JUDITH C. HANRATTY: EXECUTIVE PROMPTED OIL GIANT TO REASSESS TOLERANCE FOR RISK RETENTION

Judith C. Hanratty has given The British Petroleum Co. P.L.C. a better understanding of its risks, while showing other risk managers on a grand scale new possibilities for self-insurance.

Rather than spread its considerable risks among insurance companies, most of which had fewer resources than BP, the oil company under Ms. Hanratty's guidance chose to spread them even more broadly -- to its shareholders.

Ms. Hanratty, 54, a barrister specializing in constitutional and administrative law in her native New Zealand, moved to London in 1986 to assist in the privatization of what is now The British Petroleum Co.

She had planned to stay 18 months as a member of the BP share sale team. During that time, however, the scope of the work of the share sale team changed to include the purchase of Standard Oil of Ohio and Brit Oil. Ms. Hanratty decided to extend her stay when she was asked to run Tanker Insurance Co., BP's captive insurance company and insurance adviser.

She now is company secretary of BP.

Among many official posts in the United Kingdom, Ms. Hanratty sits on the Insurance Brokers Registration Council, the Monopolies and Mergers Commission and is a governor of the College of Law in London.

Ms. Hanratty recently spoke with London Bureau Chief Sarah Goddard about her experiences at BP and TIC.

Why did you decide to remain with BP after the privatization?

The remit was to try to bring the philosophies relating to insurance from Standard, Brit Oil and BP into some cohesion. At the time, there were differences among the three because the organizations approached problems in different ways. I had to decide then whether I stayed or went back to New Zealand. It was tempting to do something really with a lot of scope, and I was interested in the financial and economic sides.

I came into this with a completely fresh mind, which I guess is not a tradition of the insurance industry. At the TIC, all the staff had joined virtually as cadets and been in the same organization all their lives. I think that's probably true of much of the industry at that time.

What were the problems you faced as you took over TIC?

BP was running a variety of insurance activities across its empire. I think partly because of the organization of the company, it was heavily based on country autonomy, so there was quite a lot of doing their own thing in separate countries. There were two strands to the whole thing; one had to try to amalgamate in an administrative sense and to get people working in a team.

Insurance was a bit of a mystery to the rest of the organization. People thought they knew all about it because they bought their own car insurance, but then when it got bigger and it was refineries, they left it to the professionals.

There was a regime that sopped up all the larger things into the Tanker Insurance Co. Most of the insurance-related arguments we had with managers in the different countries were over price, and TIC swept all the problems away. So it was a residual insurance risk-bearer. It was run as an insurance company.

There it was, happily trotting along, and I think people were content to see the evening out of cash flows in various businesses, and it reinsured out very substantially. But there were some structural reasons why it could only participate to a partial extent in underwriting large platforms in the North Sea, for example. Those were going out for a much more substantial placement in the market.

So there was a fair amount of premium actually going into the insurance market, albeit managed by TIC, and so my attention was drawn to that money. Payment was being provided in such a way that if one was to look at the efficiency of the organization, what it was doing, who was doing it, whether it really was answering the demands of its customers, if you like, it was not as efficient as it could have been.

How did you tackle the international aspects of BP's risk exposures?

In some places, such as America and Australia, there were local mandatory insurances, so we had funded systems and so on. What we have done is systematically used the best practice in one place to enforce higher standards elsewhere, and what you find is though things are different in another place, you try and match it with its own funny, quirky requirements. I engaged the local office of a global broker -- but not always the same one -- in each place and told them what I wanted, for what I call the domestic side.

We created a competitive environment from the start and put an enormous amount of work and imagination into it. There was a certain amount of mutual learning, and we kept on testing them against each other. We've now gone miles further in what I call partnerships with suppliers. At that stage, in 1991 and 1992, we were probably pretty much at the leading edge in asking people to be partners with our insurance. And it took a long time to understand what that meant: that we would measure their performance, pay them according to whether they achieved certain preset targets. This was even different from a fee; this was saying that is your basic expectation.

I think we rowed the boat out further than anyone else at that stage. For example, we took all of the people dealing with our domestic U.K. insurance within BP and required the broker to hire them to handle BP's business from inside the broker's office.

Basically, we were buying a service and the people, and there was really no way that in BP you could grow that sort of person.

In what ways did you tackle and bring together the attitudes toward insurance brought to the table by the three organizations: BP, Standard and Brit Oil?

Standard Oil had purchased quite substantial insurance for its upstream operations. Really, I wondered why that should be, because it was a very, very large organization, with $35 billion capitalization, and I couldn't really understand why insurance was special and different from the way they looked at any other financial activity.

Myself and a colleague tried to rationalize the purchase of insurance. Then it transpired from thinking that way that really there was no value to the shareholder. This comes into focus because BP had transformed themselves over 1988, 1989.

