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

1. Charles Winter Aon’s 11th Energy Insurance Training SeminarCaptives & Risk Financing Decision Platform

2. Agenda • Risk Financing Strategy • Risk Finance Decision Platform • Managing Retained Risk & Captives

3. Risk Financing Strategy

4. 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

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

6. Risk Finance Decision Platform

7. Risk Appetite Risk Profile InsuranceMarketplace RFDP Reporting DecisionSupport 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?

8. 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

9. Risk Financing Decision Platform Components • Risk Bearing Capacity Analysis • Design & Programme Stress Testing • 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 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

10. 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

11. 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

12. Y-Axis: EBITDA (£ in millions) 1 2 3 Scenario A Threshold > 99.99% EBITDA Threshold Scenario B Threshold - 93% X-Axis: Confidence Level (%) 100% Risk Bearing Capacity Results Volatility DeterminedThrough Simulations Financial ImpactDetermined Breach PointDetermined

13. Programme Optimisation – Loss Profile Inevitable Uncertain Remote • Theportfolio of retained risks is a function of all risk classes’ • retention levels • limits of cover

14. 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

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

16. 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

17. Captives & Managing Retained Risk

18. 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

19. Financing of Retained Risk Optimal Retained Risk Decentralised Centralised Paid from localoperating revenues Paid from groupoperating revenues Structured inrisk retentionvehicle e.g. captive

20. 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

21. 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

22. 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

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

24. 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

25. 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