aon’s 11th energy insurance training seminar captives & risk financing decision platform
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Charles Winter. Aon’s 11th Energy Insurance Training Seminar Captives & Risk Financing Decision Platform. Agenda. Risk Financing Strategy Risk Finance Decision Platform Managing Retained Risk & Captives. Risk Financing Strategy. Risk Financing Strategy. - PowerPoint PPT PresentationTRANSCRIPT
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Charles Winter
Aon’s 11th Energy Insurance Training Seminar
Captives & Risk Financing Decision Platform
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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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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
Risk Financing Strategy
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Corporate Perspective of Risk
Probability
Provisions
Zero loss
Expectedloss
Unexpected lossfor which the company
has the capacity to bear
Risk Bearing Capacity
Loss1 2 3
Probability
Zero loss Loss
LossDistribution
Unexpected losswhich is unbearable
for 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?
DecisionSupport
Reporting
RFDP
InsuranceMarketplace
Risk Appetite Risk Profile
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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
Establishes appetite levels for enterprise risks and tolerance levels for insurable risks which are linked to corporate performance objectives and volatility thresholds
2. Risk Bearing Capacity Analysis
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
Generates a thorough understanding of current insurance exposures, individually and in portfolio
1. Dynamic Risk Modelling
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Key Outputs
Minimises the cost of riskwhilst managing volatility
Providing a decision–making framework for developing alternativerisk retention strategies from “low” to “high”
Within risk tolerance
Optimises the use of corporate capital
Supports the captive’s 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 ImpactDetermined1 2 3Volatility Determined
Through SimulationsBreach PointDetermined
0
$1x
$2x
$3x
$4x
$5x
$6x
$7x
2 4 6 8 10 12 14 16 18 20
X Axis: Months Forward
Confidence Level 95% or 19 out of 20 years
Confidence Level 67% or 2 out of 3 years
Prices = Mean
0
$1x
$2x
$3x
$4x
$5x
$6x
$7x
2 4 6 8 10 12 14 16 18 20
0
$1x
$2x
$3x
$4x
$5x
$6x
$7x
2 4 6 8 10 12 14 16 18 20
X Axis: Months Forward
Confidence Level 95% or 19 out of 20 years
Confidence Level 67% or 2 out of 3 years
Prices = Mean
$0
$1x
$2x
$3x
$4x
1 3 5 7 9 11 13 15 17 19 21X Axis: Months Forward
Confidence Level 95% or 19 out of 20 years
Prices = MeanConfidence Level 67% or 2 out of 3 years
$0
$1x
$2x
$3x
$4x
1 3 5 7 9 11 13 15 17 19 21
$0
$1x
$2x
$3x
$4x
1 3 5 7 9 11 13 15 17 19 21X Axis: Months Forward
Confidence Level 95% or 19 out of 20 years
Prices = MeanConfidence Level 67% or 2 out of 3 years
X Axis: Months Forward
Confidence Level 95% or 19 out of 20 years
Prices = MeanConfidence Level 67% or 2 out of 3 years
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
$4,500
$5,000
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Y-Axis: EBITDA (£ in millions)
X-Axis: Confidence Level (%)
Scenario A Threshold > 99.99%
100%
Scenario B Threshold - 93%EBITDA Threshold
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Programme Optimisation – Loss ProfileLoss Severity Distribution
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1 10 100 1,000 10,000 100,000 1,000,000 10,000,000 100,000,000
loss value
cum
ula
tive
pro
bab
ilit
y
From loss historyFrom industry dataMulti-parametric fit
NegBin(1, 0.24146)
0.00
0.05
0.10
0.15
0.20
0.25
0.30
-2 0 2 4 6 8 10
12
14
16
18
>5.0%90.0%
0.00 10.00
Frequency Distribution
Inevitable Uncertain Remote
The portfolio of retained risks is a function of all risk classes’
1. retention levels
2. 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
Percentile Statistic Agg. LossAgg. Loss Layer 5m
Agg. Loss Layer 10m
Agg. Loss Layer 25m
Agg. Loss Layer 50m
Agg. Loss Layer 100m
25% 1 in every 4 years (Good Case) 2,955,000 2,955,000 2,955,000 2,955,000 2,955,000 2,955,000
Mean Average Long-Term Loss Projection 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
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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
200,000,000
165,000,000
130,000,000
95,000,000
60,000,000
25,000,000
100,
000
200,
000
300,
000
400,
000
500,
000
600,
000
700,
000
800,
000
900,
000
1,00
0,00
01,
100,
000
1,20
0,00
01,
300,
000
1,40
0,00
01,
500,
000
1,60
0,00
01,
700,
000
1,80
0,00
01,
900,
000
2,00
0,00
0
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
Premium
Limit of Cover
Per-Occurrence Retention
Premium as Function of Retention and Limits of Cover
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270
275
280
285
290
295
300
305
310
92 93 94 95 96 97 98
Mill
ion
s
MillionsTotal Cost of Risk (Mean Retained Losses + Premium)
Net
Cap
ital
Req
uir
em
ent
(Va
lue
at R
isk
i.e
99.9
th P
erce
nti
le)
All Points
Eff icient Points
Gross Point
Current Programme
Programme Stress Testing Results – Efficient Frontier
High-Risk Strategy
Low-Risk Strategy
Medium-Risk Strategy
Lev
el o
f R
isk
Through stress testing many programme options, an Efficient Frontier, based on expected value and volatility, can be mapped
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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
$5m
$500mInsured
First Loss
Uni
nsur
ed
Residual
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Financing of Retained Risk
DecentralisedDecentralised CentralisedCentralised
Paid from groupoperating revenues
Paid from groupoperating revenues
Structured inrisk retention
vehicle e.g. captive
Structured inrisk retention
vehicle e.g. captive
Paid from localoperating revenues
Paid from localoperating revenues
Optimal Retained RiskOptimal Retained Risk
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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
Local Deductible
Layered / Group Deductible
(Re)Insurance Market
Quota Share
(Re)Insurance Market
Each and Every Loss
Aggregate LossesDesirable
UnusualCan deliver good returns
Avoids pound-swapping
Common
Captive may give greater
control Excess of loss
(Re)Insurance Market
StopLoss
Protection
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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