Who Has Received BP's Claims' Payments

Amy Schoenfeld, in a "Metrics" column in Sunday's New York Times, analyzes BP's payments as of July 2:

BP has now begun reimbursing businesses that rely on the gulf for their revenue. Since May, it has paid just under a third of the more than 90,000 claims it has received, with the checks totaling more than $144 million.

About 80 percent of the payments have gone to self-employed workers — including shrimpers, charter boat captains and beachfront condo owners — who can clearly show that the spill has affected their ability to make a profit. Fewer large businesses have been compensated because their claims are more complex and take longer to process.

So far, payments have been fairly small, averaging about $2,500 a month for a deckhand or $5,000 for a fisherman. BP estimates that about 13,000 people are receiving prepayments, often 30 days in advance.

The total bill is sure to grow exponentially, with more than 2,000 applications coming in each day. After negotiations with President Obama last month, BP promised to set aside $20 billion to continue to pay business claims and handle requests from local governments to cover cleanup and administrative costs.

Included in her article is the following graphic:

Deepwater Horizon Incident, Economic Damages, and Evaluating Risk

Richard H. Thaler, in his "Economic View" column in Sunday's New York Times Business section, responds to the question: "How to make companies more accountable for their risks?"

Related to economic damages, Thaler comments:

In thinking about governmental reform, one place to start is the 1990 Oil Pollution Act, enacted after the Exxon Valdez accident. The law fines companies $1,000 for every barrel spilled, $3,000 if they were found negligent, and holds them responsible for the costs of cleanup. They are also responsible for economic damages, like those to fisheries, but these costs are capped at $75 million unless there is negligence or a violation of safety rules.

We could raise the cap on damages, as some have suggested, but the uncapped removal costs will typically exceed economic damages, and there is a real concern about whether companies will have the ability to pay. A policy with some appeal might make drilling rights include a mandatory insurance policy with a big deductible, say $100 million, and a cap somewhere in the billions. In an ideal world, this would influence insurance companies to monitor risks closely. (But the recent experience with the American International Group reminds us that we do not live in an ideal world.)

Furthermore, this economic solution assumes that companies make good decisions once they’re given correct incentives. But the financial and oil crises should make us less confident that companies are up to the task. Mr. Hayward has acknowledged that it was “an entirely fair criticism” to say the company had not been fully prepared for a deepwater oil leak. “What is undoubtedly true,” he said, “is that we did not have the tools you would want in your tool kit.”

The spill has reduced BP’s market value by 44 percent, or about $82 billion, so it’s clear that BP had a strong economic incentive to make good contingency plans. How to require sufficient contingency planning should be a high priority in the future, along with ensuring that the Minerals Management Service has the expertise to evaluate those plans. As a Coast Guard inspector said at a Congressional hearing last month, “The pace of technology has definitely outrun the regulations.”

We are left in a difficult place. Neither the private nor the public sector seems up to handling these kinds of problems. And we can’t simply wait for the next disaster, because, as people might say if they had to use G-rated language, stuff happens.

In Tuesday's New York Times, a "News Analysis" by Jad Mouawad and Clifford Krauss reviews the current thinking on the scale of economic damages related to the Deepwater Horizon Incident:

“Our asset base is strong and valuable,” BP said in a statement last week, adding that it had “significant capacity and flexibility in dealing with the cost of responding to the incident, the environmental remediation and the payment of legitimate claims.”

With each passing day, however, the bills keep growing. If the spill were somehow stopped today, the cost to BP could be as little as $9.6 billion, according to Kevin Book, an analyst at Clear View Energy Partners. If the spill were to stop in July, 90 days after the accident, it would cost as much as $29.2 billion, he said.

BP projects that it will not be able to completely stop the spill until August, when it hopes to complete the drilling of a relief well to kill the leaking one.

Fadel Gheit, a senior oil and gas company analyst at Oppenheimer, estimates that BP will eventually face $20 billion in claims and cleanup costs. Punitive damages to the federal and state governments could double that figure. Mr. Gheit said the maximum cost could be as much as $60 billion, paid over many years.

Costs include payments for lost tourism and commercial fishing revenue in the four states most affected by the spill — Alabama, Florida, Louisiana and Mississippi.

Damages related to tourism are potentially enormous if the spill spreads beyond the Florida Panhandle and spoils beaches across that state’s coasts. Nearly 5 percent of Florida’s 19 million residents work in the tourism industry, according to tourism officials, and the nearly 80 million visitors a year bring the state an estimated $60 billion in revenue.

An analysis by the Institute for Economic Competitiveness at the University of Central Florida estimated as a worst case that the spill could cost the state $10.9 billion in lost economic activity and 195,000 jobs. Hotel owners in the beachside city of Pensacola have already projected revenue losses for June of as much as 60 percent.

