Is captive utilisation an optimal strategy
for National Oil Companies?
A 2010 industry research report
Contents
Who uses a captive insurance company? . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. 1
Does the global position of NOCs influence captive utilisation? . . .. . .. . .. . .. . 1
What factors might be impacting captive utilisation?. . .. . .. . .. . .. . .. . .. . .. . ..2
What other market dynamics are relevant? . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. 3
Can a captive add value for NOCs? . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ..4
What risks should a NOC captive participate in? . . .. . .. . .. . .. . .. . .. . .. . .. . .. . 5
How should risk funding decisions be made by a NOC?. . .. . .. . .. . .. . .. . .. . .. .6
Conclusion . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ..8
About the author. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ..8
Marsh . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 9
Captive insurance companies have been in existence for over
100 years. Over 5,000 such companies exist globally and over
70 jurisdictions have some form of captive legislation.
As perhaps the most widely accepted form of ‘alternative risk
financing’, its utilisation by certain industries varies markedly.
Who uses a captive insurance company?
In general, the oil and gas industry are significant users of captives. Oil ‘majors’
such as BP, Shell, Exxon, Chevron, Conoco, Repsol YPF, ENI, TOTAL and Woodside
each operate at least one captive insurer. Equally in the support industry,
captive utilisation is also significant with businesses such as John Wood Group,
Schlumberger, Subsea 7 and Nabors Industries operating a captive. Much as oil
‘majors’ are significant, NOCs clearly occupy a unique position within the market.
The Economist reported on 23 January 2010, that ‘75% of crude oil reserves are owned
by NOCs’ whilst ‘conventional multinationals control just 3% of the world’s reserves
and produce 10% of its oil and gas’.
Does the global position of NOCs influence
captive utilisation?
Figure 1: Oil price per barrel
It is easy to see how, with such control, captive utilisation might be different. Much
as oil prices of near US$147 a barrel, as in July 2008, are not presently being repeated,
they have been increasing (as can be seen from Figure 1). With very high levels
of cash flow generated, setting aside funds for potential loss events might seem
unnecessary. So how does captive utilisation in the NOC sector compare with the
majors? Based on an estimated total of 113 NOCs globally, Figure 2 reflects the level
12%
of captive utilisation.
NOCs operating captives include Petroleos de Venezuela, Gazprom, Statoil, Petrobras,
Petroleum Oil & Gas Corporation of South Africa and China National Offshore Oil
Corporation. Whilst this is a comparatively low utilisation rate, it is clear that
88%
significant variations exist in both size and extent of operation within NOCs. In
2006, a Stanford University study identified a ‘Universe of Significant NOCs’. Based
on those companies (a total of 36), captive utilisation is reflected in Figure 3. This
reveals a much higher level of utilisation. Interestingly a significant proportion of
those operating captives are not 100% state owned albeit they are in the majority.
NOCs without captive
NOCs with captive
Potentially, this might have impacted utilisation simply to reflect, from a governance
perspective, that property and liability interests were being protected.
Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
Source: Marsh
Figure 2: Captive utilisation
1
What factors might be impacting captive
utilisation?
In general, there are a number of factors that drive captive utilisation by oil majors.
These include:
33%
n Lack of capacity or depending on your perspective, lack of capacity at a justifiable
premium
67%
n Alignment of stakeholders’ interest with regard to funding insurable losses. Such
stakeholders would include both the local operating business and local regulators
as well as those responsible for the group overall
n Compliance with local insurance laws, accepted local operating practices and
NOCs without captive
NOCs with captive
potentially local funding requirements
Source: Marsh
n To access OIL capacity which has historically only been achievable with a captive
Figure 3: Captive utilisation
n To act as a buffer against market volatility both in terms of price and capacity,
particularly in certain risk areas
n Enhance market security by accessing reinsurers directly. The benefit is achieved
through reducing credit risk, potentially reducing price and increasing the overall
capacity available.
