CORPORATE INSURANCE STRATEGY: THE CASE OF BRITISH PETROLEUM

Presented by Group 6:Catur Rini Ariyani

Heru WijayantoKenneth Petersen

Saiful Anam

INTRODUCTION

• Insurable events represent major production cost.

• Conventionally, buying insurance for large potential losses while self insuring against smaller ones.

• British Petroleum decided major changes in insuring strategy.

• The article discuss insurance strategy on demand side and supply side.

FRAMEWORK FOR EVALUATING COERPORATE INSURANCE

• General framework for analyzing insurance strategy, identifies benefits and costs.

• Real benefits of insurance

• The supply side of corporate insurance.

The important difference between individual and corporate insurance.

• Insurance allow to transfer risk to insurance company.

• Insurance company charges a premium.• Premium loading is difference between

premium and present value of expected cost.

• Insurance company reduce the risk by pooling a large portfolio of similar risks and better access to capital market.

The real benefits of insurance

• Avoid under investment problem.

• Risk shifting within the firm.

• Service efficiencies.

• Tax Benefits.

• Regulatory Requirement.

Avoid under investment problem.

• Financial difficulty can impose large indirect cost.

• Insurance effectively serves as a funding source.

• Alternative solution would be better to reduce the amount of corporate debt.

Risk shifting within the firm.

• Employee demand higher wages.

• Management demand higher salaries.

• Suppliers will reluctant to enter into long-term contract.

Service efficiencies.

• Insurance company provide a set of related service.

• Insurance company has large data base that allow for extensive and precise actuarial analysis.

• It enable insurer estimate and classify individual exposures more accurately and price their product appropriately.

Tax Benefits.

• Benefits derive from interaction two factors. Firstly is ability to reduce volatility of reported income. Secondly is effective progressivity of most of world’s tax code.

• Tax code permit deduction of both insurance premium and of uninsured losses.

Regulatory Requirement.

• Financial responsibility laws sometimes require insurance coverage.

The Supply side of corporate insurance

Effective Competition :For routine small property and liability losses →high competitionFor large losses and for certain specialized risks → less competitionFor very high levels of all lines of insurance → less competition and higher expected insurer rents

The Supply side of corporate insurance

Two well-known problems :Moral hazard → the tendency for insured parties to exercise less careAdverse selection → the likelihood that insurers will get a riskier than average sample, given the tendency of less rizky parties to self-insure

THE CASE OF BRITISH PETROLEUM

British Petroleum (BP) comprises four operating companies:

BP Exploration BP Oil BP Chemicals BP Nutrition

The Case Of British Petroleum

British Petroleum (BP) has asset include : Exploration and extraction licenses Scientific and technical capital specific to

the oil industryBritish Petroleum (BP) has two major

concentrations oh value : Its production licenses and its facilities

In the North Sea On the Alaska North Slope

BP’s Loss Exposures

BP’s loss exposure range from routine small losses to potential losses in the multi-billion- dollar range. low scale : vehicle accidents, minor shipping accidents, industrial injuries, small fires, and equipment failures. large scale : refinery fires or explosions, minor environmental damage from oil spills, and loss of oil tankers.

BP’s loss exposures

very large scale : clean-up costs arising from major oil spills, tort claims for widespread injuries caused by release of toxic chemicals, liability for defective fuel causing a major airline disaster, and loss of an offshore rig with major loss of life.With only one or two exceptions, insurance has been unavailable above $500 million, and BP has historically self-insured in this range.

Coverage for losses below $10 mill

Is decided by each local operating unit Competitive insurance markets

Comparative advantage in claims administration

Reduces noise in performance measure for local managers

Potential tax benefits

No insurance using external insurance market

Limited competition in insurance market

Cost of enforcing contracts is highNo comparative advantage for

insurersThese losses have little impact on

total corporate value

Coverage for losses between $10 mill and $ 500 mill

Coverage for losses above $500 mill

• Size of loss exceeds capacity of insurance market

• Coninsurance with tax authorities• Increases oil prices

Summary/conclusion