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CaseStudySPRING2016StrategicDecisionMakingExamEXAMCFESDMCFESDMMorning1EDUCATIONANDEXAMINATIONCOMMITTEEOFTHESOCIETYOFACTUARIESSPRING2016EXAMCorporateFinanceandEnterpriseRiskManagementStrategicDecisionMakingCASESTUDYRPPCDynastyCorporation:ABoxFullofGrowthCopyright2016SocietyofActuariesTheEducationandExaminationCommitteeprovidesstudynotestopersonspreparingfortheexaminationsoftheSocietyofActuaries.
Theyareintendedtoacquaintcandidateswithsomeofthetheoreticalandpracticalconsiderationsinvolvedinthevarioussubjects.
Whilevaryingopinionsarepresentedwhereappropriate,limitsonthelengthofthematerialandotherconsiderationssometimespreventtheinclusionofallpossibleopinions.
Thesestudynotesdonot,however,representanyofficialopinion,interpretationsorendorsementoftheSocietyofActuariesoritsEducationandExaminationCommittee.
TheSocietyisgratefultotheauthorsfortheircontributionsinpreparingthestudynotes.
2TableofContents1RPPCDynastyCorporation31ARPPCDynastyCorporationExhibits152BlueJayAir232ABlueJayAirExhibits303BlueJayTireCo443ABlueJayTireExhibits514FrenzCorporation544AFrenzCorporationExhibits615BlueOceanP&CCompany705ABlueOceanP&CCompanyExhibits796BigBenBank806ABigBenBankExhibits857DarwinLifeInsuranceCompany877ADarwinLifeInsuranceCompanyExhibits96DisclaimerThecompaniesandeventsdepictedinthisCaseStudyarefictitious.
Anysimilaritytoanyevent,corporation,organizationandpersonlivingordeadismerelycoincidental.
WiththeexceptionofAppendix3AExhibit4whichconsistsofrealpressreleasesrelatedtotheairlineindustry,somenarrativematerialutilizesreallocationsandrealnewsorganizationstomaketheCaseStudyseemreal.
TheAssociatedPress,WallStreetJournal,Standard&Poor's,A.
M.
Bestandothersusedinthiscontexthaveneveractuallycommentedonanyofthefictitiouscompanies.
3RPPCDynastyCorporation:ABOXFULLOFGROWTH1RPPCDynastyCorporation1.
1IntroductionTheleavesrustledasJuliaandEmmanuelwalkeddownthetrailthatsurroundedFrenzCorporation'shomeoffice.
Theautumnairwasrefreshinglycoolandawakenedthesensesandmindafteranexhilaratingandexhaustingtwoweeks.
"Iappreciateallyou'vedonethepastcoupleofmonths,"andhandingJuliaabox,Emannuelsaid,"Ithoughtthiswouldbeappropriategiventhewordsofwisdomyousharedatthebeginningofthistrip.
"Sheunwrappedthegifttofindaboxofgourmetchocolates–oneofthemanyproductsFrenzsold.
JusttwoweeksearlieronOctober6,2012,shewaswithelevenotherswaitingattheairport,partoftwoCorporatePlanningTeamsassignedtovisitmanagementatRPPCDynasty'smajorbusinessesandreviewtheir3-yearplans.
Othershadaskedwhatsheexpectedfromallthepeopletheywouldmeet.
"Hmmm…myfavoritemovieisForrestGump.
Forrest'smaximwas,'Lifeislikeaboxofchocolatesyouneverknowwhatyou'regoingtoget.
'"EveryonechuckledastheyrecountedtheirfavoriteForrestGumpscenes.
Julia'steamhadbeenonawhirlwindtourtoRussia,Ontario,TexasandtheirfinalstopinAntwerp,Belgiumtotalkapparel,tires,airlinesandcoffee.
Shelookedatherwatch.
TheotherteamwasalreadyintheairontheirwaybackfromNewMexicotoDynasty'sheadquartersinLuxembourg.
HarrylookedoutthewindowandcouldseetheAtlanticcoastlineinthedistance.
Histeamhadcoveredthefinancialbusinesses–lifeinsurance,bankingandP&Cinsurance.
OnhisleftsatOliviaandSophie.
Oliviawasfullofenergytalkingaboutallthepeopletheyhadmetandtheopportunitiesthathadbeendiscussedoverthepasttwoweeks.
Therewasalottodointhenextmonthbeforenextyear'splanswerefinalizedinmid-December-alotofproposalsandalternativestoevaluate.
Ofcoursetherewerequestionsandissuestoresolve-products,markets,distribution,investmentstrategiesandimpendingregulatoryandaccountingchanges.
Somethoughttheyshouldgrowcautiouslyuntiltherecoverywasfurtheralong.
Theyfeltthatsellinginsuranceproductsandmakingbankloansinthisenvironmentsqueezedoutanymarginsandaddedtoomuchadditionalrisk.
ShethoughttheopportunitieswerenowandthatRPPCcouldn'tmovefastenough.
SherecalledthatWinstonChurchillalwaysfavoredaction-thetimetoactisnow.
Harrysaid,"Inanycasethefinancialandriskmanagementareasaregoingtobebusythenext8weeks.
RememberwhathappenedduringtheRedeployProjectlastyear.
"Juliathoughtherselfluckytohavebeengiventhisopportunity–achancetoshineinaprominentrole,achancetoreallymakeadifference.
TheRiskManagementfunctionatRPPChadonlybeenestablishedin2010.
InrealityRPPCDynastywasluckytohaveher.
Sheworkedlonghoursinpreparation.
Shehadreadreportafterreport,countlessmanagementmemos,policiesand4processdocumentsandhadlookedatnumbers,metrics,marketintelligenceanalysesandevenmorenumbers.
Shepreferredmeetinginsmallgroups.
Juliawasknownasthe"FriendlyInterrogator".
Youcouldn'tsurviveameetingunlessyou'ddoneyourhomeworkandhadthoughtthroughtheissues.
Shehelpedyoubeatyourbest.
JuliahadbeentheCRO'srighthandandwasjustappointedasCROrecently.
Herriskmanagementteamwasearningthereputationofbeingbusinesssavvy.
HerCERAstudieshadbeenusefulbutshewasgladshehadtakentheCorporateFinance&ERMTrackingettingherFellowshipin2008.
ThematerialcoveredintheStrategicDecisionMakingexamgaveherasolidbusinessfoundation,strategicmindsetandsharpenedhercriticalthinkingskills.
Bycontinuingtoreadbusinessandstrategybooksmixedinwithfirst-handexperiencehercommunicationskillsandbusinessacumenhadbeennoticed.
Lifewasindeedaboxofchocolates.
RPPCDynastyCorporationHistoryRPPCDynasty(alsoreferredtoasRPPCorDynasty)wasestablishedin2000withheadofficesinLuxembourgbyfourfoundingpartners.
Thecorporation'snameisderivedfromthefourfounder'ssurnames-Ruiz,Putin,PatelandChan.
Theyhadambitiousgoalstogrowthecorporationtobecomeitsnamesake–abusinessdynastyrespectedthroughouttheworld.
Fromthebeginning,andstilltothisday,thefocushasbeentomeettheneedsofagloballymobileclientele.
Thecorporationholdsadiversegroupofbusinesses.
LuxembourgwaschosenduetoitsbeingaEuropeanlowtaxjurisdiction.
Thebusinessrootsbeganin1985.
Mr.
Ruizwona$700,000lottery.
Withhiswinningsandhis$20,000savings,hestartedacoffeeshopbusiness.
His$720,000initialinvestmentinhisbusinesshadgrowthsteadilyintoaabilliondollarcompanytoday.
Theapparelshopbeganin1995,alsofamilyownedandoperatedbytheChanfamily.
In2000,Mr.
RuizandMs.
Chanformedapartnership.
Soonthereaftertwootherentrepreneurswerebroughtintoexpandthebrand.
In2001,withtheguidanceofMr.
Patel,aBankgroupwasformed.
In2005,theinfluenceofthemarinerbackgroundofMs.
Putin,aP&CInsurercorporationwasacquired.
TheP&Cgroupwasleadersinpersonalandcommercialmarineinsurance.
In2008,theU.
S.
financialcrisispresentedanopportunitytoacquirealifeinsurancegrouptoexpandthewealthmanagementcapabilitiesofthebankoperations.
In2010,anAirlinewasboughttoappealtothegrowingglobalmobilityofthegroup'sclientele.
TheAirlinehasbeenputthrougharestructuringinitiativetobefittedintothegroup'svision.
5RPPCDynasty'sgrowingempireconsistsofnearlytwodozencompaniesspanningavarietyofindustriesandservices.
MissionProvidehighqualityanduniquelytailoredservicetofamiliesorbusinessesthataregloballyactive.
Ourfamilyisyourfamily,comeexperienceourdifferencethatissofamiliartoyou!
!
VisionWeprovideourcustomerthecomfortofafamilyfriendwhentheyareawayfromhome.
Weareyourfamilyawayfromhome!
!
ExecutiveTeamTheExecutiveTeamincluded:CEO–Mr.
GilroyClyde(sinceinception)CFO–Mr.
HoubenHuang(5years)CRO–Ms.
JuliaReich(recentlyappointed)COO–Ms.
JaneMulroney(sinceincorporation,previouslypreformedCROfunctions)SellingaSuccessStoryMr.
HoubenHuanglookedouthiswindow.
Thetreeswerebareandthesilhouettesagainstthemorningsunalwaysleftanimpression.
Decemberwasalwaysabusymonth–finalbusinessdecisionstobringtheyeartoaclose,planningalwayswentintooverdrive,holidaygatheringsandparties,schoolconcertsandplays,decoratingandcooking.
Cookingwasalwaysfunandcamewithanimmediaterewardofwarmcookies.
OnhisdeskwerematerialsforadebtratingreviewsessionwiththeTrustyRatingAgencyonJanuary6.
Muchofthematerialwouldbeusedfortheupcominginvestoranalystsmeetingandexcerptswouldformthethemeinthe2012AnnualReporttoshareholders.
Buttheupcomingdebtissuancewasparamounttotheirgrowthplans.
LaterthismorninghewouldbemeetingformostofthedaywithGilroy,JaneandJulia.
Withinthepastfewweeks,theBoardsofDynastyanditsmanybusinesseshadadoptedmanyofManagementsrecommendations.
TheBoardshadalsosentafewproposalsbackforfurtheranalysisandconsideration.
TheCorporatePlanningTeamshadbeeninvaluableworkingwiththebusinessesandtheirplanningteams.
TheTrustyPresentationMaterialshighlightedtheDynastystory-mainmessagesandpointsManagementwishedtoarticulate.
Someofthecontentwasdoneandsomeneededtobeupdatedorrevised.
Houbenhadscribbledsomenotes–howdidthematerialconveyandpackagethefollowingthemesBusinessStrategiesAirlinechange,newmanagementcustomerfocusTireniche,challenged,needinvestmentorwillbesoldCoffeemarketleader,growthfocused6P&Ccashcow,niche(Marine(UK),Pet(Canada),Liability,Commercial,Catastrophic)lookingtoexpandtotheUSBankcustomerorientedwealthmanagementfocusgrowthbyM&AintegrationInsurancelongterminterestrisk(VA,LCOI)regulatorychangesApparelboutiquefastfollower(followCoach,MichaelKohrs),seasonalvolatilityTrustywouldhammermanagementonchallenges,strugglesandmissteps.
TherewereafewheadachesbutthebiggestmessagetosellwastheDynastysuccessstory.
Thereweretremendousopportunitiesintheirmajorbusinessesandtheacquisitionteamhadseveralnewattractiveprospectsunderconsideration.
Dynastywaswellpositionedtogrow.
TrustyPresentationMaterialsalsoincludeanexecutivesummaryoftheglobalmarketoutlook(seeExhibit1A).
Thisoutlookhelpsthecompanyinstrategizingitsglobalexpansionplan.
Itidentifiesareasthatthecompanyhascapitalizedfromtheseglobalmarketchanges.
1.
2GovernanceandRiskManagementOverviewGovernanceRPPChasthefollowingExecutiveCommittees:1.
Operation'sCommittee2.
AuditCommittee3.
FinanceCommittee4.
RiskCommittee5.
Compliance&LegalCommitteeRPPCRiskManagementFrameworkVisionStatementWeareexposedtoavarietyofrisksthatareinherentincarryingoutourbusinessactivities.
Havinganintegratedanddisciplinedapproachtoriskmanagementiskeytothesuccessofourbusiness.
Inordertoachieveprudentandmeasuredrisk-takingthatalignswithourbusinessstrategy,weareguidedbyariskmanagementframeworkthatisembeddedinourdailybusinessactivitiesandplanningprocess.
StrengthsandValueDriversARiskAppetitethatshapesbusinessstrategiesandisintegratedintoourdecision-makingprocesses.
Riskmanagementisconsideredaprofitgeneratingactivity.
Webelievepreventingourorganisationfromexperiencinglossisasbeneficialascreatingnewprofitstreamsfromnewarenas.
Aunifiedandstrongriskculturethatisembeddedacrosstheenterprisemeansthatthereisconsensusopiniononthevalueandpurposeofriskmanagement.
7ChallengeContinuedvolatilityinglobaleconomicconditions,causingheightenedmarketplaceuncertainty.
Thisisbothariskaswellasanopportunity.
OurPriorityBroadenandstrengthenriskcapabilities,includingenhancingourstresstestingfunctionstodeliverbetterinsightstobothourriskandbusinessgroups.
Webelieveinstronglyinassessingriskthroughavarietyoflenses,notsimplylookingatpastperformance.
OurPathtoDifferentiationWithinourindependentoversightframeworkandthelimitsofourriskappetite,contributetotheenterprise'scustomerfocus.
Ensurethatriskawarenessispervasivethroughouttheorganisation,atalllevels,andallfunctions,andthattheriskforrewardtrade-offisappliedeffectivelyandconsistentlyinalllevelsofdecision-making.
KeyObjectivesandRecentAchievementsAkeyobjectiveistocontinueembeddingourstrongriskcultureacrosstheenterprise,includingnewlyacquiredbusinesses:EmphasizeandensurethatatRPPCDynastyriskmanagementisaprocessofcontinualimprovement.
Reinforceourriskindependenceandourthree-lines-of-defenseapproachtomanagingriskacrosstheenterprise.
RecentAchievementsRPPCachievedtheroll-outofourfivestepmessageonourvaluebasedapproachtoenterpriseriskmanagement:UnderstandandmanageProtectourreputationDiversify.
LimittailriskMaintainstrongcapitalandliquidityOptimiseRiskReturnRPPCestablishedandformalisedtheroleofRiskChampiontoensurestrengthenedengagementbetweentheofficeoftheCROandBusinessoperatinggroups.
Value-BasedEnterpriseRiskFrameworkRPPCriskgovernancehasthreepillars.
IThefirstlineofdefenseatRPPCistheBusinessoperatinggroup,whichareresponsibleforensuringthatproductsandservicesadheretotheapprovalprocessandprofitguidelinesoftheirbusiness.
TheirmandateistopursuesuitablebusinessopportunitieswithintheRiskAppetite,andtoadoptstrategiesandpracticestooptimizereturnoncapitalemployed.
Theyaccomplishthisbyusingcomplicated8modelsofrisk,rewardandeconomiccapital.
RPPCofficersmustactwithindelegatedrisktakingauthority,andmusthaveeffectiveprocessesandcontrolsinplacetoenableittooperatewithinitsdelegatedriskauthoritiesandlimits.
IIThesecondlineofdefenseistheofficeoftheCRO,alongwithEnterpriseRiskOfficers(ERO's)andSubjectMatterExperts(SME's)asassignedforspecificriskcategoriesorsubcategories,whichprovideoversight,challengeandindependentassessmentofrisk.
Theseriskofficershaveasignificantinfluenceinthelevelofriskthatthecompanytakesandutilizesitsriskassessmentsinmajorstrategicdecisions.
IIIThethirdlineofdefenseistheCorporateAuditDivisionwhichinconductingtheinternalauditprocesswillprovideassessmentastotheeffectivenessofinternalcontrolincludingcontrol,riskmanagementandgovernanceprocessesthatsupporttheEnterprise,itsobjectivesandtheBoardofDirectors'dischargeofitsresponsibilities.
Theauditprocessincludesassessmentoftheunderwritingprocesses,claimsmanagement,andotherprocessesthatresultinsignificantrisksforthecompany.
TheCEOisresponsibleforthebusinessoperatinggroups.
Thisisknownasthefirstlineofdefense.
Thesecondlineismadeupriskofficers(ERO'sandSME's)whoworkcollaborativelywiththebusinessoperatinggroupsandareengagedthroughcorporatepoliciesthatsupportERM&PortfolioManagement(EPM).
TheseriskofficersaregovernedbytheCROandtheriskmanagementcommittee.
ThesecondlinehasadirectlinetotheBoardandthereforemeets"incamera"withtheBoard.
Thethirdline,theAuditofficers,alsohasan"incamera"withtheBoard.
RPPCBoardBoardRiskCommitteeCEOBoardAuditCommitteeRiskManagementCommitteeOperatingGroupsERM&PortfolioManagementERO'sandSME'sCorporateAuditGroupCapitalManagementReputationalRiskOperationalRisk1stlineofdefense2ndlineofdefense2ndlineofdefense3rdlineofdefenseRiskCultureEveryemployeeisresponsibleforriskmanagementatRPPC.
ThethreelinesofdefensemodelpromoteengagementanddialoguebetweentheBusinessOperatingGroups(firstline)andtheriskoffice(secondline)withintheprotocolsoftheCorporatepoliciesthatsupportEPM.
ThekeyfacilitatorofthisengagementprocessistheRiskChampion.
TheroleoftheRiskChampioniscriticaltoensuringthatthereisbuy-intotheprocessamongbothbusinessmanagersandriskofficersalike,andultimatelythesuccessenterpriseriskmanagement(ERM).
ThisengagementiscentraltoavaluebasedERMapproachasitpromotesunderstandingandalignmentwithourriskappetiteleadingtosounddecisionmaking.
9Insupportofanoverarchinggoalofcontinualimprovement,thecompanyhastwohumanresourcecorporatepoliciesthatimproveriskmanagement:(1)two-wayrotationpolicyTWRP:allowemployeestorotatebetweenriskrolesandbusinessmanagementroles;(2)continuedprofessionaldevelopmentpolicyCPDP:obligateemployeestoattendtrainingonriskmanagementprinciplesandtechniquesatleastonceeverytwoyears.
RiskPrinciplesAllmaterialriskstowhichtheenterpriseisexposedareidentified,measured,managed,monitoredandreported.
Riskawarenessmustbedemonstratedtodrivealldecision-makingwithintheenterprise.
Foranyrisk,ariskbasedapproachisusedtocalculateitsreportedEconomiccapital.
EconomicCapitalisusedtomeasureandaggregateallrisks.
RiskAppetiteTheRiskappetiteisatthecentreofourvalue-basedenterpriseriskmanagementapproach.
Theclearcommunicationofriskappetiteatalllevelswithineachlineofbusinessiscriticaltoeffectiverisk-takingindecisionmaking.
ThisisachievedwithabusinessspecificriskappetitestatementsthatarealignedwiththeRPPCriskappetitestatementapprovedbyourBoardofDirectors.
ThefollowingRPPCRiskAppetiteStatementisacleararticulationofthevaluecreationprinciplesofRPPC.
TheBoardofDirectorsofRPPCanditsexecutiveofficersdeclarethatthebusinessoperatinggroupswiththesupportofriskofficerswill:Donottakerisksthatareopaque,notwellunderstoodorthatcannotbewellmanaged.
Identifyandquantifylowprobabilitytailevents.
LimitexposuretolowprobabilitytaileventrisksthatcouldjeopardizeRPPC'screditrating,capitalpositionorreputation.
Subjectallnewproductsorservicestoarigorousreviewandapprovalprocess.
Ensurethattheperformancemanagementsystemincorporatesriskmeasures.
ProtectandenhancetheRPPCbrandbyexceedingexpectationintheproductsandservicesthatwedelivertoourclients.
PromotefocuseddifferentiationonproductsandservicesthatleverageRPPC'scorecompetenciestobuildclienttrustandtosurpassexpectations.
Maintainstrongcapitalandliquidityandfundingpositionsthatexceedregulatoryrequirements.
Maintaincompliancestandards,controlsandpracticesthatpreventregulatoryexposuresthatcouldadverselyaffectourreputation.
10IncentiveCompensationandRiskAppetiteThebusinessmanagementofRPPCisgovernedbyKeyPerformanceIndicators(KPI)andKeyRiskIndicators(KRI).
Allofficersofthecompanywillhavetheircompensationdependentonthefollowing:Foranyrisk,thereturnonitseconomiccapitalmustexceedthecostofthecapitalacquiredtofundthatrisk.
TheCEOofeachbusinessoperatinggroupmustidentifyandreportKPIthatindicatethatthisrequirementisbeingmet.
Thepaybackperiodoncapitalinvestedinabusinessoperatinggroupmustnotexceed10yearsfromthedatethatcapitalisfirstemployed.
EachoperatinggroupCEOmustreportKRIthatindicatefortheaggregateofallriskunderwritten,thatifthebusinessgroupweretosuffera1-in-100yeartaileventthatthecapitalthereafterwouldstillbeabletowithstandanother1-in-100yearevent.
Thisisreferredtoredundantcapital.
ThisiscriticaltoRPPC'smarketdiscipline,becauseclientrelationshipmanagementandsustainabilityispromotedoverpriceleadership.
ThroughtheidentificationofKPIandKRI,thebusinessmanagementindicateswhethertheriskbeingunderwritteniswithinthegroup'sriskappetite.
TheKPIandKRIarerecommendedbythebusinessCEOandareapprovedbyaRiskAppetiteConsensusMeetingthatincludesthebusinessexecutives,CRO,theappropriateriskandbusinessSubjectMatterExperts(SME's).
WhenreportingbusinessplansandKPI,thefinancialprojectionmustbebasedonacompletebusinesscycleinclusiveofseveremarketconditionsratherthansimplybestestimateassumptions.
WhenreportingKRI,scenarioresultsandanystresstestingmustbedemonstratedinthecontextofthebusinessanddirectlyrelatedtoitsbusinessdriver.
SuchKRIvaluebasedresultsmustbereported,wellunderstoodandaction-edatalllevelsofmanagementwithineachbusinessgroupandinallriskdecision-making.
ScenariosandstresstestsarebasedontransparentdeterministicscenariosrecommendedbytheBusinessandapprovedbytheRiskteam.
OnlyactualpasteventsaredeemedrelevantincommunicatingthefinancialimpactofaKRI.
Severityisassessedwheneconomiceventsorbusinessimpactaregreaterthanthreestandarddeviationsfromtheaverage.
RiskReviewandApprovalPolicyThispolicyoutlinestheproceduresforthedevelopment,review,andproceduresfortheapprovalofnewproductsandserviceswithintheRPPCconglomerate.
Thepolicyisimportantbecauseitbalancesthegoalofdeliveringnewproductsinatimelyandefficientmannerwiththeneedtomanagepricingandproductdevelopmentrisk.
Pricingandproductdevelopmentriskistheriskoffinancialand/orreputationallossasaresultoftheunexpectedperformanceofaproductorwherethecostsincurredaregreaterthanthoseassumedinthepricingoftheproduct.
ThispolicyrequirestheestablishmentofproductpricingguidelinesthatdescribeprofittargetsforRPPCandperformancemetricsthatmustbecalculatedforallnewproductsandservices.
This11policyalsorequirestheestablishmentofaproductpricingcommitteethatmeetsperiodicallytoexaminetheprofitabilityofcurrentandfuturesalesascomparedtotheproductpricingguidelines.
TheRoleofRiskChampionTheRiskChampionisacriticalrolewhichfacilitatestheRiskReviewandApprovalProcess(RRAP).
TheRiskChampionisresponsibleforidentifyingtherelevantbusinessmanagers,riskmanagersandSME'swhichareneededtocompletetherequiredriskassessmentandriskanalysis.
Inthisway,theRiskChampionservestheroleofarbitratorforfindingtheappropriateforumtoresolveareasofdisputebetweenthebusinessandtheriskreview.
Thepurposeoffosteringdialogueandcollaborationistobuildandmaintainthebuy-inofallstakeholdersthroughouttheRRAP.
TheRiskChampionisthekeycommunicationbridgebetweenthefirstlineandthesecondlineofdefenseintheriskframework.
Thispolicyinvolvesthefollowingstages:Feasibility–Forallnewproductsandservices,areportassessingthefeasibilityofthenewproductorservicemustbecreated.
Thisreportwillprovidehigh-levelbusinessrationaleandriskassessmentfortheproductorservice,andmustbepresentedtotheproductpricingcommitteebeforeanyfurtherdevelopmentisundertaken.
Inthisphase,allkeystakeholdersmustbeidentifiedandinterviewed,andanykeyissueswouldbeidentifiedandfurtherinformationmayberequiredbeforeproceedingwithdevelopment.
ProductAssessment–Allaspectsoftheproductdesignmustbeassessedincludingthemarketinganalysisandsupportingresearch,thedistributionplan,pricingestimates,salesprojections,riskadjustedreturnoncapital,andtaximplications.
RiskAssessment–Allaspectsoftherisksoftheproductorservicemustbeassessed,includingexposuresandratingsascomparedtotheriskappetitestatement.
Theassessmentshouldalsoincludeasummaryoftheappropriateproceduresandcontrolstobeimplemented,oralreadyinplace,thatarerequiredtomanagethenewproductorserviceonceitislaunched.
Sign-offandApproval–Sign-offandapprovalofthenewproductorserviceisrequiredbytheofficeoftheCRO,theproductpricingcommittee,andtheoperationalheadofthebusinessunit.
Thisapprovalisgainedthroughinitialfeasibilitystudyandtheproductandriskassessmentsandanyresultingsubsequentdiscussionandanalysis.
Documentation–Anofficialrecordmustbekeptofthefeasibilitystudy,productandriskassessments,andtheapprovalandsign-offforms.
Thesecouldbereviewedtheinternalauditfunction,externalauditors,orregulatorsasevidenceofappropriateduediligenceandcompliancewithinternalprocedures,aswellasprovidingtherationalefortheassessmentsanddecisionmaking.
12RiskMonitoringTherearethreedisciplinestotheriskmonitoringapproach:PostimplementationreviewRiskbasedcapitalassessmentStresstestingPostimplementationreviewisthecoredisciplinewithintheengagementapproachthatembodiesourthreelinesofdefensemodel.
Wheneverabusinessoperatinggrouphaslaunchedaninitiative,thegroupbusinessmanagersareobligatedtodevelopandreportKeyPerformanceIndicators(KPI)andKeyRiskIndicators(KRI)thatarespecificallyrelatedtotheinitiativeandthatspeakdirectlytotheriskappetiteoftheenterprise.
TheassessmentofriskbasedcapitalwithinanEconomicCapitalframeworkisoneofthekeymetricsinthemeasurementandcommunicationofanyrisktakenon.
EconomiccapitalisdeterminedbytheRiskManagementCommitteeandisunderpinnedbytheRedundantCapitalphilosophy.
Capitalisdeterminedtowithstanda1-in-100yearevent,afterwhichthecapitalpositionisstillsufficienttomeetanother1-in-100yearevent.
EconomiccapitalisalsocomparedwithregulatorycapitaltoensurecomplianceAlliedwiththeEconomicCapitalframework,strongriskmanagementandgoodbusinessmanagementreliesonidentifying"what-ifs".
Stresstestingistheuseofhistoricalextremeeconomiceventsand/orperiodsofpoormarketconditionstoquantifyandtocommunicatetheimpactonthefinancialresultsofagivenbusinessoperation.
Scenariosbasedonhistoricaleventsareeasytocommunicateandtogetengagementwhenassessingvaluebasedimpact.
Onanon-goingbasis,keyriskfactorsareidentifiedonaglobalbasisbytheRiskManagementCommittee.
Thesekeyriskfactorsaredevelopedfromon-goingglobalmarketresearchandoutlookstudieswhichidentifyglobalmarkettrendsandareasofemergingrisks.
Exhibit1AprovidesanexecutivesummaryoftherecentglobalmarketoutlookcompletedbytheRiskManagementCommittee.
OperationsCommitteeInanefforttocreateamoreholisticriskoversightstructure,theCROinconjunctionwiththeRiskChampionwanttobetterunderstandthecommonalityandinteractionofrisksbetweenindividualbusinessoperatinggroups.
AnewinitiativethisyearistoestablishaCROsponsoredOperationscommittee.
TheOperationscommitteewillmeetonaquarterlybasis,separatefromtheriskcommittee,toassessongoingriskinRPPC.
Amongsttheirgoals,thecommitteeseekstounderstandtherisksbeingtakenthroughoutthecompany,discussdifferentriskpoliciesandissues,andstrengthengovernance.
OneofthemajormandatesoftheOperationscommitteewillbetoexploreindepththeriskofdifferentoperatingfunctions.
13ThemembersofthiscommitteearetheCRO,COO,CEO,CRO,RiskChampion,andahumanresourcerepresentativefromRPPC.
Otherguestattendeesareinvitedonanas-neededbasisfromthevariousbusinessgroupsdependingontheagendaofthemeeting.
MeetingnotesandschedulesFirstMeetingAgendaInthiscommitteemeeting,severaloftheproposedandrecentinvestmentsinthevariousoperatinggroupswillbeinvestigated.
TheseareshowninExhibit2.
RiskModellingJulia,CRO,hasrecentlyhiredariskconsultantgroup,FASTAnalytics,toproposeaquantitativeframeworkinmeasuringandmanagingRPPCcorporation'srisksduetothediversityofitsinvestmentandbusinessventures.
Mr.
Otto,principalofFASTAnalytics,hasdraftedaproposalnaming"ManagingRiskswithFastActuarialSimulationTechnology"asshownonExhibit3.
1.
3NewVentureOnNovember12,2015,RobertSigurdson,aRPPC'sBoardmember,wascontactedbyMyhotel'spresident,RandySmith,todiscusssomeofMyhotel'srecentmarketingactivities.
Randy,aclosefriendofRobert,isexcitedabouttherecentexpansionofhishotelchainintothetimesharingvacationarea.
However,thisexpansionhascausedsomefinancialstraintoitscompany.
Inaddition,Myhotel'sloyaltyprogramhascausedsomevolatilitytoMyhotel'sfinancialresultsinrecentyears.
Theloyaltyprogramwasestablishedin1999duetoashorttermneedtomarkettheMyhotelbrandmorebroadlyandtoincreasecustomersalesinanewmarketsegmentatthattime.
Overtheyears,thisloyaltyprogramhasgrownsignificantlyandthusRandyhassetupanewsubsidiarytotakeoverthisprogramayearago.
However,withthisnewsubsidiarybeingsetupandtherecentexpansionplan,Myhotel'scapitalpositionisstrained.
ThusRandyiswillingtolookatconvertingthesubsidiaryintoajointventureoroutrightsellingthissubsidiaryforsomeupfrontcash.
Roberthastakennoteofthepotentialriskexposureofthisloyaltybusinessduringtheirdiscussion.
HethinksthisbusinessmaybeagoodfittoRPPC'scurrentbusinesslines.
ThusheisconsideringaproposaltoRandytoacquirethissubsidiaryasanewlineofbusinessforRPPC.
RandyappearstobeenthusiasticaboutthepotentialsaleandhasagreedtogiveRPPCaccesstothefinancialdatarequiredtoassessthecompany.
RobertreturnedtoRPPCanddiscussedwiththeExecutiveteamwhichincludesGilroy(CEO),Houben(CFO),Julia(CRO)andJane(COO)regardingthisopportunitytotestthewatersbeforeapproachingotherBoardmembers.
ThefollowingisthediscussionthattakesplaceinthemeetingonNovember30,2015:14"HeyGilroy,ImetwithmyfriendRandytheotherdayandseeapotentialopportunityforusatRPPC.
Randy'shotelchaincurrentlyhasasubsidiarythatoffersaloyaltyprogramtohishotelchainwhichhelpstheminincreasingthehotel'smarketshare.
However,duetotherecentexpansionofhisbusinessinotherareas,Randyisthinkingofpartneringwithafinancialconglomeratelikeusideallybutwouldalsoconsiderasaleofferifthepriceisright.
Whatdoyouthinkofthisopportunity"Robertbegins.
"Loyaltycompanyhmmm,IamnotsureRob.
WejuststartedtoconsidertheBlueJayAirloyaltyprogramnottoolongagoandwentintosomenewchallengeswiththecutininterchangefees1andincreasedburn–to-earnratio2.
Iamabitworriedofgoingfull-blownintotheloyaltybusinessandtheitsstrainonourcapital.
Besides,IthinkAIMCO,apubliclytradedloyaltycompany,hastakenanosediveintheirsharepricerecentlybecauseoffutureearningsstrainduetoreducedinterchangefeesandreducedmarginscausedbyincreasedcostsofredemption.
Badcombination!