From a NOC perspective, factors impacting captive utilisation include:
n A significantly less litigious environment than many of the countries in which
majors are headquartered. With fewer losses and lower loss settlements, the
need for different funding mechanisms is reduced;
n The level of insurance being purchased is much less or indeed, may not occur at all;
n Do government stakeholders require the purchase of insurance? This needs to
exist before one might think about formalising the funding of any risk being
retained;
n Many of the countries from which NOCs operate have a very competitive
domestic insurance market but with little capacity for Energy Risks. Equally,
the cross shareholdings that can exist create a very close relationship with little
incentive for the NOC to retain risk;
n Very few countries from which NOCs operate have captive legislation. Therefore,
the establishment of a captive in another country will lead to assets being
deposited in a third country. As a government controlled company, this may not
be acceptable. However, over recent years this has been changing with Bahrain,
Qatar and Dubai all having established captive legislation.
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Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
What other market dynamics are relevant?
The ‘Petroleum Economist’ reported in January 2010 that the doubling of petrol prices
(in the US) and more in other countries over the past 10 years is forcing a rethink of
driving habits and the vehicles used. Equally, a report published by Global Insight in
the third quarter of 2008 titled ‘Outlook for Light Vehicle Sales Under A High Oil Price
Scenario’ reflected that a persistently high oil price would drive down usage.
Whilst fuel efficiency is likely to increase (and not just in motor vehicles) the
backlash over climate change also has an impact. This may be at government level
(such as in the EU with the introduction of CO2 emissions limited to an average of
130g/km per vehicle across a motor manufacturer’s entire vehicle range and due to
be implemented between 2012 and 2015) or at a more personal level (simply choosing
to use a vehicle less).
Of course, reduced consumption due to higher prices results in the available supply of
commodities, such as oil, lasting longer. This maintains a higher level of cash flow for
those companies who control it. Therefore, in terms of funding for risk, this is largely
neutral. Reflecting on this, it is perhaps worth considering the experiences of BP.
In the Journal of Applied Corporate Finance in 1993, BP’s decision to largely abandon
‘... doubling of petrol prices
(in the US) and more in other
countries over the past 10
years is forcing a rethink of
driving habits...’
the purchase of mid range and catastrophe insurance was examined. Whilst the
rationale for not purchasing such insurance was largely acknowledged, the report
identified that perhaps the real ‘need’ for insurance related to ‘risk-assessment,
monitoring, and loss settlement services’. In essence, the rigour of the process
of placing insurance was as vital as any cover that was put in place. This was
particularly the case for BP given that the level of indemnity limit available was
often below BP’s real needs. Other beneficial areas identified also included tax and
regulatory considerations.
Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
3
Can a captive add value for NOCs?
For NOCs, many of whom are also in a similar situation with regard to coverage, can
a captive add value? Whilst there are many generic reasons for captive utilisation
(and earlier we looked at ones more focused on the oil and gas industry), the benefit
to NOCs will often include the following:
n Rigour of process in identifying and valuing assets and managing losses. Over
recent years, rebuilding costs have increased substantially impacting both
property damage values and business interruption costs. Using the latest data,
a project that would have cost US$100 million in 2000 would have cost US$172.5
million in 2009. Of late, inflationary building costs have levelled off as reflected
in the IHS CERA Downstream Captive Costs Index (DCCI). The Index recently
reflected that the last 6 months of 2009 had seen costs increase by 1.5%. Across
a variety of industries, loss management can be an issue. Where the formalised
‘... Over recent years,
rebuilding costs have
increased substantially
impacting both property
damage values and
business interruption
costs ...’
process of purchasing insurance is not in place, many losses effectively
‘disappear’ in the capital expenditure budget;
n Direct reinsurance market access. Accessing capital providers directly and
increasing competition on the placement (or limits available) can help in
managing costs and the breadth of coverage;
n Management of insurance relationships with joint venture partners. Many of the
majors utilise a captive insurer to manage the retentions on major projects and/
or joint ventures, at least for their percentage interest. It is equally appropriate
for the NOC to do the same. As a wider point, helping such ‘local’ operations
manage their exposure can provide some benefit;
n Management of risk within international business operations. Many NOCs have
expanded internationally introducing them to a different regulatory environment,
insurance market and risk profile. The manner in which the international
operations are run (and potentially financed) will have a bearing on the level of
risk that the NOC takes, whether by desire or default. Accordingly, it is likely
that a captive will have more of a role in order to manage this from a group
perspective versus ‘leaving it’ to the overseas business.
It must be recognised that all NOCs are different and that the extent or manner of
expansion varies. However, the desire to acquire assets for the benefit of a given
country’s expanding population is clearly apparent. With many NOCs expanding
in Africa, a market with fewer internationally experienced oil and gas insurers and
limited capacity, the role will be more pronounced.
