Risk Management Can We?

1
Risk Management Can We?

• Presented by
• Dan C. Jones
• Clinical Assistant Professor
• University of Houston
• May 20, 2009
• Energy Risk USA 2009

2
Lets see how well we have done
3

• 1937- New London, Texas
• Natural Gas explosion is school over 200
  killed
• Now use t-butyl mercaptan or thioplane

4

• 1989- Exxon Valdez
• Spilled 10.8 million gallon of crude of coast
  of Alaska, Prince William Sound
• Now require double hull crude carriers in all
  US ports
• March 2009 Korean vessel found a drilling
  rig lost after IKE, Double Hull prevented any
  spill

5

• 2004- Explosion BP plant Texas City
• Extensive damage. BP admitted fault but
  ignition came during recovery cycle but
  fatalities due to location of work trailers

6

• 2005- Hurricane Katrina Rita
• Failure of flood gates New Orleans
• Inadequate wave clearance offshore platforms
  for class 5 storm
• Inadequate response FEMA

7

• 2008- Hurricane Ike
• Class 2 winds offshore
• Class 5 storm surge Galveston Bay and
  Trinity Bay
• Now referred to as Integrated Kinetic
  Energy
• over 2,000,000 million customers lost power.
  Unforeseen especially by CenterPoint.

8

• 1984- Bhopal India- Union Carbide pesticide
  plant
• 300 killed, thousands injured release of 42
  tons of methyl isocyanate
• Plant was not following safety and operating
  guidelines of Union Carbide

9

• 1986 Chernobyl, Ukraine explosion released more
  than 400 times the radioactivity than with
  atomic bombing of Hiroshima
• Built a sarcophagus a cover for the reactor
• That and Three Mile Island incident stopped
  any nuclear construction, in US in 1970s.
  Now 4 projects being considered in Texas

10

• 2002 Approved repository site in Yucca Mountain
  Nevada
• Operational 2010, to be sealed 2035
• Repository in solid rock 1000 feet underground
  and on average 1000 feet above water table
• Holds 77000 metric tons of waste
• Plulonuim-239 has half life of 24000 years
• Cost 9 billion
• 2010 budget includes no funding for Yucca
  Mountain
• Present 100 nuclear plants-20 of electricity
• 30 plants in planning stage

11

• Asbestos- Alaska Pipe Line recognition Asbestosis
  and mesothelioma but was used in shipbuilding in
  1940s
• Used by the Ancient Greeks because of its soft
  and pliant properties- the miracle mineral
• Over 80 companies involved with asbestos have
  filed for chapter 11 beginning with Johns
  Mansville

12

• US Air Flight 1549
• Sulley Sullenberger
• Airbus A 320-214
• N10GUS

13

• 1988 North Sea- Piper Alpha Platform
• Explosion many workers killed platform
  severely damaged.
• Equipment stacked near crew quarters
• Due to economic effort for more production

14
SEMPRA Energy

• Owners of San Diego Gas Electric- SDGE
• 2007 Wildfires in California
• Have 1.1 billion tower of liability insurance on
  aggregate basis and now totally consumed.

15

• But in all my experience, I have never been in
  any accident of any sort worth speaking about I
  have never seen but one vessel in distress in all
  my years at sea. I never saw a wreck and never
  have been wrecked nor was I ever in any
  predicament that threatened to end in any
  disaster of any sort.

16

• EJ Smith
• Captain-Titanic
• 1907

17

• We can add others not directly part of energy but
  which impact us all
• 9-11 2001
• Enron 2001
• AIG 2008
• Banking system 2007-08
• We do live in a risky world

18

• Retain and pay from internal funds
• Control eliminate or minimize losses
• Transfer usually by insurance but can include
  contractual transfer

19

• Insurance Buyer
• Insurance Manager
• Risk Manager
• Director of Risk Management
• Enterprise Risk Management
• Sustainability Risk Management

20
Risks we have failed to manage

• Banks
• Investment Houses
• Merrill Lynch
• Lehman Bros
• Bear Stearns
• All from
• Sub prime Credit Crises
• Mortgage valued securities
• CDOs- Collateralized Debt Obligations
• Credit Default Swaps
• AIG- a subject all its own

21
ERM

• John Hampton- St Peters College
• COSO
• Failure

22
New Risks

• Cyber Liability
• Gamma- Ray Burst
• Nanotechnology
• Somalia Pirates
• Global Warming

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http//www.houstonpress.com/
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• Raises questions
• How do we?
• When do we start?
• Can it make a difference?
• Should we start with education?

