Forget the windstorms, forget the floods. The real action in risk management over the past couple of years has been in the noncatastrophe department: wrestling with the insurance placements for a $22.5 billion company called Halliburton and its former $13 billion subsidiary, KBR.
To the outside world, the separation took place in November 2006 when KBR was spun out from Halliburton. But for the risk management community, the process really ended in April when the two companies completed the divorce of their insurance programs.
When the time for the breakup finally came, Halliburton's Director of Risk Management James W. Ferguson was ready, his contingency plans in place. They were the result of a query issued five years earlier by Doug Foshee, Halliburton's former chief financial officer, who asked what Halliburton's insurance program would look like if it split the insurance coverage for its energy services and engineering units. "I did some research and told him that for an extra $10 million per year we could have two really good programs," says Ferguson.
But $10 million was too much for Ferguson's bosses. Instead, Halliburton kept the insurance program intact until late 2006 into early 2007 when the announcement was made that KBR would be spun off as a separate company through an initial public stock offering.
"We had been getting ready to split everything at the initial public offering, but we actually only split the D&O because at that point we would have separate boards," says Ferguson. "It was fairly innovative. We did not just buy extended programs for our current policies. We added two totally new programs so that any claims that arose that predated the IPO would be covered."
The D&O transaction was complicated, as provisions in the policy concerned coverage of subsidiaries, says Bain Head, senior vice president for the financial services division of Birmingham, Ala.-based McGriff, Seibels & Williams Inc.
"We decided the best way to proceed was to create a separate D&O run-off with an extended tail," she says.
And so they did, with KBR brokers taking over the insurance placements as of the separation date.
"The negotiation was on how to pay for a set of two similar policies," Ferguson adds, looking back on the discussions. "We had several discussions on whether one plus one equaled one or equaled two."
In addition, Halliburton also held some surety bonds for KBR in exchange for a fee, Ferguson says.
For KBR and David Fox, its director of risk management, the separation was like starting fresh in a way. Fox and his team had to determine what insurance programs would be best for the organization, now freed from its behemoth parent.
But by the same token, KBR had a strong legacy and track record with brokers and carriers inherited from Halliburton.
"The first thing I recommended was to have risk management as part of treasury rather than legal," Fox says. One of the advantages is that insurance, credit and cost of capital are all in one place.
"We don't just see risk as hazards," says Fox, who saw an opportunity to inculcate an enterprise risk management mindset into KBR. "We get a lot of early signals through the financials. And we have the opportunity to elevate awareness. It is important for us to stay close to our colleagues in the legal department, but within finance we can see risks early and act early."
Fox says the smartest play was to stick closely to the policies and programs as Halliburton had them. That would keep things simple on the risk management side--"straight down the middle of the fairway," Fox says--while the other complexities of the tricky separation were sorted out.
"The idea was to do something broader than just insurance," says Fox. "We wanted to move to enterprisewide risk management."
A four-phase approach was born. Phase one, in August 2006, was a request for proposal from brokers who would represent KBR. "We wanted to get them on board early. We called seven, and thought we would choose one to keep it simple."
KBR ultimately signed with four: Aon, a legacy broker from Halliburton for primary casualty coverage; McGriff, Seibels & Williams, also a legacy for financial services, D&O and fiduciary coverage; Wortham Insurance & Risk Management, a new Houston-based broker, for the excess liability program; and Benfield, the London house that had just opened an office in Houston to handle property lines.
Phase two began with the IPO last November. "At the initial separation, we were trying to mirror the program we had at Halliburton for KBR," says Fox. "That was set in motion with the brokers."
The third phase consists in reassessing the insurance program as a stand-alone company, and the last phase is to customize the policies as renewals come up.
"We wanted both stability and innovation," says Fox.
The key decision, Fox says, was to replicate the Halliburton program and avoid the temptation to start tabula rasa.
"We had to make a few adjustments, just nits here and there, but we were not trying to beat the market. We just wanted to get it done rather than trying to tailor fit the program before the separation was complete."