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Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
What risks should a NOC captive participate in?
In many ways, the typical risk areas are similar to that of the majors.
Such risks would include:
n Property Damage and Business Interruption
13%
13%
n Liability
24%
37%
n Marine
13%
n Aviation
n Construction
n Environmental
n Terrorism
n Control of Well.
$10m - $50m
$50m - $100m
$100m - $1bn
Over $1bn
Source: Marsh
Figure 4: Captive capitalisation of
benchmarked oil majors
From analysis recently undertaken by Marsh on a sample of majors, the level of
capitalisation also helps set some context as to the level of risk being assumed.
However, given the unique nature of each NOC or indeed each company generally, it
is perhaps more useful to consider the appropriate process that should be adopted
in determining the value of a captive and the decision to finance risk using one
mechanism versus another.
Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
Less than $10m
5
How should risk funding decisions be made by
a NOC?
Taking the right risks at the right time ensures optimal captive deployment and it is
in this area that the right process is vital. Successful captive optimisation and the
recognition of when not to use the captive are necessary to enhance its long term
effectiveness.
How is such captive optimisation achieved and what is best practice? Three
fundamental principles govern the process of evaluation. These are:
n Realising and positioning the purchase of insurance as only one of a number of
tactics that can be deployed, as part of a broader, long-term risk management
and financing strategy;
n Focus on delivering a higher return of capital or simply delivering the lowest
ultimate cost (but with the correct assessment of all the costs involved). This
involves moving away from looking at the direct cost of insurance to the lost
return to the business had it been deployed differently;
n Matching the buying needs of the NOC with its appetite to take risk, the losses
‘... taking the right risks
at the right time ensures
optimal captive deployment
and it is in this area that the
right process is vital ...’
it is likely to sustain and the capital cost associated with its various financing
options. Clearly for government sponsored companies, the cost of allocating
capital might be considered minimal.
Having established the principles, three broad best practice steps are involved in
pursuing an optimal programme that ensures capital is well allocated. These are:
Understanding the strategy and current position of the business
This is wide-ranging, covering areas such as historic losses, business continuity,
corporate governance, board level attitudes toward risk, identification of information
gaps and a ‘snapshot’ of the business. This part of the process contains many
qualitative aspects and is vital in the engagement process of senior management. As
highlighted earlier, there are numerous factors needing consideration many of which
are external;
Analysis and model data
Creating decision-making tools from raw data is a critical stage in the process.
Different aspects within this include stress testing the adequacy of current risk
financing arrangements, defining an appropriate risk tolerance calculation for the
business, analysing the current structure and retention levels, creating theoretical
and market based pricing models and the evaluation of alternative risk financing
tools;
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Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
Design and place risk financing solutions
This is the critical point at which it is possible to demonstrate that capital has been
allocated as efficiently as possible. Having established which risk financing structure
is most appropriate in terms of type, limits and retentions the placement must be
finalised. A final decision can be made around carriers, a risk in itself, but with the
underwriting submission having been enhanced through this process, more market
interest should have been created. As was highlighted in the review of BP decisions,
value is created as much in the process as in the final result.
In looking at this process and the way the business interacts with the risk transfer
markets, how is captive involvement optimised in this process? In Marsh’s view, there
have been three distinct phases of captive development. The first involved captives
established over 100 years ago in the same country as the parent and which often
developed into a separate insurer in its own right. The second stage involved captive
development during the 1960s where the concept gained ground and provided
the underlying basis for development over the next 40 years. This stage of captive
development was focused on managing costs associated with deductibles or excesses
and for a period, largely for tax reasons, included underwriting some third party
business, albeit generally unsuccessfully. The third stage involved what we term
‘optimised captives’, being those captives pursuing a clear, documented strategy but
adjusting tactics to make best use of its capital given the actions of the external risk
transfer market. In our mind, NOCs that have been operating a captive for a number
of years will be progressing towards the latter stage.
