How much risk should you retain?
Palisade Risk Conference, 29 September 2015, Oslo
Ronan Barrett, Risk Consultant
Power
Generation
Downstream
Energy
Oilfield Service
Companies
Construction
Upstream
Energy
Project
Cargo
Agenda
•
•
•
•
Energy Insurance Markets
Risk Retention principles
“Cost of Risk” vs “Cost of Risk and Capital”
Conclusions
Energy Insurance Markets
Upstream / E&P
(Exploration and
Production)
Power Generation
Midstream
Downstream
Renewables
Energy Insurance Markets continued …
When things
go wrong!
2015 Losses to date
Risk Retention
Principles
Risk retention principles continued ……
Catastrophic
losses
• Traditional insurance/risk transfer, due to its
efficiency in dealing with these events
• Top 2%- 5% of loss frequency
Medium sized
events – once every
5- 7 years
“Predictable” incidents –
happen relatively often but have
lesser impact
• Group retention (or captive) to
participate up to 95%-98% of all
frequency
• Operating deductibles
should absorb 75%-80%
of all loss frequency
Cost of Risk
vs
Cost of Risk and Capital
Risk retention – Traditional approach
Cost of risk (Expected losses at a given retention)
Losses forecasted using @Risk
X
Cost of excess insurance
X
Quotes from the commercial insurance market
_____
Total cost of Risk
X
Risk Retention - Loss Forecasting
• Client Data
– Below $10m a clients experience can give us an reliable frequency and
severity for our model.
– Even large oil companies will have a very low claims frequency above
$5m/$10m
• Industry Data
– To support modelling and decision-making it is usually beneficial to also use
wider Energy industry loss data
– To assess probability of large individual losses (above $25m; $50m; $100m
etc.) by key business sectors
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
Market Loss Data – raw data example – Frequency of
Refining losses > $10m
25
20
15
10
5
0
Risk Retention
Loss Forecasting – using industry data
Year of Loss UP / Down/ Power
Loss Type
Cause
Location
Category
Indexed BI US$
Indexed PD US$
Indexed Total US$
2014
Downstream
PD,BI
Fire + explosion/VCE
Siberia
Refinery
847,410,000
173,100,000
1,020,510,000
1988
Downstream
PD,BI
Fire + explosion/VCE
Louisiana
Refinery
508,110,000
487,785,600
995,895,600
2001
Downstream
PD,BI
Fire no explosion
Illinois
Refinery
500,208,000
343,525,200
843,733,200
2013
Downstream
PD,BI
Fire no explosion
Buenos Aires
Refinery
536,865,000
230,085,000
766,950,000
2008
Downstream
PD,BI
Fire + explosion/VCE
Texas
Refinery
157,279,200
604,920,000
762,199,200
2000
Downstream
PD
Fire + explosion/VCE
Mina Al Ahmadi
Refinery
744,832,000
744,832,000
1992
Downstream
PD,BI
Fire + explosion/VCE
La Mede
Refinery
453,460,000
696,385,000
2008
Downstream
PD
Windstorm
Texas
Refinery
685,576,000
685,576,000
2005
Downstream
PD,BI
Windstorm
Louisiana
Refinery
464,459,470
644,498,527
2011
Downstream
PD
Earthquake
Miyagi Prefecture
Refinery
584,336,000
584,336,000
2005
Downstream
PD,BI
Windstorm
Louisiana
Refinery
247,800,000
557,550,000
2005
Downstream
PD
Windstorm
Various
Refinery
557,550,000
557,550,000
1999
Downstream
PD,BI
Fire + explosion/VCE
California
Refinery
356,448,000
168,008,938
524,456,938
1989
Downstream
PD,BI
Windstorm
St. Croix
Refinery
225,896,480
272,450,088
498,346,568
1998
Downstream
PD,BI
Windstorm
Mississippi
Refinery
215,256,945
282,559,298
497,816,243
2015
Downstream
PD,BI
Fire + explosion/VCE
Ohio
Refinery
380,000,000
100,000,000
480,000,000
2005
Downstream
PD,BI
Fire + explosion/VCE
Texas
Refinery
226,737,000
247,800,000
474,537,000
2007
Downstream
PD,BI
Fire/lightning/explosion
Texas
Refinery
392,653,322
49,684,500
442,337,822
242,925,000
180,039,058
309,750,000
-
Risk Consulting Capabilities
Loss size distribution – Above $10M – based upon Industry data
Risk Consulting Capabilities
Small claims model – Up to $10m
Risk Consulting Capabilities
Small claims model – Up to $10m
Risk Consulting Capabilities
Small claims model – Above $10m
Risk Consulting Capabilities
Small claims model – Above $10m
Risk retention – Traditional approach
Propsed Retention
Current retention $10m
Year
$15m
$20m
$25m
$50m
Expected Losses <$10m
1.06
1.06
1.06
1.06
1.06
Expected Losses >$10m
0.00
0.69
1.26
1.79
3.46
Total Expected Losses
1.06
1.74
2.31
2.84
4.52
Excess Insurance
16.70
15.41
13.42
12.22
10.01
Total cost of risk
17.76
17.15
15.73
15.06
14.53
(0.61)
(2.03)
(2.70)
(3.23)
Change in Total Cost of
Risk vs $10m
Risk retention – Traditional Approach
Pitfalls of the Traditional Approach
• Traditional approach does not tell the full story
• Cost driven income statement approach
• Doesn’t consider capital costs - the cost of using group capital in the
retention decision.
Risk retention – Cost of Capital Approach
Total Cost of Risk and Capital
(A) Cost of risk (Expected losses at a given retention)
(B) Adverse retained losses (95th percentile)
(C) Capital needed to fund potential adverse losses (A-B)
(D) Cost of Capital
(E) Cost of holding capital to
fund adverse development (CxD)
(F) Excess insurance
(G) Total cost of risk (A+E+F)
X
X
X
X%
X
X
_____
X
Risk retention – Cost of Capital approach
Propsed Retention
Current retention $10m
Year
$15m
$20m
$25m
$50m
Expected Losses <$10m
1.06
1.06
1.06
1.06
1.06
Expected Losses >$10m
0.00
0.69
1.26
1.79
3.46
(A) Expected Losses
1.06
1.74
2.31
2.84
4.52
(B) Adverse retained losses 95th percentile
6.55
11.55
16.55
21.55
46.55
(C) Capital needed to fund potential
adverse losses (B-A)
5.49
9.80
14.23
24.19
47.51
(D) Cost of Capital
10%
10%
10%
10%
10%
(E) Cost of holding capital to fund adverse
development (CxD)
0.82
1.47
2.13
3.63
7.13
(F) Excess insurance
16.70
15.41
13.42
12.22
10.01
(G) Total cost of risk (A+E+F)
18.58
18.62
17.87
18.69
21.65
0.00
0.04
(0.71)
0.11
3.07
Risk retention Analysis - Conclusions
• The cost of capital is an important part of the retention decision
• Risk Modelling is an integral part of service to large corporate insurance
buyers
• Risk Modelling needs to be run in parallel with the marketing/pricing of
the excess insurance market
Thank You
Alesco is a trading name of Alesco Risk Management Services Limited. Alesco Risk Management Services Limited is an appointed representative of
Arthur J. Gallagher (UK) Limited which is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25
Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 1193013. www.alescorms.com
07/10/2015
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