Julia,anyinsightsintotheriskexposuresofthistypeofbusiness"repliesGilroy.
GilroyhandedoutanarticleonAIMCOwhichisdisplayedinExhibit4.
Juliareplies:"IagreewithyouGilroy.
WehaveseensignificantuncertaintyinourconsiderationofBlueJayAirloyaltyprogrambutwethinkourprogrammayhelptosmoothBlueJayAir'scapacitydemandandearningsvolatility.
Ifwegetintotheloyaltybusinessonitsown,theriskisprobablysimilartoaninsuranceprogramwhichmaytieupsomeofourcapital.
However,sincethisbusinessisnotregulated,themarginmaybemorelucrativethaninsuranceifthepriceandproductfeaturesaresetupproperly.
"Janejoinsin:"Butwemayhavetoworryaboutcompetitionifthemarginbecomestoolucrativeunlesswehavemanagedtobecomeanoligopoly,whichisimpossibleduetolowbarrierofentry!
"Gilroyconcludes:"IbelieveweneedtoobtainthefinancialandproductdatafromRandyfirstandcomparewithourairlineloyaltyprogrambeforedrawinganyconclusion.
Wealsoneedamarketstudyofthistypeofloyaltyprogramtoconsiderthepotentialcompetition.
Julia,pleasecontactRandyandJane,Iwantapreliminarymarketanalysisfromyou.
Let'sregroupafteramonth.
"ThanksGilroy!
"repliesRobert.
1Interchangefeesarethefeesthathelpthecreditcardissuerstocoverthevariouscostsincludingthecostsofloyaltyprograms.
Typicallythedropinthesefeeswillimpactthepricepaidpermilebycreditcardissuerstotheloyaltyprogramcompanyiftheloyaltyprogramagreementpermitsthedropinfeestobepassedthrough.
2Burn-to-earnratioistheratiooftheamountofredemptionsovertheamountofairmilessales.
151ARPPCDynastyCorporationExhibitsExhibit1GlobalMarketOutlookKeyfactorsfortheglobalmarketoutlookaresummarizedasfollows:1.
Changeindemographicsa.
Worldpopulationisgrowingbyaround2.
0billionevery15years.
About95%ofthisgrowthisaccountedforbydevelopingcountrieswhile5%bydevelopedcountries.
b.
Theworldpopulationisalsoaging,mainlyduetogreaterlifeexpectancyandtodecliningbirthrates.
Lifeexpectancydoubledfrom30to60yearsinthe20thcentury.
Atthesametime,theglobalaverageagehasrisenfrom23yearsto30years.
c.
Increasingglobalmigrationflowswherepeoplearemigratingfromsouthtonorthandbetweendevelopedcountries.
Industrializedcountriesarereliantonimmigrantstomaintaintheireconomyandcompetingwithoneanother.
2.
Increasingcomplexityandacceleratingglobalizationa.
Increasinglycomplexandinternationaltradeflows.
Theincreaseinglobalmovementsofgoodshasbeen2.
0timesandtheincreaseincapitaltransactionsisthreetimestheincreaseofglobalGDP.
b.
Increasingvaluechains.
Multinationalcompaniesareontherise,from7,000inthe1990sandtosome65,000parentcompaniestoday,with85,000foreignsubsidiaries.
c.
Increasingthedegreeofcomplexitywherethecomplexityismeasuredbynumberofpartiesinvolvedandalloftheirconnections,stabilityofconnections,networkingofsystemsetc.
Thesemeasuresincreasesignificantlyasglobalizationprocessfasteninthe1990s.
d.
Transportandtravelareexpanding.
Increasingriskofpandemicrisk.
3.
Growingdemandinmicro-insurancea.
About3billionoftheworldpopulationareinthetargetgroupformicro-insurance,mostlyintheSouthAsia,eastAsiaandpacificregions.
b.
PremiumvolumeiscurrentlyinrangeofUSD$1to$2billionandthemarketisestimatedtohavepotentialupto$60billioninpremium.
16c.
Micro-insuranceisstronglysupportedbygovernmentofdevelopingcountriesandemergingcountries,aidsagenciesandNGOsasameanstotacklepoverty.
4.
Advancingclimatechangea.
Risingnumberofweather-relatednaturalcatastrophesb.
Changesintheavailabilityoffreshwaterc.
Higherlossesfromweather-relatednaturalcatastrophesd.
AcceleratedclimatechangecouldleadtoasignificantdeclineintheglobalGDPlevel.
17Exhibit2FirstMeeting:Notes&SchedulesAsset#1Asset#2Asset#3Asset#4CreditDefaultSwapontheSeniorTrancheofMortgageBackedSecurityFixedpayeroilswapwithalargeoilproductioncompanyCalloptionwheretheunderlyingsecurityisnegativelycorrelatedwiththecounterpartyPutoptionwheretheunderlyingbondisuncorrelatedwiththecounterpartyDarwinLifeInsuranceCompanyBlueJayAirDarwinLifeInsuranceCompanyBigBenBankTheMortgageBackedSecurity(MBS)isasecuredassetbackedbyamortgageorcollectionofmortgages,whichpaysperiodicpaymentssimilartoacouponpayment.
Thesesecuritiesaregroupedintoratingsasdeterminedbyaratingagency,wheretheseniortrancheisthehighestratedmortgages.
Thecreditdefaultswap(CDS)providesprotectiononthecreditworthinessoftheMBS,sothattheriskofdefaultistransferredtotheselleroftheswap.
Aswapinwhichexchangedcashflowsaredependentonthepriceofoil.
BlueJayAirwillexchangefixedpaymentsforpaymentsbasedonthemarket'soilpriceindex.
AnagreementthatgivesDarwintheright(butnottheobligation)tobuyanunderlyingsecurityataspecifiedpricewithinaspecifictimeperiod.
AnoptioncontractgivingBigBentheright,butnottheobligation,tosellaspecifiedamountofcorporatebondsataspecifiedpricewithinaspecifiedtime.
TheMBSoffersDarwinhighercouponpaymentsthancorporatebondsinthemarket,withlittletonoriskwiththeCDSbacking.
BlueJayAirwillusetheoilswaptohedgeagainstfuelpriceincreases.
Darwinwillusecalloptionstohedgetheirvariableannuityproducts.
BigBenBankwantstouseputoptionstohedgeagainstdropsincorporatebondmarket.
18Exhibit3ManagingRiskswithFastActuarialSimulationTechnology(FAST)Inrecentyears,stochasticsimulationhasbecomethestandardtoolusedformeasuringandmanagingcomplexrisks.
Comparedtodeterministictools,stochasticsimulationprovidesafulldistributionofresultsinsteadofasinglebest-estimateresult.
Thus,riskcanbemeasuredbyapplyingriskmeasuresonthedistribution.
Onamicrolevel,companiesmayusestochasticsimulationtogenerateriskprofilesforindividualproductsandbusinesses.
Thisiscommonlydoneforthepricingandvaluationofindividualproducts.
Theeffectivenessofriskmanagementstrategiescanalsobetestedwithstochasticsimulations.
Onamacrolevel,companiesmaybeinterestedinknowingthetotalcapitalrequirementsinthefutureandtheassociatedcostsofholdingcapital.
Stochasticsimulationcanbeusedinthiscasetoprojectthecorporation'sfuturebalancesheetsunderarangeofscenarios.
Despiteitsusefulness,implementingstochasticsimulationcouldbecomecomplexwithmanyITsystemsandmanualprocesses.
Further,stochasticsimulationmayrequireasignificantinvestmentincomputationalpowerdespitethenumericaltechniquesavailable.
FastActuarialSimulationTechnology(FAST)isahigh-performanceactuarialsimulationplatformthatenablescompaniestoefficientlymanagerisksusingstochasticsimulations.
FASTimplementsstochasticsimulationinarobust5-stepprocessthateliminatesthediscontinuitybetweensystemsandenablesefficientriskaggregation.
FASTSimulationsStochasticsimulationisusedinmanysituationswheresimpleformulasarenotavailable.
FASTimplementsstochasticsimulationinanintegrated5-stepprocess:1)Identifytheriskfactorsrelatedtotheproduct/businessThisfirststepiscritical.
Realworldresultswouldbesignificantlydifferentifanimportantriskfactororeconomicvariableareleftoutofthesimulation.
FASTidentifiestheimportantriskfactorsbyre-computingresultsbyvaryingriskfactorlevels.
Thefactorsassociatedwiththemostvariationsinresultsarekept.
Thisisamodel-freesensitivityorGreekscomputation.
Greeksarehugelyimportantforriskmanagement.
TheabilitytolooktoatGreeksbeforeanyriskaggregationmakessurethatthemodelisrealisticandnoimportantriskfactorsaremissing.
FASTconsidersallcommonriskfactors.
192)SpecifyappropriatestochasticequationsandcorrelationsformodelingtheriskfactorsChoosingtherightmodelisverymuchlinkedtoitscalibration.
Aninappropriatemodelchoicewouldlimitthepossibledistributionsitcouldgenerate.
Forexample,ifthedesireddistributionofariskfactorhasafattail,thenitwouldnotbepossibleforaNormalmodeltomodelthetailrealisticallyregardlessthecalibrationprocedure.
Thesamecanbesaidaboutcorrelationstructure.
TheclassicalPearson'slinearcorrelationmaynotbethebestchoiceformanyrisksthathavebeenshowntohavenon-linearrelationship.
CopulaislikelytobemoresuitableformodelingRRPC'scomplexportfolioofbusinesses.
FASTrecommendstheappropriatemodelsbasedonthehistoricaldataspecifiedbytheuser.
3)CalibratetheparameterstostatisticaldistributionsDependingontheapplication,theparameterscanbecalibratedtoeitherrisk-neutraldistributionsorreal-worlddistributions.
Forpricingandvaluationofliquidtradedinstruments,theparametersarecalibratedtotherisk-neutraldistributionimpliedfromthemarketpricesofrelatedinstruments.
Ontheotherhand,real-worlddistributionsareusuallyobtainedfromhistoricaldata.
Byusingmodelscalibratedtoreal-worlddistributions,weassumethatthestatisticalpropertiesinthepastwillcontinuetobevalidinthefuture.
Inpractice,oneneedsbothrisk-neutralandcalibrations(seenextstep).
Becauseofthis,FASTcalibratesthemodeltobothdistributions.
Thetwodistributionsarefurtherlinkedbyavariablecalledriskpremiumtoensureconsistency.
FASTiscompatiblewithleadingmarketdataproviders.
4)RunMonteCarlosimulationsusingthecalibratedmodelOncethemodeliscalibrated,wegeneraterandomscenariosforallriskfactorsforacertaintimehorizon.
Thecashflowsarere-calculatedundereachscenario.
Thecashflowsmayincludeonlyliabilities(inthecaseofpricing)orbothassetsandliabilities(inthecaseofhedgingorassetliabilitymanagement).
Thesimplesttypeofsimulationisso-calledtime-0simulationwhereallthecashflowscalculationsarebasedonthecurrentpointintime.
Increasinglycommoninriskmanagementistheuseofnestedstochasticsimulations.
Nestedstochasticsimulationprojectsthevalueofassetsandliabilitiesforeachscenariointhefuturebyrecalculatingthevalueofreal-worldcashflowsatfuturepointintime.
Theprojectionofcashflowsatafuturetimeisarepeatofthetime-0simulationbutassumesthethenevolved(risk-neutralorreal-world)distributionsfortheriskfactors.
20OneoftheapplicationsofnestedstochasticsimulationisthevaluationofAmericanoptions.
Anotherapplicationistomeasuretheeffectivenessofhedgingstrategies.
Insomecaseswherepricingorvaluationisthegoal,Least-squaresMonteCarloiscanbeusedtoeliminatetheneedforbrute-forcenestedstochasticsimulations.
Thisisthemostcomputationallytime-consumingstep.
Dependingonthenumberofsimulationpathsandthecomplexityofthemodel,computationtimecouldbehoursordaysevenwithagridofcomputers.
FASTutilizesthepowerofgraphicprocessingunits(GPUs)toreducecomputationtimeupto100times.
Becauseofthistechnology,usersareabletoviewresultsnearreal-time.
5)AnalyzeresultsThelaststepistoextractinformationfromthedatawehaveproducedfromthestochasticsimulation.
Forindividualproducts,forexample,wemaycalculatetheexpectednetprofitofabusiness,theaveragepayoffofanoption,ortheprofitandlossofahedgingstrategy.
Forenterpriseriskmanagement,wecanmeasuretheriskbycomputetheVaRortheExpectedShortfall(TailExpectation)fromtheresultingdistribution.
Duetothehugedataoutputfromthepreviousstep,thisisnotaseasyasitseems.
Fortunately,FASTisdesignedtoworkwithbigdata.
Informationcanbeinstantlyextractedfromhugedatabaseswithouttheconstraintofspreadsheetsizelimits.
FASTSolutionsFASTprovidessolutionsforcorporationslookingtointegratestochasticsimulationsintotheirriskmanagementsystems.
FASTcanbeusedinmanypartsofRRPC'sbusinesstoimprovebusiness-levelriskmanagement.
Afewexamplesinclude:Evaluatecommoditypriceriskandthepotentialimpactofahedgeprogramtomitigatetherisk(BlueJayTireCo)Estimatethefairvalueoftheloyaltyprogram(BlueJayAir)Evaluatethepossibleworstoutcomesoftheloyaltyprogramrelatedtotheeconomicrisks(BlueJayAir)Valuationofrealoptionsembeddedinthebusinessespeciallywhenthepayoffispath-dependentortheexercisetimeisflexible.
(Allsubsidiaries)Usecatastrophemodelstosimulatetheworst-casescenariosandthesolvencycapitalrequired(BlueOceanP&C)Monitorforeignexchangeriskin-housebysimulatingFXrates(BigBenBank)21Aggregateandreportallriskse.
g.
creditrisk,marketrisk,liquidityrisk,operationalrisk(BigBenBank)Pricesecondaryguaranteesandevaluatethehedgingofsuchguarantees(DarwinLife)Onthecorporatelevel,FASTcanbeusedtoprovidethefollowingsolutions:Incorporatesimulation-basedinternalmodelingintoeconomiccapitalcalculationEstablishariskaggregationframeworkacrosstheenterpriseSatisfyregulatoryguidelinesandproduceforward-lookingriskandcapitalreportsforthebankingandinsurancedivisionsEvaluateandcomparesubsidiaryperformanceonarisk-adjustedreturnbasis,i.
e.
returnadjustedforthecostofcapitalStochasticsimulationplaysanimportantroleintheseapplications.
Amajorchallengeinimplementingstochasticsimulationistomakesurethesystemisabletoproduceresultsinatimelymanner,especiallyduringtimesofstress.
Duetothelargenumberofscenariosthatneedtobegenerated,RRPCneedstobalancebetweenaccuracyandspeed(asaconsequenceofcomputationalpower).
Themarket-leadingperformanceofFASTenablesthecompanytodealwiththemostcomplexsituationefficiently.
Insteadofwaitingforthesystemtofinishcomputation,theusercanbefocusedonbusinessproblemsandreceivereal-timeriskstatistics.
Additionally,FASTisatransparentsystem.
Auditorsandregulatorsmaylookatthedetailsofthemodelsandcodingifsodesired.
GrossoBankusedtorelyonin-houseadhocsystemstocomputeitsportfoliorisks.
Themodelswererunovernighttoobtainriskstatistics.
WiththeintroductionofBaselIII,thebankisfurtherrequiredtoprovidelongtermriskestimates.
Combinedwiththetimelyreportingprinciple,theexistinginfrastructurewasclearlyinadequate.
AfterswitchingtoFAST,GrossoBankwasabletoreducetheruntimeto10minutesandautomatetheprocesses.
Asaresult,thebanknotonlyenhanceditsreportingcapabilitiesbutalsoreduceditsoveralloverheadexpenses.
Inconclusion,FASTprovidesastreamlined5-stepprocessthateliminatestheneedformanyseparatesystemsandimprovesproductivity.
Thehighperformanceofthesystemenablesthecompanytoachievethegoalofefficientriskmanagementandtimelyreporting.
22Exhibit4AIMCONewsExcerptUncertaintyinAIMCOfromlowerinterchangefeesandsmaller-than-expectedinternationalearnings–IsAIMCOtakingoffSourcefromBloombergandGlobeandMailThesharepriceoftheCanadianloyaltyprogramcompany,AIMCO,aninitialpublicoffering(IPO)lastyear,hastakenanosedivefromC$17toC$10pershareduetonotmeetinganalysts'earningsexpectation.
DuringIPOlastyear,AIMCOhadcompletedatransactionwithamajorcreditcardcompanytoofferairmilestothecreditcardcompany'sexistingcustomers.
Atthattime,AIMCOgreatlyenhancedthebenefitstoitsairmilemembersbynegotiatinganincreaseinavailableseatswithamajorcommercialairlinecompany.
However,theincreasedavailabilityhasputupwardpressureoncostsforAIMCO.
Atthesametime,AIMCOwasonlyabletosecureamarginalincreaseinpricepermilepaidbythecreditcardcompany.
Thereisatimingissueassociatedwiththenewdeal.
Asairmilesmemberscannowasawholeusemanymoremilesthattheyearnduetotheincreasedavailability,thisputsignificantpressureonAMICO'searnings.
AIMCOmustnowspendanincreasingamounttosatisfyredemptionsevenasitmaybesellingfewermilestothecredit-cardissuers.
Thisisexpressedasa"burn-to-earn"ratio.
ThisratioisnowworkingagainstAIMCO.
Duringthepastyear,competitionshavebeenfierceasothercreditcardcompaniesstartedtheirownself-insuredprogramswhichaddedtheflexibilityofreimbursingtheirmemberswiththecostsofanyairtravelseats.
Ascompetitionsintensified,theinterchangefee,whicharethefeesthathelpcardissuerscoverthevariouscostsincludingthecostsofloyaltyprograms,havedecreasedfrom2%to1.
5%forthenextfiveyears.
AIMCOandtheanalystsexpectcardissuerstoabsorbtheblowbycuttingtheamounttheywillpayfortheairmiles.
ThisdecreaseininterchangefeeshavecalledintoquestionAIMCO'sestimatesoffreecashflowastheAIMCO'sagreementwiththecreditcardcompanyallowsAIMCOto"sharethepain"ofaninterchangecut.
AIMCOestimatesaboutC$100millionofgrossbillingmaybeatriskif100%ofthecutininterchangefeesarepassedthroughtoAIMCO.
Witha50%share,thetargetestimatewillresultinC$50millionoflostfreecashflow.
Inaddition,thecurrencyexchangemayalsopresentanissueforAIMCOwhichoperatesinternationally.
TherecentdeclineinCanadiandollarputsahugecostpressureonAIMCO'sUSoperationwhichlockedintheirpricingexchangeratelastyearwithouthedgingtheirpricingexchangerate.
AlloftheabovefactorshaveresultedintheearningsestimatetodropfromtheC$17toC$10target,withanegativeoutlookifexistingcompetitionsanddropinCanadiancurrencyexchangeratecontinuetopersist.
InvestorsshouldexpectAIMCOtositontherunwayforsometimebeforeanypotentialtakeoff.
232BlueJayAirOtherservicesarecustomer-oriented.
Theairlineindustryisincreasinglyanti-consumer.
It'sbecomearealhassletotravel.
Thatisouropportunity-aslongaswearegivenachancetocompetefairly.
JohnFeather,CEOofBlueJayAir,wassittinginhisnewlyrenovatedexecutiveofficeandponderingthefuturestrategicdirectionofhiscompany.
BlueJayAirhadundergoneamajorcorporatereorganizationtwoyearsago.
WithanewlyappointedBoardandatotalreplacementoftheseniormanagementthecompanyhadacompletelynewface.
Itwastimetorebuilditsimageandre-positionitselfinthehighlycompetitivelocalairlinemarketandreconsiderexpandingintotheinternationalarena.
BlueJayAirhadmadesubstantialinvestmentsthatincludedmajorinfrastructure.
Changecouldn'tcomefastenoughforJohn.
Everyaspectofserviceandoperationsneededtogetbetter.
Itwastheonlyway.
Changinginfrastructurewasharduptoapoint.
Changingattitudesandbehaviorandwinningcustomers–thatwashard.
HowfastandhowhardshouldhepushSomewantedreamsofdatatomoveforward.
StaylocalGointernationalWhichroutesWhichplanesRemodelornewDidtheyhaveenoughcapitalAccessthecapitalmarketsSellBlueJayTireHehadagoodteam.
HerecalledoneofWarrenBuffett'scommentsheappliedtohismanagementstyle,"Giveapersonoranationafinereputationtoliveuptoandtheywillliveuptoit.
"JohnwasestablishingBlueJayAir'sreputation.
Hewasconfidenthisteamwouldmeetthechallenge.
2.
1BackgroundBlueJayAirwasoriginallyincorporatedintheUnitedStatesintheearly1970s.
Itwasasmalllocalcommercialpassengercarrier,operatingonlyintheEasternregionoftheUnitedStates.
Itstargetmarketwashigh-endbusinessclientelelocatedinmajorcitiesalongtheeastcoastoftheUnitedStates.
Sincethen,BlueJayhadgonethroughthreemergersandtwosignificantacquisitionsoverthelast40years.
Thecompanyhadbeentransformedfromafocusedhigh-endregionalcompanytoanexpandedprice-competitivecommercialcarrier,coveringthefullgeographicalregionofUnitedStatesaswellasmajorcitiesinCanada.
Duringthepast40years,theairlineindustryhadgonethroughseveralsignificantcyclicalbusinesscycles,witheachearningcycletrendinglowerthantheprecedingcycle,whichresultedinsignificantpressureonthebusinessmarginsandprofits.
Inaddition,withthederegulationintheairlineindustryduringtheReaganadministration,thenumberofcommercialcarriershadexplodedexponentially,therebyhadmateriallydecreasedconsumerpricesandalsoreducedtheserviceleveloftheairlineindustry.
Duetoreducedmargins,mostcompanieshadseverelycurbeditsoperatingcostsbyreducingstafflevelorrestrainingsalaryincreases.
Asaresult,labourdisputesanddisruptionshadbecomeamajorconcernintheindustry.
Thenegativeimpactontheindustrywascompoundedwithanagingworkforceandinsufficienttrainingforthenewstaff24especiallyforthepilots.
Frequencyofaccidentoccurrenceshadtrendedupwardsduetolackofqualifiedmanpowerandinsufficientcompensationlevel.
Despitealltheperilsintheindustry,BlueJayAirwasresilientinsurfingthedestructivewavesthroughdifferentreorganizationandrestructuringefforts.
ThelatestacquisitionbyRPPCwasviewedpositivelybyshareholdersandinvestors.
In2010,theWallJournalquotedthat"thetakeoverisastepforwardforBlueJayAir.
"JohnFeather,whohasover20yearsofairlineexperience,isviewedasa"turnaround"CEObytheindustry.
ThustheparentcompanyhashighexpectationinJohn'snewstrategicvision.
2.
2StrategiesBlueJayAir'snewstrategicvisionistobecomethemostcustomer-orientedairlinecompanyintheworld,providingthebestservicestothemarketplace.
Comfort,punctualityandsafetyarethethreeimportantvirtuesthatthecompanyhasadopted.
ThusthenumberonepriorityforBlueJayistorebrandthecompanyandimage.
Inordertosuccessfullyrebrandthecompany,thecompanyhasdoneanextensivestudyonitscustomerbaseandidentifieditscustomers.
Johnbelievesthatunderstandingandknowingthecustomersisanimportantsteptoimproveprofitabilityforthecompanyinthelongrun.
Basedonthecustomerbasestudy,thecompanyfoundthatmorethan55%ofitscustomersaretravellingforbusinessreasons.
Thispercentageissignificantlyaboveindustrynormwhichisgenerallyaround20%.
Thisfoundingcouldstemfromthefactthatthecompanywasoriginallyacommercialpassengercarriercateringtobusinesstravelersandsoitsrelationshipwiththebusinesscommunitywasdeep-rootedanduniquecomparedtoitscompetitors.
Infact,theexpansiontoleisuretraveloverthelast15yearsdidnotincreaseitsmarketshareandprofitmarginasthenumberofbusinesstravelersdeclinedfromover80%to55%duetoreducedservices.
Therebrandingandthechangeofbusinessmodelmayregainthecompany'smarketabilityandimproveprofitabilityovertime.
Atthetimeofacquisition,thecompanyreconsidereditsmarketoperationsincludingtheexpansiontointernationaloperationsduetoincreaseddemandforinternationaltravelcausedbyglobalizationofthebusinessworld.
Inordertomakethisstrategypossible,thecompanyhasbeennegotiatingwithseveralinternationalairportauthoritiesinseveralEuropeanandAsianfinancialcentresandmajorcitiesoverthelasttwoyearstosecureaboardingspace.
Someofthesenegotiationsareclosetofruition.
Costcontrolisakeyelementinthisindustry.
LabourrelationshipmanagementisakeycostcontrolelementforBlueJayAirasthelabourforceisnotcurrentlyunionized,whichisveryrareintheindustry.
Inordertomaintainthisniche,BlueJayrequiresaneffectivemanagementteamtofosteraculturalchangewithoutdamagingtherelationshipwiththeemployeesandensurethattheirneedsareaddressedtoreducethedesiretounionize.
Inthepastfewdecades,thecompanyhadimplementedprofitsharingschemes,regularsalaryscaleandbenefitreviews,frequentemployeenetworkingevents,employeesuggestionboxesandanemployeediversityteamtofostercommunicationandpayequitybetweenmanagementandregularstaff.
These25effortshavebeenworkingasunionizationhasnotmaterialized.
Thusthecompanywouldliketomaintainitscurrentemployeerelationshipstrategy.
Theonlycaveatisthatinordertostaycompetitive,thecompanyhastocontinuetakingfurthersignificantexpensecontrolmeasuresparticularlyintheseareasofstaffcount,staffexpensesandinformationtechnologyexpenditures.
Asaresultthecompanyhasstartedtocutbackonmosttrainingprogramsexceptthecurrentpilotandsafetytrainingprogramsinordertofosterourvisionofbeingthe"safest"airlineintheindustry.
Thecompanyalsoimposestougherstandardstoqualifyforthe"top-scaledcommercialpilot"categoryinordertoensureBlueJaypilotsareofhighestquality.
2.
3RiskManagementBlueJayAir,beingahighlyleveragedcapitalintensivecompany,abilitytoraisedebtandservicingthedebtsarecrucialtothesurvivalofthecompany.
Thusakeyriskmanagementobjectiveistomaintainthecreditratingofthecompanywithintheinvestmentgradecategories,i.
e.
,BBB-orhigher.
AsBlueJayAirhassignificantpensionliabilitiesforitsexistinglabourforce,abilitytofundthepensionliabilitieshasbecomeacrucialissueforthecompany,especiallyintoday'slowinterestrateenvironment.
BlueJayAirhasincreasedexposuretointerestratevolatilityduetothesignificantamountoflong-termdebtandfinanceleasesthatithasenteredintosinceincorporation.
SincebeingacquiredbyRPPCDynasty,BlueJayAirhasestablishedariskmanagementcommitteeheadedbyawell-knownriskmanager,JimPeters.
JimwasformerlytheChiefRiskOfficer(CRO)ofamajorCanadianbankandhewasrecruitedbyJohnundertherecommendationfromHowardCreston,formerCROofRPPCDynasty.
JimwasahedgefundmanagerbeforehebecametheCROofthebankandthushehasextensiveknowledgeinimplementingriskmanagementstrategies.
Overthelasttwoyears,Jimhasputtogetheradynamicallyhedgedportfoliothathandlesthecommodityexposuresthatthecompanyhasbeenfacingaswellastheinterestraterisks.
Inaddition,JimhasestablishedaTreasuryroleundertheriskmanagementcommitteetocentralizethelong-termandshort-termfundraisingactivitiesofthecompanyanddealwiththeliquidityandcreditrisksofthecompany.
ThisroleisheadedbyElaineSaunderswhowasaformerTreasurerofaNewYorkbasedinvestmentbank.
Elainehasasignificantnetworkwithventurecapitalists,pensionfundmanagersaswellasprivateequityfundmanagers.
ElainehasalsoworkedintheInvestorRelationsareaofamajorUSCommercialBankandthushasdealtwithcreditratingagenciessuchasStandard&Poor's,Moody's,A.
M.
BestandFitch.
Overthelasttwoyears,shehasimplementedaliquiditymodelandacreditmodeltomonitorthecompany'songoingliquidityandcreditneeds.
TheRiskManagementrolesandfunctionsarestillintheprogressofrefinementandadjustments.
Thestaffingrequirementintheseareasishighlyspecializedandwilltaketimetoestablishafullstaffcomplement.
Asaresult,thestaffworkloadiscurrentlyintensiveandturnoverrateisslightlyhigherthantheotherareas.
262.
4OperationsPlanesIthasbeen10yearssinceBlueJayAirpurchasedthecurrentfleetofplanes.
Thecurrentfleetofplanesisstartingtoage.
Limitedpassengercapacityrendersmostofthefleetasunsuitableforinternationalflights.
Inordertoimplementaninternationalexpansionstrategy,thecompanywillhavetoorderorrefurbishsomelargerplaneswithupdatedfeaturessuchasWi-Fi,expandedbusinessclasses,flatbeds,bars,andstrongerengineswithadditionalsafetyfeaturestobedeliveredoverthenextfewyears.
Theseplanesarecateredforaddedcomfort,safetyandshorterflighttime.
Theyaretheidealplanesforinternationaltravel.
However,thecostsofthesenewplanesandrefurbishmentsaresignificantandwillrequirecapitalinjectionordebtguaranteesfromRPPCDynastyasBlueJayAiralonecannotbearthesecostswithoutjeopardizingthecreditratingofthecompany.
Evenfortheshorthaulplanes,thecurrentfleetrequiresupdatessuchasWi-Ficapability,individualTVscreensandstrongerenginestoprovideadditionalcomfortforbusinesstravelers.
Thiswillalsorequireadditionalfundingandsupportfromtheparentcompany,RPPCDynasty.
Giventhecurrentbusinessneeds,themajorityofaircraftsownedbyBlueJayAirareX730manufacturedbyXolarAircraft.
X730isatwin-engineshort-tomedium-rangewidebodyjetairlinerwhichcantypicallyseat280passengersinatwo-classlayout,withamaximumrangeof8000kmwhenfullyloaded.
OtherthanBlueJayAir,onlyfiveairlinespossessthistypeofaircraft.
FourofthemuseX730aswellforshorttomediumdistance.
TheremainingonesuseS999manufacturedbySkyliteAircraftformediumdistance.
S999isatwin-enginemedium-rangewidebodyjetairlinerwhichiscomparabletoX730.
XolarAircrafthasaverylonghistoryandismorefamousthanSkyliteAircraft.
Asoftoday,thestockpriceforSkyliteAircraftissubstantiallydepressedduetoitshighbook-to-marketvalue.
BlueJayAirisconsideringacquiringoneofthetwoaircraftmanufacturersaboveinordertoextendthepresenceintoanotherstageoftheindustrychain.
Theywillnothaveenoughcashforeitherofthecompanies,thereforetheyneedtobringinnewinvestorsorsellBlueJayTireinordertocompletetheacquisition.
RebeccaGibbs,VPofOperations,submittedthefollowinginformationandconsiderationsforbothAircraftmanufacturers.
XolarAircraftisaUnitedstates-basedcorporationwithaverylonghistorythatdesigns,manufactureandsellsfixed-wingaircraft.
ThecompanyproducesX730whichisamongthemostrecognizableaircraftsformanyyears.
X730wasinvolvedin27accidentsin40yearsofservices,includingaveryfamousincidentnamedthe306AirDisaster.
Xolarhasbeenprofitableforover10yearsuntillastyearwheretheylostanumberofneworderstocompetitorSkyliteAircraftandthusresultedinanunprofitableposition.
Consideringtheresultofpast10years,RebeccabelievesthatlastyearwasjustabadexperienceandXolarwillperformbacktothenormallevel27nextyear.
Inparticular,Xolaraircraftishavingacost-cuttingcampaignandexpectstoseesomepositivetrendsincostcontrol.
Rebeccabelievesthatthecampaignwouldbeeffective.
Thereforesheincludedsomecostreductioninherforecast,theresultbeingthatXolarAircraftwouldbeprofitable.
SkyliteAircraftisanaircraftmanufacturingsubsidiaryofaglobalaerospaceanddefensecorporation.
ThecompanyproducesandmarketsS999whichhasbeenadirectcompetitorofX730inlast20years.
S999wasonlyinvolvedin11accidentsinthisperiod.
RebeccaisinfavourofSkyliteforsafetyreasonsincesafetyisveryimportanttoairlines.
Ontheotherhand,duetoitssubstantialoperations,Skylitehashadsignificantcostoverrunissues.
Thusthecompanyhasnotbeenprofitablefora5yearperiod.
However,lastyearSkyliteengineeredaturnaroundduetothenewmarketingstrategicwhichledtoanumberofnewordersduringtheyear.