Finally, in the New York Times "Reuters BreakingViews" section, Christopher Hughes sets forth some reasons why BP might not agree to set setting up and funding an escrow account to cover the increasing claims (including economic damages) related to the Incident.

President Obama may speak to the issues of economic damages during his address from the Oval Office tonight.

Claims on Insurance Companies Related to Deepwater Horizon Incident

In an article in today's Wall Street Journal, losses related to the Deepwater Horizon incident are approximately $611 million to date, with...

Estimates for the total insured loss range from $1.4 billion to $3.5 billion, with Zurich-based Swiss Re so far having taken the hardest hit, estimating the catastrophe will cost it around $200 million.

High as it might be, the total insured loss will probably turn out to be only a fraction of the actual cost of the disaster.

The insurance industry "got lucky," because only around 20% of the losses incurred so far in connection with spill are being carried by the industry, said Stephen Catlin, chief executive of London-based reinsurance company Catlin Group Ltd., speaking at Euroforum's annual reinsurance summit in Zurich recently.

In contrast, billions of dollars in claims will be made in connection with the oil spill. But, as BP PLC, which is operator and majority owner of the project, self-insured much of the risk instead of buying liability insurance, losses for the insurance industry will be capped, credit rater Moody's Investors Service noted in a recent report.

Claims will come from many sources. Among them will be thousands of commercial fishermen and tourist companies whose businesses have been harmed by the oil spill off the Louisiana cost.

"In our view, potential business-interruption claims represent the largest unknown for insurers," Moody's said. But even in a worst-case scenario, they aren't expected to exceed $3.5 billion, the upper range of the estimate of industry losses.

Deepwater Horizon Incident, human factors, and economic damages.

David Leonhardt, in a column in today's New York Times Magazine, discusses BP's managers' "seeming indifference to safety and environmental issues," especially the proverbial "black swan" event.

Much of this indifference stemmed from an obsession with profits, come what may. But there also appears to have been another factor, one more universally human, at work. The people running BP did a dreadful job of estimating the true chances of events that seemed unlikely — and may even have been unlikely — but that would bring enormous costs.

Leonhardt points out that in the case of the Deepwater Horizon incident, governmental policy "...actually encouraged BP to underestimate the odds of a catastrophe...."

In a little-noticed provision in a 1990 law passed after the Exxon Valdez spill, Congress capped a spiller’s liability over and above cleanup costs at $75 million for a rig spill. Even if the economic damages — to tourism, fishing and the like — stretch into the billions, the responsible party is on the hook for only $75 million. (In this instance, BP has agreed to waive the cap for claims it deems legitimate.) Michael Greenstone, an M.I.T. economist who runs the Hamilton Project in Washington, says the law fundamentally distorts a company’s decision making. Without the cap, executives would have to weigh the possible revenue from a well against the cost of drilling there and the risk of damage. With the cap, they can largely ignore the potential damage beyond cleanup costs. So they end up drilling wells even in places where the damage can be horrific, like close to a shoreline.

Human factors resulted in management underestimating the chance of the incident. Federal law lead them to the underestimating of its costs.

Deepwater Horizon Incident and Economic Damages

Regarding the economic damages resulting from the Deepwater Horizon incident, in recent days, the process of claim review and subsequent payment has come under examination. For example, see this description (http://www.ag.louisiana.gov/Article.aspx?articleID=411&catID=1) of a state court action filed by the Louisiana Attorney General James D. “Buddy” Caldwell seeking information about the payment and processing of claims.

One can file a claim for damages for the following losses – bodily injury, property damage, loss of income -- using BP’s online claim submission form (https://www.bp.com/secure/iframe.do?categoryId=9033722&contentId=7062138). It appears that ESIS is the third-party administrator on behalf of BP. For further information on ESIS, see this page (http://www2.esis.com/ESISRoot/ESIS/) and this page (http://www2.esis.com/ESISRoot/ESIS/Services/Catastrophe+Management/).

This New York Times article (http://www.nytimes.com/2010/06/02/us/02liability.html?scp=1&sq=Rising%20Cleanup%20costs&st=cse) from Wednesday, June 2, 2010, includes several interesting comments:

• “Because of its considerable profits and size, it does not buy outside insurance for such disasters.” That is, BP is self-insured.

• “Lawyers are planning lawsuits of every conceivable type in federal and state courts alike, seeking money for personal injury, lost business, damage to the environment and the sharp drop in the companies’ stock prices.” In addition, for lawsuits filed in federal court, the United States Judicial Panel on Multidistrict Litigation will conduct a hearing in July regarding where the cases will be consolidated.

