India is Iran's second-largest buyer, taking around a quarter of its oil exports worth around $1 billion a month.
"If cover is not available then all Indian refiners will have to halt imports from Iran or else they will have to take a huge risk," P.P. Upadhya, managing director of Mangalore Refinery and Petrochemicals Ltd, told Reuters in a telephone interview. MRPL is India's biggest buyer of Iran crude.
"Insurance companies said if I buy Iranian crude my refinery's insurance cover will be cancelled ... If we don't get insurance for the refinery then we will stop buying Iranian crude."
It was not immediately clear why this has become an issue now, several months after Europe and the U.S. introduced tough sanctions aimed at Iran's oil trade to force Tehran to the negotiating table over its nuclear programme.
But in a letter in January seen by Reuters, the General Insurance Corp of India, the national reinsurer, told the General Insurance Council, an industry group, that it had "dawned" on insurers that cover and losses on processing the crude would not be payable by reinsurers due to existing sanctions.
A source at another refiner that buys Iranian crude, Hindustan Petroleum Corp (HPCL), also said imports were threatened by the insurance problems.
"Iran imports will be stopped soon," the HPCL source told Reuters. "As far as insurance is concerned, we are all sailing in the same boat."
HPCL is Iran's third-biggest Indian buyer and warned last month that insurers may withdraw cover because of sanctions.
MRPL's Upadhya declined to say how soon the company would have to stop Iranian imports. But MRPL has issued tenders to buy three cargoes of 650,000 barrels of crude to load in April, according to documents seen by Reuters. Two of the cargoes are high sulphur and could be used to replace Iranian oil.
"There is a problem on the insurance front for Iran oil," Upadhya said when asked about the tenders.
Oil is Iran's biggest income generator so a halt in sales to India would be a heavy blow for Tehran. Sanctions more than halved the country's crude exports in 2012.
In January, India imported over 286,000 barrels per day (bpd) of Iran's around 1.1 million bpd total exports.
This is the first time that insurance problems have had a direct impact on refineries processing Iranian crude.
The lack of insurance cover dates back to April 2012, Upadhya said, but was clarified by insurers only in February this year.
MRPL has written to India's federal oil ministry asking for an alternative insurance mechanism, Upadhya said.
"Refineries processing Iranian crude would be severely hit," MRPL told India's oil secretary in a letter dated February 27 and seen by Reuters. There would be no cover for claims if the plant was processing Iranian crude, MRPL said.
An Indian government source said last month that New Delhi would find a way to ensure refineries have cover but gave no details.
Insurers rely on European reinsurance markets to hedge their risk. EU sanctions have blocked European maritime reinsurers from any involvement in insuring shipments of Iranian oil.
That forced a temporary halt in mid-2012 to imports by two of Iran's other top Asian buyers, Japan and South Korea.
India's government stepped in to provide emergency insurance but it was a fraction of the $1 billion liability coverage that a supertanker would typically need and has rarely been used.
India's refiners have already slashed imports from Iran as they joined other major Asian buyers in reducing purchases to secure waivers from the sanctions.
MRPL had already expected to cut nearly 40 percent or its Iranian imports in the fiscal year ending March 31.
In the first 10 months of the current fiscal year, India reduced Iran crude imports by nearly 22 percent on the year, data from trade sources shows.