RISK MANAGERS PROFILE SETUP OF TWO ASIAN CAPTIVES

HONG KONG -- While few Asian parent companies have captive insurance companies, the oil and petrochemical industries are the exception.

The sole captives of South Korea and the Philippines both are domiciled in Bermuda and owned by oil and petrochemical companies.

Risk managers from Seoul-based SK Corp. and Manila, Philippines-based Petron Corp. profiled their captives at the first East Asian Captives Forum, held at Hong Kong's JW Marriott Hotel Sept. 16-17.

Petron Corp. is the Philippines' largest oil company, supplying 42% of the nation's market. It has 40 storage depots and 1,000 gasoline stations scattered throughout the Philippines.

Carlos H. Yturzaeta, risk manager for Petron Corp. and general manager of Petrogen Insurance Corp., said Petron established its captive in Bermuda in November 1995.

But the company began moving toward self-insurance much earlier; in 1990, it established a motor vehicle self-insurance fund. Other risks were insured in the traditional markets.

"Because of our good loss record," Petron was able to save 30 million pesos ($681,000) after three years, Mr. Yturzaeta said.

Petron's fund expanded to cover other risks, though not its oil refinery or its largest oil storage terminal.

"We set aside the premiums we would have paid the insurers and deposited the money in the self-insurance fund," Mr. Yturzaeta said. A good loss ratio meant "substantial" funds were added to the pool, he told the forum.

The next step was calculating the premiums that would have been paid if the company had bought insurance for environmental impairment liability, pollution, and directors and officers liability. The premiums that would have been paid for those coverages over six years added $22 million to the fund. Previously, these risks were uninsured, Mr. Yturzaeta said.

Mr. Yturzaeta said employees were trained to "act like risk managers" and were given incentives to be risk-conscious. Risk management coordinators were appointed throughout the company and sent to training programs within and outside the Philippines.

Rates for Petron's traditional insurance programs were decreasing, and the company also increased deductibles. For example, the deductible for the refinery, now valued at $1 billion, was increased progressively from $2,000 to $200,000.

Assets also were revalued to "reflect the correct insured values." Valuations first were done in 1991, and then every three years, by appraisers acceptable to the lead underwriters.

"We became more confident that we were properly covered, and the reinsurers were more comfortable with our risks, as they could compute the (estimated maximum losses). . .as a basis for their underwriting," he said.

Before establishing a captive, Petron gathered historical data on losses and premiums over 10 years. "We met service providers, brokers, reinsurers and captive owners. An independent captive manager validated our feasibility study and, after some recalculations and verification of the captive insurance markets, we decided to set up the captive in Bermuda," Mr. Yturzaeta said.

"Set up your own study, because you know your risks better than anyone, but get an independent study to validate your own," he said.

He told prospective captive owners to carefully evaluate domiciles. "What can they offer, apart from good beaches and summer holidays? Choose the domicile which gives you the benefits you are looking for," he said.

Mr. Yturzaeta said a hybrid of the internal and external studies was presented to the management board before it gave the go-ahead. That process took four years. Petron still is the only Philippines-based company to own a captive. "A lot of people talk to me about it, but they must start with a general appreciation of risk management first," Mr. Yturzaeta noted.

Petron took $1.5 million from its self-insurance fund to establish the captive. In its first year, it earned about $650,000 from a single property program. The captive, Overseas Ventures Insurance Corp. Ltd., now writes property/casualty and marine cargo risks for Petron.

While Petron uses a captive manager, IRM Ltd., Mr. Yturzaeta said he had not "relinquished placement of retrocession." Reinsurance brokers handle administrative documentation only.

Mr. Yturzaeta's philosophy is to get three-year placement deals with reinsurers. "We need stability in our rates. You can find cheap rates, but as a prudent insurer, you must look at the capabilities of your reinsurer."

Direct access to reinsurers was "a big factor" in Petron's decision to establish a captive. "We have less need for brokers, because we are an insurer ourselves; commissions previously earned by brokers now go to us," he said.

Because the Philippines Insurance Commission required a fronting company in the Philippines before a risk could be written offshore, Petron established its own domestic insurer, Petrogen Insurance Corp., in 1996. Again, the self-insurance fund provided the capital required.

Mr. Yturzaeta said the captive has earned $1.2 million over the past two years. The domestic insurer's income was $1 million in its first year.

Petron still maintains the self-insurance fund to cover its uninsured risks.

Mr. Yturzaeta said captives and insurance are only a part of the risk management program and that a "top-to-bottom approach" is required for any program to be successful. Petron's program combines risk control and risk financing, using a combination of traditional insurance, deductibles, a self-insurance pool, and the onshore and offshore captives.

Joonsung Choi, manager of insurance, group finance and the insurance team for SK Corp. in Seoul, South Korea, said his company chose Bermuda as a domicile because it offered a favorable investment environment, a strict supervisory system, and a reduced tax burden for the parent company.

As Korea's first captive, approval was required from the Ministry of Finance and Economy, and SK Corp. had to convince domestic insurers there would be no negative effects for them.

The finance ministry restricted the captive, SK Insurance (Bermuda) Ltd., to writing reinsurance only, which left the status of domestic insurers unchanged.

It took SK three years to implement the plan; the captive was established in September 1996.

In its first year, the J&H Marsh & McLennan Inc.-managed captive wrote SK's non-marine package, with a total premium of $19.3 million, of which the captive retained $3.6 million.

The captive's earned premiums in its first year, fiscal 1996, were $2.4 million, with a net operating profit of $176,000. In fiscal 1997, earned premium rose 16% to $2.7 million, with a net operating profit of $124,000.

After a clean loss record in its first year, Mr. Choi said SK considered supplementing the captive with a finite risk program to write its primary layers, after a 15% share was written by the domestic insurance market, but decided against it.

In November of last year, at its second renewal, SK again considered a finite risk program to supplement the captive, but the soft market and the lead domestic insurer's "more aggressive attitude" meant the conventional program was more competitive.

Before this year's renewals, SK is benchmarking its captive's performance against that of Japanese oil companies' operating captives. While the risk profiles are similar, Mr. Choi said the Japanese captives generally retain smaller portions of the risk, and that the captives' purpose is "mainly to avoid domestic tariffs and secure lower rates from the international market."

Mr. Choi plans to increase the captive's net retention level gradually and to integrate the separate non-marine, marine and energy, petroleum/liquefied petroleum gas filling stations, aircraft refueling liability and auto packages into a single, multiline package.

He also plans to change the captive's status from an indirect reinsurance captive to a direct captive.

Examining lessons learned by SK in establishing its captive, Mr. Choi said the initial capitalization, at $10 million, could have been less.