Aon’s 11th Energy Insurance Training Seminar Captives & Risk Financing Decision Platform Charles Winter

Agenda Risk Financing Strategy Risk Finance Decision Platform Managing Retained Risk & Captives

Risk Financing Strategy

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

Corporate Perspective of Risk Loss Distribution Probability Probability Risk Bearing Capacity Provisions Zero Zero loss loss Loss Loss 1 2 3 Expected loss Unexpected loss for which the company has the capacity to bear Unexpected loss which is unbearable for the company

Risk Finance Decision Platform

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? Decision Support Reporting RFDP Insurance Marketplace Risk Appetite Risk Profile

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

Risk Financing Decision Platform Components Dynamic Risk Modelling Risk Bearing Capacity Analysis Design & Programme Stress Testing Generates a thorough understanding of current insurance exposures, individually and in portfolio Establishes appetite levels for enterprise risks and tolerance levels for insurable risks which are linked to corporate performance objectives and volatility thresholds 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

Key Outputs Providing a decision–making framework for developing alternative risk retention strategies from “low” to “high” Optimises the use of corporate capital Supports the captive’s strategy and underwriting/funding requirements

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

Risk Bearing Capacity Results 1 2 3 Volatility Determined Through Simulations Financial Impact Determined Breach Point Determined Y-Axis: EBITDA (£ in millions) X-Axis: Confidence Level (%) Scenario A Threshold > 99.99% 100% Scenario B Threshold - 93% EBITDA Threshold

Programme Optimisation – Loss Profile Inevitable Uncertain Remote The portfolio of retained risks is a function of all risk classes’ retention levels limits of cover

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

Programme Optimisation - Pricing For each line of risk, a premium / pricing model is developed to assess the risk transfer cost at alternative attachment points

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

Captives & Managing Retained Risk

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

Financing of Retained Risk Optimal Retained Risk Decentralised Centralised Paid from local operating revenues Paid from group operating revenues Structured in risk retention vehicle e.g. captive

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

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

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

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 Layered / Group Deductible Stop Loss Protection Common Local Deductible Desirable Aggregate Losses Avoids pound-swapping

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

Trends New formations flow Increasing use of existing companies 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