Reviews of Economic Books

Of the economics book I have read recently, I have found the following two especially interesting:

• Lords of Finance: The Bankers Who Broke the World, by Liaquat Ahamed (The 2010 Pulitzer Prize Winner in History and on the New York Times “The 10 Best Books of 2009”)

• How Markets Fail: The Logic of Economic Calamities, by John Cassidy (Nominated as a finalist for the 2010 Pulitzer Prize Winner in general nonfiction and one of The Economist’s “Books of the Year”)

Lords of Finance tells the story of the slide from the boom of the 1920’s to the Great Depression by profiling four men in charge of the principal central banks: Benjamin Strong (Federal Reserve Bank of New York), Montagu Norman (Bank of England), Hjalmar Schacht (German Reichsbank), and Emile Moreau (Banque de France).

These men had the task of restructuring the international finance system after World War One. Individually, each banker’s objective was to preserve the value of their country’s currency. All of the currencies were on the gold standard, which tied the value of their currency to the specific quantity of gold it held. The amount of gold reserves held by the central bank determined their supply of money and credit.

This belief -- the need to adhere to the gold standard because it provided stability -- became an economic straightjacket. Since the total amount of gold reserves available globally had not grown recently (South African gold deposits had not yet been discovered) and the value of a country’s currency was directly tied to the specific quantity of gold reserves, the world supply of money and credit was severely constrained.

Central bankers, without the ability to stimulate their economies by increasing the supply of money and credit, by 1931, faced a global economy which was in its second year of a depression. Manufacturing and production in most countries had shrunk, and unemployment had risen. The New York Fed, to preserve its gold, stopped the flow of capital to Europe. The stock market crash followed. Then, a series of banking panics – bank closings – led to the collapse of the banking system, threatening the stability of the global economic system. The Great Depression followed, along with the political rise of Hitler and Nazism, and then World War Two.

In Lords of Finance, Ahamed has written a fascinating history of the inter war period between World War One and Two. The author uses the relationships between the four central bankers (each an interesting character) to narrate his story. He shows how the relationships among the four men ultimately led to difficulties, how the central banking systems were interconnected, and how a problem in one country inevitably led to problems elsewhere.

In How Markets Fail, John Cassidy, a veteran financial journalist whose work primarily appears in The New Yorker, has combined a history of ideas, the story of the present financial crisis, and a “call to arms.”

First of all, Cassidy believes it is important to understand the intellectual and historical context in which financial crises occur. For the present crisis, he describes the increased belief in, and adherence to, “free market” or “utopian” economics. Simply put, the late 20th century economic belief system has been: “self-interest plus competition equals nirvana.” Cassidy then describes “reality economics;” the study of economics focused on inter-dependencies: what you do affects my welfare and what I do affects yours. Free market economics often fails to consider these inter-dependencies.

Cassidy demonstrates how the underlying economic thought – adherence to free market philosophy – and the pursuit of self interest, both created and prolonged the “Great Recession.” For example, companies and individuals in the real estate industry made quick and easy profits through the sale of subprime mortgages; they acted rationally as individuals in their self interest. Yet, the combined levels of subprime mortgages were deeply detrimental to the economy.

Why did our present financial crisis occur? According to Cassidy: bad economic policy decisions – based on adherence to the free market philosophy – played an important role. Also, the Federal Reserve kept interest rates too low for too long, distorting the price signals the market sends and creating the conditions for a housing bubble. Finally, very few people paid attention to the inter-dependencies in the market system; when the crisis began, the markets reacted in ways that no one had anticipated.

Cassidy’s call to arms -- he makes a strong case that the intellectual and historical context and dominate economic ideas have important practical consequences. Individuals reacted to the immediate financial incentives they faced, and regulatory frameworks in which the economy operated reflected a free market philosophy. There were no institutionalized concerns for the limitations of the free market idolatry, and no concern for the complexity and inter-dependencies of the international financial system.

Cassidy’s study of the intellectual and historical context of the “Great Recession" is especially interesting reading. For someone interested in expanding your understanding of free market economics, you will find this book especially interesting.

Toyota Motor Corp. Unintended Acceleration ... Class Litigation

The U. S. Judicial Panel on Multidistrict Litigation ordered (available here) the consolidation (“centralization”) of eleven actions which “…assert economic damages on behalf of certain classes and/or individuals stemming from an alleged defect in certain Toyota vehicles that causes sudden, unintended acceleration.” The Panel commented that “…we are initially persuaded that the centralized proceedings should eventually include the related personal injury and wrongful death actions.”

As for why the Panel chose the Central District of California, it indicated that Toyota’s U. S. corporate headquarters is located within the District, and relevant documents and likely witnesses would be found there.

The Order renamed the litigation: “In re.: Toyota Motor Corp. Unintended Acceleration Marketing, Sales Practices, and Products Liability Litigation;” it assigned the cases to the Honorable James V. Selna, of the Central District of California.