There was an exception, however, in the property coverage area. "We are a professional services company with just a smidgen of the property in the Halliburton portfolio," Fox says.
Overall, Fox also says the carriers were "very receptive. There was a lot of disclosure," says Fox.
The last two phases are going according to plan, and KBR is poised to execute on an enterprise risk management plan. "ERM is always a stretch--that is the point--it is a topic that everyone internally has to get their heads around, and the brokers are much more comfortable now," he says.
Risk managers, brokers and the support teams involved in assuring KBR's coverage in the wake of the Halliburton separation might be tempted to wallow in a little self-congratulation, but Fox is more excited about the future.
"It was an interesting opportunity to create a program out of whole cloth--it has been fun," he says. "But I look forward to the ERM and implementing that through our referrals."
"The key is Fox's understanding of ERM," says Bill Martin, CEO of Benfield Corporate Risk, the U.S. operation of the London house. "This has been a great chance to form a partnership."
The main strength of the ERM approach, says Martin, former president of the U.S. Marine & Energy group at Marsh, is the "ability to illuminate risks that underwriters may not understand; to go to the market with common parameters. In effect, ERM is a sophisticated form of preunderwriting."
Echoing Fox, Martin says he is savoring the next opportunity rather than the just-completed success. "Now we are getting into the nitty-gritty of how to reduce their total cost of risk."
While the D&O program was the only one to be split at the time of the IPO, the excess liability program provided brokers with its own set of challenges. "Excess liability was tricky," admits John S. Parsley, executive vice president with Newport Beach, Calif.-based Alliant Insurance Services Inc., now part of the investment company Blackstone Group. "We had to recast the loss experience as if Halliburton and KBR had been separate all the way back.
"Also, it took a little finesse to get to the proper people at the carriers, to break through the silos,"he says. London reinsurer Lloyd's, for example, is generally more flexible on marine/energy than on nonmarine lines.
In the first foray into the market, in September 2006 in advance of the IPO, Parsley says it was important to expose Halliburton and KBR to underwriters. "We had sat around the same table twice a year for the past 20 years and talked around this subject, now it is for real," he recalls.
Though tempted to tweak the programs, Parsley, who had been with Aon on the Halliburton account, says it required some discipline on the part of brokers to stick to Ferguson's blueprint of mirror-image programs for Halliburton and KBR.
"As a broker, there was the intellectual challenge of wanting to change things," says Parsley. "But that was not the brief, so we did not do that."
The looming renewal dates were also a challenge, and it was important to get the market to agree to two policies even as Halliburton last fall still had majority control of KBR, Parsley also says.
Premiums were the specter in the back of everyone's mind. "Cutting a $20 billion program into two $10 billion programs is still a big placement," says Parsley.
Remember that at the time the market was still "limping along" after paying out big sums from two years of hurricanes in the Gulf. Placing that kind of cover wasn't a slam dunk by any means, even for a company like Halliburton. "We did considerably better than we expected," says Parsley. "Good presentation was critical."
Head at McGriff had formerly headed a team at Aon that handled coverage for Halliburton. When she moved to McGriff in 2001, she picked up D&O, fiduciary liability and commercial crime insurance for Halliburton the following year.
If there was one broker familiar with the insurance coverage of Halliburton and its subsidiaries, it was Head. And so when it came time to split the D&O program at the time of the November 2006 IPO, the broker had what she thought was the perfect structure in place.
"We had everything set in July, lots of carriers, lots of Bermuda capacity, 14 layers, three programs: two continuing and one run-off," says Head.
But the Friday before the coverage was to take effect, brokers were sent scrambling after they were informed of a possible delay in the IPO.
A complication had been found in the reporting of a KBR offshore project, and the entire public offering had to be put on hold. "We decided to extend the existing program pro-rata rather than renew," says Head. "There had been no claims, and the underwriters were being very accommodating. We would then go back to the original plan of the three programs once the IPO was rescheduled."
