Aon’s 11th Energy Insurance Training Seminar
Captives & Risk Financing Decision Platform
Charles Winter
0
Agenda
• Risk Financing Strategy
• Risk Finance Decision Platform
• Managing Retained Risk & Captives
1
Risk Financing Strategy
2
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
3
Corporate Perspective of Risk
Loss
Distribution
Probability
Risk Bearing Capacity
Provisions
Zero loss
1
2
Expected
loss
Unexpected loss
for which the company
has the capacity to bear
3
Loss
Unexpected loss
which is unbearable
for the company
4
Risk Finance Decision Platform
5
Risk Finance Decision Platform
 Are my insurance programmes:
– Appropriate, optimal, and fairly priced?
Risk Appetite
Risk Profile
Insurance
Marketplace
RFDP
Decision
Support
– 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?
Reporting
6
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
7
Risk Financing Decision Platform Components
1. Dynamic Risk
Modelling
Generates a thorough
understanding of current
insurance exposures,
individually and in portfolio
2. Risk Bearing
Capacity Analysis
Establishes appetite
levels for enterprise risks
and tolerance levels for
insurable risks which are
linked to corporate
performance objectives
and volatility thresholds
3. Design & Programme
Stress Testing
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
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Key Outputs
Providing a decision–making framework for developing alternative
risk retention strategies from “low” to “high”
Within risk tolerance
Minimises the cost of risk
whilst managing volatility
Optimises the use of corporate capital
Supports the captive’s strategy and underwriting/funding requirements
9
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
10
Risk Bearing Capacity Results
1
Volatility Determined
Through Simulations
2
3
Financial Impact
Determined
Breach Point
Determined
$7x
$6x
Confidence Level 95%
or 19 out of 20 years
$5x
$4x
$5,000
$3x
Y-Axis: EBITDA (£ in millions)
$4,500
Prices = Mean
$4,000
$2x
Confidence Level 67%
or 2 out of 3 years
$1x
$3,500
$3,000
0
2
4
6
8
10
12
14
16
18
20
X Axis: Months Forward
$2,500
Scenario A Threshold > 99.99%
$2,000
$1,500
$1,000
EBITDA Threshold
Scenario B Threshold - 93%
$500
$4x
Confidence Level 95%
or 19 out of 20 years
$0
0%
X-Axis:
(%)
10%Confidence
20% Level30%
40%
50%
60%
70%
80%
90%
$3x
100%
$2x
$1x
Confidence Level 67%
or 2 out of 3 years
Prices = Mean
$0
1
3
5
7
9
11
13
15
17
19
21
X Axis: Months Forward
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Programme Optimisation – Loss Profile
Loss Severity Distribution
Frequency Distribution
100%
NegBin(1, 0.24146)
90%
0.30
cumulative probability
80%
0.25
70%
From loss history
From industry data
Multi-parametric fit
60%
50%
0.20
0.15
40%
0.10
30%
0.05
20%
18
16
14
12
8
6
4
2
0
-2
0.00
10
10%
0%
1
10
100
1,000
10,000
100,000
1,000,000
10,000,000
100,000,000
loss value
90.0%
0.00
Inevitable
Uncertain
5.0%
10.00
Remote
The portfolio of retained risks is a function of all risk classes’
1.
retention levels
2.
limits of cover
12
>
Aggregate Loss Forecasts
Percentile
Statistic
25%
1 in every 4 years (Good Case)
Mean
Average Long-Term Loss Projection
Agg. Loss
Agg. Loss
Layer 5m
Agg. Loss
Layer 10m
Agg. Loss
Layer 25m
Agg. Loss
Layer 50m
Agg. Loss
Layer 100m
2,955,000
2,955,000
2,955,000
2,955,000
2,955,000
2,955,000
13,109,000
6,440,000
7,667,000
9,752,000
11,348,000
12,450,000
80%
1 in every 5 years (Bad Case)
14,264,000
9,884,000
12,477,000
14,264,000
14,264,000
14,264,000
90%
1 in every 10 years (Bad Case)
29,366,000
12,527,000
16,120,000
26,826,000
29,366,000
29,366,000
95%
1 in every 20 years (Bad Case)
50,417,000
14,928,000
19,904,000
31,779,000
50,176,000
50,417,000
99%
1 in every 100 years (Bad Case)
122,962,000
19,788,000
27,464,000
47,690,000
67,095,000
105,488,000
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
13
Programme Optimisation - Pricing
Premium as Function of Retention and Limits of Cover
700,000
600,000
500,000
400,000
Premium
300,000
200,000
200,000,000
165,000,000
100,000
130,000,000
95,000,000
60,000,000
25,000,000
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
1,000,000
1,100,000
1,200,000
1,300,000
1,400,000
1,500,000
1,600,000
1,700,000
1,800,000
1,900,000
2,000,000
Limit of Cover
Per-Occurrence Retention
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
Net Capital Requirement (Value at Risk i.e 99.9th Percentile)
Level of Risk
Millions
 Through stress testing many programme options, an Efficient Frontier,
based on expected value and volatility, can be mapped
310
All Points
Efficient Points
305
Gross Point
Current Programme
300
High-Risk
295 Strategy
290
285
Medium-Risk
Strategy
280
275
270
92
93
94
95
96
Low-Risk
Total Cost of Risk (MeanStrategy
Retained Losses + Premium)
97
98
M illions
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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
Uninsured
Residual
$500m
Insured
$5m
First Loss
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Financing of Retained Risk
Optimal Retained Risk
Decentralised
Paid from local
operating revenues
Centralised
Paid from group
operating revenues
Structured in
risk retention
vehicle 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
 Oil Majors
 Service Companies
 National Oil Companies




Property damage / business interruption
Control of well
Liability
Marine





Aviation
Constriction
Environmental
Terrorism
Employee benefits
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Captive Participation
Can deliver good returns
Captive may
give greater
control
Unusual
(Re)Insurance Market
(Re)Insurance
Market
Quota Share
(Re)Insurance
Market
Each and
Every Loss
Commo
n
Excess
of loss
Layered / Group Deductible
Stop
Loss
Protection
Local Deductible
Aggregate Losses
Desirable
Avoids poundswapping
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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
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