Energy company insurance managers have faced significant challenges in recent months. Not only has the pandemic impacted the demand for energy and company operations, but coming on top of the hardening insurance market, and increased scrutiny of risks by insurers, placing an insurance program within budget constraints has been a real challenge for many firms. Coupled with significant changes in strategy announced by many major players in the industry in response to rising public concerns on climate change - which will significantly impact future risk exposures - insurance managers may be forgiven for feeling that all these changes are conspiring to make their already challenging roles increasingly difficult to fulfil.
A key element of the challenge is to be able to communicate the trade-off between the cost of insuring risk and the cost of retaining that risk. This is particularly the case in years where the cost of insurance has increased sharply, albeit from a low base. CFOs and Treasurers are happy enough to limit the spend on premiums at renewal, but in the event of a loss the focus is always on the cover provided and seldom on the premium paid. In addition, communicating this to a senior audience that is unfamiliar with insurance at renewal time (especially when there hasn’t been a large loss) can also pose problems. How do you clearly show this trade-off between cost and risk without becoming embroiled in the detail of individual covers across different businesses and individual countries?
What is needed is an approach that allows insurance managers to fully understand what the key drivers of risk are, how they may be mitigated, and how different strategies balance the need for protection against losses at an affordable cost. Yet at the same time, all this detail needs to be summarised in a format easily recognised and understood by senior management, so decisions can made based on data driven insights and market intelligence to optimise premium spend as well as highlight were risk mitigation initiatives will add the most value.
The insurance manager of a large oil company with interests in refining, construction and chemicals was concerned that they was no longer purchasing the ‘right’ insurance programme. For some time their company had been acquiring new businesses and had also divested some other businesses over the same period, resulting in a significantly larger business with a different mix of risks. In addition, the hardening market had meant their predecessor had purchased less insurance than in previous years, which they feared had resulted in more risk being retained than senior management realised. Their concerns were underlined by a more conservative approach to risk that had been adopted by the new management team and they wanted to review the company’s insurance strategy in order to ensure alignment with the new and more prudent approach. In discussions with them, it became clear that there were four key questions that needed to be addressed:
By combining their company’s own data with industry data, detailed and up-to-date knowledge of the available risk transfer markets and modern analytics, we quickly developed a better understanding of the company’s risk exposures and their variability.
The exhibit above shows both the quantum of the company’s energy risks in each country as well as how volatile these risks can be. From this, we were able to show where the risk in a particular country exceeds the risk appetite (shown in red in Figure 1 above) indicating where insurance was required to keep the risk within appetite. Furthermore, we were also able to show how these risks varied by activity as shown in Figure 2 above, which helped to ensure these businesses were buying the optimal insurance cover in relation to the risk exposure within each business.
The final two questions were addressed with our Connected Risk Intelligence approach, which shows the impact of different insurance strategies on the company’s cost budget and risk appetite. By considering all the energy risks in a single portfolio view, we were able to show how effective the current insurance program was, as well as comparing the merits of alternative structures. Figure 3 on the next page shows the range of different insurance strategies (each dot represents a different strategy) that are possible for this company.
The objective was to reduce the amount of retained risk and at the same time reduce the expected annual cost and move to a more efficient programme, closer to the edge of the “cloud” in the above diagram.
The purple dots show the suitable efficient insurance structures – that is those structures have the lowest cost for a given level of retained risk. The first conclusion we could draw was that the current structure was inefficient and that there was money left on the table that could be put to better use. There were 4 alternative strategies, each with its own merits that we then considered:
Option C was selected, as it offered the lowest risk within the budgetary constraints imposed by the CFO.
The Insurance Management team found this process extremely helpful as it enabled them to:
The approach was also highly valued by the Treasurer and CFO since they were familiar with risk transfer and risk hedging, but less familiar with insurance, our results provided them with a clear audit trail of objective decision making.
Andy Smyth is Senior Partner in Willis Towers Watson’s Strategic Risk Solutions division in London. Andy.Smyth@WillisTowersWatson.com