26
UH-GEMI Founding Vision

• A premier human-capital supplier for the energy
  industry.
• A principal venue to join and develop issues of
  critical interest to the energy industry.
• A research partner for the industry.

27
Major Educational Programs

• Undergraduate Global Energy Management (GEM)
  Program
• Graduate Energy Certificates
• China GEMBA program

28
Global Energy Management (GEM) Program

• GEM-Professional Program (Option to do a 5 year
  BBA/MS in Finance)
• GEM-Track
• Global Energy Management Minor

29
China GEMBA Program

• EMBA program in Beijing and Houston for Senior
  SINOPEC and CNPC Executives on leadership track
• Instruction by UH Faculty in Beijing Students
  Come to Houston for a few courses graduation

30
GEMI Conferences Workshops

• Energy Trading Marketing
• Recent Trends in the Power Industry
• Petrochemicals Refining
• Bio-fuels

31
Risk Management Scholarships

• Bauer- Annual
• 3- Houston Marine Insurance Seminar
• 2- Local Chapter RIMS
• 4- Dedicated Endowments

32
New Courses

• Carbon Trading- January 2009 EMBA
• Petroleum Engineering- Fall 2009
• Degree Plan

33
All of these sources provide us the energy we
need to live our busy lives.

34
Tier I

• John Gresham- The Associate
• Bermuda Monetary Authority

35
Tier I- USA

• Texas 3 UT, AM, Rice
• California- 9
• New York- 7
• Research Funds 150 million plus

36
Tier One Committees

1. National Competitiveness
2. Student Success
3. Community Involvement
4. Athletic Competitiveness
5. National and Local Recognition
6. Resource Competitiveness

37
Tier One Contributions

• 5,000 new jobs
• 129 million in wages to the regional economy
• 7.5 million in additional state revenue
• 202 million in local sales

38
Insurance Regulation

• State Regulation
• Federal Regulation
• Optional Regulation
• Insurance CZAR Candidate
• Opinions

39
Insurance Patriarchs

• Maurice (Hank) Greenberg
• Warren Buffet
• A third one as replacement

40

• Is ERM the answer?
• Is RMI education the answer?
• Can Tier I help this conundrum?
• Can insurances continue business as usual?

41

• Is the insurance market stable?
• Will the regulation applying to insurance, state
  vs. federal change?
• Will we have federal regulation?
• Will new leaders become known for the insurance
  industry?

42
Summary

• We all have risks
• Our challenge is to finance the losses that occur
• Risk management is the art of selection of the
  method(s) to pay
• We cannot eliminate all risk nor should we

43
Risk Assumption

• Assume risks that are comfortable and predictable
• Transfer those risks that could negatively impact
  your company
• Be mindful of the risk bearing capacity of your
  company
• There are limitations- one is Chapter 11

44
BPApril 20, 2010

• BP Blow out
• Maccando Blow out
• Deepwater Horizon Blow out
• Vessell - 575,000,000
• 11 deaths
• 17 injured

45
Gulf Issues/Energy

• BP Pollution Liability
• Liability
• Force Majors
• Insurance
• No Insurance
• Available Limits
• Inspections
• Regulation

46
Energy Insurance and Risk ManagementFinance
4397/7397

• Professor Dan C. Jones
• C.T. Bauer College of Business

47

• Risk financing vs. Risk management
• Risk and the world
• As a society, always sought to reduce
  uncertainty-tribes/clans
• Business but an extension and risk is at heart
  of ALL business operation
• Decisions cross borders and industries-harm to
  stakeholders

48

• Language of risk insurance
• Risk
• Speculative risk
• Pure risk
• New term-enterprise risk
• Management of Risks
• A process
• Identification and evaluation
• Exploration of Techniques
• Implementations and review
• Current Risk management
• Losses without gain
• Holistic approach

49

• Fundamentals of risk uncertainty
• Risk- variation of outcomes
• Uncertainty- the doubt from inability to predict
  future (outcomes)
• Arises from risk
• Add managers and becomes complicated

