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SPRING 2014 EXAM CFESDMB Strategic Decision Making Exam (Part B) CASE STUDY

CFESDMB

EDUCATION AND EXAMINATION COMMITTEE OF THE SOCIETY OF ACTUARIES SPRING 2014 EXAM Advanced Corporate Finance and Enterprise Risk Management Strategic Decision Making CASE STUDY RPPC Dynasty Corporation: A Box Full of Growth

Copyright 2013 Society of Actuaries

The Education and Examination Committee provides study notes to persons preparing for the examinations of the Society of Actuaries. They are intended to acquaint candidates with some of the theoretical and practical considerations involved in the various subjects. While varying opinions are presented where appropriate, limits on the length of the material and other considerations sometimes prevent the inclusion of all possible opinions. These study notes do not, however, represent any official opinion, interpretations or endorsement of the Society of Actuaries or its Education and Examination Committee. The Society is grateful to the authors for their contributions in preparing the study notes.

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Table of Contents 1 1A 2 2A 3 3A 4 4A 5 5A 6 6A 7 7A

RPPC Dynasty Corporation RPPC Dynasty Corporation Exhibits Blue Jay Air Blue Jay Air Exhibits Blue Jay Tire Co Blue Jay Tire Exhibits Frenz Corporation Frenz Corporation Exhibits Blue Ocean P&C Company Blue Ocean P&C Company Exhibits Big Ben Bank Big Ben Bank Exhibits Darwin Life Insurance Company Darwin Life Insurance Company Exhibits

3 13 15 21 29 36 39 46 55 64 65 69 70 79

Disclaimer The companies and events depicted in this Case Study are fictitious. Any similarity to any event, corporation, organization and person living or dead is merely coincidental. With the exception of Appendix 3A Exhibit 4 which consists of real press releases related to the airline industry, some narrative material utilizes real locations and real news organizations to make the Case Study seem real. The Associated Press, Wall Street Journal, Standard & Poor’s, A.M. Best and others used in this context have never actually commented on any of the fictitious companies.

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RPPC Dynasty Corporation: A BOX FULL OF GROWTH 1

RPPC Dynasty Corporation

1.1

Introduction

The leaves rustled as Julia and Emmanuel walked down the trail that surrounded Frenz Corporation’s home office. The autumn air was refreshingly cool and awakened the senses and mind after an exhilarating and exhausting two weeks. “I appreciate all you've done the past couple of months,” and handing Julia a box, Emannuel said, “I thought this would be appropriate given the words of wisdom you shared at the beginning of this trip.” She unwrapped the gift to find a box of gourmet chocolates – one of the many products Frenz sold. Just two weeks earlier on October 6, 2012, she was with eleven others waiting at the airport, part of two Corporate Planning Teams assigned to visit management at RPPC Dynasty’s major businesses and review their 3-year plans. Others had asked what she expected from all the people they would meet. “Hmmm … my favorite movie is Forrest Gump. Forrest’s maxim was, ‘Life is like a box of chocolates you never know what you're going to get.’” Everyone chuckled as they recounted their favorite Forrest Gump scenes. Julia’s team had been on a whirlwind tour to Russia, Ontario, Texas and their final stop in Antwerp, Belgium to talk apparel, tires, airlines and coffee. She looked at her watch. The other team was already in the air on their way back from New Mexico to Dynasty’s headquarters in Luxembourg. Harry looked out the window and could see the Atlantic coastline in the distance. His team had covered the financial businesses – life insurance, banking and P&C insurance. On his left sat Olivia and Sophie. Olivia was full of energy talking about all the people they had met and the opportunities that had been discussed over the past two weeks. There was a lot to do in the next month before next year's plans were finalized in mid-December - a lot of proposals and alternatives to evaluate. Of course there were questions and issues to resolve - products, markets, distribution, investment strategies and impending regulatory and accounting changes. Some thought they should grow cautiously until the recovery was further along. They felt that selling insurance products and making bank loans in this environment squeezed out any margins and added too much additional risk. She thought the opportunities were now and that RPPC couldn’t move fast enough. She recalled that Winston Churchill always favored action - the time to act is now. Harry said, “In any case the financial and risk management areas are going to be busy the next 8 weeks. Remember what happened during the Redeploy Project last year.” Julia thought herself lucky to have been given this opportunity – a chance to shine in a prominent role, a chance to really make a difference. The Risk Management function at RPPC had only been established in 2010. In reality RPPC Dynasty was lucky to have her. She worked long hours in preparation. She had read report after report, countless management memos, 3

policies and process documents and had looked at numbers, metrics, market intelligence analyses and even more numbers. She preferred meeting in small groups. Julia was known as the “Friendly Interrogator”. You couldn’t survive a meeting unless you’d done your homework and had thought through the issues. She helped you be at your best. Julia had been the CRO’s right hand and was just appointed as CRO recently. Her risk management team was earning the reputation of being business savvy. Her CERA studies had been useful but she was glad she had taken the Corporate Finance & ERM Track in getting her Fellowship in 2008. The material covered in the Strategic Decision Making exam gave her a solid business foundation, strategic mindset and sharpened her critical thinking skills. By continuing to read business and strategy books mixed in with first-hand experience her communication skills and business acumen had been noticed. Life was indeed a box of chocolates.

