Captive Value Creation Modeling
Captive Value Creation Modeling Quantifying the value of a captive to its parent Javier (Hobby) Pardo Manager, Risk Management & Insurance Nexen Inc. June 9, 2010
Nexen’s Operations Norway
Canada
United Kingdom United States
Yemen Colombia
Nigeria
Captive Lines of Business Overview ØDeductible Buy Downs -
Property damage Control of well Business interruption Third party liability
ØAtlantic named windstorm business interruption ØConstruction ØSpecial products - Excess PD/BI on target risk - Drill contract buy back
Why build a model? ØCaptive can be perceived as a non-core operation - Should we continue to invest in it? - Should we grow the company? - How quickly? How much capital will it require?
ØProvide justification for going concern & for growth - Performance measurement is critical - Captives have many moving parts
Captive Model Methodology ØTwo independent approaches - Nexen Internal - Service provider (Willis)
ØEach model had components in it that the other didn’t ØValue position should be within +/- 10%
Captive Model Methodology Nexen Approach ØFour Primary Elements: 1) Tax Effect 2) Operating Effect 3) Premium Savings 4) Opportunity Cost ØAggregation of year approach ØOne step model ØCalculates incremental value of the captive
Captive Model Methodology Nexen Approach Ø Tax effect: premiums paid to your captive lower your taxable income Tax savings at the BU level (Premium expense) Premium paid x local tax rate (Taxes payable in Barbados) (Premium income) (Taxes payable at the BU level) (Business interruption claims) Tax savings in Barbados (Claims expenses) Net Tax savings (Loss)
Captive Model Methodology Nexen Approach ØOperating effect Investment gains within captive (Operating expense within captive) Tax savings at captive level i.e. Income statement deductions for IBNR Net Operating Effect
Premium Savings YOUR CAPTIVE YOUR COMPANY
THIRD PARTY INSURER
Ø Premiums can go to one of two places: – The external insurance market, or – To your captive
Ø There are many advantages to keeping the funds within your organization.
Captive Model Methodology Nexen Approach ØOpportunity cost of funds - Costs of forming and establishing the captive - What would you have done with the funds if you didn’t create a captive? - Do you have trapped capital? i.e. reserve requirements - Principal x hurdle rate x time = opportunity cost of funds
Summary of Nexen Approach Tax Effect + Operating Effect + Opportunity Cost of funds = Incremental Value Created
Captive Model Methodology Willis Approach • Income statement approach • Year-by-year analysis • Two step model – Captive scenario – No captive scenario
• Calculates incremental value of the captive
Captive Model Methodology Willis Approach Gross premiums (Reinsurance) (Other underwriting expenses) Net premiums (Change in reserves) (Paid losses) (Operating expenses) Investment Income Income before taxes Tax effects net of FAPI Barbados taxes Corporate tax Net Position
Summary of Willis Approach Net position of Captive scenario (No captive scenario) Incremental Value add *Two step model
The Intangibles • • • •
Additional capacity Custom products Direct access to re-insurance Underwriting stability
Greater Control
Lessons Learned Ø Need Input from: -
Tax professional Treasury professionals Insurance professionals External consultants with deep captive expertise
Ø Expressing the value as a dollar range consistent with CFO language - What to do with the intangible benefits
Ø What is the optimal “level of detail”
Applications of the Model ØFinancial Justification ØManagement tool for profitability ØManagement tool for underwriting ØOngoing utility ØStrategic Planning
Questions?
Nexen’s Operations Norway
Canada
United Kingdom United States
Yemen Colombia
Nigeria
Captive Lines of Business Overview ØDeductible Buy Downs -
Property damage Control of well Business interruption Third party liability
ØAtlantic named windstorm business interruption ØConstruction ØSpecial products - Excess PD/BI on target risk - Drill contract buy back
Why build a model? ØCaptive can be perceived as a non-core operation - Should we continue to invest in it? - Should we grow the company? - How quickly? How much capital will it require?
ØProvide justification for going concern & for growth - Performance measurement is critical - Captives have many moving parts
Captive Model Methodology ØTwo independent approaches - Nexen Internal - Service provider (Willis)
ØEach model had components in it that the other didn’t ØValue position should be within +/- 10%
Captive Model Methodology Nexen Approach ØFour Primary Elements: 1) Tax Effect 2) Operating Effect 3) Premium Savings 4) Opportunity Cost ØAggregation of year approach ØOne step model ØCalculates incremental value of the captive
Captive Model Methodology Nexen Approach Ø Tax effect: premiums paid to your captive lower your taxable income Tax savings at the BU level (Premium expense) Premium paid x local tax rate (Taxes payable in Barbados) (Premium income) (Taxes payable at the BU level) (Business interruption claims) Tax savings in Barbados (Claims expenses) Net Tax savings (Loss)
Captive Model Methodology Nexen Approach ØOperating effect Investment gains within captive (Operating expense within captive) Tax savings at captive level i.e. Income statement deductions for IBNR Net Operating Effect
Premium Savings YOUR CAPTIVE YOUR COMPANY
THIRD PARTY INSURER
Ø Premiums can go to one of two places: – The external insurance market, or – To your captive
Ø There are many advantages to keeping the funds within your organization.
Captive Model Methodology Nexen Approach ØOpportunity cost of funds - Costs of forming and establishing the captive - What would you have done with the funds if you didn’t create a captive? - Do you have trapped capital? i.e. reserve requirements - Principal x hurdle rate x time = opportunity cost of funds
Summary of Nexen Approach Tax Effect + Operating Effect + Opportunity Cost of funds = Incremental Value Created
Captive Model Methodology Willis Approach • Income statement approach • Year-by-year analysis • Two step model – Captive scenario – No captive scenario
• Calculates incremental value of the captive
Captive Model Methodology Willis Approach Gross premiums (Reinsurance) (Other underwriting expenses) Net premiums (Change in reserves) (Paid losses) (Operating expenses) Investment Income Income before taxes Tax effects net of FAPI Barbados taxes Corporate tax Net Position
Summary of Willis Approach Net position of Captive scenario (No captive scenario) Incremental Value add *Two step model
The Intangibles • • • •
Additional capacity Custom products Direct access to re-insurance Underwriting stability
Greater Control
Lessons Learned Ø Need Input from: -
Tax professional Treasury professionals Insurance professionals External consultants with deep captive expertise
Ø Expressing the value as a dollar range consistent with CFO language - What to do with the intangible benefits
Ø What is the optimal “level of detail”
Applications of the Model ØFinancial Justification ØManagement tool for profitability ØManagement tool for underwriting ØOngoing utility ØStrategic Planning
Questions?