50

• Corporate demand for insurance
• Risk managers assumed risk neutral
• Assumption
• Increasing wealth leads to inc. Satisfaction
  AND
• Marginal utility constant as wealth increases
• Individuals risk adverse but
• Owners / shareholders are not
• Investors require higher return if unable to
  diversify or systemic risk
• CAPM theory

51

• Shareholder risk aversion does not explain why
  corporations buy insurance why?
• Insurance companies have comparative advantage
• Insurance can lower cost of financial distress
• Insurers may have service efficiencies
• Insurance can lower tax liabilities (property)
• Regulated industries have higher demand
• Compulsory insurance laws
• Financial consideration of stock price

52

• Practitioners increasingly taking holistic
  approach
• Conceptual and applied economic knowledge
  continues to expand
• Private markets can not deal with some societal
  risks
• Publicly traded companies undergoing evolutionary
  changes
• Resources committed to understanding capacity of
  capital markets
• A challenge for ALL

53

• Economic development
• Benefits
• More competitive
• Better values
• Shareholder value increased
• Cash flow leveling
• Reduces insolvency
• Expands credit availability
• Loss control / risk control
• Reduced costs results and better able to compete

54

• Property rights and economic freedom
• Right to own real personal property
• Right to enter into contracts
• Right to be compensated for tortious acts
• Needed
• A system and a means to enforce
• Markets are means of exchanging property rights
• Insurance can not function without defined
  ownership interests
• Restrictive - monopolies, insider trading

55

• Hard market
• Soft market
• Hurricane Andrew
• 9/11
• Today

56

• Value of insurance company services
• Pricing, underwriting, claims handling
• Pricing - statisticians / actuaries
• Time lag of loss payments and premium payments
• Competitive premium is of expected losses,
  expenses, profit
• Investment return
• Life companies -calculable
• Non-life - long tail claims
• Government treatment

57

• Internationalization of business creates
  internationalization of financial services
• No one market can provide all needed coverage
• Oil refineries
• Oil tankers
• Off shore rigs
• Satellites
• Jumbo jets
• Environmental impairment
• National markets benefit
• Increase competitiveness

58

• The financial environment
• Finance and insurance have much in common
• Each provide its customers tools for managing
  risks AND
• Valuation methods are the same
• Fair value of the security
• An insurance policy
• Based on discounted cash value of future cash
  flows

59

• Same definition of risk- the variation of future
  results from expected values
• Rely on same fundamental concepts
• Risk pooling
• Risk transfer
• Therefore we have convergence as insurance
  company managers, owners and customers must
  recognize and understand

60

• Risk management fundamentals
• What is risk?
• Is risk different if building a new plant in
  Jakarta?
• Currency
• Language
• Training / hiring
• Laws
• Separate
• Hazard risk management
• Financial risk management

61

• Objective of risk management - to contribute to a
  firms value
• Factors
• Unmanaged risk reduce value of firm
• With increase in risk, cost of doing business
  increases
• Results in lower levels expected cash flow
• Reciprocal is that
• Reducing risk increases cash flow
• Increases value of firm

62

• Risk assessment
• Identification of exposure
• Analyzing to determine potential impact
• Assets subject to loss
• Tangible, intangible, human
• The analysis should answer
• What assets are exposed
• What perils can cause harm
• What are potential consequences

63

• Financial loss
• Property
• Real property
• Personal property
• Intangible property
• Net income losses (revenue less expenses)
• Fire losses
• Auto accident
• Employee injury
• Magnitude function of revenue decrease
• Insurance terms - time element or business
  interruption because it is time dependent

64

• Liability losses
• Occur when parties assert legal rights
• Many types - mostly civil in nature
• Defective products
• Environmental impairment
• Injury to employees
• Breach of contract
• Profession errors or omissions
• Huge cost associated with defense even if no
  liability

65

• Personnel losses - human assets
• Injury
• Disability
• Death
• Retirement
• Resignation
• Kidnapping
• Which consumes most time?