Usingthenewestdatacollectedoverlastyear,RebeccaforecastedaprofitablepositionforSkyliteAircraftincomingyears.
LoyaltyProgramAspartofthechangeinmarketingstrategy,abusinesstravelloyaltyprogramisbeingconsideredtoencouragefrequentbusinesstravels.
BlueJayAirisconsideringprogressivebonuspointsystemsasflightfrequencyincreasesoverashortperiodoftime.
Inaddition,BlueJayAirwouldliketoexpanditsrewardsystemsbypartneringwithotherbusinesspartnersanditsaffiliatedcompanies.
Thiswillsubstantiallyincreasetheincentiveofbusinesstravelsbybusinessexecutives.
Forexample,BlueJayAirispartneringtheloyaltycardwithitsaffiliatedbank'sbankcreditanddebitcardstointroduceacombinedcreditcardwithan"enhancedairpointsrewardsystem.
"Thispartnershipshouldfurtherincreasethevalueoftheloyaltyprogram.
Amodificationtotheexistingapplicationformisrequiredtoaccommodatetheexpansionofthisnewenhancedloyaltyprogram.
Thecurrentapplicationisanonlineformwhichisanelectronicversionofapaperform.
Thepaperformiscurrentlyfivepageslongwith30differentquestionsrelatedtothecustomers'personalinformationandpreferences.
Thecustomerdataiscrucialforcurrentandfuturemarketinganalysis.
However,thecurrentcompletionrateismuchlowerthanthetargetrateduetotheextensiveinformationrequiredtobefilledout.
TravelInsuranceProgramInadditiontothetravelloyaltyprogramconsideration,BlueJayAirisexploringanopportunitytooffertravelinsurancetotheairline'scustomers.
Aspartoftheircommitmenttobecomethemostcustomer-orientedairline,theproposedsolutionenvisionsafullycustomizablecoveragepackagethatallowseachtravelertochoosewhatbestfitstheirneeds.
BlueJayAirhasidentifiedBlueOceanastheidealstrategicpartnertosuccessfullyexecutethisventure,andCEOsJohnFeatherandEdwardBluehaveeagerlypreparedabusinesscasetobringforwardtotheRPPCBoard.
TheyareveryexcitedaboutthepotentialsynergiesthisinitiativecanrealizefortheRPPCDynasty.
28Aspartoftheproposal,theriskfunctionsfrombothcompanieshavecollaboratedonapreliminaryriskreview,andhaveidentifiedsomeconcernswiththeinitiative.
AnemailthreaddiscussingsomeofthekeyissuesofthisnewproposalareshownintheSection2AExhibit1.
BookingSystemenhancementsWiththetechnologicaladvancementsoverthelastfewdecades,BlueJayAirisconsideringrevampingitsbookingsystemtoenhanceitsinternetbookingcapabilityaswellasintroducingdifferentmobilephoneappsforthemajormobilephonesystems.
Thenewsystemwillautomaticallylinkupwiththeloyaltyandcreditcardsforeaseofuseofloyaltypoints.
Itwillincludetrackingofflightschedules,weathersystems,timezonesandotherpertinentinformation.
Itwillincorporatemanyaddedfeaturesthatwillmakebusinesstravelenjoyable.
BusinessLoungesBlueJayAirwillrenovateallitsbusinessloungesinmajorcitiestoenhanceitsbusinesstravelstrategytostaycompetitive.
NewbusinessloungeswillofferfreeWi-Fi,freeinternetaccessandamenitiessuchasgourmetFrenzcoffeeandspecialtyteas,snacks,massagechairswithmusicselectionandflatbeds.
Thegoalistomakebusinesstravelersascomfortableaspossiblewhilewaitingfortheirflights.
BaggageandBaggageSystemsBlueJayAirwillincorporateachargeforeachpieceofluggagebeingchecked-insincemostbusinesstravelersdonotcheck-intheirluggageandinresponsetotheircompetitors'pricing.
Freeluggagecheck-inisnolongeravailableexceptforinternationalflightsforwhichBlueJayAirwillreduceitsfreeluggagecheck-inpolicyfromtwopiecestoonepiecewithnochangetothecurrentweightlimit.
ThecurrentBaggageTrackingsystemseemstobeadequateandBlueJayAirhasnoplantoupgradeitssystems.
OtherCostMeasuresBlueJayAirhasdecidedtodiscontinueitstravelagencyprogramswithdifferenttravelagenciesaspartofthecontinuingefforttokeepthecompanyascostefficientaspossible.
Insteadthecompanywillestablishdirectbusinessrelationshipswithitsbusinessclientbase.
BlueJayAirwillnegotiatedirectcontractualarrangementswithitsbusinessclientsinordertocustomizeclientneedsandleveragelong-termclientbusinessrelationships.
Areferralprogramwillalsobeofferedtoitsbusinessclientsinordertoexpanditscustomerbaseinthemostdirectandefficientmanner.
Thisreferralprogramwillbecombinedwiththeloyaltyprogramtooptimizevalueforexistingcustomers.
FinancialStatements29DetailedfinancialstatementsareshownintheSection2AExhibits2to4.
RecentNewsonCompetitorsRecently,severalairlinecompanieshaveappearedontheheadlinesnewsinUSandCanadaasshowninExhibit5.
BalancedScorecardInordertoclarifyBlueJayAir'svisionandstrategiesandtoenhanceexecutionofthesestrategies,thebusinessoperationteamhasestablishedabalancedscorecardforBlueJayAir.
Theintentofthisbalancedscorecardistoprovideseniormanagementwithfeedbackofboththeinternalbusinessprocessesandexternaloutcomes,whichallowsforcontinuousimprovementofstrategicperformanceandresults.
ThebalancedscorecardframeworkisshowninExhibit6.
RecentMandatorySanitaryMeasuresDuetoconcernsregardingrecentElobaoutbreaks,BlueJayAirhastakena"cleanplane"policy.
Allplaneshavetobesprayedorwipedwithanti-bacterialcleaningagentinbetweenflights.
Inaddition,allpersonnelhastoweardisposalglovesinservingcustomersandhandlingbaggage.
FlightstohighlyinfectedcountriesarecancelledbasedontravelwarningsissuedbytheOverseasSecurityAdvisoryCouncil.
302ABlueJayAirExhibitsEXHIBIT1EmailthreaddiscussingtheTravelInsuranceprogramissuesFrom:JimPetersSent:August28th,20159:00pmTo:GeoffOlivecc:JohnFeather,EdwardBlueSubject:TravelInsuranceRiskReviewHiGeoff,HasyourteamreviewedthepricingonthetravelinsuranceproposalI'mnotcomfortablethatthetailriskisbeingpickeduphere.
Isn'titpossiblethatataileventlikeaplanecrashcanaffectmultipletravelinsurancepoliciesThanks,JimPetersHeadofRiskManagementCommittee,BlueJayAirTelephone:(617)5552222From:GeoffOliveSent:August29th,20158:45amTo:JimPeterscc:JohnFeather,EdwardBlueSubject:TravelInsuranceRiskReviewHiJim,I'mworriedthetailriskhereisactuallytoohighforustoretain.
Asweallknow,RPPCwantstolimititsexposuretotaileventrisks.
Weshouldsitdownanddiscusssomerisktransferoptions.
Thanks,GeoffOliveCRO,BlueOceanInc.
Telephone:44(0)2075457777From:JimPetersSent:August29th,201510:30amTo:GeoffOlivecc:JohnFeather,EdwardBlue31Subject:TravelInsuranceRiskReviewIthinkthat'sworthexploring.
Ialsohaveafewsuggestionsontheeconomiccapitalmodelyou'vebeenusingforpricing.
We'llneedtoensurethattaildependenceisproperlymodeled.
I'llsendyousomeofourworkonthis.
32Exhibit2BlueJayAirCorporationNON-CONSOLIDATEDSTATEMENTSOFOPERATIONS(USDollarsinmillions)FiscalYearEndedDec31,2015Dec31,2014Dec31,2013Operatingrevenues:Passenger1,5441,2351,074Other291242207Totalrevenues1,8351,4771,281Operatingexpenses:Aircraftfuel574462401Wages,salariesandbenefits359289251Capacitypurchaseagreements172138120Airportandnavigationfees158127110Depreciation,amortization&impairment967767Aircraftmaintenance1108977Sales&Distributioncosts735951Aircraftrent493934Food,beveragesandsupplies423329CommunicationsandInformationtechnology332723Other191513Totaloperatingexpenses1,6841,3561,176NetOperatingincome150121105Non-operatingincome(expenses)Foreignexchangegain(loss)1510(29)Interestincome555Interestexpense(44)(36)(31)Interestcapitalized21(5)Netfinancingexpenserelatingtoemployeebenefits(2)(2)(15)Lossonfinancialinstrumentsrecordedatfairvalue(3)(7)(33)Other(1)(2)(19)Totalnon-operatingexpense(28)(31)(127)Income(loss)beforeincometaxes12290(22)Incometaxes(43)(32)8Netincome(loss)7959(14)33EXHIBIT3BlueJayAirCorporationNON-CONSOLIDATEDSTATEMENTOFFINANCIALPOSITION(USDollarsinmillions)FiscalYearEndedDec31,2015Dec31,2014Dec31,2013ASSETSCurrent:CashandCashequivalents150140136Short-terminvestments21018283Totalcash&Short-terminvestments360322219Restrictedcash151515Accountsreceivable200160127Aircraftfuelinventory916348Sparepartsandsuppliesinventory1208033Prepaidexpenses&othercurrentassets15010070Totalcurrentassets576418293Propertyandequipment545509474Intangibleassets212121Goodwill313131Depositandotherassets971Totalassets1,5421,3081,039LIABILITIESCurrent:Accountpayable&accruedliabilities15010770Advanceticketsales310250181Currentportionoflong-termdebt&financeleases1108061Totalcurrentliabilities570437312Long-termdebtandfinanceleases470450320Pension&otherbenefitliabilities545556580Maintenanceprovisions605560Otherlong-termliabilities504843Totalliabilities1,6951,5461,315EQUITYShareholders'equitySharecapital909090Contributedsurplus302545Deficit(273)(352)(411)Totalshareholders'equity(153)(238)(276)Totalliabilities&equity1,5421,3081,03934EXHIBIT4BlueJayAirCorporationNON-CONSOLIDATEDSTATEMENTOFCASHFLOW(USDollarsinmillions)FiscalYearEndedDec31,2015Dec31,2014Dec31,2013CashFlowsfrom(usedfor)Operating:Netincome(loss)7959(14)Adjustmentstoreconciletonetcashfromoperations:Adjustfornon-cashitems:Depreciation,amortization&impairment967767Fuel&otherderivatives(20)(11)14AdjustforChangesinnon-cashworkingcapitalitems:Changeininventories(68)(62)(32)Changeinaccountreceivable(40)(33)(59)ChangeinAccountPayable4337(37)Changeinadvanceticketsales606957Changeinpension&otherbenefitliabilities(11)(24)24Changeinmaintenanceprovisions5(5)5Other(50)(30)(20)Netcashflowfromoperatingactivities95775FinancingProceedsfromborrowings150100125Reductionoflong-termdebtobligations(63)64(104)Reductionoffinanceleaseobligations&Distributionsrelatedtoaircraftspecialpurposeleasingentities(35)(10)(74)ContributedSurplus6(20)35Netcashflowsusedinfinancingactivities58134(18)InvestingShort-terminvestments(28)(99)(8)Additionstoproperty,equipment&intangibleassets(136)(114)(36)Proceedsfromsaleofassets424Foreignexchangegain(loss)(4)(3)7Other2(1)0Netcashflowsusedininvestingactivities(162)(214)(33)Decreaseincash&cashequivalents(10)(4)(46)Cash&cashequivalents,beginningofyear155151105Cash&cashequivalents,endofyear16515515135EXHIBIT5HeadlineNewsExcerptsonCompetitors5.
1SouthwestAirlinesKeyRevenueMeasureIsFlatforSouthwestAirlinesDALLAS--SouthwestAirlinesCo.
saidFridaythatakeyrevenuemeasurewasflatinMarch,anothersignthatairlinesarestrugglingtosellmorehigh-faretickets.
Southwest,whichownsAirTranAirways,saidthattrafficonthetwocarriersrose4percentlastmonthcomparedwithayearearlier,aspassengersflew9.
44billionmiles.
Despitetheincreaseintraffic,SouthwestsaidthatpassengerrevenueforeachseatflyingonemilewasunchangedfromMarch2012.
Thatstatisticisacloselywatchedindicatorofpricingpowerintheairlinebusiness.
Airlinesareleavingfeweremptyseatsontheirplanes_occupancyisatlevelsnotseensince1945_buttheyappeartobesellingfewerseatsatthehighestfaresordiscountingmoretickets.
Earlierthisweek,DeltaAirLinesInc.
andUSAirwaysGroupInc.
reportedweaker-than-expectedfiguresforthesamerevenue-per-milestatisticandsaidthatlast-minutebookingsweredisappointing.
That'simportantbecausepassengersusuallymustpaymoreforlast-minutetickets.
DeltaandUSAirwaysblamedtheweaknessinlatebookingsonautomaticfederalspendingcuts,whichpresumablywouldresultinlesstravelbygovernmentemployees.
Dallas-basedSouthwest,thenation'sfourth-largestairline,raisedpassenger-carryingcapacityinMarchby3.
8percent.
Airlinescanincreasecapacitybyaddingflightsormakinglongertrips,whichSouthwestdid.
Withtrafficrisingslightlyfasterthancapacity,planeswereabitmorefull.
Southwestsaidaverageoccupancywas82percent,upfrom81.
8percentinMarch2012.
Inlatemorningtrading,sharesofSouthwestfell16cents,or1.
3percent,to$12.
64_aboutdoubletherateofdeclineintheStandard&Poor's500index.
5.
2VirginAmericaVirginAmerica:MoreEliteFliersWantedInabidtoattractcovetedelitefrequentfliersfromotherairlines,VirginAmericaonTuesdayextendeditsstatusmatchprogram.
VirginAmericafirstintroducedtheprogramlastNovember.
CertainAmericanandUnitedroadwarriorsholdingelitestatuswerematchedtoVirgin'sSilverorGoldElevatestatus.
(Readmore:VirginAmericaWoosEliteAmerican,UnitedFliers)TheprogramwasscheduledtoendApril30.
ButVirginhasextendedituntilJune30andisinvitingSouthwestAirlineselitestoparticipate.
36Travelerswhoflyatleast25,000milesannuallyonAmericanorUnitedwillbematchedtoVirginAmericaElevateSilverstatus.
Thosewhofly75,000milesormoreonUnited—or100,000milesormoreonAmerican—willbegivenElevateGoldstatus.
(Readmore:HowFlying,JustFortheMiles,CanPayOff)ForSouthwestfliers,thosewhoholdA-ListorA-ListPreferredstatus—25or50qualifyingone-wayflightsannually—willbematchedtoElevateSilverstatus.
SouthwestCompanionPassholders—100ormoreone-wayflightsannually—willbegivenElevateGoldStatus.
ThematchedstatusupgradewillbevaliduntilJune30.
Travelerscanextendtheirstatusthroughtheendof2013byaccumulatingeither8,000statuspointsforSilver,or12,000statuspointsforGoldbyJune30,2013.
…5.
3AirCanada&WestjetAnewsetofheadwindsforAirCanada&WestjetByBrendaBouw,TheGlobeandMailOct21,2014AirlinestockshavehitsomerecentturbulenceamidconcernsoverslowingglobaleconomicgrowthandtheEbolaoutbreak,butsomeinvestorsseeabuyingopportunity,especiallyaslowerfuelpricescutoperatingcosts.
SharesofCanada'stwomajorairlines,WestJetAirlinesLtd.
andAirCanada,havedippedinrecentweeks,evenasbothreportsteadytrafficincreasesandexpecttoreceiveextrarevenuefromnewlyintroducedbaggagefees.
AlowerCanadiandollarisaheadwindfortheairlines,sincetheymakemajorpurchasesinU.
S.
dollars,suchasfuel,whichmakesupabout25percentto35percentofanairline'scostbase.
Someanalystssaythatshouldbeoffsetbythedropinthepriceofthecommodityproducedfromoil.
BenchmarkGulfCoastjetfuelpriceshavefallentoabout$2.
40(U.
S.
)pergallon,downalmost20percentfrom$2.
95inJune.
"Thedramaticdropinfuelpricesrecentlydoes,inourview,providesignificantcostreliefthatshouldbenefiteveryoneintheindustry,"saidBenCherniavsky,ananalystatRaymondJamesLtd.
,inarecentnote.
Still,hediscouragesinvestorsfromviewingairlinestocksasawaytoplayfallingoilprices,sayingGDPgrowthhasagreaterimpactonairlineprofits.
"Itdoesn'tmatterwhatfuelcostsiftheseatsareempty,"Mr.
Cherniavskysaid.
Hehasa"strongbuy"onWestJet,callingitthecarrierwiththelowercosts,andrecentlyupgradedAirCanadato"marketperform"(similartoahold)from"underperform"(similartoa37sell),citinglowerfuelpricesanditsunderperformancecomparedwiththeoverallsectorandtheS&P/TSXcompositeindex.
AirCanadashareshavefallenabout25percentfromasix-yearhighof$10.
90(Canadian)reachedinJune.
WestJetshareshitanall-timehighof$33.
33inmid-September,buthavefallenabout7percentsince.
(Bothstockshaverecoveredinthepastcoupleofdaysalongsidethebroadermarkets.
)Bothstockshavebeenaffectedbyconcernsabouttheimpactontrafficfromadownturnintheglobaleconomy,thespreadoftheEbolavirusandcompetitionfromother,smallercarriers.
KonarkGupta,ananalystatMacquarieCapitalMarkets,saidAirCanadahasbeenharderhitthanWestJetandoveralongerperiodbecauseofitsthinnermarginsandgreaterexposuretointernationalmarkets,includingtheweakeningEuropeaneconomy.
Mr.
Guptaalsodoesn'tbelieveinvestorsshouldbetonlowerfuelpricestolowercostslong-term.
"Fuelisuncertain.
Whatweareseeingwithfuelpricesrightnowislikelyatemporaryshift.
[Prices]couldrebound,"saidMr.
Gupta,whohasa"buy"onWestJetanda"hold"onAirCanada.
BruceCampbell,presidentandportfoliomanageratCampbellLee&Ross,saidhisfirmdoesn'townairlinestocksbecausetheindustry'scostsaremainlyfuelandlabour,bothofwhichtheyhavelittlecontrolover.
However,ifthestockswerehitbyareboundinfuelpriceshemightconsiderthemasashort-termplaygivenwhathecallsthe"fragilepsycheofthemarket"today.
"Wedon'tlikethelong-termbusiness,butiftheygothitalotthenyoumighthavetolookandsay,'There'ssomuchvalueherewehavetodoit.
'Ifwediddothatitwouldbenewforus,"hesaid.
BMONesbittBurnsanalystFadiChamounsaidsteepsell-offsinairlinestockshaveproventobeabuyingopportunitiesinthepast,withtheexceptionofrecessions.
"Wedonotsensethedemandenvironmenthasdeterioratedandweremainpositiveontheoutlookforpassengertraffic,"Mr.
Chamounsaidinanote.
Hehasan"outperform"onbothAirCanadaandWestJet.
CanaccordGenuityanalystDavidTyermanbelievesit'sagoodtimetobuyairlinestocks,butsaidthe"wildcard"isthehealthoftheNorthAmericaneconomy.
"Atthispoint,theCanadianandU.
S.
economicoutlookremainssupportiveforairlinedemand,"Mr.
Tyermansaidinanote.
38AirCanadaconfirmsnovelfinancingfornewplanesByRossMarowits,THECANADIANPRESSApril25,2013MONTREAL—AirCanadaconfirmedWednesdaythatitplanstotapintoanovelway—atleastinCanada—offinancingthepurchaseoffivenewBoeing777aircraft.
TheMontreal-basedairlineannouncedtheprivateofferingofthreetranchesofenhancedequipmenttrustcertificates(EETC)worthUS$714.
5million.
TheaircraftarescheduledfordeliverybetweenJune2013andFebruary2014.
LoxleyAviationLtd.
hasbeencreatedtofacilitateAirCanada'sinauguraloffering,Moody'sInvestorsServicesaidinassigningratingsofBaa3totrancheA,B1totrancheBandB3totrancheC.
Theaircraft,configuredwith458seatsineconomy,premiumeconomyandpremiumclasses,willbeusedascollateral.
AirCanada(TSX:ACB)usesthelargestplanesinitsfleetonlong-haulroutes.
…ChrisMurrayofPIFinancialCorp.
hadpredictedthecarrierwouldbecomethefirstCanadianairlinetotapintoanewwaytofinanceaircraftpurchasesthatreducesinterestrates.
Ottawa'sapprovalinDecemberofanaircraftprotocolopensthedoorseffectiveApril1totheEETCtrustmarketthathasbeenusedbyU.
S.
carriersfornearly20years.
MurrayaddedinareportlastweekthatAirCanadamayalsoconsiderthesamefinancingarrangementforitsnewBoeing787planessettobegindeliverynextyear.
…AirCanada'spoorpunctualitycouldcostcustomers,expertwarnsCarrierrankedlastof28majorinternationalairlinesCBCNewsPosted:Apr5,20137:31PMET.
LastUpdated:Apr5,20137:29PMETAirCanadahastheworston-timearrivalperformanceofanymajorinternationalairline,aCBCMarketplaceinvestigationhasfound.
NumbersfromtravelinformationgroupFlightStatsshowedjust60.
89percentoftheCanadiancarrier'sflightslandedontimein2012,theworston-timeperformancerecordof28internationalairlines.
AirCanada'srecordworsensonthepopularVancouver-Torontocorridorwhereonly55percentofflightsarrivedontimein2012.
AirCanadacompetitorWestJetlandedontime70percentofthetimeonthatsameroute.
Theairline'sperformanceis"notgood,"saysAnmingZhang,professorofairtransportationattheUniversityofBritishColumbia.
Hespeculatesthattheairline'spoorpunctualitywillcostitcustomers.
39"Ifyoucanarriveontime,itisconsideredbypassengersasaqualityofservice,"hesaid.
"Unhappycustomersarenotwillingtotakeyourflightifthere'sacompetitorflight[that'sontime].
"Zhangsaysmanyfactorscancauselateflights,includingpoorweatherandinternationalconnections.
HepointsoutthatWestJethastheadvantageofbeingalargelydomesticairline,whileAirCanadafliestoEuropeandAsia,long-haulflightsthataremorepronetodelays.
HealsosaysAirCanada'sfleetcouldbeaproblem,sincethevarietyofaircrafttypescanslowmaintenanceandrepairs.
"Iftheairlineworkswithasingleaircrafttype,it'smucheasier,youknowtheaircraftinsideandout,"hetoldMarketplaceco-hostEricaJohnson.
"Onceyoumixwithdifferentaircrafttypesandparts,therewillbemorecomplicatedoperations.
"WestJetusesjustoneaircrafttype.
"[Usingonemodel]ismuchsimpler,"hesaid.
"Ifyouhavesevenoreightaircrafttypes,versusjustoneaircrafttype,thepartsareuniformandmechanicsknowexactlywhathappened.
It'smuchfaster.
"Top-rankedJapanAirlines,whichlandsmorethan90percentofflightsontime,has10differentaircrafttypes.
AirCanadarespondedtoMarketplace'sinvestigationwithawrittenstatementsaying,inpart,"AirCanadaisnowengagedinacompany-wide,on-time-performanceinitiativethatisresultingincontinuousimprovementinthisarea.
"StartingApril10,AirCanadawillrequirecustomersonmostflightstochecktheirbags45minutesbeforedeparturetime,insteadofthecurrent30minutes.
Zhangsayscheckingbagsearlierisapositivestepthatshouldsavetime,buthealsoencouragesAirCanadatobemoretransparentaboutitsdelays.
"Customerspayforthisserviceandtheyhavetherighttherighttoconsumetheproductasthecompanyhasadvertised,"hesaid.
"Theyhaveascheduleddeparturetime[and]ascheduledarrivaltime,andtheyareentitledtoseewhythereisadeviationfromtheproductyouprovideandtheproductyoudeclaredintermsofqualityaspects.
"405.
4PorterAirlinePorteraimstobecomeCanada's3rdnationalairlineCBCNewsPosted:Apr10,201310:25AMET.
LastUpdated:Apr10,20133:53PMETPorterAirlinesconfirmedtodayitplanstobuyupto30CS100jetsfromMontreal-basedBombardier,whichwouldexpandtheregionalcarrier'sreachfromcoasttocoast,andtakedirectaimatAirCanadaandWestJet.
"Webelieveitistimetospreadourwings,"presidentandCEOBobDelucesaidatanewsconferenceatBillyBishopTorontoCityAirport,wherePorterisbased.
"AndsoIpresenttoyouourvisionforthefutureofPorterAirlines—avisionwithservicetodestinationsacrossNorthAmerica,fromCalgaryandVancouver,toLosAngeles,MiamiandOrlando.
"ThemovepushesPorterintodirectcompetitionwithAirCanadaandWestJetasanationalcarrier,whilesettingupapotentialpoliticalstandoffoverexpansionoftheislandairportindowntownToronto.
'WebelievetheCS100istheperfectaircraftforthenextstageofourgrowthformanyreasons,nottheleastofwhichisthatitisthequietestcommercialjetinproduction.
'—BobDeluce,PorterCEOTheconditionaldealistobuy12BombardierCS100s,withoptionson18more.
ThedealalsoincludespurchaserightsforsixofBombardier'sQ400turbopropaircraft,currentlythemainstayofthePorterfleet.
Thetotalpurchasecouldreach$2.
29billionUSifalltheoptionsandpurchaserightsareexercised.
Deliveryofthefirstjet,whichhasseatingfor107passengers,isexpectedin2016.
TheconditionalpurchaseagreementsignedonTuesdayisacoupforBombardier,andushersinachangeinCanadianaviation.
That'sbecausetheCSeriesjetscanfly5,400kmwithoutrefuelling,muchfartherthanthecurrentfleetofQ400turbopropplanesthatPorterfliestoconnect19citiesacrossEasternCanadaandtheU.
S.
Theairlinesaidtheexpansioncouldmean1,000newemployees,whichwouldbringthetotalto2,400.
PotentialpricewarJosephD'Cruz,aUniversityofTorontobusinessprofessorandaviationexpert,saidthemovecouldbegoodnewsforconsumers.
Theannouncementcouldleadtoapoliticaldisputeovertheairport,whichisnearresidentsontheislandandthecity'sheavilypopulateddowntown.
(MarivelTaruc/CBC)"It'sgoingtobeinterestingtowatchhowWestJetandAirCanadareactoncePorterstartsbitingintotheirbusiness,"hetoldCBCNews.
"They'regoingtoretaliate,andtheonlywaytheycanretaliateislowerprices.
""Thismaytriggeraviciouspricewar,"D'Cruzsaid.
41AirCanadasaidthatbeforeittakesapositiononfurtherinvestmentattheislandairport,itwantsassurancethattakeoffandlandingslotswillbecomeavailableforotherairlinesthathavebeenseekingincreasedaccess.
Canada'slargestairlinecurrentlyhasonlyenoughlandingandtakeoffslotstoofferservicebetweenMontrealandtheairportontheTorontowaterfront.
WestJetAirlinesdidnotdirectlyaddressPorter'splans,butsaiditremainsfocusedonkeepingitsownbusiness.
"Weexpectcompetitiontoincreaseandarepreparingaccordingly,"WestJetspokesmanRobertPalmersaidinastatement.
…InaseparateinterviewwithTheCanadianPress,KokonisnotedthatPorter'splaneshavebeenflyinglessfullwhileloadfactorsatWestJetandAirCanadahavebeenimproving.
"Inazerosumgamewherethey'reallsortofchasingthesamepassenger,itdoesgiveonepauseforconcernthatPortermightbestrugglinginsomeareas.
"Despitetheexpansion,Delucesaidtakingtheprivatelyheldairlinepublicandraisingmoneythroughaninitialpublicofferingisnotapriorityrightnow.
Thecompanyhadplannedtoissuesharesonthepublicmarketsinthepast,butshelvedthemforvariousreasons.
"We'venotthoughtaboutanIPOinmostrecenttimes,"Delucesaid.
"Sometimeinthefutureit'sapossibility.
"5.
5OrangeSkyAirlineOrangeSkyTroubledPastFinallyEmergingFromBankruptcyExcerptAdaptationfrom3rdEditionofOrganizationalBehavior:AStrategicApproachbyHitt,Michael,Miller,C.
Chet,andColella,JohnWiley&SonsMay30,2014OrangeSkyAirlinesfinallyemergedfrombankruptcyonApril1,2014after3yearsand51daysofinternalconflictsanddeterioratedmanagement-laborrelations,whichledtofallingstockpricesandincreasinglydissatisfiedcustomers.
Thelong-datedlabourproblemdatedbackatleastto2001whenthecompany'sdifferentuniongroups(pilots,mechanicsflightattendants)wereatoddswiththecompanyandwitheachother.
Thecompanywasabletoobtainagreementwiththepilots'andthemechanics'unionmemberstoreducetheirpayinexchangefor25%and20%ofcompany'sstockrespectivelyand10%tonon-unionemployees.
However,thisexchangewasnotendorsedbytheflightattendants'unionwhichendedindisputeamongthedifferentunions.
Asaresult,thecustomerserviceswereimpactedandflightdelaysoccurredmorefrequentlythanotherairlines.
Inaddition,managementwasblamingtheunionsforallthedilemmasresulted,whereastheunionsfeltmanagementwasmakingpoordecisions,ignoringtheirinputandtopexecutiveswerestillreceivingexcessivecompensation;therebyleadingtotoxicmanagement-42labourrelations.
Astimeprogressed,OrangeSkyexperiencedmorelossescausedbysubstantialreductioninflightsalesespeciallyduringthe2008financialcrisis,mis-managementandinabilityofOrangeSkytoobtainloanofalmost$1.
5billionfromAirTransportationStabilizationBoard(ATSB)tocoveritsdebtinearly2009.
Asaconditionofsuchloan,OrangeSkywouldhavetomakemorecutbacksandreductioninwagesandbenefits.
Forthistooccur,allunionswouldhavetoagreetopaycuts.
OrangeSkymanagementwasunabletoreachconsensuswiththeunions.
Asaresult,OrangeSkyAirlinefiledforbankruptcyinearly2011inordertosettlewiththedifferentunionsandcreditors.
Today,OrangeSkystockdroppedtolessthanUS$1pershare.
5.
6RecentAirlineIncidentsBritishAirwaysplanecatchesfireatLasVegasairportTheGuardianSeptember9,2015ABritishAirwaysjethascaughtfireatLasVegasairport,sendingsmokebillowingintotheair,aftersufferingwhatthepilotdescribedasa"catastrophicfailure"oftheleftengine.
Fireofficialssaid14peopleweretakentoSunrisehospitaltobetreatedforminorinjuries,includingcutsandbruises,mostaresultofslidingdowntheinflatablechutestoescape.
All157passengersand13crew–includingthreepilots–onboardwereevacuated,andthefirewasswiftlyputoutbyaround50firefighters.
Anairportspokeswomantoldreporters:"Allpassengerswereevacuatedquicklyandsafelyandtakenbybustotheterminal.
"Wecannotexpressenoughgratitudetotheemergencyresponsecrews,aswellastheBritishAirwayscrew.
"TheNationalTransportationSafetyBoardwasinvestigatingtheincident,sheadded.
Theplaneabortedtake-offshortlybeforethefirebrokeout.
TheFederalAviationAdministration(FAA)saidtheBoeing's777leftengine–manufacturedbyGeneralElectric–burstintoflames.
DramaticimagesofflightBA2276weresharedonsocialmediabymembersofthepublicattheairport,whichisfivemilessouthofdowntownLasVegas.
GuardianreporterJacobSteinbergwasontheplaneandtweetedabouttheevacuation:"JustevacuatedonaBritishAirwaysflightatLasVegasairportafteranenginecaughtfire.
Don'tthinkanyonehurt.
"Wasasleepastheplanetookoff.
Cametoacrashinghalt.
Smellofsmoke.
Initiallytoldtostayseated,thenshoutofevacuate.
Couldsmellandseesmokebutwasonothersideofplane.
Onepersonsaidfiremeltedacoupleofwindows.
"43TheCrashofDelta1086:Typical!
TheEconomistMarch10,2015MOSTaviationaccidentsaren'tlikethedisappearanceofMalaysiaAirlinesFlight370lastyear.
ThecrashofDeltaAirLinesFlight1086atNewYork'sLaGuardiaairportlastweekisfarmoretypical.
Delta1086,aMcDonnellDouglasMD-80,waslandingatLaGuardiainasnowstormwhenitskiddedofftherunwayandintoanearthenbermthatseparatestheairportfromFlushingBay.
Threepeoplewerehospitalised,butnoonewaskilledandallpassengersweresuccessfullyevacuated.
