A federal investigation into cartel activity and the payment of bribes to obtain contracts with Brazilian state oil firm, Petrobras, has implicated a number of top executives, a host of powerful politicians and many of its main oil and gas contractors.
The ramifications are likely to be widespread and we recommend all insurers and reinsurers of Brazilian D&O, FI, liability, construction, surety and similar risks to monitor their exposure.
A number of corruption allegations have been circulating for some time. However, the scale of the issue became clear when former Petrobras director, Paulo Roberto Costa was incriminated in a huge money-laundering scheme and confessed to having received bribes from many of Petrobras’ most important contractors. Subsequent testimony from other senior executives has corroborated these allegations and revealed what seems to be institutionalized corruption, involving a cartel of Petrobras’ main EPC contractors who colluded to inflate prices, allocate contracts amongst themselves and offer kick-backs to senior management and politicians associated with the governing coalition.
Petrobras has already blacklisted 28 of its regular contractors, including all of the leading Brazilian EPC contractors, which are accused of cartel activity. However, the allegations are more wide ranging and have also accused most of Brazil’s main shipyards, a number of significant owners of offshore vessels and oil platforms, as well as certain leading international suppliers to the industry.
It is not just the accused companies that are at risk. While the extent of the damage is still being assessed, Petrobras is unable to publish its audited accounts, some contractual payments are being withheld, new projects have been put on ice and financing has dried up. Certain highly-leveraged contractors are on the verge of bankruptcy and a number of large projects are at risk of being cancelled or significantly downsized. In a country where Petrobras is responsible for around 90% of oil and gas spending, which in turn accounts for around 10% of GDP, this paralysis threatens the entire industry and the wider economy. And it does not stop there; there is a risk of contagion to the banking sector, particularly local banks that are heavily exposed to Petrobras and its contractors. There are consequential exposures to insurers and even the international reinsurance market.
An emerging risk to insurance and reinsurance markets relates to surety bonds. In the Brazilian oil and gas industry, these are a common way of guaranteeing performance of major construction projects, including for oil production platforms, drilling rigs and other offshore infrastructure, the value of which can often stretch into billions of dollars. They are sometimes required as a condition to participating in tender processes and can also be placed as security for ongoing judicial claims. In Brazil, the three largest insurers of surety risks are J. Malucelli, BTG Pactual and Austral and according to SUSEP, the Brazilian (re)insurance regulator, insurers usually retain 30% of the risk and the remaining 70% is transferred to reinsurers. It has been reported that the Brazilian surety market was worth R$1.3 billion in 2014.
The Petrobras scandal has been hitting the international insurance headlines due to the multi-billion dollar lawsuit filed in the New York Courts on Christmas Eve last year. The underlying frauds and corruption are relied upon to found a central allegation that Petrobras (1) made statements regarding its outlook and prospects and asset values which were false, misleading and caused its share and deal valuations to be artificially high; and (2) was involved in fraudulent schemes to deceive the market.
Petrobras’ D&O policy with US$250m cover, brokered by AON, was renewed in September 2014 with Itau Seguros, ACE and Mapfre Seguros as co-insurers. Petrobras has confirmed that this policy covers directors and ex-directors of its subsidiaries. Although D&O wordings usually exclude financial losses and legal defence costs when the claim results from illicit enrichment, illegal, malicious or criminal acts or omissions, until there is a court determination that executives were guilty of such misconduct, insurers will usually be expected to fund the costs of legal proceedings. It is worth noting that Brazilian courts have a tendency to protect insureds in the interpretation of policy coverage. Another relevant issue is that, whilst penalties are expressly excluded from most policies, some of the companies and executives involved seem to be engaging with Brazilian authorities to agree a global settlement agreement that could conflate potential criminal liability with civil liability and blur coverage lines.
It is foreseeable that as the bribery investigations progress, notifications under the D&O and Liability policies of Petrobras’s contractors will follow.
The serious difficulties that the oil industry is now facing are also likely to cause friction between contractors and their clients at different levels of the supply chain. This has the potential to increase commercial claims, delay projects and possibly increase security risks, as staff are laid off and corners cut. This is likely, in turn, to lead to a general increase in claims, including under construction all risks and liability policies.
The overall exposure of the international reinsurance market will depend on the detail of policy wordings, levels of reinsurance and local retention. Complex coverage issues will arise. However, there is also a concern that the current allegations are just the tip of the iceberg. Similar allegations have been made in relation to hydroelectric projects, transportation concessions and other public works projects. As investigations develop and illicit funds are traced, it is possible that other misdeeds may come to light.
We recommend all insurers and reinsurers of Brazilian D&O, FI, liability, construction, surety and similar risks to monitor their emerging exposures as the Petrobras scandal broadens and deepens.