66

• External influences broadening scope of risks
• Globalization
• Industry consolidation
• Deregulation
• Regulatory attention to corporate governance
• Sarbanes-Oxley
• Technological progress enabling better risk
  quantification and analysis

67
Internal Factors

• Increased firm value the emphasis
• Reduces inefficiencies inherent in traditional
  approach
• Improving capital efficiencies
• Stabilize earnings
• Reduce expected costs of external capital

68
Forces Creating Uncertainty

• Technology and Internet
• Increased worldwide competition
• Freer trade and investment worldwide
• Complex financial instruments, notably
  derivatives
• Deregulation of key industries
• Changes in organizational structures resulting
  from downsizing, reengineering, and mergers
• Higher customer expectations for products and
  services
• More and larger mergers

69

• Enterprise Risk Management (ERM)
• Synonymous with
• Integrated Risk Management (IRM)
• Holistic Risk Management
• Enterprise-wide Risk Management
• Strategic Risk Management

70
Alternatives to Insurance

• Retentions
• Self Insurance
• Captives
• Mutual Company
• Industry developments as alternative
• Weather
• Loss portfolio transfer
• Finite
• Securitization

71
Retention Capacity
Rules of Thumb

• Shareholders Equity 2 - 3
• Pre-tax Earnings 5 - 10
• Cash Flow 4 5
• Total Assets 1 2
• Earnings 10

72
Risk Management Continuum
Mitigate
Retain
Transfer
73
Lets see how well we have done
74

• 1937 New London, Texas
• Natural Gas explosion is school over 200 killed
• Now use t-butyl mercaptan or thioplane

75

• 1989 Exxon Valdez
• Spilled 10.8 million gallon of crude of coast of
  Alaska, Prince William Sound
• Now require double hull crude carriers in all US
  ports
• March 2009 Korean vessel found a drilling rig
  lost after IKE, Double Hull prevented any spill

76

• 2004 Explosion BP plant Texas City
• Extensive damage. BP admitted fault but ignition
  came during recovery cycle but fatalities due to
  location of work trailers

77

• 2005 Hurricane Katrina Rita
• Failure of flood gates New Orleans
• Inadequate wave clearance offshore platforms
  for class 5 storm
• Inadequate response FEMA

78

• 2008 Hurricane Ike
• Class 2 winds offshore
• Class 5 storm surge Galveston Bay and Trinity Bay
• Now referred to as Integrated Kinetic Energy
• Over 2,000,000 million customers lost power.
• Unforeseen especially by CenterPoint.

79

• 1984 - Bhopal India- Union Carbide pesticide
  plant
• 300 killed, thousands injured release of 42 tons
  of methyl isocyanate
• Plant was not following safety and operating
  guidelines of Union Carbide

80

• 1986
• Chernobyl, Ukraine explosion released more than
  400 times the radioactivity than with atomic
  bombing of Hiroshima
• Built a sarcophagus a cover for the reactor
• That and Three Mile Island incident stopped any
  nuclear construction, in US in 1970s.
• Now 4 projects being considered in Texas

81

• 2002
• Approved repository site in Yucca Mountain Nevada
• Operational 2010, to be sealed 2035
• Repository in solid rock 1000 feet underground
  and on average 1000 feet above water table
• Holds 77000 metric tons of waste
• Plulonuim-239 has half life of 24000 years
• Cost 9 billion
• 2010 budget includes no funding for Yucca
  Mountain
• Present 100 nuclear plants-20 of electricity
• 30 plants in planning stage

82

• Asbestos- Alaska Pipe Line recognition Asbestosis
  and mesothelioma but was used in shipbuilding in
  1940s
• Used by the Ancient Greeks because of its soft
  and pliant properties- the miracle mineral
• Over 80 companies involved with asbestos have
  filed for chapter 11 beginning with Johns
  Mansville

83

• US Air Flight 1549
• Sulley Sullenberger
• Airbus A 320-214
• N10GUS

84

• 1988
• North Sea- Piper Alpha Platform
• Explosion many workers killed platform severely
  damaged.
• Equipment stacked near crew quarters
• Due to economic effort for more production

85
SEMPRA Energy

• Owners of San Diego Gas Electric- SDGE
• 2007 Wildfires in California
• Have 1.1 billion tower of liability insurance on
  aggregate basis and now totally consumed.

86

• But in all my experience, I have never been in
  any accident of any sort worth speaking about I
  have never seen but one vessel in distress in all
  my years at sea. I never saw a wreck and never
  have been wrecked nor was I ever in any
  predicament that threatened to end in any
  disaster of any sort.

87

• EJ Smith
• Captain-Titanic
• 1907

88

• We can add others not directly part of energy but
  which impact us all
• 9-11 2001
• Enron 2001
• AIG 2008
• Banking system 2007-08
• We do live in a risky world