Thisisasclosetoaprototypicalairlineaccidentasyoucanget.
Itwassurvivable,happenedduringtakeofforlanding,anddidn'tresultinthetotallossoftheplane.
Manyplanesgetintotroublebecauseofbadweather,whichcertainlycouldhavebeenacontributingfactorinthiscase(theNationalTransportationSafetyBoardisstillinvestigating).
Itisalsonotclearwhetherpiloterrorplayedanyrole,butthecrewoftheplanecertainlydeservecreditformanagingaquickandcompleteevacuation,especiallysincetheaircraftwasleakingfuel.
TheAssociatedPresshasagoodroundupofpossiblecausestheNTSBwillinvestigate.
AsDennisMersereaunotesoveratGawker,oneofthelessonshereisthattravellersshouldresistcomplainingtotheairlinesaboutbadweather.
Itistotallyoutsideoftheircontrol,andpoorconditionsmakeflyingsignificantlymoredangerous.
Americanairportshave,inrecentdecades,struckagoodbalancebetweenremainingopenwhenitissafetodosoandclosingwhenit'snot.
Andwhenyouthinkaboutaeroplaneaccidents,remember:you'reincrediblyunlikelytobeinone.
Butifyouare,it'llprobablybemorelikeDelta1086thanMH370.
44EXHIBIT6BlueJayAirCorporation'sBalancedScorecardFramework45EXHIBIT7JACDEC2014AviationSafetyReviewFrom:JimPetersSent:December1,20159:00amTo:JohnFeatherSubject:JACDEC2014AviationSafetyReviewJohn–Myteamhasreviewedresultsofthe2014AviationSaftyReviewandsummarizedasfollows.
Pleaseletmeknowifyouwouldliketodiscusschangestoanyofourprogramsbasedontheresultsofthisreport.
-JimIn2014theworldsdeathtollincommericalairtransporthasrisennearlyfourtimesoverthe2013numbers.
Spectacularaccidentscrippledtheunprecedentedsafetyrecordoflastyear.
"Thisisthesecondhighestinthepasttenyears,"writesJan-ArwedRichter,founderoftheHamburgAircraftAccidentoffice,called"JetAirlinerCrashDataEvaluationCentre"(JACDEC).
Thenumberliesalmostfourtimeshigherthaninthepreviousyear,whenonly251peoplewerekilledinaviationaccidentskilledRighterexplainedinapreviouslypublishedpaperfortheaviationmagazine"AeroInternational".
AbouthalfofthefatalitiescamefromtheAsia-Pacificregion.
Althoughflyingremainsthesafestwayoftravelling,2014marksanuntypicallyyearcomparedtoaseriesofyearswithfallingnumbersofvictims.
2014alsowhirledthroughtheJACDECsecuritylistofthe60largestairlines.
Theworld'snewleadingairlineintermsofitssafetyrecord,isCathayPacificfromHongKong,followedbyEmirates,EVAAirofTaiwanandAirCanada.
ThesafestairlineinEuropeisthereforenowtheDutchKLMinfifth,aheadofAirNewZealandandQantasofAustralia.
Thus,thetwomajordisastersaffectedMalaysiaAirlinesfellfrom34thto57thplacenow.
Lufthansaremainsunchangedclaimedtheir12thplace.
Germany'ssecondlargestairlineAirBerlinclimbedfrom26thto20thplace.
"Fromtheobserved60largestairlinesmorethanhalfadozenlostoneoftheiraircraft",itsaysinthearticle.
TheJACDECsafetyscoreisprimalirycalculatedbytherenevuetrafficperformanceofanairlineinrelationtothenumberofseriousincidentsandtotallossesitexperiencedupto30yearsback.
46ThesafestregionsinwereNorthAmericaandEurasia(includingRussiaplusallGUSStateseastofUkraine)protrudeoutpositive:Therewasnotasingleflightaccidentdeath.
ForLatinAmerica,theanalystcameto10deathsmostlyonflightswithvintagemachinesonnon-scheduledoperations.
TheMiddleEastandCentralAsiaremainedat57.
Africawasagainanaccidentfocus,itexperienced18aircraftlossesand134fatalities,althoughtheexceededbyEurope.
IncludingthedisasteroftheMalaysianBoeing777overtheeasternUkraine,theregiontotalswithanumberof300fatalitiesnowhasthepenultimateplace.
MostdeathsoccuredintheAsia-Pacificregion,wherethehalfofallfatalitiesoccuredinthepastyear.
From:JohnFeatherSent:December1,20159:05amTo:JimPetersSubject:RE:JACDEC2014AviationSafetyReviewJim–Budgetforimprovementsislimited,butinterestedinimprovingourrank.
Pleaseadvise.
JF473BlueJayTireCo"Whosaidanypublicityisgoodpublicity,"wonderedPierreBeaudry,CEOofBlueJayTireCo(BJT).
Hefurtherreflectedthatitwasparadoxicalthatleaderswholiveduringseverecrisesgetthemostpressandthusthehighestrankingsfromhistoriansandthepopularpublic–ministers,presidents,mayorsandcivilleaders.
BJTwasexperiencingbothpublicityandacrisis.
Pierrewasconfidenthisteamwouldnavigatetherecallcrisissuccessfully.
Itwasnotthefirstchallengetheyhadfacednorwoulditbethelast.
"Howmanymajorstrategicissuescanpileonatonce"ThoughtPierre.
"Wehaveatirerecallandunionnegotiationsatthesametimethatoilpricesaredecreasingandminimumwageincreasing.
"Thedecreasingoilpriceshaveproventobepositivefortiresalesasbothconsumerandcommercialvehicleusagewasontherise.
Theindustrywasrifewithgrowth,buttheplantsinthesouthernstateswerenearcapacity.
BJTneedstoexpandtheirproductioncapacitysoontosupportitsgrowth.
Thisandotherlaborconcernswouldneedtobediscussedwiththeunionrepresentativesforthenewcontracts.
Eventhoughthetirerecallhadonlycausedasmallrippleinconsumersentimentsofar,Pierreremainedweary.
Besttotreadgentlyinlightofrecentevents.
Inlightoftherecall,Pierreknewthepresswouldshownomercy.
HeknewtheBoardwoulddemandchange.
WhatwentwrongTheyhadriskgovernancepolicies,theyhadriskdashboards,theyperformedpolicyaudits,theyhadtrainingprogramsandtheyhadawell-staffedriskmanagementfunction.
HowwouldthecrisisaltertheirplansandgrowthstrategiesBeforethecrisistheyhadtoughchoicestomake.
Nowthechoiceswouldbeeventougher.
Howshouldhereshapetheirplans3.
1BackgroundEarlyHistoryTheDurableTireCorporation(alsoreferredtoasDurable)hasbeenoperatinginCanadasince1920.
Thecompanyhasasmallandloyalcustomerbaseinruralareas.
ThehighqualityproductprovedtobeverywellsuitedtotheruggedCanadianfrontier.
Durablebuilttiresforfarming-relatedvehiclesandsmallplanesintendedtobeusedondirtroadsoroff-roadonfarmsandsmallcommunitytowns.
Thecompanyfounders,theEasternfamily,werealsofarmers.
Durablealsomanufacturedspecialtysoldinnichemarkets.
TheEasternsalwaysfocusedonprovidingthebestqualitytiresthatwouldlive-uptothefamilynameandbrand.
Whenthefamilypatriarchpassedawayin2000,thefamilydecidedtosellitsinterestinthecompany.
ThecompanywasacquiredbyBlueJaysAir(BJA).
BJAhadbeenoneofDurable'sclientsforspecialtytiresinsmallaircraftsthatflewintheNorthernreachesofCanada.
48UnderBJASince2001UnderBJAmanagement,DurableTirewasre-brandedforbroaderappeal.
TheBJAgroupfeltthatitcouldleveragethecapabilitiesofthemanufacturingprocesstodevelopabroaderrangeoftires.
Thetirecompanyre-brandedwithintheBJAgrouptobecomeBlueJayTire(BJT).
In2001,theBJAteaminitiateda5yearplantoexpandsalesanditsdistributionreachintocommercialvehiclesacrosstheUSA.
TheBJAmanagementteamincreaseditsfocusandoversighttowardstheBJTventureanditsever-improvingfinancialresultsasBlueJay'sstrugglesworsenedduetoincreasedcompetitionandsqueezedmargins.
In2006,havingsuccessfullymetandsurpassedthe5yearplanobjectivessetoutin2001,theBJAboarddirectedtheEagleTiredivisiontopursueanevenmoreambitiousgrowthstrategy.
Withfunding,BJTpurchasedtwomanufacturingplantsinthesouthernUSAandre-fittedtheoperationwithdirectionfromtheirCanadianoperations.
AnexecutiveteamunderthebannerofBlueJayTireUSA(BJT-USA)wassetupbytheBJAboard.
ThiscompanyoperatedwithoversightfromitsCanadianheadoffice.
BJT-USAengineerswereaskedtosettargetsatdoubletheirpre-acquisitionproductionlevelsorabouttripletheleveloftheCanadianmanufacturingplant.
Atthesametime,BJTintroducedatirewarrantyprogramthathelpedtoenhancethetiresalesandestablishthetirebrand.
Withapremiumofabout50%ofthetirecosts,thewarrantyprogramprovidesfreetirereplacementforsevenyearsfrompurchasedateofeverytire.
Sinceinception,thistirewarrantyprogramwaswellreceived.
BJT-USAsurpasseditsaletargetseachandeveryyearfrom2006-2014.
BJT-USA,despiteitssize,achieveda3rdplacemarketpositionintiresalesforcompactcarsandsmallSUVvehiclesinthesouthernU.
S.
A.
By2008BJTdominatedtheearningsoftheBlueJaysAirgroup.
BJTinearly2014accountedfor20%oftherevenueandanastounding43%oftheprofitoftheAirlinegroup.
BJTmanagementwasheraldedbytheexecutiveteam,theboardanditsshareholdersasthe"star"oftheAirlinegroup.
FinancialsDetailed5yearfinancialstatementsareshowninAppendix3AExhibits1to3.
3.
2RiskFactorsThefollowingriskfactorexcerptsaretakenfromthe2014AnnualReport.
CommodityRiskAlthoughthereisalargeamountofsyntheticrubberusedinthemanufacturingprocess,thecompanystilldependsagreatdealonnaturalrubber.
Typicallythatissourcedincountriessomewhatlessstablethanthedevelopedworld.
Naturalrubberproductionissubjecttoweatherrelatedrisks.
IntheTireIndustryrubberrepresents52%oftotalmanufacturingpurchases.
A$0.
10perkilogramincreaseinnaturalrubberpriceswouldleadtoanestimated$0.
5Mincreaseinmanufacturingcosts.
49BJThasmaintainedthesamesupplierforover30years.
TherelationshipisverystrongandBJTbenefitsfromstablepricing.
InthepastdecadeBJThasachievedthelowestpricesonitscommoditypurchasesbecauseitsgrowthstrategyhasalsobenefitedthesupplier.
VolumediscountshavebeenpassedontoBJTintheformofbetterpricing.
ForBJTrubbernowrepresentsonly48%ofcompanypurchasesdownfrom60%atthestartofthemillennium.
CommodityriskisconsideredtobelowerforBJTthanitscompetitors.
ManufacturingRiskTheprocessofmakingtiresinvolveschemicalsandflammableingredients.
Thisposesconcernsfortheworkersandtheriskoffireislarge.
Inaddition,thesizeofthefinishedproductincreasestheriskofworkerdisabilities.
Alost-timeinjuryisdefinedasanoccurrencethatresultedinafatality,permanentdisabilityortimelostfromworkofoneday/shiftormore.
TheLostTimeInjuryFrequencyRate(LTIFR),thenumberoflost-timeinjuriespermillionhoursworked,iscalculatedas:=Numberoflosttimeinjuriesx1,000,000TotalhoursworkedinaccountingperiodOverall,theBJTmanufacturingplantshavereportedaLTIFRofbetween2.
16and2.
69inrecentyears.
Thiscomparesreasonablywelltotheindustryaverageof2.
38.
Inparticular,theLTIFRfortheCanadianBJTplanthashadbestinclasssafetyrecordsatlessthan2.
0sinceinter-companysurveysbegan.
Incomparison,theU.
S.
plantshavebeenbetween2.
56to2.
99sincebeingacquiredbyBJT.
Themanufacturingprocesshadbeenestablishedbythecompanyfoundersandhashadprovensuccessovermanydecades.
ThesameprocessandstandardsareusedinbothCanadianandU.
S.
plants.
Thecorecompetencesforqualityassuranceareinthepeoplewhomanagetheprocessandthecultureofqualitymanagementispassedonwithintheoperationsteamfromexperiencedstafftonewassociates.
QualitymanagementisconsideredbyExecutiveManagementtobeagrass-rootscompetenceofthecompany.
ManufacturingriskiscurrentlyconsideredtobemediumforBJT.
Management'srecentfocushasbeentoreturntothehistoricalCanadianoperationallevelof1.
92.
AprogramrecentlyimplementedinvitesretiredCanadianandformerBJTplantoperatorstoconductqualitymanagementtrainingforexistingstaff.
LaborRiskTiremanufacturingplantstypicallyhaveunionizedlaborforces.
Thecompanymightfacecontentiouslaborissuesinanumberofmanufacturingplantswithunionizedlabor.
HistoricallytheCanadianoperationhasnothadunionizedlabor.
However,50%oftheemployeesworkinginthetwoU.
S.
plantsareUnionmembers.
ThecurrentUnioncontractexpiresin2016.
50Afternormalizingforstandardoflivingdifferentialsandexchangeratesbetweengeographicallocations,thelaborcostintheCanadianoperationis35%lowerthansimilaroperationsintheU.
S.
Therehasnotbeenanydisruptionintheworkforceatanyplants.
LaborriskiscurrentlyconsideredbyExecutiveManagementtobelow.
However,thenumberofstaffthatelectforUnionrepresentationhasbeenincreasing.
LegalRiskThepossibilityofclass-actionlawsuitsexists,particularlyintheUS.
Alargeriskstemsfromthechancesofpayingoutlargeclaimsand/orhavingwide-spreadproductrecalls.
BJThasnotexperiencedanylitigationactioninitshistory.
DistributorRiskBJTsellsalmostallitstiresthroughindependentdistributors.
BJThaslongstandingrelationshipswithseveralCanadiancardealershipsastheirsoleorprimarytiresupplier.
InsuranceRiskThekeyrisksinatireoperationareproductliabilityandproductrecall.
Somecompaniesuseacaptiveinsurancecompanytohandlethisexposure.
HistoricallyBJThasretaineditsrisks.
Theboardhasrequestedafeasibilityreporttoexaminethesolutiontoeffectivelymitigatethisexposure.
EnvironmentalRiskTiresareaneasytargetforenvironmentalgroups.
Billionsoftiresareproducedeachyearandbillionsarediscarded.
Thematerialstoproducetiresandthemanufacturingprocesscanbethesubjectofenvironmentalconcerns.
BJTmaintainsarecyclingplantfortherubberinitsdiscardedtires.
ThisplantisonlyabletosupportoperationsinCanadaduepartlytosubsidiesavailablefromtheCanadiangovernment.
EffortsintheU.
S.
forasimilarplantarenotlikelytobeeconomical.
Environmentalriskisconsideredtobelowduetooperationsizeandoverallmarketshare.
EconomicRiskThenumberofmilesdrivenhasalargeimpactonthedemandfortires.
Thestateoftheworldeconomyhasadirectimpactonthecompany'sabilitytogrowandexpand.
BJThaschosentotargetcompactcarsandsmallSUVswhichexperiencedincreasedsalesduringthefinancialcrisis(2008–2010).
Itwasanticipatedthattheincreasedgasolinepriceswouldcontinuethetrendtowardsthesmallvehicles.
Thisstrategywasproventobeeffectiveasacounter-cyclicalimpactonsales.
BJTexperiencedmarketsharegrowthfrom5%to8%duringthefinancialcrisis.
However,withrecentvolatilityingasolineprices,itisdifficulttoanticipatewhethersuchtrendwillcontinue.
Overall,economicriskforBJTisconsideredmedium.
51ReputationalRiskOneofthecompany'sprimarystrengthsisitsbrandname.
BJTmustconstantlyassurethatitsproductsareofthehighestqualityandinvestinresearch&developmenttocontinuallyimproveitsproducts.
BJThasgrowingbrandawarenesswithintheU.
S.
market.
BJTusessocialmediamonitoringtoolstoassessitsbrandawareness.
BrandawarenessisconsideredtobeacriticaldeterminantofBJT'sgrowingpresenceinitschosentargetmarket.
BJTmonitors5mediachannels(e.
g.
newspapers,televisionstationsandwebsites)fortheirpositive/negativeratio.
MediachannelPositive/negativeratioBlog1.
5InternetForum2.
7Newspaper1.
9Onlinenewspaper1.
7AssociatedPress(AP)Newswire3.
2Allmediacombined2.
2Iftheoutlierof3.
2correspondingtotheAPNewswireisomitted,thentheaveragepositive/negativeratiois2.
0withastandarddeviationof0.
4.
Pro-BJTinformationisgenerallyabouttwiceaspersuasiveascon-BJTmessages.
Theratiohasgrownfrom1.
8to2.
2sinceBJTbeganmonitoringitsbrand.
ThisisheldtobeasignofBJT'sgrowingreputationinitschosenmarket.
Reputationalriskisconsideredtobelow.
PoliticalRiskThecompanyisexposedtopoliticalriskthroughimport/exportquotasandpricecontrols.
TheNorthAmericanFreeTradeAgreement(NAFTA)betweenU.
S.
A.
,CanadaandMexicogavebirthtotheU.
S.
operationsofBJT.
BJTisexposedtofuturechangesinthisagreement.
Duringthecrisis,U.
S.
interestlobbygroupsdemandedstrongernationalistpolicies.
TherecontinuestobestrongpoliticalsupportforNAFTA,inthecurrentUSadministration.
However,whenpoliticalleadershipistochangeintheU.
S.
andthepooreconomicgrowthtopersist,NAFTAmightberevisited.
ThesupplychainisalsoexposedtopoliticalriskduetothegeographicallocationofthesupplierswhichareprimarilyinMalaysia.
PoliticalriskisconsideredamediumriskforBJTasasmallCanadianfirmoperatingintheU.
S.
CurrencyRiskManufacturingcostsandtherevenuegeneratedareindifferentcurrenciesresultinginapossibleloss.
BJTCanadianoperationsandsalesareinCanadiandollarsandtheU.
SoperationsandsalesareinU.
S.
dollars.
85%oftherawmaterialsaresourcedfromMalaysia.
523.
3RecallRecentTireRecallIssueBelowaretheheadlinenewsandaseriesofemailsuncoveredbytheinvestigativejournalistthatledtotherecenttirerecall.
BlueJayTirequalityorquantity,youdecidebyJenniferTruthSmallville,Arizona(AssociatedPress–August2nd2014):TheBlueJayTireCo(BJT)reportedinMay2014thatatiredefectwhichcausedasinglecaraccidentwasanisolatedincident.
PierreBeaudry,CEO,issuedastatementsaying"BlueJayTirehasalonghistoryofmanufacturingexcellencebutonbehalfofouremployeesweextendourcondolencestotheFranklinfamilyfortheirloss.
WeregretthataBJTtirewasresponsibleforthisaccident.
Onbehalfofourengineers,linemanagersandproductionteam,IcanassuretheFranklinandanyfamilyintheUSAthatwedoeverythinginourpowertoensureourtiresarethehighestqualityontheroad".
ThetireinvolvedonthedayinMay,wastheRU42WDmodel.
Over40millionofthesetireshavebeensoldintheUSA.
Theofficialreportontheaccidentdisclosedthatthedefectivetiresexplodedcausingasuddenlossofdrivercontrol.
InJuly,thisreporteruncoveredanumberofemailrecordrelatedtoRU42WDtiresinBJT'smanufacturingprocess.
InanemaildatedAug8th2010,theBJT(Canada)headengineer,PaulGoslingindicatedreservationwiththespeedoftheproductionlineresultinginunevenrubberdensitytoaBJT(USA)executive,JackTavares.
Thefollowupresponsesindicatethatsomecorrectiveactionwastakentoredressthesituation.
Whencontacted,theBJT(USA)headengineer,ChrisCarpenter,atthetimereportedtothispaper:"Theproductionprocessalwaysranwithinitsdesignlimits.
Butwedidnoticetiredensityvariations.
Weneverdidtestthepossibleimpactoflowdensitytiresonautomobilestravellingatspeed.
Insteadwereliedonthefactthatthetirethreadweartestswerealwayswithinthetolerancescommonlyusedbyalltirecompaniesatthetime".
ChrisCarpenternowworksforarivalfirm.
BJT(USA)refusedtocommentwhencontactedabouttheseinternalmemosandthecommentsofMr.
Carpenter.
BelowareseriesofemailsthatwereuncoveredbyAPjournalists:From:PaulGoslingTo:JackTavaresDate:August8,2010Subject:StickyvalvesandrubberdensityontiresJack–53AftervisitingET-USAplant,IdidnotfeelthatenoughQualityAssuranceisinplace.
Ingeneral,Ithinkproductionistoofasttomatchdemandandnotenoughchecksarebeingmade.
Specifically,Ihavenoticedtwoitems:stickyvalvesonmodelRU42WRandunevenrubberdensityonRU42WD.
Irecommendthelinemanagerstomonitortheseissuesmorecloselyandtotightenthealloweddefects–eventhoughthismayslowproduction–soastocorrecttheseissues.
Althoughthevalveismoreofanuisance,thedensityismoreofasafetyissue,buttobeclear,thelowdensityareasarestillwithinprescribeddensitylimits–therearejustsomenoticeablevariationswithinthetires.
Iwillkeepyouposted.
PaulGoslingHeadEngineerBlueJayTire(Canada)From:JackTavaresTo:PaulGoslingDate:August12,2010Subject:RE:StickyvalvesandrubberdensityontiresPaulGoodcatch–IwillfollowupwithChrisregardingbothRU42WRandRU42WD.
Hopeyouenjoyedyourvisit!
JackTavaresChiefRiskOfficerBlueJayTire(USA)From:ChrisCarpenterTo:JackTavaresDate:September9,2010Subject:TireproductionJackThisistosummarizeourcallsoverthepastmonth.
Ithinkwehavebothissuessolved:asImentionedonthephone,thestickyvaluesonRU42WRwereeasilyfixedbyincreasingthelubricantonthesiliconmachine.
RU42WDrequiredmoreeffortandtooklonger.
Wediscoveredasmallinconsistencyonthecentrifugeconsole.
Mystaffrecalibrateditandwehaveeliminatedthedensityissue.
Wealsoincreasedourspecinspectionsfrom1in200to1in20untilwewereconfidentthefixtook.
Wearebackuptoregularproductionlevelsagain.
Weareactuallyconsideringincreasingtheproductspeed.
54Thanksagain,ChrisChrisCarpenterHeadEngineerBlueJayTire(USA)553ABlueJayTireExhibitsEXHIBIT1BlueJayTireCorporationNON-CONSOLIDATEDSTATEMENTSOFOPERATIONS(USDollarsinmillions)FISCALYEARending12/31/YYYY201420132012201120102009TotalGrossSales317296277259242230CostofSales(1)CostofRawMaterials(16)(15)(14)(13)(12)(12)ProductionCosts(2)(32)(30)(28)(26)(24)(23)Depreciation&Amortization(20)(20)(20)(20)(20)(5)ShippingCosts(7)(6)(5)(4)(3)(3)Other(4)(5)(6)(7)(8)(4)TotalCostsofSales(79)(76)(73)(70)(67)(46)NetRevenue239221204189175184OperatingExpensesResearchDevelopment192122232425SellingGeneral&Administrative(3)514743403735Non-Recurring(4)627066232717ForeignExchangeGain(Loss)11(6)(8)152014Other(5)604950802710TotalOperatingExpenses203180173181135101OperatingIncomeorLoss36413284083IncomefromOtherRevenueandContinuingOperationsOtherRevenue–Warrantyprogram797469656158OtherRevenue–BookSales13109875TireReplacementExpenses(40)(37)(35)(32)(30)(29)TotalOtherIncome/ExpensesNet(6)534744403734EarningsBeforeInterest&Taxes8888754877116InterestExpenses323228282418IncomeBeforeTaxes565647205399IncomeTaxes1111941120NetIncomefromContinuingOps454538164279Notes:(1)Includescostofmaterial&productionwithoverhead(2)Includessalaries&overheadsdirectlyrelatedtoproduction(3)Includessalariesotherthanproductionrelated(4)Includesoperationalprocessupgrades(5)Predominantlyinjuryclaims(6)PerformanceofthetirewarrantyprogramandSalesfromtravel&restaurantguidebooks56EXHIBIT2BlueJayTireCorporationNON-CONSOLIDATEDSTATEMENTOFFINANCIALPOSITION(USDollarsinmillions)FISCALYEARending12/31/YYYY201420132012201120102009ASSETSCurrentAssetsCashandCashEquivalents746863575249ShortTermInvestments11382808489111Receivables21109983Inventory616053584837TotalCurrentAssets269220205207198201LongTermInvestments1,2491,2501,1001,1091,004940PropertyPlantandEquipment10012014016018050AccumulatedAmortization-2040---IntangibleAssets25252525255OtherAssets1226468423353TOTALASSETS1,7651,6991,5781,5431,4391,248LIABILITIESandEQUITYCurrentLiabilitiesAccountspayable644422Short/CurrentTermDebt66555-OtherCurrentLiabilities424332TotalCurrentLiabilities15131311103LongTermDebt542534457465380250OtherLiabilities453435323018TOTALLIABILITIES603581505508420271EquityRetainedEarnings1,1121,0671,023985969927Capital505050505050TOTALEQUITY1,1621,1171,0731,0351,019977TOTALLIABILITIESandEQUITY1,7651,6991,5781,5431,4391,24857EXHIBIT3BlueJayTireCorporationNON-CONSOLIDATEDSTATEMENTOFCASHFLOW(USDollarsinmillions)FISCALYEARending12/31/YYYY201420132012201120102009NetIncome454538164279OperatingActivities,CashFlowsProvidedByorUsedInDepreciation20202020205Amortizationofdeferredexpenses202020000AdjustmentsToNetIncome:ChangesInAccountsReceivables(11)(1)(1)(1)(4)(1)ChangesInLiabilities/AccountPayables2(0)111(4)ChangesInInventories(1)(7)4(9)(11)3ChangesInOtherOperatingActivities00(60)000TotalCashFlowFromOperatingActivities757722274883InvestingActivities,CashFlowsProvidedByorUsedInCapitalExpenditures0000(170)(10)Investments(32)(1)3622(91)Foreignexchangegain(loss)00000(2)OtherCashflowsfromInvestingActivities(56)(146)(17)(114)(44)0TotalCashFlowFromInvestingActivities(88)(147)(14)(109)(192)(103)FinancingActivities,CashFlowsProvidedByorUsedInDividendsPaid000000SalePurchaseofStock000000NetBorrowings779(8)8513522OtherCashFlowsfromFinancingActivities13(3)52145TotalCashFlowFromFinancingActivities2076(3)8714826Cash&cashequivalents,beginningofyear686357524942Cash&cashequivalents,endofyear746863575249ChangeInCashandCashEquivalents665547584FrenzCorporationDavidGillet,CEO,waslookingforwardtoseeingthetravelingshowLesMisérablesinafewweeks.
HeassociatedthemusicalanditsworldwidesuccesswiththesuccessofFrenzandhisowncareer.
HehadfirstseenthemusicalafewmonthsafteritopenedontheWestEndin1985shortlyafterjoiningFrenz.
Davidrecalled,"Inourearlydayswhatwewe'redoingwasnew-specialtycoffeefortheworkeronthemove.
We'vealwaysbeeninfrontofthecurve–wewereearlypioneersofstoreWi-Fi.
Ourcustomerswereonthemoveviatheinternet.
Witheachpassingyearcompetitiongetsfiercer.
Eachsuccessiscopied.
Weareexpandinggloballyandexpandingproductlinesbutourcompetitionismovingintoourmarkets.
"DavidwantedtoaccelerateFrenz'sexpansion.
Hisperspectiveonfuturegrowthwasglobal.
HowwelldidFrenz'sadvantagestravelgloballyWhatwasthebestwaytogrowespeciallyintheemergingmarketsFrenzhadanopportunitytosecureitssupplyofcoffeebeanstofuelitsgrowth.
Hewantedtoincreasetherateofnewstoreopeningsandenterednewcountries.
Hewasconcernedaboutwhichgeographicregions,whetherstoresshouldbefranchiseedevelopedorcompanyowned.
Hewantedtoexpandproductofferings.
Frenzhadanumberofproductsintrialmarketsandcities.
Whichproductsshouldbeexpandedwithinacountry,aregionorgloballyHowmanyvariationsShouldtheybethesamegloballyorcustomizedforlocaltastesHewantedtoincreasebrandrecognitionandincreasecustomertrafficespeciallyinrecentlyenteredcountries.
WhatwasthemosteffectivemeansofmarketingandhowshouldmarketingcostsbeallocatedHowshouldFrenzleverageitsrelationshipwithothersistercompaniesinpromotingitsbrandthroughotherchannelsExistingstoresgeneratedcash.
Openingnewstoreswascapitalintensive.
HowwouldFrenzfundgrowthWhatweretherisksassociatedwithfranchisingHowdoFrenzmanagethelicenseesCouldFrenzcontinuetobechooseyaboutsiteselectionandnewmanagersWouldcorporatesupportandqualityorservicesufferwithrapidexpansionandnewlocalesNewproductshadlowerprofitmargins.
ShouldtheyhavepromotionalsalesdiscountsuponintroductionWouldnewproductssabotagesalesofhighermarginproductsHighunemploymentandhighgaspriceshadhinderedsalesandgrowth.
WasthisthenewnormThecompetitorswereofferingproductsatlowerpricepoints.
HowshouldFrenzrespondWithexpansionofthedigitalworld,howwouldFrenztacklethisnewmarketShouldFrenzexpandandinvestinitsdigitaltechnologywhichwouldtakeawayresourcesandcapitalfromitscorebusinessTheparentcompany,RPPCDynastywantedaglobalriskmanagementframeworkforallitssubsidiaries.
HowdidFrenzfitinthisframeworkWasthecurrentglobalfundingallocationfromRPPCDynastyadequateforthefuturegrowthofFrenzShouldFrenzcontinuetorelyondebttofunditsgrowthorrequestmoreequityinvestmentfromRPPCWouldcapitalbeanissuewithFrenz'sexpansionplan594.
1BackgroundOneoftheRPPCDynasty'sowners,Mr.
RuizstartedFrenzCorporation(alsoreferredtoasFrenz)in1985fromhis$700,000lotterywinningsand$20,000savings.
Frenzwasinitiallyasoleownershipcompanyuntil1988whenthevalueofthecompanyhadgrownto1.
2million.
ItwasthenincorporatedinBelgium.
In2000,FrenzCorporationbecameawhollyownedsubsidiaryofRPPCDynastywhenMr.
RuizwentintoapartnershipwithMs.
Chan,theownerofanapparelcorporation.
Overthenext10years,ithasgrownintoaglobalpremierroaster,marketerandretailerofspecialtycoffeeintheEuropeanandAmericancountries.
IthasoperationsinmostmajorcitiesofEuropeandAmerica,includingalldevelopedcountriesandsomedevelopingcountries.
Otherthancompany-operatedstores,Frenzalsosellsavarietyofcoffeeandteaproductsandlicensesitstrademarksthroughmanyotherchannelssuchasfranchises,groceries,privateclubs,hotels,cruiseshipsandnationalfoodserviceaccounts.
Today,Frenzisoneofthemostrecognizedandrespectedbrandinthe"premier"coffeehousesaswellashouseholdbrandinthedevelopedworld.
ItsmaincompetitorsinthecoffeehousesmarketincludeStarbucks,McDonald's,DouweEgberts,DeltaCafés,GenoveseCoffeeandMarkusCoffee.
Itshouseholdbrand'smaincompetitorsincludeNescafè,Folgers,MaxwellHouse,Jacobs,DouweEgbertsandStarbucks.
Twoaspectsofitsmainobjectiveistomaintainitscompetitivestandingandtocontinueitsdisciplinedexpansionofthestorebase,primarilyfocusedongrowthindevelopingcountries.
MissionStatementFrenz'smissionstatementis:Oneperson,onecup,onecommunity,oneworld.
Wecareaboutourfamily.
Thismissionstatementfocusesonourobjectiveofbeingthemostrecognizablecoffeebrandintheworld.
BoardofDirectorsFrenz'sBoardconsistsofeightmembers.
ThreeboardmembersareChiefExecutiveOfficersorBoardChairmeninleadingpubliccompaniesinBelgium,twoareBoardmembersofourholdingcompanyandtheremainingBoardmembersareexecutiveofficersofFrenz.