Based on this, the following general characteristics apply to an optimised captive:
n A clearly documented strategy exists which addresses how the captive supports
the business and identifies ways to increase that support. For a NOC, the value a
‘... the capital (and retained
earnings) held in the captive
reflects both the current and
reasonably foreseeable
needs of the captive ...’
captive brings needs to be reinforced on a regular basis. This is particularly the
case given the issues previously identified;
n A clear evaluation approach exists for the alteration of existing risk levels or the
acceptance of new risks;
n The capital (and retained earnings) held in the captive reflects both the current
and reasonably foreseeable needs of the captive. With the high level of cash flow
enjoyed by some NOCs, the benefit of this may be muted;
n That the return on the capital employed by the captive is at least equal to that
within the core business;
n The investment strategy is reflective both of the underlying nature of the risks
within the captive e.g. frequency, volatility and timing of payments and reflects
the need to limit the cash flow impact of the captive on its owner;
n The tactics involved in implementing the strategy need to be reviewed at a
regular date, at least annually, in order to ensure that the strategy is achieved;
n Recognition that a captive programme that changes from one renewal to the next
may actually provide best value.
Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
7
Conclusion
NOCs are unique in the position they hold within the global economy. Many of the
operational risks that they have to deal with every day are similar to those of private
companies in the oil and gas industry. The financial pressures are different for many
of the NOCs particularly given the cash flows that have been enjoyed over recent
times. However, as was reviewed by the Journal of Applied Corporate Finance, the
value of insurance is as much in the process of placement and administration as in
the cover provided.
Reflecting this, a captive has a role to play for NOCs generally, particularly for those
with joint venture arrangements or who have operations in third party countries.
The latter point regarding international expansion is a foreseeable result of both
expanding populations and the finite level of such resource being available. NOCs
with a strong cash flow are clearly seeking to ‘manage’ this issue. As they do so,
covering insurable risks in those countries will be important as will the utilisation of
a captive vehicle.
With the increase in countries that have captive legislation which are much closer
to home for NOCs, this has also become a more relevant factor. For NOCs, it is now
possible to establish a captive within their own, or very local, jurisdiction.
It is difficult to foresee an environment where captives effectively replace the
general insurance market, whether domestic or international, but an increasing role
is possible. Ensuring that the role of the captive is optimal and that the process is
best practice will continue to remain a challenge in a rapidly changing economic
environment.
About the author
Jonathan is currently a Senior Vice President and responsible for Marsh’s captive
consulting services within the EMEA region. Jonathan is part of Marsh’s Risk Finance
Group.
Jonathan has significant risk financing experience and most recently led Marsh’s UK
Captive Consulting Group. He previously worked for ACE European Group where he
had responsibility for developing ACE’s fronting business in Europe.
Jonathan has spent more than 15 years working with multinational clients across
Jonathan Groves,
Senior Vice President
a variety of risk financing areas – including spending time in Europe as well as 3½
years in Bermuda. He is an Associate of the Chartered Insurance Institute (ACII), an
Associate of the Institute of Risk Management (AIRM) and has a Masters in Business
Administration (MBA).
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Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
Marsh
Marsh is the leading global captive manager and captive advisor.
Marsh manages captives in over 25 jurisdictions including Barbados, Bermuda,
Cayman, Canada, Dubai, Guernsey, Ireland, Isle of Man, Luxembourg, Malta, New
Zealand, Singapore, Sweden and the US.
EMEA
London
Jonathan Groves
Telephone:
+44 20 7357 1225
E-mail:
[email protected]
Luxembourg
Fred Gabriel
Telephone:
+35 249 695 1328
E-mail:
[email protected]
North America
New York
Art Koritzinsky, New York
Telephone:
+1 203 229 6768
E-mail:
[email protected]
Bermuda
Scott Gemmell, Bermuda
Telephone:
+441 297 9749
E-mail:
[email protected]
Asia
Singapore
Vic Pannuzzo
Telephone:
+65 6531 2100
E-mail:
[email protected]
Is captive utilisation an optimal strategy for National Oil Companies – An industry research report
9
The information contained herein is based on sources
we believe reliable and should be understood to be
general risk management and insurance information
only. The information is not intended to be taken as
advice with respect to any individual situation and
cannot be relied upon as such.
Statements concerning legal, tax or accounting
matters should be understood to be general
observations based solely on our experience as
insurance brokers and risk consultants and should
not be relied upon as legal, tax or accounting advice,
which we are not authorised to provide.
Marsh Ltd
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Registered Office: 1 Tower Place West, Tower Place,
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