When we came in in 1990, we analyzed this on the basis of what benefit there would be paying this amount of money to shareholders. BP already was well diversified and was paying to reduce volatility in cash flows, but in fact we could well absorb it ourselves. To some extent, insurance appeared to give a solution to managers -- it was a psychological device. Because we're insured, it doesn't matter -- we've passed the problem somewhere else. So you had to think, well, there is a downside to all this as well, apart from the financial one.

As became obvious with the distressing events of the Exxon Valdez, there is the point of managing crises, giving people the confidence that management understand the risks, and putting them right. And because of the technical and specialized nature of the oil industry, that is a very substantial part of investor confidence. Reputation is absolutely vital, and an insurance policy cannot save your reputation.

We did an analysis on what our expectation of loss would be at various levels: Less than $10 million, between $10 million and $500 million and above $500 million. We tried to match the analysis to some rule of thumb-type feeling against the insurance industry.

The analysis showed a relatively infrequent one-in-30-year possibility of a loss more than $1 billion. The average annual loss in the category of $10 million to $500 million was about $70 million a year. That is a number that could be easily eaten by the general finances of the group. It was very easy for it to eat those up as they occurred, simply allowing them to happen. And in that context we accepted that individual managers would not be blamed or penalized by the financial effects of these, if they did not arise from culpable misdemeanor by them. The emphasis moved off the purely financial side; they really had to understand all the risks of the organization as a whole.

BP is now self-insured for the vast majority of its program. What made you decide to pull your coverage from the traditional insurance market?

We realized that effectively insuring is not much different from other financial transactions -- you borrow the money before you know whether you are going to need it -- and with the changes in technology, you very well may not need to do it.

And you were paying something on the order of 30% in interest and transaction costs. I think the reason was the poor old insurance industry was swallowing these things as best it could at that time in the late 1980s, and we were saying these people were just handing these things on, and the premium dollar was ending up substantially less when it gets to the ultimate risk- bearer. You only had to look at the major slips to realize that this was a massively complex process.

Very shortly after I took the job, they were still trying to solve a claim that was on the liability account. The claim went into three markets and it made me realize then that when you get to very large claims, there is a value to the insurers in delaying. These large lumps of money are very hard to manage for any organization. I think the industry at that stage really wasn't well equipped; it certainly wasn't able to efficiently deal with the large claims. The efficiency has improved enormously; the bigger players are looking all the time at ways in which they can diversify out into the capital markets.

BP came to a clear conclusion that its insurable risks were of a nature that it would be more economically efficient for the shareholders to diversify that risk into the capital markets. Ninety-seven percent are diversified funds. The reality is the point at which there would be a real impact has only one or two possible scenarios -- where the immediate impact would be more than $2 billion.

The TIC sits as a small instrument that can be used by the corporation when it's appropriate, for example when it needs to buy insurance for a joint venture. It doesn't buy reinsurance and is capitalized to $500 million.

Are you considering using the capital markets for BP's catastrophic coverage?

We have been looking at that. They just need time to develop, but that doesn't mean to say that they aren't doing interesting things. I don't think we are in a position to really be a vanguard, but we have a very active watching brief on what is going on.

What impact has your approach to the insurance program had on BP?

We split risk apart, really. We put a lot of heavy responsibility onto others. The other thing is that we said this insurance was just simply a swapping shop, the TIC became an institution. Since the privatization, BP has atomized into 80 business units, and the managers have the responsibility of understanding risks. They have all the processes necessary to deal with the risks themselves with due guidance from the corporation as a whole.

It has driven a better understanding of risks. There is a better-managed process to analyze, understand and price risks, and the continual evaluation of what might be happening in the outside world that might be of value to the shareholder.

We have continued to add up what we have saved. We are banking the stream of money that would have come back if the risk had happened, and that which would have been lost in transaction costs. It is a very substantial amount of money over a period of time.

Since we did this, the corporation has become more diversified. It has a bigger spread of activities across the globe, and each time we add a different and uncorrelated risk to the corporation's portfolio, we are constantly carrying out an internal diversification process.

What changes do you see happening in the insurance and risk management world?

There is a never-ending science of understanding risk and quantifying it, deciding the best balance of risk the individual organization can bear and how to get rid of risk that it feels is unwise to bear. People will go on inventing better instruments and put pressure on producers. I don't think we will ever cut out brokers as a profession, but they are not necessarily always going to act as an intermediary.

There will be certain products where a risk manager will feel confident as a buyer to buy them because they know them or trust the brand. But sometimes they need professional advice before they go and buy the brand.

It can be hard for people to go out and get the best product for themselves. The intermediary must provide it at the point it can really add value and is truly acting as a professional.