InrecentyearsRPPCDynastyCorporation,theholdingcompanyofFrenz,hasadoptedaglobalcompanyriskmanagementmandateinordertoensureconsistentandunifiedriskmanagementpolicies,strategiesandprocessesamongtheconglomerategroupsofcompanies.
InconjunctionwiththenewmandateDynastyrecentlyhiredaGlobalChiefRiskOfficertooverseeimplementation.
InresponsetothenewriskmanagementstrategyFrenz'sBoardhiredanexperiencedChiefRiskOfficer,RobertKaplan,todeveloptheriskmanagementstrategiesforFrenzandtoensurethatthesestrategiesfitinDynasty'sglobalriskmanagementmandate.
RobertKaplan'sresponsibilitiesincludeproperintegrationofriskmanagementstrategiesandpolicieswiththeglobalstrategiesandpolicies,smoothandcontrolledimplementationofthesestrategiesandcultivationofanacceptableriskmanagementcultureforFrenzfacilitatingitsultimategoalofbecomingthetopcoffeecompanyintheworld.
60WiththisnewmandatetheBoardmembershavesomedisagreementsastowhichBoardCommitteeshouldbegiventheresponsibilityofoverseeingtheworkofRobertKaplan.
SomeBoardmembersbelievethattheAuditCommittee'sroleshouldbeexpandedtooverseethisnewriskmanagementmandate.
SomeBoardCommitteemembersbelievethatthisnewmandateinvolvessignificantstrategicchangesandshouldbetheExecutiveCommittee'srole.
SomebelievethatitshouldbetheroleofRelatedPartyandConductReviewCommitteeRole'sasthestrategieswillinvolvesignificantrelatedpartytransactions.
TheBoardofDirectorshasrequestedRobertKaplanconsultwiththeGlobalChiefRiskOfficerandprovidearecommendation.
MarketStrategiesFrenzisdominantinthehigh-endspecialtycoffeemarketespeciallythroughitspremiercoffeehouseoutletswhichhaveovera40%marketshareinEurope.
However,itsmarketsharesinNorthAmerica,LatinAmerica,developingcountriesandhouseholdcoffeeconstituteonlyabout18%,11%,5%and16%respectively.
Thereissignificantgrowthpotentialinthesecountrieswherethecustomerbaseisstillexpandingandrepresentsachancetoincreasemarketsharewithoutthepressuretotakecustomersfromcompetitors.
Frenz'scurrentmarketstrategiesareasfollows:Continueitsdominantmarketpositioninthecoffeehousesbyorganicexpansionofitscompany-operatedcoffeehousesinthedevelopedcountriesthroughbuildingmoreofthesecompany-operatedcoffeehousesinfinancialdistrictsandhighsocio-economicareas;Furthernurturerelationshipswithandloyaltyfromotherdistributorssuchashigh-endhotels,privateclubs,universities,cruise-linersandupscalegroceryandretailoutletssuchasbookstoresanddepartmentstores;Expandintomoredevelopingcountriesthroughacquisitionoflocalcoffeehousechains,franchisingandorganicgrowthintomorecitiesandfinancialdistrictsofthedevelopingcountriesespeciallythefastgrowingAsianmarket;TargetlocaladvertisingincertaincountriestoexpanditshouseholdbrandrecognitionaswellasmoreendorsementswithcertainsignificanteventssuchastheWorldCup,theOlympics,theWorldExhibitionandeventsofregionalsignificance;MaintainasignificantbudgetdevotedtoFrenz'srenownedmarketingcapabilitywhichduetoinvestmentsovermanyyearshasachievedsignificanteconomiesofscale;Furtherenhancethecompany'sabilitytoquicklydevelopandrolloutnewandinnovativeproductswhichhelpsdefendagainstpotentialcoffeesubstitutesaswellasservingtofurtherdifferentiateFrenzfromitscompetitors;Expandandbuildthebrand'sdigitalpresenceandenhanceanalyticstobetterunderstandcustomerpreferencesandprofiles.
Frenzisalsoexploringverticalintegrationbyowningandcontrollingitssourcesofkeyingredientssuchascoffeebeansplantationsandteaplantationsinordertoenhanceitsqualitycontrolaswellasdevelopingitsownnicheproducts.
61RiskProfilesFrenzfacessignificantsupply-chainriskssuchascommoditypricerisksandshippingcostsanddemandriskssuchassignificantcompetitivepressuresandchangeinconsumermarkets.
Italsofacesoperationrisks,litigationandreputationalrisksandothermarketriskswhichincludeforeigncurrencyexchangerisk,equitysecurityprices,andinterestrates.
Italsofacesstaffturnover,litigationandreputationalrisks.
EachoftheserisksisdescribedindetailinAppendix4A.
RiskManagementHistoryUponincorporationin1988,Frenz'sowner,Mr.
Ruiz,startedtodevelopriskframeworkforFrenz.
HestartedbybuildingaRiskCommitteewhichconsistedofthe4persons:Lamb,Messy,PercyandSilvia.
LaterherealizedthathisRiskCommitteewaslackinganecessaryriskperspectivesoherecruitedonemoremember,Zheng,intotheRiskCommittee.
Inthepost-1988period,Mr.
Ruizhasastrongviewontheriskenvironment,italignswithZheng'sriskapproach;thereforeMr.
RuizappointedZhengamongalloftheRiskCommitteememberstoheaduptheriskmanagementprogramofthecoffeeshop.
Inthenexttwoyears,Zheng'sapproachhadproventobeasuccessintheenvironmentoftheperiod.
Attheendof1990,Mr.
Ruizisnotconfidentonhisviewontheriskenvironmentintheupcomingperiod,butsinceZhenghasprovenhisprogram,Mr.
Ruizdecidedtocontinuewiththesameriskmanagementprogramforthecoffeeshop.
AfterMr.
RuizandMs.
ChancombinedtheircompaniesunderRPPCDynasty,aRiskCommitteewasformerlyestablishedintheBoardofRPPCDynastytooverseetheriskmanagementprocessesinthesubsidiaries.
Frenz'sriskmanagementmandatefollowsRPPCDynasty'svisionanddirectionsince2000.
FinancialStatementsDetailedfinancialstatementsareshowninExhibits1and2.
4.
2GrowthGrowthisnevereasyasthefollowingexamplesofexternalandinternalgrowthpainsillustrated.
ExternalChallengesDuringthefinancialcrisisin2008Frenzsufferedsignificantlossesduetoreducedmarketdemandaswellassignificantinvestmentlosses.
SomeBoardmemberswereunhappywiththegeographicalmarketconcentrationwhichcausedFrenz'slosses.
Today,theMarketingVicePresident,AnthonyPirot,isbeingempoweredtoimplementtherecentmarketstrategicgoalssetbytheBoard.
AnthonyPirot'sfirstpriorityistoexpandintothefastgrowingAsianmarket.
AnthonyPirotcurrentlyleadsateamoftwentyexperiencedandmaturemarketingstaffwhoseexperienceispredominantlytargetingthehighersocio-economicclienteleinthedevelopedcountriesinEuropeandUnitedStates.
62Thisexpansionstrategywillrequiresignificantcapital.
ThenewChiefRiskOfficer,RobertKaplan,isuneasywiththeexpansionstrategyascashflowinFrenzwillgreatlybestrainedwithoutadditionaldebtfinancingwhichinturnincreasestheCompany'sleverageratioabovetheconglomeratemandatedthreshold.
InadditionAnthonyisexpandingitsproductlinessuchasthesuper-premiumcoffeemarketandbubbleteasandspecialtyfruitandmixedcoffeeandteadrinksthathavegivenFrenzareputationasaproductinnovatorinthemarket.
TothisendFrenzisexploringofferingcoffeemadefromexoticcoffeebeansandspecialtealeaves.
Thereareveryfewareasthatcanproducesuchhigh–qualitypremiumcoffeebeans.
ThebestcoffeebeansarefromCostaRica-theFincaPalmilerabuttheyareveryexpensive.
However,throughmarketresearchFrenzhasdeterminedthatitscustomersoftencannotdistinguishbetweenthepremiersuper-premiumcoffeebean,CostaRicaFincaPalmilera,anditscousintheVietombiaFincaPalmilera,whosepopularityisnotasgreat,butwhoseflavorisconsideredcomparabletoCostaRicaFincaPalmilera.
TheAsiancountryofVietombiaisthelargestproducerofVietombiaFincaPalmilera.
AlthoughVietombiaisamajorproducerofcoffee,itsdomesticconsumptionisverysmall.
Vietombiahasagrowing,export-driveneconomy.
ThehistoricalstatisticsonVietombiaissummarizedinAppendix4A.
DespiteVietombia'sincreasedparticipationininternationaltrade,10yearsagoVietombiaputinplaceapolicytopegitscurrencytothatofitsneighboringcountries.
TheeffectofthishasbeentoeffectivelydeflatethevalueofVietombia'scurrency,theRubiaceae,andasaconsequencebolsterVietombia'sexport-driveneconomy.
IndependenteconomicanalysishassuggestedthedeflationofVietombia'scurrencyhasbeeninstrumentaltothegrowthoftheVietombiaeconomy.
However,thebankingsysteminVietombiahasbeenslowinmodernizing,andalldomesticbanksprimarilyengageindomesticthriftactivity,andasaconsequencetheirriskmanagementandhedgingprogramsareintheirearlystages.
Further,thecentralbankingsystemperformslargelyasymbolicrole.
AsaresultofVietombiagovernment'seagernesstostabilizeitseconomy,thegovernmentiswillingtogiveanexclusivedealershipofthepremiumcoffeebeansproducedtheretoFrenzprovidedFrenzsetsupexclusiveproductionfacilityforthesesuper-premiumcoffeebeansinVietombia.
ThispresentsasignificantopportunityforFrenztogainfavorableaccesstoitskeyingredientnoteasilyduplicatedbycompetitors,toreduceitsrelianceonothercoffeesuppliers,andtocontrolcostsaswellasinfluenceandcontrolthequalityoffuturecoffeebeanproduction.
However,thisverticalintegrationstrategypresentssignificantupfrontcostrequirementswhichmaysubstantiallyincreasethecompany'sleverageratioandlowertheoverallcreditratingforFrenz.
63DigitalStrategyFrenzisdedicatedtomaintainingitsrenownedmarketingcapabilities,andreputationasaninnovatorintheindustry.
Giventheincreasingprevalenceoftechnologyasapreferredmediumforcommunicationandcommerce,FrenzhaslaunchedaDigitalStrategyGroup(DSG)withthegoalsof:Buildingthebrand'sdigitalpresenceUsinganalyticstounderstandcustomerpreferencesEnhancingcustomerexperiencewithtechnologyReaffirmingFrenz'soriginsasthe"specialtycoffeefortheworkeronthemove"AFrenzsmartphoneappisunderdevelopment,withthefollowingfeaturesunderconsideration:GPS-enabledsearchtofindtheclosestFrenzCoffeeHouse.
TheDSGiscontemplatingapartnershipwithanexistingGPSlocationprovider(e.
g.
,GoogleMaps)andwouldoverlayaFrenz-brandedinterface.
Userscancheck-intoaparticularlocationandsharethroughvarioussocialmediaplatforms.
Fullmenubrowsingcompletewithpricingandnutritionalinformation.
Paymentcapabilitiesboththroughprepaiddigitalgiftcardsandchargingastoredcreditcarddirectly.
Withrespecttochargingacreditcard,theDSGiscontemplatingleveragingexistingdigitalpaymentoptions(e.
g.
,ApplePay)orstoringcreditcardinformationdirectlywithintheapp.
Purchasehistoryautomaticallyrecordedwhenin-apppaymentisused.
Userscansharerecentpurchasesthroughvarioussocialmediaplatforms.
Loyaltyprogramtorewardfrequentcustomerswithexclusivepromotions(e.
g.
,every10thcoffeeisfree).
Additionalloyaltyrewardpointswouldbecreditedforotheractivities(e.
g.
,signingupafriendtotheapp).
AnappofthisscopeisnotcurrentlybeingofferedbyanyofFrenz'scompetitors;however,variousfeaturesdescribedabovehavebeenrolled-outbyothermarketparticipants.
TheDSGisparticularlyinterestedinthecustomerdatathatwillbecollectedthroughthisapp.
Thedataarchitectureandinformationsecurityisbeingdeveloped,andFrenzrecentlyhiredBillArima,anacclaimeddatascientistfromSiliconValley,togettheirpredictivemodelingcapabilitiesupandrunningassoonaspossible.
Bill'steamhasalreadydemonstratedpromisingresultsusingdatacollectedfrombetaversionsoftheapp.
FrenziscurrentlyseekingaChiefDataOfficertoensureproperdatagovernance.
ThisstrategyisacostlyundertakingforFrenzandwillbedivertingcapitalawayfromitscorebusiness.
64OverheadAllocationJeffBemowski,FrenzDivisionheadofNon-CoffeeProductMarketingslunkdownintheguestchairintheofficeofKittyDunn,Frenz'sChiefAccountingOfficer.
"Youarekillingmewithyouroverhead,"Bemowskibegins.
"I'mnotsurewhatyoumean,"repliesDunn.
"Ourpolicyforallocatingcorporateoverheadisprettystraightforwardandhasn'tchangedinseveralyears.
Overheadcostssuchascorporateadvertising,executivesalaries,therentonthishomeofficebuilding,andsoonareaccumulated.
Thenthatbucketofcorporateoverheadisspreadoverallsalesonauniformbasis.
""That'sexactlytheproblem!
"retortsBemowski.
"Ithinkweneedtochangeandweneedtochangeitnowbefore.
.
.
.
.
""Waitaminute,"saysDunn.
"Wehaveworkedveryhardtokeepouroverallcorporateoverheadundercontrol.
Infact,corporateoverheadhasincreasedatonlya5%rateperyearoverthelastfiveyears.
That'satatimewhenthecompanyhasgrownbyover250%inthosesamefiveyears.
Everysummer,wereviewtheoverheadallocationratioand,well,withallourgrowth,ithasgonedowneveryyear.
""Iknowthat,"respondsBemowski.
"WhatI'mtalkingaboutisHOWcorporateoverheadisallocated.
Look,abigpartofmybonusisdependentontheprofitabilityofFrenz'non-coffeeproducts.
Youknow,themusicCDs,greetingcards,coffeecups,etc.
thatwesell.
I'vebeenpushingourstoremanagerstomovetheseproductsbutyourallocationmethodforcorporateoverheaddisguisesthetrueprofitabilityofmypartoftheoperation.
""Wellitisazerosumgame.
Theoverheadistheoverheadanditallhastobeallocatedsomewhere,"repliedDunn.
"YeahbutaCDcostsmorethanacupofcoffee,"arguedBemowski.
"WhenFrenzdoessomethinglikerunacommercial,weareadvertisingthewholebrand.
WewanttogetcustomerstocomeintoourstorestohavethewholeFrenzexperience.
Wegetthemtocomeintoourstoreregularlyforcoffee.
Eventually,theymaybuyourotherproductsinadditiontotheircoffee.
WhyshouldtheoneCDbesaddledwithmoreoverheadthanallthosecupsofcoffeeItjustfeelswrongtome!
""Again,"beganDunn,"eachproductgetsanallocationofcorporateoverheadbasedonitsstandardprice.
Thatkeepsitthesamefrommarkettomarket,wherepricesmightbedifferentanditnegatestheimpactofsalesanddiscountsonitems.
Thatseemslikeafairsystemtomebutifyoudon'twanttodoitthatway,whatwouldyousuggest""WellIbelieveourmodelisthateachstoreisaprofitcenter,"saysBemowski.
WetellourstoremanagersthatcorporatesupportsthembutoncetheyarepartoftheFrenzfamily,theycanmake65theirshopasprofitableastheywantittobe.
Theupsideisunlimited,theirhardworkwillpayoff.
""Wait,"interjectsDunn.
"Therearerulesforhowthestoresmustbesetupandhowtheproductisdisplayed.
Nottomentionquality…""Iknowallthat,"Bemowskicutin.
"Butweareallocatingoverheadinawaythatpunishesourmostsuccessfulstoremanagers.
Takethatcorporateoverheadandallocateitas$Xperstore.
Corporatesupportsthestore;thestoremanageristheonewhodetermineshowmuchbusinessthestoredoes.
"Betteryet,allocateCorporateoverheadtoeachstorebasedonsmoothed,budgetamounts.
ThatwayeachstoremanagerknowsjusthowmuchCorporateoverheadhehastocoverinhisstoreatthestartoftheyear.
""Isupposewecouldlookatit,"concedesDunn.
"Wehavemostofthedataandwecouldcollectsome…….
""Youfinancial-typesalwayswantmoredata.
Youareafraidtomakeadecision!
Itisobvious,changeandyouaregoingtogetabetterlookatwhatstoresareontopandwhichareonthebottom,"sputteredBemowski.
"Andyouwillseehowimportantmynon-coffeeproductsaretomakingthosetopstores,topstores.
Icanfeelitinmybones;youneedtogetonboardorgetoutoftheway.
""Wearemostcertainlynotgoingtochangeanythingwithoutstudyingitfirst,"respondedDunncalmly,"andtherearechannelstogothroughmakinganyexpenseallocationchange.
Weneedtoweightheprosandcons.
""Youcan'tsaveyourwaytogreatness,"saidBemowskigettingupandheadingtowardthedoor.
"Callmewhenthiscompanyisseriousaboutmakingrealmoney.
"Andwiththat,Bemowskiwasgone.
Dunnrubbedhertemples.
"Marketing,"shemurmuredunderherbreath.
664AFrenzCorporationExhibitsEXHIBIT1BoardofDirectorsFelixHermansistheChiefExecutiveOfficerofGenieBankofBelgium.
HeholdsaMasterofScienceinBusinessEconometrics/OperationsResearchdegreefromTilburgUniversityandhascompletedprofessionalprogramsattheNetherlandsInstituteforBanking,AmsterdamInstituteofFinance,OxfordUniversityandINSEAD.
HeiscurrentlytheChairmanoftheFrenz'sBoardandhasbeenadirectorsince2005.
FredCoppensistheChiefExecutiveOfficerofVedeguChocolate,whichisachocolatemanufacturerinBelgium.
HeholdsaMasterofSciencedegreeinautomationengineeringandhasbeenadirectorsince2009.
AbramLemaireisaViceChairman,ChiefExecutiveOfficer,ManagingDirectorandaMemberofManagementBoardatVESETGroupSA,anaffiliateofOraConstructionIndustriesCompany.
Hehasbeenadirectorsince2000.
GilroyClydeistheChiefExecutiveOfficerofRPPC,theholdingCompanyofFrenz.
Hehasbeendirectorsince2000.
OlivierCollignonistheDeputyChairmanoftheBoardofRPPC.
Hehasbeendirectorsince2000.
JulienJacobsjoinedFrenzinApril2000andhasservedasChiefExecutiveOfficersinceOctober2005.
HewastheCEOofFrenzUS,whichasubsidiaryofFrenzfromApril2003toOctober2005.
Hehasbeendirectorsince2003.
DavidGilletistheChiefExecutiveOfficerofFrenzUSsince2005andhasservedaspresident,FrenzChinaandAsiaPacific,whichasubsidiaryofFrenzsinceNovember2003.
Hehasbeendirectorsince2005.
VincentJansenistheChiefFinancialOfficerofFrenzCorporationandhasbeenadirectorsince2005.
Therearenofamilyrelationshipsamonganydirectorsorexecutiveofficers.
ThemandateoftheBoardwasestablishedatthetimeofincorporationtosupervisemanagementofthebusinessandaffairsoftheCorporationonabroadscaleratherthandailymanagement.
Itsresponsibilityincludesapprovingstrategicgoalsandobjectives,reviewofoperations,disclosureandcommunicationpolicies,oversightoffinancialreportingandotherinternalcontrols,corporategovernance,Directororientationandeducation,seniormanagementcompensationandoversight,andDirectornomination,compensationandassessment.
67Inordertoensurethattheresponsibilityiscarriedoutonacohesivemanner,theBoardhasestablishedthesub-committeestoaidincarryingoutitsresponsibilities.
ExecutiveCommitteeTheExecutiveCommitteehasandmayexercisealloranyofthepowersvestedinandexercisablebytheBoard,includingapprovaloftheannualstrategicplan.
CurrentlytheExecutiveBoardcomprisesof5boardmemberswiththeChairmanoftheBoard,FelixHermansalsoactsasChairmanofthisCommitteeandthefollowingBoardmembers:FredCoppensOlivierCollignonAbramLemaireJulienJacobsAuditCommitteeTheprimarymandateoftheAuditCommitteeistoreviewthefinancialstatementsoftheCorporationandpublicdisclosuredocumentscontainingfinancialinformationandtoreportonsuchreviewtotheBoard,tobesatisfiedthatadequateproceduresareinplaceforthereviewoftheCorporation'spublicdisclosuredocumentsthatcontainfinancialinformation,tooverseetheworkandreviewtheindependenceoftheexternalauditors,andtoreviewanyevaluationoftheCorporation'sinternalcontroloverfinancialreporting.
TheAuditCommitteecomprisesof4BoardmemberswithVincentJansen,theCFOofFrenzactingastheChairofthisCommitteeandthefollowingBoardmembers:GilroyClydeAbramLemaireDavidGilletCompensationCommitteeTheprimarymandateoftheCompensationCommitteeistoapprovecompensationpoliciesandguidelinesforemployeesoftheCorporation,toapprovecompensationarrangementsforexecutivesoftheCorporation,torecommendtotheBoardcompensationarrangementsfortheDirectorsandtooverseethemanagementofincentivecompensationplans,andtoreviewsuccessionplansforseniormanagement.
ThecurrentChairofthisCommitteeisGilroyClydewiththefollowing3Boardmembers:FelixHermansAbramLemaireOlivierCollignonRelatedPartyandConductReviewCommitteeTheprimarymandateoftheRelatedPartyandConductReviewCommitteeistorecommendtotheBoardproceduresfortheconsiderationandapprovaloftransactionswithrelatedpartiesoftheCorporationandtoreviewand,ifdeemedappropriate,toapprovesuchtransactions.
FredCoppensistheChairofthisCommitteewiththefollowing3Boardmembers:68OlivierCollignonDavidGilletVincentJansenGovernanceandNominatingCommitteeTheprimarymandateoftheGovernanceandNominatingCommitteeistooverseetheCorporation'sapproachtogovernanceissues,torecommendtotheBoardcorporategovernancepracticesconsistentwiththeCorporation'scommitmenttohighstandardsofcorporategovernance,toassesstheeffectivenessoftheBoardofDirectors,ofCommitteesoftheBoardandoftheDirectors,andtorecommendtotheBoardcandidatesforelectionasDirectorsandforappointmenttoBoardCommittees.
ThisCommitteeisalsoresponsibleinrecommendingtheBoardonthe"CodeofBusinessConductandEthics"policiestoensureandmaintainacultureofintegritythroughouttheCorporation.
ThisCodeisapplicabletoDirectors,officersandemployeesoftheCorporation.
JulienJacobs,thecurrentCEOofFrenzistheChairofthisCommitteeandtheCommitteeiscomprisedofthefollowingBoardmembers.
OlivierCollignonGilroyClydeDavidGillet69EXHIBIT2RiskProfilesSupply-ChainRisksCommoditypriceriskistheprimarysupply-chainriskforFrenz.
Pricevolatilityofkeyingredientssuchasgreencoffee,tealeavesanddairyproducts,etc.
presentsasubstantialexposuretothestabilityoftheproductpricesaswellasprofitmargins.
Thisismitigatedsomewhatbytheabilitytokeepcoffeeandteaforlongperiodsoftime,thusreducingstoragecosts.
Inaddition,oilpricesalsohaveadirectimpactonshippingcosts.
Frenzincurssubstantialshippingcostsintransportingthekeyingredientstoitsworldwideretailoutlets.
Therefore,oilpriceincreasesoverrecentyearshaserodedFrenzprofitmargin.
Supplyandpricecanbeaffectedbymultiplefactorsintheproducingcountries,includingweather,politicalandeconomicconditions.
PriceforcoffeeisalsoimpactedbytradingactivitiesintheArabicacoffeefuturesmarket,includinghedgefundsandcommodityindexfunds.
Furthermore,greencoffeepricesmaybeaffectedbyactionsofcertainorganizationsandassociationsthathavehistoricallyattemptedtoinfluencepricesofgreencoffeethroughagreementsestablishingexportquotas,increasedtariffs,embargoes,customsrestrictionsorbyrestrictingcoffeesupplies.
Similarinfluencealsoexistsforpricesoftealeaves.
Frenzhiredacommoditiesexpert,Dr.
R.
Gellar,toprovideinsighttotheunderlyingcostsoftheirprincipleingredient:coffeebeans.
ThereportheprovidedtoFrenzcitedfourkeyinputcostswhichdrivethepriceofcoffee:1.
Water2.
Fertilzer3.
Pesticides4.
LabourThesefourinputcostsdrivethewholesalepriceofcoffee,excludingthecostoftransportationwhichisgenerallyabsorbedbythepurchaser.
Relationshipswiththeproducers(coffee,tea&diary),outsidetradingcompanies,suppliersandexportersarealsopertinentinassessingtheriskofnon-deliveryonpurchasecommitmentsandqualityofingredientsdelivered.
DemandRisksCompetitioncanbefierceasthecapitalrequiredtoentertheindustryislow.
ThecompanyisfacingcompetitionnotonlyfromthespecialtybeverageshopssuchasStarbucks,Timothy's,SecondCupetc.
,butalsofromquick-servicerestaurantssuchasMcDonald's,donutshopssuchasTimHortons,dessertshops,high-endrestaurantsandotherspecialtyretailers,etc.
Thusthe70needforthecompanytokeepexpandinganddifferentiatingitsproductlinesandventureintounfamiliarterritoriesisbeinginevitable.
Customerloyaltyispertinentinthistrade.
Asaresult,thecompanywillcontinuetoexpanditspopularloyaltycardprogram,whichhasbeeneffectiveinpreventingothercompaniesfromstealingawayFrenz'scustomers,toincludeproductsfromothersistercompaniesintheconglomerategroup.
Adverseeconomicconditionsmaycausedeclinesingeneralconsumerdemandsforthesehigh-endproducts,drivingtheincreaseincostsandpressureforreducedqualityofproducts,whichinturn,mayincreaseimpactsfromnegativepublicity.
Adverseimpactsresultingnegativepublicityregardingbusinesspracticesorhealtheffectsofconsumingproducts,etc.
,mayleadtoreductionindemandandprofitabilityandincreaseinlitigation.
OperationalRisksAscompanyisfacingexpansion,risksareassociatedwitheachexpansionplanthatthecompanyisexploringandimplementationoftheseplanscanbeverychallengingandriskyastheseplansaredisruptionstotheongoingbusiness.
Delaysinstoreopeningsforreasonsbeyondcontrol,exposuretoincreasedconstructioncostsassociatedwithnewstoreopeningsandlackofdesirablerealestatelocationsavailabilitywouldalsonegativityimpactthenetrevenuesandprofitmargins.
Degreetowhichthecompanyenterinto,maintain,develop,andareabletonegotiateappropriatetermsandconditionsandenforce,commercialandotheragreementscouldhavesignificantimpactoncompanyfinancingandoperation.
Lossofkeypersonnelordifficultiesinrecruitingandretainingqualifiedpersonnelandlabourdiscord,politicalinstabilityandnaturaldisasterscouldcausesignificantbusinessinterruptionwhich,inturn,adverselyimpactsthebusinessandfinancialresults.
Adversepublicormedicalopinionsabouthealtheffects,foodtampering,foodcontamination,regionalorglobalhealthpandemiccouldseverelyandadverselyimpactthecompany'sbusiness.
Asthecompanyreliesheavilyoninformationtechnology,anymaterialfailure,inadequacy,interruptionorsecurityfailureofthetechnologycouldharmtheabilitytoeffectivelyoperatethebusiness.
LitigationandReputationRisksSuccessdependssubstantiallyonthevalueofthebrandsespeciallyinthespecialtybusiness.
Thusthecompanyhastomaintainqualityofproductandbeabletoconsistentlydeliverpositiveconsumerexperienceandengageincorporatesocialresponsibilityprogramstoenhancethecompanyreputation.
Brandvalueisbasedoninpartconsumerperceptionsonavarietyof71subjectivequalities.
Thusevenisolatedbusinessincidentsthaterodeconsumertrust,suchascontaminatedfoodorprivacybreachesparticularlyiftheincidentsreceiveconsiderablepublicityorresultinlitigationcansignificantlyreducebrandvalue.
Reputationmaybeharmedbyactionstakenbythirdpartiesthatareoutsideofthecompany'scontrol.
Thirdpartiesmayincludebusinesspartners,licenseeandpartnershiprelationships,suppliers,vendorsandanybusinessassociatesthatthecompanyhasengagedinpastorcurrentdealings.
Properhandlingofcustomers'complaintsisveryimportantinprotectingthecompany'sreputationandpreventingpotentiallitigation.
ForeignCurrencyRiskFrenzhasoperationsinmanydifferentcountries.
Frenzhascurrencyexchangeriskduetohavingthecurrenciesofgeneratedrevenuesbeingdifferentfromthecurrenciesofexpenses.
Currencyvolatilityhascausedsignificantcostsinoperationduetotimingdifferences.
RealEstateRiskFrenzhassignificantexposureinrealestatemarketsduetoinvestmentsincommercialpropertiesandoperationplants.
InterestRateRiskFrenzhasdebtissuancesandfluctuationininterestratescouldresultinsignificantimpactsonrefinancingcosts.
CapitalRiskInordertomaintainthecompany'sgrowthrate,Frenzisfacingincreasingcapitalrisks.
72EXHIBIT3FinancialStatementsandSupplementaryDataFrenzCorporationLtd.
CONSOLIDATEDSTATEMENTSOFEARNINGS(Inmillions,exceptpersharedata)FiscalYearEndedDec31,2014Dec31,2013Dec31,2012Dec31,2011Dec31,2010Dec31,2009Dec31,2008Netrevenues:Company-operatedstores$1,214$1,056$960$890$650$400$1,360Licensedstores127110100855045200CPG,foodserviceandother1341171068860100100Totalnetrevenues1,4751,2831,1661,0637605451,660Costofsalesincludingoccupancycosts583535495445375255760Storeoperatingexpenses423393366355320300400Otheroperatingexpenses494540292520100Depreciation/amortizationexpenses58555251505050General&administrativeexpenses75706556302880Restructuringcharges000531002000Totaloperatingexpenses1,1881,0981,0189899008531,390Gainonsaleofproperties11255300000Incomefromequityinvestments3322181510(175)125Operatingincome32020719689(130)(483)395Interestincomeandother,net15141155410Interestexpense(5)(3)(3)(3)(3)(3)(4)Earningsbeforeincometaxes33021820491(128)(482)401Incometaxes(73)(54)(63)(28)14144(121)Netearnings(loss)$258$163$141$63$(114)$(338)$280Earningspershare—basic$0.
52$0.
33$0.
28$0.
13$(0.
07)$(0.
68)$0.
56Cashdividendsdeclaredpershare$0.
005$0.
005$0.
005$0.
000$0.
000$0.
000$0.
01CashDividendsPaid$2.
50$2.
50$2.
52$0.
00$0.
00$0.
00$5.
0073EXHIBIT4FrenzCorporationLtd.
CONSOLIDATEDBALANCESHEETS(Inmillions,exceptpersharedata)FiscalYearEndedDec31,YYYY2014201320122011201020092008ASSETSCurrentassets:Cashandcashequivalents$187$159$138$116$90$20$200Short-terminvestments—available-for-salesecurities115988524155100Short-terminvestments—tradingsecurities352225155515Accountsreceivable,net53408430356040Inventories1029845446714395Prepaidexpenses¤tassets35284516201630Deferredincometaxes,net20212530352350Totalcurrentassets548465447275267272530Long-terminvestments—available-for-salesecurities9566101910530Equityandcostinvestments13888373415850Property,plantandequipment,net450300235245205200300Goodwill25252525252535Otherintangibleassets1010555515Otherassets5648202352530TotalAssets$1,322$1,003$779$626$532$540$990LIABILITIESANDEQUITYCurrentliabilities:Accountspayable$45$33$24$28$35$40$50Accruedcompensation&relatedcost42393640351050Accruedoccupancycosts17131517201520Accruedtaxes101010105210Insurancereserves15151515151515Otheraccruedliabilities28303226221525Deferredrevenue42494341402560Totalcurrentliabilities199189175177172122230Long-termdebt177140120110955555Otherlong-termliabilities71625245382292Totalliabilities$447$391$347$332$305$199$377Shareholders'equity:Commonstock($0.
001parvalue)—authorized,500shares;issued&o/s$0.
5$0.
5$0.
5$0.
5$0.
5$0.
5$0.
5Additionalpaid-incapital44.
844.
844.
844.
844.
844.
80.
3Otheradditionalpaid-in-capital5550343434344Retainedearnings763508347209146260598Accum.
othercomprehensiveincome118562210Totalshareholders'equity$875$612$432$294$227$341$613TOTALLIABILIATIESANDEQUITY$1,322$1,003$779$626$532$540$99074EXHIBIT5VietombiaStatisticsINFRASTRUCTUREEconomyGDP(2014)USD70.
