Charles Winter

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Aons 11th Energy Insurance Training Seminar
Captives Risk Financing Decision Platform

• Charles Winter

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Agenda

• Risk Financing Strategy
• Risk Finance Decision Platform
• Managing Retained Risk Captives

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Risk Financing Strategy
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Risk Financing Strategy

• In theory, companies have three options for
  financing group insurable risks
• Transfer all insurable risk
• Retain all risks and associated volatility
  internally
• A combination of the two
• Objective of a risk financing strategy
• Safeguard business objectives
• Minimise the overall cost of insurable risk
• A key tool is to optimise the level of retained
  risk

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Corporate Perspective of Risk
LossDistribution
Probability
Probability
Risk Bearing Capacity
Provisions
Loss
Loss
Zero
loss
Zero
loss
1
2
3
Expectedloss
Unexpected lossfor which the companyhas the
capacity to bear
Unexpected losswhich is unbearablefor the
company
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Risk Finance Decision Platform
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Risk Finance Decision Platform

• Are my insurance programmes
• Appropriate, optimal, and fairly priced?
• Aligned with financial management objectives and
  practices?
• Validated through quantitative measures and
  analytics?
• Are my insurance programme decisions
• Transparent for Board and Executive Committee
  review?
• Aligned with corporate governance practices?

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Risk-Bearing Capacity - Overview

• Risk-Bearing Capacity is an objective measure of
  risk tolerance / appetite
• Serves as a valuable decision-making and
  contingency-planning tool
• Provides guidance for setting the retention
  levels
• Identifies and assesses financial and loss
  scenarios that threaten corporate financial
  goals
• Alignment of corporate finance and risk financing

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Risk Financing Decision Platform Components

1. Risk Bearing Capacity Analysis

1. Design Programme Stress Testing

1. Dynamic Risk Modelling

Provides a cost/benefit comparison of various
risk management strategies including captive and
alternative risk strategies Provides insight
into technical pricing for various risk classes
and risk transfer layers
Establishes appetite levels for enterprise risks
and tolerance levels for insurable risks which
are linked to corporate performance objectives
and volatility thresholds
Generates a thorough understanding of current
insurance exposures, individually and in portfolio
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Key Outputs
Providing a decisionmaking framework for
developing alternative risk retention strategies
from low to high
Optimises the use of corporate capital
Supports the captives strategy and
underwriting/funding requirements
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Risk-Bearing Capacity - Process

• Analyse range of loss quantum (forecast and
  scenarios)
• Build pro-forma financial statements
• Financial planning data, analyst reports,
  financial statements
• Agree KPIs, materiality thresholds and response
  mechanisms
• Interactive process with financial management
• Run loss scenarios through financial statements
  to evaluate financial impact
• Stress test
• Determine critical pressure points and RBC

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Risk Bearing Capacity Results
Financial ImpactDetermined
Volatility DeterminedThrough Simulations
Breach PointDetermined
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Programme Optimisation Loss Profile
Inevitable
Uncertain
Remote

• The portfolio of retained risks is a function of
  all risk classes
• retention levels
• limits of cover

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Aggregate Loss Forecasts
Increasing the retention from 10m (current) to
50m increases the expected retained losses from
7.7 million - 11.3 million 1 in 20 year bad
case scenario increases retained losses from
19.9m to 50.2m
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Programme Optimisation - Pricing
For each line of risk, a premium / pricing model
is developed to assess the risk transfer cost at
alternative attachment points
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Programme Stress Testing Results Efficient
Frontier

• Through stress testing many programme options, an
  Efficient Frontier, based on expected value and
  volatility, can be mapped

High-Risk Strategy
Level of Risk
Medium-Risk Strategy
Low-Risk Strategy
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Captives Managing Retained Risk
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Managing Retained Risk

• Following optimisation retained risk may be
• First loss e.g. deductibles / SIRs / waiting
  periods
• Residual risk above the limits of the programme
• Uninsured exposures e.g. policy exclusions

Residual
500m
Uninsured
Insured
5m
First Loss
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Financing of Retained Risk
Optimal Retained Risk
Decentralised
Centralised
Paid from localoperating revenues
Paid from groupoperating revenues
Structured inrisk retentionvehicle e.g. captive
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Captive Insurance Drivers

• Cost effective to retain risk
• Access to specialist markets
• Alignment of stakeholder interests
• International co-ordination of programmes
• Structured reserving for retained risk exposures
• Fiscal benefits in some circumstances
• Creation of identifiable budget for variable
  costs

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Captive Insurance Options

• Captives have a long history
• Mutuals 100 years
• Onshore captives 80 years
• Offshore captives 40 years
• Now 5,000 captives in existence
• Pure captive definition
• An insurance company whose insurance business is
  primarily supplied and controlled by its owner,
  who is the principal beneficiary
• Cell captive
• A risk financing structure that mimics many of
  the features of an owned captive but in which the
  core capital and operational structure is
  provided by a party other than the insured
  participant
• Protected Cell Companies and equivalents
• Incorporated Cell Companies

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Captives In The Energy Sector

• Property damage / business interruption
• Control of well
• Liability
• Marine
• Aviation
• Constriction
• Environmental
• Terrorism
• Employee benefits

• Oil Majors
• Service Companies
• National Oil Companies

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Captive Participation
Can deliver good returns
Unusual
Captive may give greater control
(Re)Insurance Market
(Re)Insurance Market
Quota Share
Excess of loss
(Re)Insurance Market
Each and Every Loss
Stop Loss Protection
Layered / Group Deductible
Common
Local Deductible
Desirable
Aggregate Losses
Avoids pound-swapping
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Captive Insurance Practicalities

• Over 30 territories with specific captive
  legislation
• Flexible regulation and capitalisation approach
• Ability to provide admitted insurance
• Stability and international acceptability
• Infrastructure
• Alignment of fiscal rules
• Operation
• Operational management mainly outsourced
• Programme structuring
• Net versus gross lines
• Collateral
• Compliance

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Trends

• New formations flow
• Soft market
• But no mass retreat to the insurance market
• Increasing use of existing companies
• New lines of business
• Diversification
• Regulation
• Solvency II
• Responses including equivalence
• Taxation
• Increased scrutiny
• Compliance
• Increased focus on global insurance regulations