The objective was to minimize the chance of any coverage gap.
"We wanted the exact same language, the exact same carriers and the exact same attachment points," says Head. "Three identical programs: one for Halliburton, one for KBR and one run-off. The only difference was the negative language."
KBR was excluded from the Halliburton program except for Halliburton's role in management, whether that was control or advisement.
Halliburton wanted to push as much as possible into the run-off, and some of that had to be "clawed back," as she puts it.
"It was a complex moving picture. There was a lot that was not known. At the end the language was similar, but not identical, and the carriers were the same."
Head says the D&O program became the model for the fiduciary liability program. "The language that we so painstakingly negotiated into the D&O coverage made the fiduciary coverage a little easier."
One further wrinkle, Head says, is that the transaction was a true split and not a spin-off. "There is significant company stock in each employee benefit plan," she notes. "Who makes the decision on converting that?"
Eventually, the companies agreed to hire a third party, U.S. Trust, to vote the shares.
Fox says he's delighted with the brokers who handled the separation and gets a kick out of having Bob Hixon, the new chairman of Wortham, as his broker.
Like many brokers and buyers in the industry, Fox, Hixon and Ferguson go back a long way.
"We knew Jim (Ferguson) for years and did some ancillary builders risk and marine liability, but Wortham was not a major broker," says Hixon.
"We were asked to submit a proposal on the split, and were chosen to be the broker for KBR's builders risk and excess liability," he says.
Dealing with Halliburton and its subsidiaries, after all, did require extra care.
One challenge, for example, was making carriers comfortable with KBR's lucrative but potentially embarrassing military contracts.
"We felt like KBR and the carriers should look at the armed-services work as off the table," says Hixon. "The Defense Department is the sole remedy for those exposures, and there is not much third-party risk."
With that understanding, Hixon says that a lot of the heavy explanatory lifting has been done and that he and the carriers are now in a better position to modify KBR's program as renewals come due.
A similar challenge, says Hixon, is helping underwriters understand KBR's oil and chemical business.
"The owners in that industry, Shell, Chevron and Exxon, are providing a great deal of the coverage," he says. "Our coverage is really just excess liability."
Robert Stubbs, formerly of Jardine Lloyd Thompson Group and now founder and president of Bermuda-based Foram Brokerage, is another of the long-term brokerage partners.
"I have known Jim (Ferguson) on and off for 15 years," he says. "As part of the spin-off, he moved the Bermuda portion of Halliburton's D&O to Foram. He also knew that I worked closely with Bain (Head) at McGriff."
Cooperation among the brokers was essential to Halliburton and KBR through the separation.
"We knew this was going to be a tough placement," he says. "No one knew the exact date. But we did know the goal, which was to replicate the coverage, if not better it in terms of endorsements and enhancements."
There was also some variation in underwriters.
"Underwriters have different appetites for exposure," says Stubbs. "Some were keen on Halliburton or KBR. So we were filling in the gaps in some cases."
In some instances that filling in was done in person. Tax laws forbid Bermuda carriers from meeting with U.S. insureds in the United States. As a result, Ferguson flew to Bermuda to meet with four incumbent carriers and four new carriers interested in joining the insurance program.
"He knows everything about the company, and everyone was very comfortable with the split," says Stubbs.
That was absolutely key in reassuring carriers, given their nervousness regarding Halliburton's connections to Vice President Dick Cheney, the drumbeat of negative news coverage about Halliburton overcharging the U.S. government and its financial restatements.
Two things were tricky, though, Stubbs recalls. One was the start-stop-restart timing of the split.
"The existing programs and the extensions were not valid forever," he says. "We had to keep updating their understanding of the split so that everyone stayed comfortable."
GREGORY DL MORRIS lives in New York City.
THE OTHER COVER STORY COMPONENTS:
RELATED STORY: The KBR Story
WEB EXTRA: The End of the Beginning and
the Beginning of the End
October 1, 2007
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