1billion%exports(2014)USD62.
9billionFOB89.
73%PopulationandemploymentTotalpopulation86millionTotalemploymentinthecoffeeindustry600,000coffeegrowers%adultliteracy30%Averageschoollevelforworkersinthecoffeeindustry(farms)Grade6%ofworkerswhoarelandownersn/aNumberofworkersassociatedtoacooperative20,000%workerswithpermanentcontract5%FormsofworkersrepresentationAssociationofcoffeeprovidersNone%ofemployeeswhoarepartofatradeunionNoneGeographicalaspectsTotalareaofproduction(hectares)Cultivatedarea:506,000haNumberoffarms300,000HistoryofthecoffeeindustryDateofcreationFirstcoffeeplantationin1857inFrenchcolonyManagementsystem/stylen/aNumberofownedfarmsn/aNumberofownedthreshern/aEconomicindicatorsofcoffeeindustry(netprofit,sales,etc.
)Totalproduction:57.
6millionbags(2014)Totalexports:53.
8millionbags(2014)Exports(totalexports,%exportsagainsttotalproduction)Totalproduction961milliontons(2014)Totalexport897milliontons(2014)%participationofexportsintotalproduction:93.
34%755BlueOceanP&CCompanyRuthGreen,ChiefActuary,waswatchingtheyearinreviewshowsfrequentlybroadcastastheyearcametoaclose.
ShewatchedthereplaysofthenationalheroattheGames.
MoFarahtookgoldinboththe5000and10,000metres.
Mowasfast,UsainBoltwasfasterbutBlueOceanmovedwithgreaterspeed.
BlueOceanhadbeenbuiltoninnovationandspeedtoopportunityandspeedtomarketbecausetheyviewproductdevelopmentasalong-termstrategy.
Theysawanicheandfilledit.
Everyonelookedatthesameinformation.
Noteveryonesawthesamethings.
Otherssawonlydots.
Theymadeconnections.
Thiswasthebenefitofhavingcross-functionalteamsacrosstheorganizationthathaveacommonunderstandingofthecompany'smission,strategy,goals,marketing,sales,andlogistics.
Therewerealwaysquestions.
Othercompanieschokedfromparalysis.
BlueOceanunderwritersdidn'tjustsitonideasignoredbymanagementtoobusytobepersuaded.
Insteadmanagementaskedwhatactiontotake.
Managementsupportsthenewproductdevelopmentprocess.
Ruthkeepsanopenchannelofcommunicationfornewproductdevelopmentideas,whichrecentlyresultedinseveralnewideascomingacrossherdesk.
HowcouldshemakeithappenHowwouldtheyunderwritetherisksManagetherisksWhichsegmentsshouldtheytargetWouldthesemostrecentnicheofferingsaddvalueWhymightBlueOceanfailWhatshouldshedotoremoveormitigatethoserisksHowwillshebalancethenumberofprojectswithavailableresources5.
1BackgroundMissionandStrategicPlanOurmissionistostrengthenthebrandidentityasadominantinnovatorintheUKmarketandmaximizesustainablelong-termgrowthinshareholdervalue.
Ourstrategicplanistocapitalizeonarenaswithnewopportunities.
HistoryAsian-RussianParentCompanyacquiredBlueOcean,the5thlargestpropertyandcasualtyinsurancecompanyintheUnitedKingdom(UK),in2005.
ThisacquisitiongaveParentCompanyaccesstoBlueOcean'slucrativeinsurancemarketinUKandcontinentalEurope.
Productsincludemarine,propertycatastropheandretrocession.
Sincethen,BlueOceancontinuedtoexpandanddevelopitsinsurancebusinessesworldwide.
InSeptember2011,BlueOceanbeganwritingPetandTravelinsurancebusinessinNorthAmerica.
Asofthebeginningof2015,thecapitalbasestandsat$3billion.
RatingsGuidedbyexperiencedmanagementandbackedbyanimpressiveteamofunderwriters,actuariesandcatastropheriskmodelers,BlueOceanearnedanA.
M.
BestratingofA(Excellent)andquicklyestablisheditselfasamarketleader.
76ManagementTeamCEOEdwardBlueCFOMichaelTanChiefActuaryCLOCROBusinessOpsCAORuthGreenJeromeBlackGeoffOliveAndrewGreyMichelleRougeStrategyThetraditionalbusinessarenaforBlueOceanhasbeenthemarineinsurancemarket.
Thisfocushasbeenverysuccessfulinthecompany'straditionalgeographicalmarket,theUnitedKingdom.
Withtheexpansionintoanewregion,companymanagementdecidedtoexpanditsfocusintoPetandTravelInsurance.
InkeepingwithitsmissiontobeaninnovativeleadertheexecutiveteamisconsideringanofferingwithintheemergingRenewableEnergysector.
BlueOceanhasanongoingintiativetoidentifynewopportunitesandcanredirectthestrategicplaninreal-timetorespondtomarketforcesandnewtechnologiessuchconductingafeasibilitystudyonwhethertoofferSolarPersonalEnergyInsurancetohomeownersthathavepurchasedsolarplanelstoproducetheirownpower.
WithinthePetandTravelinsurancelines,thegoalistoestablishadominantmarketshareinthisrelativelyyounginsurancefield.
ThefinancialgoalsaretogenerateasmuchprofitandpremiumfromthisnewriskarenaascurrentlygeneratedinthecoreMarinebusiness.
OtherinnovativeideashavealsocomethroughtheChiefActuary'se-mailwhichhavebeenrelatedtoinsuranceopportunitiesintheOnlinePeer-to-PeerCommercespace,alsoknownasthe"SharingEconomy".
TravelInsuranceTravelinsurersfacedsteeprevenuedeclinesduringtherecession.
Therecessionfrom2008to2009causedconsumerdiscretionaryspendingand,therefore,consumerspendingontraveltoplummetHowever,since2010industryrevenueshavegrown.
Therecessionandassociatedturmoilintheinternationalairlineindustryboosteddemandfortravelinsurance:consumersweremoresensitivetoprotectingtheirinvestmentsintravelexpendituresduetohigherriskofflightcancellationsanddelays.
Theindustryisexpectedtocontinuegrowingoverthenextfiveyearsandexpandintonichemarketscateringtostudentsandbusinesstravelers.
TheTravelInsuranceindustryhasalowlevelofmarketshareconcentration.
InorderforBlueOceantocompeteinthisindustry,itoffersacomprehensivetravelinsuranceprogramtoitscustomers.
Theinsuranceprogramincludeslifeandaccidentaldeathanddismembermentinsurance,tripcancellationandtripinterruptioninsurance,baggagelossinsurance,medicalandhospitalizationinsurance,etc.
Itevenoffersambulanceandairtransportationcoverageincaseofmedicalemergenciesoccurredwithinthefirst60daysoftravel.
Theinsurancecanbepurchasedonapertripbasisoronanannualbasisforfrequentflyers.
Unbundlingofsomebenefitsarealsoavailable.
77Inordertofacilitatethiswiderangeofservices,BlueOceanhasestablishedpartnershipwithtravelagenciestorecoverthesalvagevalueofallcancelledtripsbyofferingdeepdiscountsinthelastminutetravelmarkets.
Inaddition,ithasestablishedpartnershipwithsomehotelchainsandairambulanceservicecompaniesinaccommodatingitscustomersincaseofemergenciesorairlinedelays.
Thesepartnershipsaremeansofreducingtheoverallcostsoftheprogram.
Despiteitsshorthistoryinthisindustry,BlueOceanhasalreadymadesignificantinroadsintothebusinessrelationshipswithitsbusinesspartners.
Theserelationshipshavebecomeitscompetitiveadvantageinthetravelindustry.
PetInsuranceWhilepetinsuranceremainsarelativelyunderdevelopedproductinNorthAmerica,withlessthan1%ofallpetsbeinginsured,Europeanlevelsofinsuredpetsrangefrom12%to50%.
InmanyEuropeancountriesinsuringyourpetisjustascommonasinsuringyourhomeorcar.
It'ssecondnature.
TheUKpetinsuranceindustryisamatureindustry.
50%ofdogsand30%ofcatsareinsuredwithapopulationestimatedat8.
3milliondogsand11.
9millioncats.
Theindustryisdiverseandprovidesconsumerswithamultitudeofchoiceintermsofproductsandtypesofcoveravailable.
Threeclearstrategieshaveappeared.
Thefirstisthe'menu-based'proposition,wherecustomersareprovidedwiththestandard'vetfees'onlyproductandallowedtochoosevariouscoverageoptionstoproduceaproductthatmeetstheirneeds.
Thesecondoption,whichthemajorityofprovidersoffer,isa'multiplecover'offering,wherecustomersareabletochooseproductsbasedonsetcoveragelimits.
Thesetypesofproductsareoftendisplayedas'bronze,silverorgold',reflectingthelevelsofcoveroffered.
Thethirdoptionisa'onesizefitsall'productthatoffersastaticveterinaryfeeslimitanddoesnotallowforflexibilitytoincreaseordecreasethislimit.
IncontinentalEuropethereare120milliondogsandcats.
Thepercentinsuredvariesbycountry.
Forexample,inSweden55%and35%ofdogsandcatsareinsuredrespectively.
TheU.
S.
petinsuranceindustryisinitsinfancy.
Approximately1%ofapopulationof155millioncatsanddogsisinsured.
TheU.
S.
industryhasgrown18%compoundedannuallyonapremiumbasissince2003.
PetInsuranceiscoverageforVeterinaryMedicalExpenses–sotheunderlyinginherentriskisahealthrisksimilartomedicalexpensesinhumans.
Althoughpetinsuranceisprimarilyahealthrisk,intheUSitisregulatedasaP&Cproduct,sinceinmoststatespetsareconsideredpropertyunderthelaw.
Typically,theyareregulatedundertheInland-Marinelineofbusiness.
PetInsuranceischaracterizedbytraitsassociatedwithreallylowrisk.
LowSeverity($230/claims)HighFrequency(1.
3claimsperpolicy/year)Ultra-Short-Tailo95%ofclaimsarepaidoutwithin3monthsofthelosso99.
9%arepaidoutin12monthsBecauseoftheultra-shorttailpropertiesthereisverylittleopportunitytoearninvestmentonreserves.
782015PremiumIncome*2015Reportedprofit*Marine1,600120Pet40025Travel30030*(millions)5.
2OpportunityOutlookforProperty&Casualty[General]Insurancein2016:ConditionoftheEconomicandInvestmentMarketsFor2016,PropertyandCasualtycompanieswillcontinuetoexperiencealowinterestrateenvironmentandaslowrecoveryoftheglobalrecession.
Companiesshouldexpectlimitedinvestmentincomeandwillneedtorelyonimprovingunderwritingmarginsasamajorincomesource.
Notwithstandingthelowinterestexpectations,companieswillbecompelledtostrengthentheirinvestmentportfoliosregardingdesiredlevelsofriskandreturn.
ThiswillparticularlybethecaseinEurope,wherecompaniesfacehighuncertaintyontheirsovereigndebt.
EuropeaninsurershavealreadyreducedtheirexposurestoGreece,Ireland,Italy,Portugal,andSpain(GIIPS)holdingsinordertoincreaselower-riskassets.
Toincreaseportfolioreturns,moreresourcesandawarenesswillneedtobeallocatedtoriskmanagement.
Companieswillneedtobetterunderstandhowtheseadditionalrisksaffecttheiroverallriskprofiles.
Largercompaniesshouldtrytodevelopacompetitiveadvantage,throughtheirgreateraccesstoandcapacityofavailableassetclasses.
AvailableAreasforGrowthGrowthforPropertyandCasualtycompanieswillneedtocomefromavarietyofsources,asorganicgrowthbecomesmorechallenging.
ParticularlyintheU.
S.
andCanada,theabsenceofaclear,hardmarketwillcompelcompaniestoseekalternativewaystogrow.
Diversificationandexpansionbygeographiclocation,byproduct,andbydistributionsourcewillbecomeimportantareasofgrowthin2016.
MergersandAcquisitionsmayprovetobeoneopportunityforthistypeofgrowth.
ImportantgeographicareasforexpansionincludeemergingmarketsinAsia-PacificandLatinAmerica.
Expansionintotheseareas,though,encompassesintegrationissues(differingcultures,systems,accounting,andreporting)andwillamplifycurrencyandpoliticalrisks.
Overall,however,companiesmustbeawareofhowanytypeofexpansionwillcreatenewrisksandunderstandhowthesenewrisksmaychangetheiroverallriskprofile.
Additionally,Product&Casualtyinsurershavetheopportunitytoinsurenewandemergingexposuresthroughadditionalproductdevelopment.
Potentialproductareasincludecyber79liability,nanotechnology,andnewenergysources.
Offeringnewproductsfornewareasimprovesclientrelationshipsandattractsandretainsnewcustomers.
Finally,theexistingcustomerbasemustbeutilizedasamechanismofgrowth.
Cross-sellingtothisbasewillbeanimportantsourceofincreasedprofitabilityandpersistency.
Likedevelopingnewproductsfornewexposures,holdingmultiplepoliciesandinsuringmultipleitemswiththesamecustomerimprovestheclientrelationshipandwillimprovethelikelihoodadditionalproductswillbepurchasedinthefuture.
CustomerPreferencesSocietalfactorsincludingtechnologyandthegrowthofsocialmediaareleadingtomarketingchanges.
However,theuseoftheinternetasaresourceisgrowingmoreslowlythanexpected.
Research3hasshownthatthoseusingtheinternettoresearchinsuranceandthoseusingquotecomparisonwebsitesarestillintheminority.
Thoughthisgrowthisslow,theinternetasaresourcecannotbeignored.
Itwillbeimperativethatonlineandnon-onlinechannelsareintegrated,andthatcompaniescarefullyassessemergingcustomerpreferences.
Also,insurancecompanieswillneedtodevelopandmaintainwaystoprotecttheirimageintheexpandingdigitalworld.
Customerswillalsoseekmoresophisticatedlevelsofcustomerserviceandprotection.
Providingtheseservicescanbecomeafundamentalcompetitiveadvantage.
Inaddition,customerswillexpecttoberewardedforinsuringmultipleproductswithoneinsureraswellastheircontinuedloyalty.
Pricingmodelsmustbeflexibletotheseexpectations.
Furthermore,itemsthatwillcontinuetobeofparticularimportancetothepolicyholderincludeprice,productflexibility,thesimplicityofthesalesandtherenewalprocesses,andgoodclaimsexperience.
InEurope,regulatorychangeswillreflectthecustomers'desireforsimpler,moretransparentproducts.
TheChangingCharacterofDataThevolumeofavailabledataisrapidlyexpanding.
Asdatabecomesmorelargeandcomplex,theimportanceofextractingmeaningfulinformationbecomesarequirement.
InthiseraofBigData,acompetitiveadvantagewillexistforthosewhoareabletocapture,analyze,andintegratedatafrommultiplesourceswithexistingsystemsandinformation.
Astechnologyimproves,additionalsourcesofdataemerge.
PropertyandCasualtycompanieswillmorecommonlyusedvehicletelematics,videomonitors,securitysystems,andgamingsystemstogatherdata.
Thesenewmethodsofobtaininginformation,however,willplacefurtherdemandsonIT.
Innovationthroughtheincreasedavailabilityofdatawillbeakeydifferentiatorin2016.
Companieswillhavethepotentialtousehistoricdataforamyriadofdecision-makingpurposes.
3ResearchwasfromtheUSAandCanada.
80Insightsoncross-sellingandcustomerretentioncanbeobtainedbyusingdata.
Moreover,insurerswillbepropelledtoupdatetheirinfrastructure(focusingonclaimsandbilling)asconsumersdesireavalue-addedserviceexperiencethroughtechnologicalmeans.
Again,anemphasiswillbeplacedonthesuccessfulintegrationofhistoricandnewdatafrommultiplesources.
Furthermore,outsourcingmaybecomelessutilized,asmoreenterprisesfindthatthecostsavingsmaycomeatthecostofbettercustomerserviceaswellasdataintegration.
Moreandmoreavailabledatamaycreateashortageofdatamanagementtalent.
CompanieswilldemandnewskillsetsandwillmorecommonlyutilizeaChiefDataOfficertooverseedataintegration,storage,use,etc.
Inaddition,thecustomerwilldemandthatdatawillremainsecureandpersonalinformationwillremainprivate.
TheRegulatoryEnvironmentPropertyandCasualtyinsurersmustalsobemindfulofsignificantregulatorychangesthatoccurredin2013andbeyond.
Overall,regulatorychangeswillattempttoimprovecapitalmanagementandallocationregardingproductmixandgeographicpresence.
SolvencyII,regardingcapitaladequacy,wentintoeffectJanuary1st,2014.
ItwillbenecessarytoreviewandrefinecapitalmanagementstrategiesinordertobeSolvencyIIcompliant.
Throughtheyear,companiesmustfinalizethetestingandintegrationofSolvencyIIsystems.
Thesecostswillhaveaneffectonincomestatements,andcompaniesmustbepreparedtospeaktoconcernsfromtheirstakeholders.
SomeEuropeancountrieswillalsoberequestingcompaniestosupplytheirSolvencyIIcapitalpositionsthroughouttheyear.
Likewise,theNAICSolvencyModernizationInitiative(SMI)andOwnRiskSolvencyAssessment(ORSA)seekimprovecapitaladequacyforcompaniesoperationintheUSA.
IssuesandprojectswhichremaintobecompletedbySMIincludechangesregardingCapitalrequirements,GovernanceandRiskManagement,GroupSupervision,StatutoryAccountingandFinancialReporting,andReinsurance.
TheRiskManagementandOwnRiskandSolvencyAssessmentModelActwasadoptedinSeptemberof2012.
ChangestotheORSAGuidanceManualstartedtoenactin2013,withfullimplementationofORSAamongthestatesin2015.
InsurerswillalsobepreparingforchangesbroughtonbyIFRS9(assetaccounting)andIFRS4PhaseII(liabilityaccounting.
)Itisanticipatedthatthesechangeswillbeimplementedin2016andbetween2016and2018,withrespecttotheabove.
Onceagain,addressingtheseimplementationsinvolvesmodificationstodata,systems,andprocesses.
Otherregulatoryconcernsbyregionareasfollows:EuropeoThelargedegreeandcomplexityofemergingtaxlawespeciallyintheareaofBasisErosion&ProfitSharing(BEPS)andTransferPricing(TP)oEuropeanbanongender-basedpricingoAnticipateupcomingnon-bankrecoveryandresolutionplanning81oActionsofthe2013EuropeanParliament,including,MarketsinFinancialInstrumentsDirective(MIFIDII)PackagedRetailInvestmentProducts(PRIPs)InsuranceMeditationDirective(IMD)Proposedrevisions(2015F)couldchallengeexistingdistributionmodelswhilecreatingopportunitiestodevelopnewmodelsImprovedtransparencyUSAoAddressingenterpriserisk/accountabilityofmanagementandtheboardthroughchangestoSOXandSECrules,forinstanceoAbroaderfocusonfinancialservicesandenhancedcapitallevels,includingconcernswithrun-on-the-bankrisk,mayaffectProperty&CasualtyInsurers.
CanadaoB9guideline,EarthquakeExposureSoundPracticesoThenewCorporateGovernanceguideline,withfullimplementationnolaterthanJanuary31,2016.
OtherRegionsTheprecedingsectionshaveplacedanemphasisoninsightsinEurope,theUS,andCanada.
Areasofimportanceforotherregionsareasfollows:Asia-PacificoTop-linegrowthopportunities(emerginghealth&pensionsmarkets)oSelectiveinentering/exitingoFar-reachingimplicationsofchangingregulationsonoperations,structures,andbusinessmodelsoIncreasingseverityandfrequencyofnaturaldisastersoTechnologicalinvestmentoMobiletechnologyLatinAmericaoRealeconomicgrowthratesoSustainableprofitabilityoEmergingmiddleclassoOpportunitiesinBrazilandChiletointegrateadvancedriskandcapitalmanagementwithregulatoryreformsoSubstantialCATlossexposuresoMobiletechnology'seffectonconsumerbehavioroFlexibility,innovation,strategicalliancesNordicCountries82oVariedeconomicclimateoEffectsofEuropeanregulation(capitalandriskmanagement,distribution,productdesign)oTransparencyregardingproductpricing,costs,andconsumerbenefitscrucialtogrowthoFocusonriskselectionandpricingwhenitcomestodevelopinganinvestmentportfolioRenewableEnergyInsuranceBusinessprofileRenewableenergyanditsassociatedtechnologiesareanemergingindustry.
Thereareconsiderableuncertaintiesforcompaniesoperatinginthisindustrytopredicttheirincomegenerationcapabilities.
Therearetwokeysourcesofuncertainty:1)theproductivityofagiventechnologytogenerategivenunitsofenergy,and2)marketpriceofsellingunits.
Theintendedfocusofourinsurancesolutionforthisindustryistoofferprotectionontheincomegeneratedbyenergysuppliers.
Therenewableenergylinesofbusinesssegmentsinclude:TypesSolarWindWaterCommercialandpersonalOverviewofSolarPersonalEnergyInsuranceThetargethomeownerforthisinsuranceprogramhasover1,000sq.
ft.
availableroofspaceformountingsolarpanels.
Thetypicalclienthaspurchasedsolarpanelsthatcangeneratebetween7,000to12,000khwofenergyperyearanddependingonthecostofthepanelscanbeenticedintoafixedcontracttoselltheenergygeneratedforbetween30cto60cperkhw(c=cents).
Asolarpersonalcontractwouldeitherguaranteethenumberofunitsthataregenerated(7000khw),orthesalepriceperunit(30-60c),orboth(4000khwsoldat40c).
InexchangeBlueOceanwouldreceivetheactualunitsofenergygeneratedandwouldsellthemintheenergymarketviaelectricalcompanies.
Someoftheelectriccompanieswouldbeeitherprivatelyownedorgovernmentregulatedorrunbythestatedepartment.
ThereisatrendinNorthAmericaforfamiliestopurchasetheirownpersonalsolargrids.
Ourfiveyearplanistobecomethefaceoftheinsurancetothisgroup.
BlueOceanFeasibilityStudy–2015InitiativeBlueOceanhiredAbleEnergyConsultingGroup.
Exhibit1providesMarketDataonthenumberofdetachedhomesintheU.
S.
,energyproductionpersolarpanelandelectriccompanyseasonalpricesandvolatilities.
Asexpectedwithallnewproductdevelopmentprojects,BlueOceantakesaconcept83andproduct,andconsistentlyconductsmarkettestingtodetermineiftheprojectshouldbeundertakenbythecompany.
Belowisanexcerptfromthebusinessplanpro-formathatwascreatedtogainfundingapprovaltoenterthislineofbusiness.
20162017201820192020No.
ofhomesinsured1,2002,6004,2006,0008,000Noofelectriccocontracts511172533Energy(khw)genperhome9,00013,50020,25030,37545,563Feespaidperkhw(cents)6050403020EnergyCoresalerate(cents)8070605040Contingencyliability(MM)1.
081.
622.
433.
655.
47Targetcapital(MM)2.
167.
0217.
0136.
4572.
9ReservemethodologyBelowisanemailthreaddiscussingthereservemethodologyfortherenewableenergybusiness.
From:MichaelTanSent:March28th,20159:00pmTo:RuthGreenSubject:RiskcapitalHiRuth,HowareyouThanksforsendingmethedraftplan.
Ihavereviewedthehighlevelfinancialprojections.
Inoticedthatthecontingencyliabilityincreasesfasterthanthefeeincomeline.
CanwehaveameetingtodiscusstheresultsIamreviewingthecorporatelevelcapitalfigures.
Iwouldalsoliketodiscusscapitalforthislineofbusiness.
Thanks,MichaelTanCFO,BlueOceanInc.
Telephone:44(0)2075458888From:RuthGreenSent:March28th,20159:08pmTo:MichaelTanSubject:Re:RiskCapital84HiMichael,Iamdoingwell.
Hopealliswellwithyou.
Thanksforyournote.
Iamalsoreviewingthesefiguresinmoredetailandrecentlyengagedwithanexternalactuarialfirm.
Iwillsetupameetingassoonasthisreviewiscompleted.
Thankyou,RuthGreenChiefActuary,,BlueOceanInc.
Telephone:44(0)2075459999From:EdwardBlueSent:March28th,201512:01pmTo:GeoffOlivecc:RuthGreenSubject:RiskfactorsRemindmetheriskfactorswithincapitalcalculationFrom:GeoffOliveSent:March29th,20157:05amTo:EdwardBluecc:RuthGreenSubject:Re:RiskfactorsHereisthelistofriskfactors:WeatherMechanicsDefaultrateEnergyconversionratioCounterpartyOnlinePeer-to-PeerCommerceInsuranceOpportunities–2016InitiativeThee-mailbelowwassenttoRuthGreenbyEdwardBlue:From:EdwardBlueSent:March15th,201611:00amTo:RuthGreenSubject:NewProductInitiative–OnlineP2PInsuranceHiRuth,Imetwithoursalesandmarketingteamlastweekandtheyhadanewproductideaofdevelopinginsurancetargetedtowardscompaniesthatengageinonlinepeer-to-peercommerce("sharingeconomy").
Ithinkit'sworthexploringthisspacebecausethesharingeconomyhasbeenrapidlygrowingandcompaniessuchasAirbnb,anaccommodationmatchingservice,andUberandLyft,both85transportationnetworkcompanies,haveallmadehugewavesinthemedianotonlyduetheirexpansiveglobalgrowth,butalsofromtheirincreasingcritcismsandcontroversies,overissuessuchasaccidents,propertydamage,andlackofregulations.
Inordertopushthisinitiativeforward,I'dlikeyoutoassistourpricingteamwiththefollowingnewproductdevelopmentjourney:Phase1–Identifyandbrainstormthepossibleinsuranceopportunitiesthatcanbeofferedtoaccommodationandride-sharingserviceswithoursales,marketing,andpricingteams,andidentifytheexternalpartnersandcollaborationeffortrequiredandthatcanbeleveragedforthesuccessofthenewinsuranceproductsPhase2–PerformfeasibilitystudiestounderstandthetargetmarketacceptanceandrevenueprojectionsfortheproductsPhase3–Determinethecostsassociatedwithdevelopingtheproduct,launchingandmarketingtheproduct,supportingtheproductthroughouronlineplatformandcustomerservice,andmaintainingrequiredcapitalPhase4–Developmeaningfulindicatorstotrackthefinancialperformanceoftheproductthroughoutitslifecycle,considerpossiblefutureriskswithlaunchinganewinnovativeproduct,andquantifytheserisksPhase5–Agreeongo/no-gocriteriaonwhethertomoveforwardwiththenewinsuranceproductsfromconcepttolaunchanddecideonago/no-godecisionLetmeknowwhenyouwouldliketodiscussourplaninmoredetail,justtalktomyexecutiveassistantandshecanpenyouinatourearliestconvenience.
Thanks,Ed865ABlueOceanP&CCompanyExhibitsSOLARENERGYSTATISTICS(SOUTHERNUSA)Year20052006200720082009201020112012201320142015WeatherRelatedNumberofRainydays7184796776978483798177Numberofsevereweather(storms)192792931673914374035PoliticalSupportStateswithenergyrebateprograms11122336677%ofvotersconsideredcandidatesrecordonenvironmentalissue1%1%2%3%5%10%12%13%15%17%20%ManufacturingBaseNumberofpanelprovidercompanies014810152022232527Numberofpanelmanufacturers11233455567Costofphotovoltaiccells(keycomponent)113103907066636250494745Energyproductioncapacity10sq.
ft.
panel(KwH)4266798939511235167819312391253828973256Componentsreporteddefectiveasrateperactiveunits10%10%9%8%10%7%6%8%6%5%4%ConsumerReportsCostof10khwpanelsystem(USD000's)1251101059590858075706560Numberofhomeswithmorethan1000sq.
ft.
roof45,12955,89167,90175,462105,087129,971145,923170,798189,321190,908195,133ElectricCompanySolarenergyusageAveragepurchaserateforsolarenergyperkhw(cents)70855787801058865818577%ofTotalgridenergythatisSolarpowered1%2%1%3%3%5%5%5%6%6%7%AbleEnergyConsultingGroupcopyright2015876BigBenBankMaggieCrawley,ChiefRiskOfficer,lookedacrossthetable.
Shewonderedwhentobringtheintenseongoingdebatetoaclose.
Suchforthcomingdialoguewasasoughtafterdimensionintheriskmanagementprocess.
However,unlessthemanagementteamcameupwithsuccessfulideasandeffectivemarketpositions,opportunitieswouldfadeawaylikethemorningdew.
Sophisticatedproductsandservicesneedconsiderabletimefordevelopmentandsecuringcommitmentfrompartners.
WasBigBenidentifyingtherightriskmetricsHowshouldtheriskprofilebehaveandevolvingovertimeWeretheysimplymonitoringbusinessintelligenceorwasriskinformationformingtheirdecisionsHowcouldtheyleveragetheexpertiseoftheirinsurancegroup,DarwinHowcouldtheycrossselltoDynasty'shigh-endclienteleNewregulationsandscrutinyseemednever-ending.
6.
1OverviewThebankinggroupwasformedin2001underthedirectorshipofMr.
SaleenPatel.
Mr.
Patelgainedhiswealthasaself-directedfundmanagerusingfundamentalassetselectionandkeyinsightsintothebusinessmodelsofhisinvestments.
TheinitialfocusofMr.
Patel'sbankinggroupwasfindingbestinclassfundsforitshighnetworth(HNW)clients.
Mr.
Patel'sfundmanagementbusinesswasformedin1990anditssuccesswasprimarilybuiltwithinEuropeanfinancialcentres.
Akeygrowthdifferentiator,intheinitialyears,wasBigBen'sPrivateBankingdivision,whichofferedexclusiveconciergesevicestoitsHNWclients.
AnothercompetitiveadvantagethatBigBenenjoyed,wasMr.
Patel'snetworkofconnections,thatincludedmanymembersofNYC,London,andZurichhighsociety.
Mr.
Patel'sreputedfundmanagement,andtaxmanagement,prowessalsocontributedtothesuccessofBigBen.
However,thefinancialcrisispresentedsomeunexpectedchallenges.
TheAUMfelldramaticallyandsomeoftheinvestorsexperiencedhardshipsintheirownbusinesses.
ThefundperformancewasdramaticallynegativeandthesubsequentincreaseinredemptionsseverelyimpactedoverallAUMandforcedarevisioninthestrategicapproach.
Products/ServicesSinceinceptionthecriticalprofitdriverhasbeentheexcessoftheMER(managementexpenseratio)chargedontheAUMovertheoperationalcostsoffulfillingthefundmanagementmandate.
BigBenBankisaworldleaderintheETFmarket,andhasastrongbrandandaloyalinvestorbase.
ButMERsforETF'sarecomingunderincreaseddownwardpressureasmorecompetitorscomeintothisfundarena.
88Traditionalpersonalandcommercialbankinghasbeenasmaller,butsignificant,componentoftherevenuepie.
Theoperationalmodelofthepersonalbankingdivisionisprimarilyonline,ratherthanphysicalbranches,butexpertiseexistsonemergingtechnologiesandconnectivitywithatime-criticalcustomerbase.
Thisapproachwasmeanttomeettheneedsofagloballymobileclientele.
Fundtransferandforeignexchangetransactionswereoncethemajorityoftransactionsbutthetravellers'chequebusinessisslowing.
Transfersandtransactionsarenowdominatedbyanultra-highlimitVISAcardprogram.
Foreignexchangetransactionsand"bestrates"areanattractivefeatureoftheVISAprogram.
Thephysicaldistributionmodelisalmostnon-existentandcannotsupportbroad-basedbanking.
RevisedstrategyTheexecutivegroup,followingstrongdirectionfromthefourpartners,hasbeenaskedtore-engineerthebusinessfocus,byloweringtheminimuminvestableassetsrequirementforparticipationintheservicestraditionallyoffered,exclusively,totheBank's(HNW)customers,andbyofferingmoreholisticwealthmanagementandfinancialplanningservices.
AsaresulttheholdingcompanydecidedtoacquireDarwinLifeinsurancegroupin2008.
Mr.
PatelarticulatedBigBen'srevisedstrategyinthefollowingexcerptfromarecentspeech:"Ourvisionistobethewealthmanagementsolutionsproviderofchoice,andtoexpandtheBank'scliente-basebyexpandingourretailbanking,wealthmanagement,andinsurancedivision.
Wewillalsobuildnewglobalplatforms,tosupportthisnewgrowth.
Ourpathtodifferentiationistodeliverapersonalisedanduniquefinancialplanningexperiencetoourclients,andbybuildingacultureofinnovation.
"RiskManagementBigBenBankhasfromthebeginningprideditselfonastrongriskcultureandhashadanactiveriskmanagementfunction.
