rather than the risk being placed elsewhere with other insurers outside the Lloyd’s market. Some syndicates found themselves having covered Piper Alpha many times over. This phenomenon became known as the London Market Excess of Loss spiral or LMX spiral.
Underwriters of the time were committing their syndicates to offering excess loss cover despite having little experience in this class of business. They had little understanding of the underlying exposures they were covering. There was little if any, monitoring by Lloyd’s of the potential exposure to the risks syndicates were covering.
Until the Piper Alpha disaster excess of loss reinsurance arrangements were seen as a profitable business. Historically very little had been paid out on these policies.
As a direct consequence of these issues, many of the Names faced significant personal financial losses. One Lloyd’s syndicate, Syndicate 298 ceased trading, in part, as a result of the losses it incurred following the Piper Alpha disaster.
Many changes have been introduced to Lloyd’s following the Piper Alpha disaster. To prevent a similar occurrence in the future and provide confidence in the market, the Realistic Disaster Scenario (RDS) framework was introduced to Lloyd’s in 1995. This now enables individual underwriters and Lloyd’s as a market to better understand disasters and demonstrate an accurate understanding of risk accumulations for major offshore risks. These scenarios are regularly reviewed to ensure they remain realistic.
Furthermore, since the 1994 underwriting year, Lloyd’s has allowed corporate capital to enter. So much so that capital provided by individual Names is said to be less than 10% of that available. There is now less risk of individuals being declared bankrupt following a major event such as that of the Piper Alpha disaster.
Before Piper Alpha insurers had customarily provided an unlimited amount of indemnity under Employers’ Liability policies. Following the realisation of the potential exposure in a single location highlighted by Piper Alpha, insurers and their reinsurers began to withdraw unlimited cover under these policies. Insurers now offer a standard limit of £10 million, but offshore risks are often limited to £5 million. This is a minimum requirement set by legislation known as The Employers’ Liability (Compulsory Insurance) Regulations 1998. This underwriting measure has helped insurers quantify their risk exposure.
As to be expected of an event of this seriousness and magnitude a Public Inquiry was set up in November 1988 to establish the cause of the disaster. The inquiry was led by Lord Cullen, a Scottish judge.
A report released following the inquiry made 106 recommendations for changes to North Sea safety procedures and led to the formation of the Offshore Safety Act 1992 intended to secure the safety, health, and welfare of people on offshore installations. These recommendations and improved control over safety issues on offshore platforms have had a positive benefit for insurers in improving the nature of the risk on which they offer cover.
In conclusion, it is now over 36 years since the Piper Alpha tragedy and the lives of the people lost on that fateful night in July 1988 should not be forgotten. Thankfully, following the Cullen Inquiry, safety improvements for those working in inhospitable environments such as the North Sea have emerged. These improvements have in turn improved the insurable risks covered by insurers. Whilst claims made by dependents of the deceased and those injured were agreed upon and settled promptly, the tragedy also highlighted deficiencies in systems being implemented by Lloyd’s of London, the oldest insurance market in the world. Today the risk systems implemented by Lloyd’s are much more precise following a review in the aftermath of Piper Alpha and confidence in the insurance market restored.
Author: John Lane – Fellow of the Chartered Insurance Institute, Insurance Museum Volunteer and Amateur Insurance Historian