Thebankcapitalwassomewhatstrained,duringthe2008Financialcrises,butBigBenhasregainedagoodcapitalposition,inrecentyears.
Withagreaterfocusoninnovation-basedsolutionsandwealthmanagementsolutionsintertwinedwiththeInsurancegroup,theriskmanagementfunctionwillneedtoevolveandadaptitsstrengthstoamoreagileenvironment.
TheExecutivemindsethasbeentoincreasefocusonthefinancialplanningsalesapproach,toleveragethewealthmanagementcapabilitieswithininsurancecontractsandtoformulateaone-stopshoppinginterfacetoourgloballymobileclientele.
Thekeyisstillourprivateclub;ourbrand;ourfamily!
!
89RegulatoryChallengesTheBaselCommitteeissuedinDecember2010theBaselIIIrulestext,whichpresentsthedetailsofglobalregulatorystandardsonbankcapitaladequacyandliquidityagreedbytheGovernorsandHeadsofSupervision,andendorsedbytheG20LeadersattheirNovember2010Seoulsummit.
TherulestextpresentsthedetailsoftheBaselIIIFramework,whichcoversbothmicro-prudentialandmacro-prudentialelements.
TheFrameworksetsouthigherandbetter-qualitycapital,betterriskcoverage,theintroductionofaleverageratioasabackstoptotherisk-basedrequirement,measurestopromotethebuild-upofcapitalthatcanbedrawndowninperiodsofstress,andtheintroductionoftwogloballiquiditystandards.
ThroughauthoritiesprovidedintheDodd-FrankAct,theFederalReserveBoard(FRB)regulatesattheholdingcompanylevelanumberofcompaniesthatareprimarilylifeinsurers.
TheDodd-FrankActalsoauthorizedtheFRBtosupervisenonbankfinancialcompaniesdesignatedassystemicallyimportantbytheFinancialStabilityOversightCouncil(FSOC),someofwhichmaybeinsurers.
Inaddition,Section171(theCollinsAmendment)oftheDodd-FrankActauthorizestheFRBtoestablishcapitalstandardsfortheseinsurancecompanies.
TheFRBexercisedthesenewauthoritiesonJune7,2012,issuingthreeproposedruleswhichcollectivelyimplementBaselIIIcapitalstandardsandSection171oftheDodd-FrankAct.
6.
2RecentDevelopmentAdrianRoger,BigBenCEO,hasbeenlookingenviouslyattheperformanceoftheCanadianBanksduringthefinancialcrisis.
Thebankingindustrygloballysufferedthroughaperiodofinstabilityanddistrustthatwaspreventedfromarun-on-the-bankscenariobythetimelyinterventionofcentralbanksandgovernmentledbailouts.
ThismorningAdrianRogerwasreviewingthestrategicplaybookofthefivelargestbanksinCanada.
Justaweekafterearningsseason,onewouldassumeCanadianBanksdon'thavemuchelsetosayabouttheiroperations.
However,thebanks'currentandincomingCEO'sallspokeatabankingconferenceonWednesdayandtheyalllaidouttheirgrowthstrategiesforthecomingyear,withthehopeofluringinvestors.
RoyalBankofAlberta(RBAC)–afteracampaigntosomewhatdistancethebankfromcapitalmarkets,CEOJohnHolmeshaschangedhistune.
Nowwholesalebanking,particularlyintheUnitedStates,ismarketedasagrowthdriver.
Thereisgoodreasonforthis:Before,thecapitalmarketsdivisionwasboostedbyamajortradingoperation.
Thatstillexists,butisn'tnearlythesamesize.
RBA,andotherbanks,hadtoscalebackbecauseofregulatorychangesandnewcapitalrules.
Today,thecapitalmarketsarmisdrivenbylendingandorigination;theUSlendingbookhasdoubledinsizesince2008,afterspendingthepreviouseightyearsshrinking.
Wealthmanagementisanothermajorfocus.
90VancouverBank(VB)–AfterarecordquarterforitsCanadianpersonalandcommercialarm,VBhopestoreplicatethesuccessintheUnitedStates.
TheUSeconomyisonthemend,andthebank'sdepositssouthoftheborderareclimbing.
Thekeytasknowisfindingpeopleandbusinessestolendto.
VB'sU.
S.
depositstotalabout$185billion(USD),butitsloansaddupto$100billion.
ThebankhasdonesomebuyingtoincreaselendingbutincomingCEOCarterLaisaidhewill"seriouslylook"atotherassetsthatbecomeavailable.
Expensesareanothermajorfocus.
FirstBankofManitoba–NomatterhowhardyoupushCEOPatrickWong,herefusestosayhisbankreliesononeunitoveranother:AtManitobaBank,it'sallaboutdiversity.
ThoughMr.
WongacknowledgedloangrowthismoderatinginCanada,creditmetricssuchasdelinquenciesandloanlossesareallinsolidshape.
Internationally,LatinAmericaisstillthemajorhope,butit'salongtermbetManitobaBankisn'ttryingtorampupincountriessuchasColumbiaandChiletooquickly.
Instead,itwillkeepofferingsaferproducts,suchasautoloans,creditcardsandinsurance.
BankofToronto(BTMO)–HavingjustreportedrecordquarterlyearningsinCanadianpersonalandcommercialbanking,BTO'smajorfocusistogetitsU.
S.
equivalentfiringonallcylinders.
ThebankrecentlylaunchedamajormarketingcampaignintheMidwesttogetU.
S.
householdsfamiliarwiththeBTObrand,andCEOJohnConnorhopesthatwillhelpthebankexpandinurbanmarkets.
WhileU.
S.
depositgrowthishealthy,"it'sthecommercialbanking,themid-marketbusinessthatforthenextcoupleofyearsisgoingtobetherealstrongsourceofgrowth",hesaid.
InCanada,BTOispushingtoexpanditsretailoperation.
CrownBank(CB)–Wealthmanagementiswhereit'sat.
AfterbuyingAmericanInvestmentsandPacificTrustPrivateWealthManagement,CBisonthehuntformorewealthmanagementassets–particularlysouthoftheCanadian-U.
S.
border.
"MuchofthegrowththatweareplanningwillcomefromtheU.
S.
,"CEOGoeffMacDonaldsaid.
CBhassetatargetofgetting15percentofitsearningsfromwealthmanagement,andnowthebank'satthe11percentmark.
Itisalsoinvesting$134million(CAD)–spreadovermanyyears–torevampitsretailarm'sbackofficesystems.
LaurentNationalBank–InvestorshavelongpunishedNationalforitsalmostsingularprovincialfocus(Quebec)anditsstrengthinwholesalebanking.
CEOFrancoisBouchersaidrecentrecordearningsprovehehasnoreasontochangecourse.
Thebank'sfundamentalsintheseareasarestrong,too.
QuebechaslowerhouseholddebtlevelsthantherestofCanada,inlargepartbecauseitshousingmarketsoutsideofMontrealaren'ttoohot,sobuyersdon'tneedmassivemortgages.
Plus,morethanhalfofitswholesalebankingrevenuescomefromoutsideQuebec,soithelpstodiversifythebank'soverallearningsmix.
AdrianRogerponderedhisnotes,andthoughtaboutthebusinessdivisions:(1)personalandcommercial,(2)wealthmanagement,(3)assetmanagementand(4)investmentbanking.
91BigBenhadcomealongwayinashortperiodoftime.
Thestrategytofocusontheveryhighnetworthgloballyactivebusinesstravelerhadproventobeawisechoice.
Butwasthegrowthtrajectoryabouttoslowsimplybecausethenumberofpotentialclientsinthismarketissmall.
WhatnewservicescouldsustainthegrowthofBigBen'sbusinessesWerethereothermarketsthatcouldbepenetratedbyleveragingtheexistingoperationalsystemsanddistributiontogroworganicallyWhatemergingfinancialcrisisorregulatorychangesmightbeahindrancetofutureplans926ABigBenBankExhibitsEXHIBIT1BigBenBankFinancialDataI.
YearEndBalanceSheetBigBenBalanceSheet2015$million2014$millionIncrease/(Decrease)$millionIncrease/(Decrease)%AssetsAdvancesandinvestmentsCashandbalancesatcentralbanks4,7363,2721,46445%Loansandadvancestobanks6,5985,2061,39227%Loansandadvancestocustomers2,6382,4362028%Investmentsecuritiesheldatamortisedcost5494836614%14,52111,3973,12527%AssetsheldatfairvalueInvestmentsecuritiesheldavailable-for-sale7,9797,09788212%Financialassetsheldatfairvaluethroughprofitorloss2,4832,702(219)(8)%Derivativefinancialinstruments6,7934,7862,00742%17,25514,5852,67018%Otherassets4,3924,0743178%Totalassets36,16830,0566,11220%LiabilitiesDepositsanddebtsecuritiesinissueDepositsbybanks6,5485,0371,51130%Customeraccounts3,7583,699582%Debtsecuritiesinissue6,1284,0852,04350%16,43412,8223,61228%LiabilitiesheldatfairvalueFinancialliabilitiesheldatfairvaluethroughprofitorloss2,1602,268(108)(5)%Derivativefinancialinstruments6,8934,7132,17946%9,0536,9812,07130%Subordinatedliabilitiesandotherborrowedfunds3,2723,1161565%Otherliabilities5,1524,9382144%Totalliabilities33,91027,8576,05322%Equity2,2582,199593%Totalliabilitiesandshareholders'funds36,16830,0566,11220%93II.
LiquidityRiskPolicyThefollowingdataarethe3liquiditymeasuresthebankhadusedtomonitortheirliquidityexposuresforthepast5years(mmdenotesmillions).
Measure20102012201320142015LiquidityIndex(%)82%88%89%90%90%FinancingGap($mm)$1,050mm$813mm$1,392mm$750mm-$850mmNetLiquidity($mm)-$750mm$1,187mm$608mm$1,250mm-$800mmThebankalsohasaliquiditycrisisplanthatoutlinedtherolesandresponsibilitiesofeachexecutiveduringaliquiditycrisis.
Furthermore,theplanalsodefinedamandatorydecision-makingprocessandcommunicationsthatneedtotakeplaceduringthecrisis.
Theplanalsodefinedthecriteriatotriggertheliquiditycrisisplan.
Thesearetheonlymeasuresortoolsthebankusedtomanageandmonitortheirliquidityriskuptothispoint.
Thebankcameoutfrom2008financialcrisisunscratched.
Thebankstayedsolventanddidnothavesevereliquidityproblemandtheexecutivesofthebankareveryhappywiththeperformanceofthebankafterlookingatthesehistoricalmeasuresandcomfortablewiththecurrentliquidityriskmitigationpolicy.
III.
InvestmentLimitsandtriggersCriteriaInstructionsLimitperissuerFixedIncomePermitted20%ofportfolioMarketValueRealEstatesPermitted10%ofportfolioMarketValueEquitiesPermitted20%ofportfolioMarketValueDerivatives*Permitted15%ofportfolioMarketValueFICategoryLimit(%ofportfolioMarketValue)Treasury/Agency100%SovereignTreasury100%Corporate/CreditB+50%*DerivativeFinancialInstrumentswritten:ForwardContractInterestswapCurrencySwapPut/Calloptions947DarwinLifeInsuranceCompanyCEOBrandonKaladingottotheofficeearlyMondayonacrispcoldJanuarymorningtogetinashortwork-outontheelliptical.
OvertheweekendhefinallyhadachancetoreadhisfavoritehistorianPaulJohnson'snewbookonthecompany'snamesake–Darwin:PortraitofaGenius.
OntheTVmonitorwereNFLplayoffhighlights–somegameswentdowntothewire-excitingbackandforthleadchangesuptothelastplay–andsomeNCAAbasketballhighlightsoftheweekend'sclosegamesandupsets.
AnAT&Tadhadchildrenstatingobviouslythattwothingswerebetterthanone.
Brandonwonderedifseveraldozenthingswerebetterthanafew.
BrandonhadabreakfastmeetingwiththeCFO,CRO,ChiefActuaryandChiefMarketingOfficerat8:00a.
m.
ItwasafollowuptooneheldlastSeptember.
DarwinhadtremendoustoplinegrowthinitsTerm,UniversalLife(UL)andVariableAnnuities(VA)overthepast5years.
Lifesaleshadgrownata30%rateinanindustrywithflatlifesales.
VAsalesfortheindustryhadreboundedsincethefinancialcrisis.
Darwinhadnotbeenaplayerpre-crisisbutsincethecrisisVAsbecameattractiveandreasonable.
Pre-crisis,insurancecompanieshadaggressivelypricedproductswithrichbenefitsby,intheviewofmany,bytakingontoomuchrisk.
Thecrisishadresultedinmanycompaniesexitingorgreatlyreducingthebenefits.
BreakfastlastSeptemberwasapregamekick-offtoaseriesofall-daymeetingssplitintoaseries30or45minutesmeetingstoevaluatenumerousinitiativesandopportunitiesthecompanycouldpursue.
ThesemeetingswerejustapreludetothebusinessplanningandbudgetingactivitiestooccurinNovember.
AteamfromDynastyvisitedafewweekslater.
Itwasagoodexchangeduringafewintensedays.
Since2011histeamhadbeeninoverdriveworkingonafewlargeinitiatives.
2015seemedtoposeevenmorechallenges.
Theexternalenvironmentcreatedheadwindsfromlowinterestratestonewregulationsandaccountingrequirementstolessconsumerdisposableincometofiercecompetition.
Therewasalotofturbulenceintheindustry.
Sincethecrisiscompanieshadbeenandwerecontinuingtoexitproductlinesandmarketsandsheddingdistributioncapacity.
WeretheydoingenoughDidthefrontlinehaveenoughauthorityandresourcestodothelittlethingsHowcouldDarwincontinueitsextraordinarygrowthWhatwouldbethelimitsofthatgrowthHowcouldthecompanytakeadvantageofitspositiontoextenditsreachOr,weretheydoingtoomuchEverytimeyouturnedaroundtheWallStreetJournal'sfront-pageseemedtocoveryetanotherhigh-riskmeltdown.
Noindustry,especiallythefinancialsector,wasimmune.
Darwinhadaggressiveplans.
DidtheyhaveahandleontheriskstheyweretakingOnethinghedidknow,standingstillwasariskhewasn'tgoingtotake.
Brandonneededthefront-linebusinessmanagerstoseeandgrabopportunities,opportunitiesthatweren'tplannedfororoneoftheirobjectivesatthebeginningoftheyear.
95BackgroundDarwinLifeisamid-sizelifeinsurerheadquarteredinAlbuquerque,NewMexicowithanincreasingpresenceinthedomesticU.
S.
market.
Lifesalesaredistributedprimarilythroughanagencysystemandannuitysalesaredistributedprimarilythroughfinancialinstitutionalchannels(e.
g.
,banksandbroker-dealers).
Darwinhasexperiencedaneraofsuccesssinceembarkingonanewstrategicdirectionundernewleadershiptenyearsago.
Successtangiblymeasuredbygrowthinearnings,revenueanddistributioncapacity.
Recentgrowthhasbeenfueledbycorecompetencies-distributionrelationshipsandproduct/servicedevelopment.
Priortothestrategicchange,Darwinlackedfocuswithlittletonodifferentiation,highcostsandstagnantsales.
Priormanagement'sviewwasthatthecustomerwastheagentnotthepolicyholders.
Therewasnofocusonprofitabilityorgrowth.
Operationslackeddisciplinewithfrequentexceptionstoadministrativeandunderwritingstandards.
Productsincludedtraditionalwholelife,leveltermandcurrentassumptionUniversalLife(UL).
AlthoughDarwinofferedfixedandvariableannuitiestherewasnofocusonassetaccumulationproducts,specificallyvariableannuitiesordistributioncapacitywithinthefinancialinstitutionalmarkets.
Tenyearsago,newmanagementshiftedstrategytobefocusedonwealthmanagementandacustomerfocustargetingmiddletoupperincomeindividuals,professionalsandsmallbusinessownerswithestateplanning,tax-deferredaccumulation,traditionalincomepreservationandretirementincomeprotectionneeds.
Thisstrategicfocusandmanagement'ssolidexecutionthroughtheearly2000'scaughttheeyeofRPPCDynasty.
DynastythoughtDarwinwasanattractivepropertyanditbecameaffordablewhenthemarketandfinancialindustrystocksinparticular,nose-dived.
Inhindsighttheacquisitionwasabargain.
Atthetimetherehadbeenmuchheateddebate.
Darwin'sfocusonwealthmanagementwasagreatstrategicfitwithRPPC'sfinancialdivision–products,distributionanddevelopment.
Coreproductsegmentsareuniversallife,highcashvaluetraditionallifeandvariableannuities.
Non-coresegmentsincludegroupannuities,individualfixedannuitiesandtermlife.
Darwinenhanceditsuniversallifeproductstobettersuittheconsumers'insurance,estateandbusinessplanningneedsandalsointroducedULwithsecondaryguarantees.
Darwinhaspursuedanaggressiveorganicgrowthstrategyfocusingonindividuallifeandindividualvariableannuitiesthroughexpandingandenhancingdistributionchannelandsalesgrowth.
Darwindistributeslifeprimarilythroughcareeragents,banks,anddirectmarketingchannels.
Thetraditionalagencychannelutilizesavariablecoststructurewithcompensationincentiveswhichpromotesstrongpersistency.
Bank-ownedlifeinsurance(BOLI)productsaremarketedthroughindependentmarketingorganizationsthatspecializeintheBOLImarket.
In2009theyexpandedannuitydistributionintofinancialinstitutions.
Theirdistributionstrategyhasbeentoaddmajornewoutlets,penetrateexistingoutletsandtoexpandtheagencydistributionby2-3regionalofficesperyear.
Boththeagentandinstitutionaldistributionexpansionsrequiredasignificantinvestment.
96Agentserviceremainsimportant.
Customerfocuscreatesachangeinperspectivethatiscriticalinadministrativeandunderwritingpracticeswhichtranslateintoconsumervalueandexpectedhigherprofits.
Adisciplinedoperationstrategywassplitintoseparateoperationalstrategiesforpricing,underwriting,investments,financialreporting,claims,reinsurance,technology,corporategovernanceandriskmanagement.
OverthepastdecadeDarwinhadbecomeaninnovatorinservice-providingwealthmanagementsolutionstoindividuals-includingexpertiseindesignanddistributionoftax-shelteredortaxminimizingstrategiessuchasestateplanningandsmallbusinessownersuccessionplanning.
Darwininvestedintechnologyandstafftoserviceboththecustomeranddistributionchannelssuchasnewadministrativeandreportingplatforms,implementedanimagingandautomatedworkflowsystem,andestablishedateamsothatahumananswersthephonewithinfourrings95%ofthetime.
Thisattentiononcustomerfocusandattentiontoservicesetsthemapartfromtheirpeergroupandsupportsanaggressiveorganicgrowthstrategy.
Darwinoffersabroadarrayofcompetitiveproductswithcustomizationforspecificdistributionchannels.
Darwinhasnotpursuedafirsttomarketstrategybuthasdevelopedcompetencytobeafastfollowerandreplicatenewproductdesignsinthemarket.
Darwinsometimeslackstheexpertisetoreplicateprocessesandinfrastructure.
Theyhaveinvestedheavilyinfrontenddistributing,issuingandprocessingofnewbusiness.
Theyhavebuiltstrongrelationshipswiththeagencyandinstitutionaldistributionchannels.
Darwinutilizesavariablecostdistributionstructureandhadagrowingsalesforceingeographicbreadthanddepth.
Darwinhashadhighcostspartlyduetomisalignedresources.
Legacyproductsandsystemshavedrainedresources.
Asaresultnotenoughresourceshavebeendevotedtoinfrastructureorinforcemanagement.
Resourcesaredevotedtonewproductsandnewbusinessandpriorityplacedoncustomerserviceandgrowthindistributions.
Dedicatedresourcestomanageinforcebusinesshavebeeninsufficient.
Darwinwasslowrelativetoitspeergroupinactivelymanagingitsspreadcompressionduetolowinterestrates.
Timeconstraintsandlackofexpertiseinsomecuttingedgeproductareasresultedinlessthaneffectivebackendareasincludingriskmitigationandmanagementoperationalmonitoringandreporting.
Greaterspeedisneededtorespondtobusinessproblemsincludingriskmonitoringandescalation.
Operationalareasaresilo-basedresultinginlesseffectivecollaborationandcross-functionalcontinuousimprovementprocesses.
Darwinismovingtowardsadisciplinedoperationalfocusinunderwriting,investmentsanddiversifiedcompetitiveproducts.
Darwinhassolidratingsfromeverymajorratingagency–A.
M.
Best,StandardandPoor's,Moody's,Fitch,andInsightRatings.
FinancialAnalysisDarwinhasoutperformedtheindustryoverthepast10yearsregardinggrowthinlifesales,annuitysales,equity,assets,anddistributioncapacity.
Relativetotheindustryandsimilarlyratedcompanies,Darwinunfavorablyhashigherleverage,lowerinterestcoverageandlowerliquidityandfavorablyhashigherreturnoncapitalandlowerexpenses.
Relativetoitspeergroup,Darwinhashadaloweroperatingincomemarginandalowernetincomemargin,ahigherinvestmentyield,ahigherexpense97ratio,highergrowthinlifeinsuranceinforce,highergrowthinequity,andaveragemortalityandpersistency.
TheMarketThe55-75agegrouphas$7trillionininvestableassetsandwithinadecadethe401(k)/IRArollovermarketwillexceed$1trillionperyear.
Theshiftfromlifeprotectiontopre-retirementaccumulationtopost-retirementincomeprotectionandretirementassetmanagementwillaccelerate.
Asprotectionmovesfrompre-maturedeathtoprotectionfromlongevitythereareopportunitiesforcompanieswithproduct,distribution,andservice(trust,processandadvice).
Variabledeferredannuitieshavetransformedfromtax-deferredmutualfundinvestmentstoguaranteedretirementvehicles.
Protectionisthedifferentiatorversusotherfinancialservices(e.
g.
,85%ofallvariableannuitysaleshavelivingbenefitriders).
Successfulcompanieswillhavewellpositioneddefensiblemarketpositions,pricingpower,advancedtechnologyandsystemstoenhanceserviceandprocessandlowercosts,operationalefficiencies,experiencedmanagement,high-qualityfinancialreportingandcorporategovernance,strongasset-liabilitymanagement,investmentandriskmanagement,afocusedandbalancedgrowthstrategy,theabilitytoinnovateproductsanddistributionbypartneringwithotherservices(financialplanners,estateattorneys,taxexperts,andhealthcareadvisors),andtheabilitytobuildcustomerrelationships.
RiskManagementDarwinformalizeditsriskmanagementfunctionwiththecreationofanERMCommitteein2007followedbyanewaCROpositionandaRiskManagementdepartmentin2008.
TheCommitteemeetsquarterly.
Itspurposeistobuildsustainablecompetitiveadvantagesbyfullyintegratingriskmanagementintodailybusinessactivitiesandstrategicplanning.
ExcerptsfromitsCharterchargetheCommitteeto:Increasetheenterprise'svaluethroughpromotionofrobustriskmanagementframework/processes.
Alignriskpreferences,appetiteandtoleranceswithstrategyMonitorDarwin'soverallriskexposureandensurerisksaremeasuredandwell-managed.
Anticipateriskexposureandrecommendactionwhereexposuresaredeemedexcessiveorwhereopportunitiesexistforcompetitiveadvantages.
TheCharteralsospecifiestheCommittee'sComposition,Authority,MeetingsandResponsibilities.
Darwin'sriskappetitestatementis:I.
CapitalTheprobabilityofa15percentlossofStatutoryequityinoneyearislessthan0.
5percent.
II.
EarningsTheprobabilityofnegativeGAAPearningsinoneyearislessthan5percent.
III.
RatingsMaintainanAAfinancialstrengthrating.
Maintaincapital10%aboveminimumAAcapitalrequirements.
MaintainanAratingonseniorunsecureddebt.
98Risktolerancesarebasedontheestimatedimpactofquantifiedrisksonstatutorycapitalsincethecoremissionispolicyholderprotection.
Marketrisk,creditrisk,underwritingrisk,operationalrisk,strategicandliquidityrisksarequantifiedusingavarietyofmetricstocapturemultipleperspectives.
InvestmentPolicyandStrategyTheinvestmentdepartmentmanagesthegeneralaccountinvestments.
TheChiefInvestmentOfficer(CIO)reportstotheCFO.
InvestmentpolicyandstrategyisreviewedandapprovedbyaninternalmanagementcommitteeconsistingoftheCEO,CFO,CIO,andSVPs(orVPs)ofitsmajorbusinesslines.
Internalmanagementcommitteedecisionsaresubjecttoreviewbytheboard'sinvestmentcommittee.
Theinternalmanagementcommitteemeetsquarterlyandisresponsibleforreviewinginvestmentresultsandapprovingtheuseofnewinvestmentinstruments.
Day-to-daydecision-makingauthorityisdelegatedtotheCIO,uptospecifiedlimits.
TheCIOmaydelegateapprovalauthoritytohisorhersubordinates.
TransactionsinexcessoftheCIO'sapprovallimitrequireapprovalbytheCEOandCFO.
Thecompany'sgeneralaccountisinvestedprimarilyinfixed-incomeassets.
Withinthegeneralaccountthereareseparateinvestmentportfoliosforeachofthemainproductlines.
Variableannuityinvestmentaccountsareheldinaseparate(segregated)accountandaremanagedbyathird-partyinvestmentadvisor.
RisksCreditRiskDarwininvestsininvestmentgradequalitybonds(S&PatoraboveBBB-).
Fixed-incomesecuritiesinthegeneralaccounthaveexposurelimitsatindividualobligor(issuer)andsectorlevels.
Obligor-levellimitsvaryaccordingtoassettypeandcreditquality,asdeterminedbyexternalratingagencies.
Theinvestmentdepartmentmonitorscomplianceoftheexposurelimits.
Foreachportfolio,thereareweightedaveragecreditqualitytargets.
Portfoliocreditqualityismeasuredbyconvertingeachasset'sexternalcreditratingintoanumericalscore.
Scoresarealinearfunctionofcreditratings(AAA=1,AA=2,etc.
).
Sub-categoryratings(i.
e.
+or-)areignoredinthescale.
Thecompanypreferstomaintainascoreabove3.
5foreachlineofbusiness.
MarketRiskSemi-annuallywithineachblockofbusiness,Darwinmeasurestheeffectivedurationoftheassetsandliabilities.
Iftheassetandliabilitydurationsarefurtherapartthan0.
5,theassetportfolioisrebalancedsuchthatitsneweffectivedurationequalsthatoftheliabilities.
TheVAhedgingprogramusesasemi-statichedgeupdatedformarketfactorsweeklyandforinforcechangesmonthly.
Thekeyriskmeasuresarethemarketgreeks.
Darwincurrentlyhedgesdeltaandrho.
Theprogrampurchasesderivativessothatatleast90%ofliabilitydeltaand50%rhoarehedged.
Existinghedgesarenotsoldifthehedgeratioexceedsthesethresholds.
Gamma,vegaandcrossgreeksareself-insuredduetosystemcomplexity,thecostofhedges,thetendencyofequityvolatilitytomean99revertandotherfactors.
Hedgeeffectivenessismeasuredusingarollingtwelve-monthaverageofprogramgainsandlosses.
LiquidityRiskTheliquiditypolicyrequiresDarwintoholdsufficientliquidassetstomeetdemandsforcashinaliquiditycrisis.
Onescenarioconsidersareputationalliquiditycrisiswheremarketscontinuetooperatenormallyandtheliquiditycrunchaffectsonlythecompany.
Theliquiditystresstestanticipatessituationswherethecompany'sabilitytosellassetstomeetcashneedsfromitsliabilityproductsishinderedbythemarkettakingadvantageofthecompanyduringthecrisis.
Anotherscenarioconsidersacrisisinwhichtheentiremarketisnotabletosellassetsatareasonablevalue.
OperationalRiskTheCROisresponsibleforcollectinganddisseminatingriskinformation.
Areportispreparedmonthlyanddistributedtoexecutivemanagement.
StressTestingStochastictestingissupplementedwithdeterministicscenario-basedstresstests,performedannually.
Eachtestisappliedasshockstothemodelassumptions(forexample,mortality,lapseandmarketassumptions).
Interestrateshaveafloorof0.
10%AdditionalriskfactorsaredescribedinAppendix7Exhibit3.
LiquidityandcapitalVinAtium'sPCbeepedasanewe-mailarrived.
Itwastheagendafortomorrow's10a.
m.
-12p.
m.
meeting.
VinwasanewmemberoftheLiquidityandCapitalCommitteeanditwouldbeherfirstmeeting.
ArecentlyadoptedERMpolicychargedthecommitteewithanannualreviewofDarwin'sLiquidityPlanandCapitalPlan.
Therecentfinancialcrisistaughttheimportanceofliquidityandcapital-managinginnormalconditionsisonething,managinginacrisisisanother!
LikemanycompaniesduringthecrisisDarwinrespondedbybuildinglargecashbalancesfarexceedingpre-crisismaximumcashlimitsperDarwin'sInvestmentPolicy.
Atitspeakcashrepresented10%ofgeneralaccountassets.
ManagementandtheBoardwantedtodemonstratefinancialstrengthtopolicyholders,ratingagenciesandanalyststhatundernoconditionswouldtheyneedtosellassetsatthesaleprices.
Darwinhadhistoricallyusedstandardaccountingliquidityratiostomeasureliquidityandamaturityladdertoanalyzetheirabilitytofundcashoutflowsovertime.
RBCwastheprimarycapitalmeasure.
Variousstressscenariosweretestedalthoughuntilthefinancialcrisisthefocuswasontheliabilitysideandsomeeventsuchadowngraderesultinginhighsurrenderrates.
ThebusinessandfinancialforecastsprovidedbytheActuarialReportingandAccountingdepartmentswerekeytoolsinmanagingappropriatelevels.
100In2008-09shehadalwayswonderedwhatwastherightcashlevel.
Darwinhadstoppedbuyingnewinvestmentsuntilitscashlevelswereextraordinarilyhigh(shefelttoohigh).
Howeveritwasbetterthatnoanalystcouldquestionwhetheritwasenough.
Nocompanywantedtobedowngraded.
ProtectingthepolicyholdersandDarwin'sratingswasworththecost.
Butifresourceshadbeenmarshaledandthemodelshadproducedbetterinformation,couldDarwinhavedemonstratedalowercashlevelwassufficientHoldingcashwasacostlydragonearningsduetotheforegoneinvestmentincome.
Earningsrepresentedfuturecapital.
Today'scapitalproblemswerecreatedbyyesterday'ssolutiontoliquidity.
InreviewingtheLiquidityPlanandCapitalPlanandhowtheywereputintopractice,sheasked,WerethetimeframedimensionsbeingappropriatelyaddressedWereallsourcesandusesofliquidityidentifiedWeretheyusingtherightmetricstomeasureofliquiditypositionInaliquiditycrisiswereresponsibilities,possibleactionsandactioncriteriaclearlydefinedWerecapitalallocationsandreturnsoncapitalappropriatelyrisk-adjustedRBCwasaconstraintbutwhatwastherightcapitalmeasureEconomiccapitalWeretheyconsideringtheappropriatestressandwhat-ifscenariosShethoughtDarwin'sliquidityandcapitalmanagementwasgoodbutcouldbebetter.
Howevershewashesitanttoaskanyquestionsduringthemeeting.
Beingateamplayermeantnotaskingquestions.
Herrolewouldbetocarryoutanymarchingorders.
TheCommitteewasevaluatinganumberofinitiativestoimproveDarwin'sliquidityandcapitalposition.
Toimproveliquidityandcapitaltheagendaitemsincluded:SecuritizingredundanttermandULSGreserves,Reinsuring20and30yearleveltermModifyingandexpandinglinesofcreditandothercreditfacilitiesBecomingamemberoftheFederalLoanSystemwhichprovidedanalternativetobanksChangingproductdesignsandtoimproveliquidityRevisitingcapitalintensiveproductsincluding15/20/30yearterm,ULSG,fixedannuitiesandVAs-reduceGuaranteesandincreaseRates.
Hedgingun-hedgedliabilitiesImplementingrenewal/replacementproductstrategiesAsshelookedovertheAgenda,shereflected:Thisisagoodlist…Securitizationsarecomplicatedandexpensive.
ShehadtofindaMemoandWhitePaper–ithadahighlevelviewofredundantreserves,securitizationflows,costs,risks.
WithnofirsthandexperienceDarwinlackedexpertise.
Theywouldhavetoputtogethertherightteam,ateamthatcouldidentifyandworkthroughtheissues…timely.
WhatwouldthecurvebeItwouldtakeresourcesfrommanydepartmentstopullthatoffReinsurancewasagoodwaytomanagecapitalbutwhatwouldtheearningstrade-offbeHowdowedeterminetherightlevelsforcreditfacilities–stresstestsStochastictests–whatCTECapitalintensiveproductsThatprettymuchcoverseverythingwesellexceptwholelife–didtheyleaveanythingout-marketingwillbesuperreceptive…101IwonderwhatliabilitiesandhedgingtheyhaveinmindIwonderwhatproductstrategiestheyareconsideringThecommitteewouldn'tbeabletopusheverythingthroughtheinitiativeandbudgetprocess.
Shewonderediftheywouldonlydiscusswhatneededtobedoneoriftheywouldalsodiscusshowtomakethingshappen.
BrandonKaladin,CEO,hadjustsentoutanemailtotheCommitteeregardingtheagendaofthismeeting:All:Pleasetakenoteoftheagendafortomorrow'sLiquidityandCapitalmeeting.
Weonlyhave2hoursblockedoffforthismeetingandit'sunlikelythatwe'llgetthrougheachoftheitems.
Ihaveorderedtheagendaintermsofmypriority,addressingthesecuritizationofterm(andUSLG)redundanciesandreinsuranceoftermproductsfirst.
Somerecenteffortwithinthiscommitteehasbeenspentunderstandingourcapitalpositionsonourwealthmanagementlines,andasourlargestin-forceblockthatmaybeprudent.
TomorrowIthinkit'simportanttomakesureweaddressourstrategyonthetraditionalblockfirst.
IhaveafewthoughtsinparticularonoursecuritizationstrategybasedonsomediscussionswithformercolleaguesthatIthinkthisgroupwillbenefitfrom.
Ilookforwardtoourdiscussion.
Brandon,CEOPriortobecomingCEOofDarwin,BrandonwastheChiefActuaryforamedium-sizedlifeinsurerwritingprimarilyLifebusiness.
Hewasveryeagertosharehisexperienceswithhisteam.
VinwasponderinghowtoaddressBrandon'spriorities.
ANewProductAnneKofsky,VPLifeInsuranceDivisionhadmadeaproposaltoexpandtheofferingoflifeinsuranceproductintoUniversalLifewithSecondaryGuarantees(ULSG)toappealtothemiddletoupperincomeclientele.
Theproposedproductintroducedamarketvalueadjustment(MVA).
InitialproductdevelopmenteffortsindicatedthattheproductwillproduceaStatutoryinternalrateofreturn(IRR)at15%whichisabovethehurdleratesetbytheholdingcompany.
Thenewproductdesignreflectsgeneralaccountinvestmentsupportedbyaportfolioofinvestmentgradecorporatebondssupplementedbyinterestderivativesandcreditdefaultswaps(CDS)tomanagetheinterestandcreditrisk,competitivepricingintheguaranteedprovisionsaswellasmoderateassumptionsinshadowaccountprojectionsandafinancialreinsuranceagreementtoreducetheonerouscapitalrequirement.
Belowisane-mailexcerptfromtheCEO.
102From:BrandonKaladin,CEOSent:Monday,March2520157:36PMTo:JosieBrennan,CROcc:AnneKofsky,VPSubject:Re:ULSGMVAAnne'sreportontheproposedULSGwithMVAlooksverypromisingbothintermsofrevenueandprofit.
Iseetheactuariesusednewstochasticmodelswithmultipleinterestscenariosanddynamicconsumerbehavior.
Josie,Iknowyourteamhasbeeninvolvedandisstillreviewing.
Asaggressiveasour3-yearULsalesgrowthareIdon'twanttohaveamisfireonlaunchingaULproductlikeABCLifeandXYZwhichwithdrewproductsfromthemarketwithinayearafterintroduction.
Theiragentswerenothappy.
Couldyouperformamorecomprehensivereviewthanusualtoevaluateifthemodelsareadequatetocaptureallthemajorriskcategoriesandiftheadditionalrisk-takingisalignedwithourriskappetiteHaveyousettledonnewriskmetricsandwhatwillbeontheriskdashboardThetargetlaunchisstillJune17.
RatingagencypreparationBeforethemeetingstarted,BeckyandStanleywerediscussinglastnight'sepisodesofDowntonAbbeyandSherlockHolmesonPBS.
SeniorVPandChiefCorporateActuaryRogerHeilmanenteredandconductedtheweeklymeetingfortheCorporateDepartment.
TowardstheendofthemeetingRogersaid,"TodayIreceivedtheagendaanddiscussionpointsfromInsightRatings.
Theyalwaysaskforalot.
Youneverknowwhatwillendupbeingdiscussedsoweneedtobeoverprepared.
Theymightnotcovereverythingonthelistbutyouneverknow.
Whattheydodiscusstheygrillyouonsoweneedtobeprepared.
AndourpreparationforInsightlastyearwasoftremendousvaluewhenDynastyfolksvisiteduslastfall.
Thiswillbesimilartolastyear–weneedtoanticipateandbeabletoanswer99%ofwhattheycouldask.
InadditiontothediscussionpointswewillusethelistIdevelopedofadditionalorfollow-upquestionstheycouldask.
AnyquestionsGood,I'dliketoseeeverythingintwoweeks.
"OnthewaybacktotheirdesksBeckyandStanleygroaned.
"Becky,lastyear'slisthadover100extremelydetailedanalysisitems,forwhichnoneofthedatawasreadilyavailable.
""Yeah,Stanley,nordowehavedecentanalyticaltoolstoanalyzethedata.
It'sallmanuallyintensive.
Thedataisnotstandardized,ithasinconsistentformattingandscatteredacrossthefourcornersofthebuilding.
LastyearRogersaidhewasgoingtomakequalitydataforanalysisanddecisionmakingapriorityformanagement.
"Hesaid,"wellgarbageinandgarbage–ohweneedtogetsomethingusefulout.
"Shesaid"wecouldtaketheresourcesandtimespentondevelopingafootnotetoafootnotethatisburiedinafilecabinetorrunningfromcrisistocrisisanddevotethemtomaterialissuesthatwouldmakeadifference/impact.
"ExcerptsfromInsightRatingsemailandDiscussionPointsareinAppendix7AExhibit1.
1037ADarwinLifeInsuranceCompanyExhibitsEXHIBIT1RatingAgencyInsightRatings1InsightDrive,CapitalCityphone123/555-6500www.
InsightRatings.
comMarch7,2015RogerHeilmanSeniorVPandChiefCorporateActuaryDarwinLifeInsuranceCo123MainStreetAlbuquerque,NMDearRoger:Thefollowingarealistofitemsthatwewouldliketodiscussforourupcoming9am–4pmApril12th,2015meeting.
Anitemofparticularconcernthatwewillspendtimeonwillbeyourinvestmentportfolioandyourcapitallevels.
Withthecurrentlowinterestrateenvironment,ourratingcommitteeisexaminingcloselyinvestmentportfoliosandtheeffectinvestmentperformancehasandwillhaveonearningsandcapital.
Aspartofouryearroundratingprocess,wewilllooktodeterminetheratingforthecompanyshortlyafterthecompletionoftheratingmeetingandthemanagementdiscussionsthatwillfollow.
Asaresult,wewouldappreciateacomprehensiveresponsetotheitemsnotedintheattachment.
Ifyouhaveanyquestionsregardingourrequestpleasecallme.
Pleasesupplementthisrequestwithanyadditionalinformationthatyoufeelwouldbehelpfultoourreview.
Inorderforustofullyreviewyourinformation,submittwocopiesofthisinformationatleastoneweekpriortothemeetingdatetoallowtimetoreviewthematerial.
Ilookforwardtomeetingyouandthemanagementteam.
Regards,MorganHubbardFinancialAnalystLife/HealthDivision104BelowareexcerptsfromtheInsightRatingsDiscussionPointsattachment.
MeetingAgendaStrategyOverviewCorporateGovernanceandAuditCommitteeUpdateBusinessLineReviewIndividualLifeIndividualAnnuitiesDistributionFinancialProjections(splitbyproductandbydistribution)InvestmentsAsset/LiabilityManagementandLiquidityInvestmentsCapitalManagementEnterpriseRiskManagementInformationRequestsAudited(ifavailable)2014StatutoryandGAAPFinancialStatements3-yearPlan:StatutoryandGAAPstatementsUpdatedbankfacilityagreementsCashflowtestingsummaryProductbrochureandillustrationfortopsellinglifeproducts,VAandfixedannuity.
LIMRAsalesinformationondifferentproducts;alsoshowpersistencyHoldingcompanyonlyISandBSthatshowsassetdetailsBusinesswithBigBenBank:lifeinsurancein-forceandlifeandannuitysalesProfitabilitymeasuresRetailfixedannuityandvariableannuityflowinformationincludingnetsalesandspreadsQuestionsOverviewReviewDarwin'sCorporateStrategyandcapitalallocationintheorganization.
ReviewthemostrecentBoardofDirectorspresentationmaterials.
DiscussthesynergiesofDarwin'scurrentbusinesssegments.
Provideupdatesonanyrecent/potentialacquisitions,salesorstrategicaffiliations.
DiscussventureswithBigBenBank.
Discussplansformaintaininglong-termtoplinegrowth(i.
e.
revenue)aswellasplanstoimproveoperatingperformance(specificallystatutoryearningsperformance)andyourcapitalandsurplusposition.
HowwillDarwinmaintainitscompetitiveadvantageinthemarketplaceCorporateGovernanceandAuditCommitteeUpdate…severalbulletpointsBusinesslinereview105Reviewmarketing/businessplanforthecompanyincludingchangesinproduct,market,orgeographicfocus/expansion.
Discusscurrentbusinessplansbylineofbusinessincludingcurrentproductdevelopmentplansandhowtrendsinproductdesignandtechnologyareincorporated.
Discusstheimpactofthecurrentinterestrateenvironmentonyourcorebusinesslines.
Reviewyourclaimsexperienceversuspricingassumptions.
Discussthecompany'suseofmortalityreinsurance.
Discussthepricingonfixedannuityandlifeproducts.
Quantifytargetpricingspreads;quantifyannuitygrossandnetspreads–historicalandprojected.
DistributionDiscussagentretentionstatisticsDiscusssalespromotions-quantifycostsandimpactonsalesDiscusscompetitionintheULandVAmarketsReviewyourdistributionchannelstrategyandgrowthplans.
FinancialProjectionsDiscussanymaterialvariancesincludingmargins,directandnetpremiums,expenses,benefitsandcommissionlevels.
Provideaby-lineanalysisofperformance/profitabilityincludingthesourcesofearnings.
Discussthecompany'sdifferentproductsincludingprofittargets,anticipatedemergenceofstatutoryearnings,acquisitioncostsandsensitivitiestodifferentriskfactorssuchasexpense,interestrate,equitymarkets,mortalityandlapse.
InvestmentsProvideimpairmentsin2014and2015YTD.
Providecurrentportfolioyieldsandnewmoneyratesinaggregateandfordifferentclasses.
Discussanychangestotheinvestmentstrategy.
Reviewalternativeassetsandsub-primemortgage/alt-AandCMBSexposures.
Discussdevelopmentsinportfoliocreditqualityandexpectedinvestmentrelatedrealizedandunrealizedlosses.
Provideyourinvestmentpoliciesandanarrativeoninvestmentstrategies.
Discussyourinvestmentstrategyandanyexpectedchangesinthenearterm.
ALMReviewofasset/liabilitymanagement,cashflowtesting/sensitivityanalysis.
WerethereanychangestopricingassumptionsbecauseofinvestmentperformanceDescribetheVAhedgingstrategyandtherisksbeinghedged.
WhichrisksarenothedgedCapitalManagementQuantifytheimpactofredundantreservesinterm(XXX)andUL(AXXX).
HowdoesthecompanyintendtodealwiththereservestrainWhatwasthereserveimpactofAG38in2015Anyproductchanges106Discusssecuritizationplans.
Discussthecompany'suseofreinsurance.
Anychangesinreinsuranceprogram/retentionDiscusscapitaladequacyasmeasuredbythecompanyandfutureaccesstocapital.
EnterpriseRiskManagement…severalbulletpointsMiscellaneousUpdateandsummaryofoutstandinglitigation,marketconductand/orcomplianceissues.
Discussanyexpensecontrolinitiatives.
…severaladditionalbulletpoints107EXHIBIT2BusinessIntelligenceProductComparisonsDarwintracksmarketpositionwithineachbusinesssegment.
Considerationsincludepremiumspaid,benefits,features,creditedratesandguaranteeperiod,otherguarantees,fees,surrendercharges,service,andpolicycashvaluesovertime(undercurrentassumptionsandunderguarantees).
Competitorstrackedvarybysegmentandproduct.
DistributionCapacityDarwintracksAgencydistributiongrowthbynumberofagents,bygeographicpenetration,totalsalesbyagents,salesoverprioryearsalesforsameagentsbandedbyyearsofservice,retentionratesandtrainingcosts.
DarwintracksInstitutionaldistributiongrowthbydistributorcount,numberofwholesalers,numberofappointedrepresentatives,rankingwithineachpartner,changeinpercentageshareanddollarvolumewithineachpartnerandnumberofappointedReps.
FinancialGrowthDarwinmeasuresfinancialgrowthusingthefollowingKPIs:GAAPearnings,Statutoryequity,totalassetsundermanagement,lifeinsurancesales(firstyearpremium),variableannuitysalesandfixedannuitysales,RBCratioanddebtratio.
Darwinvs.
Industryvs.
PeerGroupDarwinusesthefollowingtobenchmarkitself.
1.
NAICRiskBasedCapital(RBC)Ratio2.
CapitalGrowthSharpeRatio3.
FinancialLeverage4.
EarningInterestCoverage5.
CashFlowInterestCoverage6.
ReturnonCapital7.
ExpenseRatio8.
LiquidityRatio9.
IndividualLifePremiumasa%ofTotal108EXHIBIT3RiskFactorsInadditiontotherisksoutlinedintheBackgroundmaterialinSection7numerousotherrisksinclude:RiskFactorsEconomicconditionsmaymateriallyadverselyaffectourbusinessandresultsofoperations.
TheCompany'sstrategiesformitigatingrisksarisingfromitsday-to-dayoperationsmayproveineffectiveresultinginamaterialadverseeffectonitsoperationalresultsandfinancialcondition.
Thedevelopmentandmaintenanceofourvariousdistributionsystemsarecriticaltogrowthinproductsalesandprofits.
Aratingsdowngradeorothernegativeactionbyaratingagencycouldmateriallyandnegativelyaffectourbusiness,financialconditionandresultsofoperations.
TheCompany'sresultsandfinancialconditionmaybenegativelyaffectedshouldactualexperiencedifferfrommanagement'sassumptionsandestimates.
TheCompanycouldbeforcedtosellinvestmentsatalosstocoverpolicyholderwithdrawalsInterestratefluctuationsorsignificantandsustainedperiodsoflowinterestratescouldnegativelyaffecttheCompany'sinterestearningsandspreadincomeorotherwiseimpactitsbusiness.
EquitymarketvolatilitycouldnegativelyimpacttheCompany'sbusiness.
TheCompany'suseofderivativefinancialinstrumentswithinitsriskmanagementstrategymaynotbeeffectiveorsufficient.
TheuseofreinsuranceintroducesvariabilityintheCompany'sstatementsofincome.
TheCompanyishighlyregulatedandsubjecttonumerouslegalrestrictionsandregulations.
Changesinregulationmayreduceourprofitabilityandgrowth.
Newaccountingrules,changestoexistingaccountingrules,orthegrantofpermittedaccountingpracticestocompetitorscouldnegativelyimpacttheCompany.
Financialservicescompaniesarefrequentlythetargetsoflegalproceedings,includingclassactionlitigation,whichcouldresultinsubstantialjudgments.
Changestotaxlaworinterpretationsofexistingtaxlawcouldincreaseourtaxcosts.
Companiesinthefinancialservicesindustryaresometimesthetargetoflawenforcementinvestigationsandthefocusofincreasedregulatoryscrutiny.
Litigationcouldresultinsubstantialjudgmentsagainstusorouraffiliates.
TheCompany'sabilitytomaintaincompetitiveunitcostsisdependentuponthelevelofnewsalesandpersistencyofexistingbusiness.
TheCompany'sinvestmentsaresubjecttomarketandcreditrisks.
Theseriskscouldbeheightenedduringperiodsofextremevolatilityordisruptioninfinancialandcreditmarkets.
109TheCompany'sreinsurerscouldfailtomeetassumedobligations,increaserates,orbesubjecttoadversedevelopmentsthatcouldaffecttheCompany.
Adversecapitalandcreditmarketconditionsmaysignificantlyaffectourabilitytomeetliquidityandfinancingneedsoraccesscapital,aswellasaffectourcostofcapital.
TheCompanycouldbeadverselyaffectedbyaninabilitytoaccessitscreditfacilityTheamountofstatutorycapitalthattheCompanyhasandtheamountofstatutorycapitalthatitmustholdtomaintainitsratingsandmeetotherrequirementscanvarysignificantlyfromtimetotimeandissensitivetoanumberoffactorsoutsideoftheCompany'scontrol.
TheCompany'sabilitytogrowdependsinlargepartuponthecontinuedavailabilityofcapital.
Theoccurrenceofcomputerviruses,networksecuritybreaches,disasters,orotherunanticipatedeventscouldaffectthedataprocessingsystemsofDarwinoritsaffiliatesandcoulddamageourbusinessandadverselyaffectourfinancialconditionandresultsofoperations.
110EXHIBIT4FinancialData:GAAPIncomeStatements(in000s)Total201420152016201720182019REVENUESPremium-FirstYear784,780911,7201,077,8801,289,7101,594,2602,090,450Premium-Renewal222,890255,630293,230329,160365,520401,560TotalPremiums1,007,6701,167,3501,371,1101,618,8701,959,7802,492,010NetInvestmentIncome597,270595,330606,450624,430647,770685,240Otherincome42,05051,36061,15073,19085,850103,940TotalRevenues1,646,9901,814,0402,038,7102,316,4902,693,4003,281,190BENEFITSANDEXPENSESClaims100,500129,890143,730168,890198,370235,170Surrenderandotherbenefits601,710659,910722,420726,080791,210863,940Inc.
inreserves&S/ATransfers588,460695,250835,0201,052,6001,320,8101,776,940TotalBenefits1,290,6701,485,0501,701,1701,947,5702,310,3902,876,050FieldCompensation83,650100,920119,100138,800161,100193,200ChangeinDAC(49,100)(63,270)(75,070)(87,090)(100,330)(120,350)TotalAcquisitionCosts34,55037,65044,03051,71060,77072,850TotalAdministrativeExpenses69,28077,22084,09091,70099,740107,750TotalBenefitsandExpenses1,394,5001,599,9201,829,2902,090,9802,470,9003,056,650EBIT252,490214,120209,420225,510222,500224,540Interest18,00018,00018,00018,00018,0007,375Tax82,10068,60067,00072,60071,60076,000NetIncome170,390145,520142,420152,910150,900148,540VariableAnnuities201420152016201720182019REVENUESPremium-FirstYear561,000669,800812,6001,000,0001,280,0001,750,000Premium-RenewalTotalPremiums561,000669,800812,6001,000,0001,280,0001,750,000NetInvestmentIncome73,70085,00098,000119,000142,000175,000Otherincome25,80033,40040,60050,50061,60076,500TotalRevenues660,500788,200951,2001,169,5001,483,6002,001,500BENEFITSANDEXPENSESClaims16,20028,80036,00046,60059,20075,100Surrenderandotherbenefits114,650161,100193,650228,100276,450315,700Inc.
inreserves&S/ATransfers474,250536,300649,250807,4001,038,0001,464,500111TotalBenefits605,100726,200878,9001,082,1001,373,6501,855,300FieldCompensation30,20038,30046,40056,10069,00090,800ChangeinDAC(13,400)(20,900)(24,300)(28,500)(36,900)(52,300)TotalAcquisitionCosts16,80017,40022,10027,60032,10038,500TotalAdministrativeExpenses14,30017,40020,20024,10028,20032,800TotalBenefitsandExpenses636,200761,000921,2001,133,8001,433,9501,926,600EBIT24,30027,20030,00035,70049,65074,900InterestTax8,5009,50010,50012,50017,40026,200NetIncome15,80017,70019,50023,20032,25048,700UniversalLife201420152016201720182019REVENUESPremium-FirstYear58,78072,42089,480106,810125,360145,650Premium-Renewal47,59064,73082,03096,460111,020125,060TotalPremiums106,370137,150171,510203,270236,380270,710NetInvestmentIncome110,770106,530105,850109,730114,170121,040Otherincome5,8506,7608,4509,4909,75011,440TotalRevenues222,990250,440285,810322,490360,300403,190BENEFITSANDEXPENSES0.
360.
350.
360.
360.
360.
36Claims27,30035,29033,93038,09042,77047,970Surrenderandotherbenefits32,76032,11036,27041,08045,76051,740Increaseinreserves92,310120,250152,270182,600214,410246,440TotalBenefits152,370187,650222,470261,770302,940346,150FieldCompensation21,45025,22032,20038,50045,10052,400ChangeinDAC(13,000)(16,770)(24,670)(31,790)(36,830)(41,350)TotalAcquisitionCosts8,4508,4507,5306,7108,27011,050TotalAdministrativeExpenses13,78014,82015,99016,90017,94018,850TotalBenefitsandExpenses174,600210,920245,990285,380329,150376,050EBIT48,39039,52039,82037,11031,15027,140InterestTax16,90013,80013,90013,00010,9009,500NetIncome31,49025,72025,92024,11020,25017,640112TraditionalLife201420152016201720182019REVENUESPremium-FirstYear34,00034,00036,40038,50040,20041,700Premium-Renewal54,90063,10071,20080,00089,30098,600TotalPremiums88,90097,100107,600118,500129,500140,300NetInvestmentIncome51,20050,50051,70053,00054,50056,700OtherincomeTotalRevenues140,100147,600159,300171,500184,000197,000BENEFITSANDEXPENSESClaims15,80015,80017,20018,80020,50022,300Surrenderandotherbenefits31,90029,80031,20033,00034,90036,800Increaseinreserves34,40045,40051,30058,30064,80071,300TotalBenefits82,10091,00099,700110,100120,200130,400FieldCompensation18,10020,50022,50025,10027,50030,000ChangeinDAC(9,300)(11,200)(11,700)(12,600)(13,200)(13,800)TotalAcquisitionCosts8,8009,30010,80012,50014,30016,200TotalAdministrativeExpenses9,20010,30010,90011,50012,20012,700TotalBenefitsandExpenses100,100110,600121,400134,100146,700159,300EBIT40,00037,00037,90037,40037,30037,700InterestTax14,00013,00013,30013,10013,10013,200NetIncome26,00024,00024,60024,30024,20024,500Term201420152016201720182019REVENUESPremium-FirstYear14,30017,50019,40021,40022,70024,100Premium-Renewal44,70052,80063,00073,70084,20093,900TotalPremiums59,00070,30082,40095,100106,900118,000NetInvestmentIncome20,40020,50022,00024,10026,80030,100OtherincomeTotalRevenues79,40090,800104,400119,200133,700148,100BENEFITSANDEXPENSESClaims22,90028,60035,90044,20053,00065,200Surrenderandotherbenefits400500500500500500Increaseinreserves10,80011,10012,00013,20014,60015,100TotalBenefits34,10040,20048,40057,90068,10080,800FieldCompensation8,20010,80011,70012,60012,90013,100ChangeinDAC(11,200)(12,300)(12,600)(12,600)(12,000)(11,500)113TotalAcquisitionCosts(3,000)(1,500)(900)-9001,600TotalAdministrativeExpenses21,20023,10024,80026,50028,00029,500TotalBenefitsandExpenses52,30061,80072,30084,40097,000111,900EBIT27,10029,00032,10034,80036,70036,200InterestTax9,50010,20011,20012,20012,80012,700NetIncome17,60018,80020,90022,60023,90023,500Other201420152016201720182019REVENUESPremium-FirstYear116,700118,000120,000123,000126,000129,000Premium-Renewal75,70075,00077,00079,00081,00084,000TotalPremiums192,400193,000197,000202,000207,000213,000NetInvestmentIncome341,200332,800328,900318,600310,300302,400Otherincome10,40011,20012,10013,20014,50016,000TotalRevenues544,000537,000538,000533,800531,800531,400BENEFITSANDEXPENSESClaims18,30021,40020,70021,20022,90024,600Surrenderandotherbenefits422,000436,400460,800423,400433,600459,200Increaseinreserves(23,300)(17,800)(29,800)(8,900)(11,000)(20,400)TotalBenefits417,000440,000451,700435,700445,500463,400FieldCompensation5,7006,1006,3006,5006,6006,900ChangeinDAC(2,200)(2,100)(1,800)(1,600)(1,400)(1,400)TotalAcquisitionCosts3,5004,0004,5004,9005,2005,500TotalAdministrativeExpenses10,80011,60012,20012,70013,40013,900TotalBenefitsandExpenses431,300455,600468,400453,300464,100482,800EBIT112,70081,40069,60080,50067,70048,600InterestTax39,40028,50024,40028,20023,70017,000NetIncome73,30052,90045,20052,30044,00031,600114EXHIBIT5FinancialData:StatutoryBalanceSheets(in000s)andDebtTotal201420152016201720182019CashandInvestedAssets10,222,30010,466,40010,671,90011,006,00011,404,70011,725,300SeparateAccountAssets1,878,1002,128,2002,515,9003,057,8003,777,9004,872,200DeferredTaxAssetTotalAssets12,100,40012,594,60013,187,80014,063,80015,182,60016,597,500StatutoryReserves11,231,20011,716,00012,299,00013,160,20014,280,30015,856,500Debt225,000225,000225,000225,000225,00075,000TotalLiabilities11,456,20011,941,00012,524,00013,385,20014,505,30015,931,500StatutoryEquity644,200653,600663,800678,600677,300666,000RBC338%333%324%312%306%287%DebtRatio35%34%34%33%33%11%VariableAnnuity201420152016201720182019Cash,InvestedandOtherAssets365,100457,300459,700532,900608,800687,600SeparateAccountAssets1,878,1002,128,2002,515,9003,057,8003,777,9004,872,200DeferredTaxAssetTotalAssets2,243,2002,585,5002,975,6003,590,7004,386,7005,559,800StatutoryReserves2,086,2002,417,4002,797,1003,398,7004,198,3005,385,700TotalLiabilities2,086,2002,417,4002,797,1003,398,7004,198,3005,385,700StatutoryEquity157,000168,100178,500192,000188,400174,100UniversalLife201420152016201720182019Cash,InvestedandOtherAssets1,929,2002,001,9002,102,3002,237,1002,406,8002,617,100DeferredTaxAssetTotalAssets1,929,2002,001,9002,102,3002,237,1002,406,8002,617,100StatutoryReserves1,820,0001,897,5002,002,2002,140,7002,314,2002,528,600TotalLiabilities1,820,0001,897,5002,002,2002,140,7002,314,2002,528,600StatutoryEquity109,200104,400100,10096,40092,60088,500115TraditionalLife201420152016201720182019Cash,InvestedandOtherAssets936,000966,1001,005,7001,050,5001,101,5001,158,100DeferredTaxAssetTotalAssets936,000966,1001,005,7001,050,5001,101,5001,158,100StatutoryReserves900,000928,900967,0001,010,1001,059,1001,113,500TotalLiabilities900,000928,900967,0001,010,1001,059,1001,113,500StatutoryEquity36,00037,20038,70040,40042,40044,600Term201420152016201720182019Cash,InvestedandOtherAssets442,000478,800530,000598,600687,600798,700DeferredTaxAssetTotalAssets442,000478,800530,000598,600687,600798,700StatutoryReserves425,000460,400509,600575,500661,100768,000TotalLiabilities425,000460,400509,600575,500661,100768,000StatutoryEquity17,00018,40020,40023,10026,50030,700Other201420152016201720182019Cash,InvestedandOtherAssets6,300,0006,312,3006,324,2006,336,9006,350,0006,363,800DeferredTaxAssetTotalAssets6,300,0006,312,3006,324,2006,336,9006,350,0006,363,800StatutoryReserves6,000,0006,011,8006,023,1006,035,2006,047,6006,060,700TotalLiabilities6,000,0006,011,8006,023,1006,035,2006,047,6006,060,700StatutoryEquity300,000300,500301,100301,700302,400303,100Corp250,000250,000250,000250,000250,000100,000DebtIssuanceIssueIssueDateMaturityDateRateFaceAmountSeniornotesissue1Mar20001Mar20158.
50%150,000Seniornotesissue15Jun201015Jun20307.
00%75,000116EXHIBIT6SensitivityTestsTermSensitivities(in000s)Baseline20152016201720182019Sales21,40022,70024,10025,60027,200GAAPEarnings:Inforce7,1006,9007,1006,3005,100GAAPEarnings:NewBusiness15,50017,00016,40026,20028,000GAAPTotalEarnings22,60023,90023,50032,50033,100StatutoryCapital23,10026,50030,70033,76534,294LapseUp15%Sales21,40022,70024,10025,60027,200GAAPEarnings:Inforce7,4557,9358,8758,5057,395GAAPEarnings:NewBusiness15,19015,47013,77620,17419,600GAAPTotalEarnings22,64523,40522,65128,67926,995StatutoryCapital22,63825,17527,63028,36326,749LapseDown15%Sales21,40022,70024,10025,60027,200GAAPEarnings:Inforce7,4555,8654,6152,8351,275GAAPEarnings:NewBusiness15,19016,83016,40026,46228,560GAAPTotalEarnings22,64522,69521,01529,29729,835StatutoryCapital23,79328,09033,46338,15440,124SalesUp15%Sales24,61026,10527,71529,44031,280GAAPEarnings:Inforce7,1006,9007,1006,3005,100GAAPEarnings:NewBusiness17,82519,55018,86030,13032,200GAAPTotalEarnings24,92526,45025,96036,43037,300StatutoryCapital23,56228,09033,77038,83040,810SalesDown15%Sales18,19019,29520,48521,76023,120GAAPEarnings:Inforce7,1006,9007,1006,3005,100GAAPEarnings:NewBusiness13,17514,45013,94022,27023,800GAAPTotalEarnings20,27521,35021,04028,57028,900StatutoryCapital22,63825,17527,63028,36326,749117VariableAnnuitySensitivities(in000s)Baseline20152016201720182019Sales1,000,0001,280,0001,750,0002,100,0002,520,000GAAPEarnings:Inforce17,40017,90018,20018,90019,200GAAPEarnings:NewBusiness5,80014,35030,50039,50050,900GAAPTotalEarnings23,20032,25048,70058,40070,100StatutoryCapital192,000188,400174,100178,300181,900MarketUp15%at31Dec2014Sales1,000,0001,280,0001,750,0002,100,0002,520,000GAAPEarnings:Inforce24,00025,00025,90027,20028,200GAAPEarnings:NewBusiness5,80014,35030,50039,50050,900GAAPTotalEarnings29,80039,35056,40066,70079,100StatutoryCapital232,000230,400218,200224,600230,500MarketDown15%at31Dec2014Sales1,000,0001,280,0001,750,0002,100,0002,520,000GAAPEarnings:Inforce10,80010,80010,50010,60010,200GAAPEarnings:NewBusiness5,80014,35030,50039,50050,900GAAPTotalEarnings16,60025,15041,00050,10061,100StatutoryCapital112,000104,40085,90085,70084,700SalesUp15%Sales1,150,0001,472,0002,012,5002,415,0002,898,000GAAPEarnings:Inforce17,40017,90018,20018,90019,200GAAPEarnings:NewBusiness26,70037,10056,00067,20080,600GAAPTotalEarnings44,10055,00074,20086,10099,800StatutoryCapital190,500184,980168,055169,105168,925SalesDown15%Sales850,0001,088,0001,487,5001,785,0002,142,000GAAPEarnings:Inforce17,40017,90018,20018,90019,200GAAPEarnings:NewBusiness19,72027,41341,39549,64059,585GAAPTotalEarnings37,12045,31359,59568,54078,785StatutoryCapital193,500191,820180,145187,495194,875118EXHIBIT7FinancialData:InforceStatisticsTotal201420152016201720182019DeathBenefitInforce(in000's)103,119,763105,583,877108,447,334120,000,000127,697,000134,299,000PolicyContractCount303,125332,458364,656400,000420,400441,844VariableAnnuityDeathBenefitInforce(in000's)12,355,00011,843,00011,519,00018,000,00017,297,00018,055,000PolicyContractCount30,05333,05836,36440,00042,00044,100UniversalLifeDeathBenefitInforce(in000's)51,830,25654,421,76957,142,85760,000,00064,800,00069,984,000PolicyContractCount32,65234,93837,38340,00042,40044,944TraditionalLifeDeathBenefitInforce(in000's)28,571,00028,571,00028,571,00030,000,00032,400,00032,400,000PolicyContractCount75,13182,64590,909100,000105,000110,250TermDeathBenefitInforce(in000's)4,807,5075,192,1085,607,4776,000,0006,600,0007,260,000PolicyContractCount150,263165,289181,818200,000210,000220,500OtherDeathBenefitInforce(in000's)5,556,0005,556,0005,607,0006,000,0006,600,0006,600,000PolicyContractCount15,02616,52918,18220,00021,00022,050