RPPC Dynasty Corporation History RPPC Dynasty (also referred to as RPPC or Dynasty) was established in 2000 with head offices in Luxembourg by four founding partners. The corporation’s name is derived from the four founder’s surnames - Ruiz, Putin, Patel and Chan. They had ambitious goals to grow the corporation to become its namesake – a business dynasty respected throughout the world. From the beginning, and still to this day, the focus has been to meet the needs of a globally mobile clientele. The corporation holds a diverse group of businesses. Luxembourg was chosen due to its being a European low tax jurisdiction. The business roots began with the coffee shop owned and operated by the Ruiz family since 1985. The apparel shop began in 1995, also family owned and operated by the Chan family. In 2000, Mr. Ruiz and Ms. Chan formed a partnership. Soon thereafter two other entrepreneurs were brought in to expand the brand. In 2001, with the guidance of Mr. Patel, a Bank group was formed. In 2005, the influence of the mariner background of Ms. Putin, a P&C Insurer corporation was acquired. The P&C group was leaders in personal and commercial marine insurance. In 2008, the U.S. financial crisis presented an opportunity to acquire a life insurance group to expand the wealth management capabilities of the bank operations. In 2010, an Airline was bought to appeal to the growing global mobility of the group’s clientele. The Airline has been put through a restructuring initiative to be fitted into the group’s vision. RPPC Dynasty’s growing empire consists of nearly two dozen companies spanning a variety of industries and services. 4

Mission Provide high quality and uniquely tailored service to families or businesses that are globally active. Our family is your family, come experience our difference that is so familiar to you!! Vision We provide our customer the comfort of a family friend when they are away from home. We are your family away from home!! Executive Team The Executive Team included: CEO – Mr. Gilroy Clyde (since inception) CFO – Mr. Houben Huang (5 years) CRO – Ms. Julia Reich (recently appointed) COO – Ms. Jane Mulroney (since incorporation + default CRO) Selling a Success Story Mr. Houben Huang looked out his window. The trees were bare and the silhouettes against the morning sun always left an impression. December was always a busy month – final business decisions to bring the year to a close, planning always went into overdrive, holiday gatherings and parties, school concerts and plays, decorating and cooking. Cooking was always fun and came with an immediate reward of warm cookies. On his desk were materials for a debt rating review session with the Trusty Rating Agency on January 6. Much of the material would be used for the upcoming investor analysts meeting and excerpts would form the theme in the 2012 Annual Report to shareholders. But the upcoming debt issuance was paramount to their growth plans. Later this morning he would be meeting for most of the day with Gilroy, Jane and Julia. Within the past few weeks, the Boards of Dynasty and its many businesses had adopted many of Managements recommendations. The Boards had also sent a few proposals back for further analysis and consideration. The Corporate Planning Teams had been invaluable working with the businesses and their planning teams. The Trusty Presentation Materials highlighted the Dynasty story - main messages and points Management wished to articulate. Some of the content was done and some needed to be updated or revised. Houben had scribbled some notes – how did the material convey and package the following themes? Business Strategies Airline change, new management customer focus Tire niche, challenged, need investment or will be sold Coffee market leader, growth focused P&C cash cow, niche (Marine (UK), Pet (Canada), Liability, Commercial, Catastrophic) looking to expand to the US 5

Bank customer oriented wealth management focus growth by M&A integration Insurance long term interest risk (VA, LCOI) regulatory changes Apparel boutique fast follower (follow Coach, Michael Kohrs), seasonal volatility Trusty would hammer management on challenges, struggles and missteps. There were a few headaches but the biggest message to sell was the Dynasty success story. There were tremendous opportunities in their major businesses and the acquisition team had several new attractive prospects under consideration. Dynasty was well positioned to grow. Trusty Presentation Materials also include an executive summary of the global market outlook (see Exhibit 1A). This outlook helps the company in strategizing its global expansion plan. It identifies areas that the company has capitalized from these global market changes.

1.2

Governance and Risk Management Overview

Governance RPPC has the following Executive Committees: 1. Operation’s Committee 2. Audit Committee 3. Finance Committee 4. Risk Committee 5. Compliance & Legal Committee

RPPC Risk Management Framework Vision Statement We are exposed to a variety of risks that are inherent in carrying out our business activities. Having an integrated and disciplined approach to risk management is key to the success of our business. In order to achieve prudent and measured risk-taking that aligns with our business strategy, we are guided by a risk management framework that is embedded in our daily business activities and planning process. Strengths and Value Drivers  A Risk Appetite that shapes business strategies and is integrated into our decision-making processes. Risk management is considered a profit generating activity. We believe preventing our organisation from experiencing loss is as beneficial as creating new profit streams from new arenas.  A unified and strong risk culture that is embedded across the enterprise means that there is consensus opinion on the value and purpose of risk management.

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Challenge  Continued volatility in global economic conditions, causing heightened marketplace uncertainty. This is both a risk as well as an opportunity. Our Priority  Broaden and strengthen risk capabilities, including enhancing our stress testing functions to deliver better insights to both our risk and business groups. We believe in strongly in assessing risk through a variety of lenses, not simply looking at past performance. Our Path to Differentiation  Within our independent oversight framework and the limits of our risk appetite, contribute to the enterprise’s customer focus.  Ensure that risk awareness is pervasive throughout the organisation, at all levels, and all functions, and that the risk for reward trade-off is applied effectively and consistently in all levels of decision-making.

Key Objectives and Recent Achievements A key objective is to continue embedding our strong risk culture across the enterprise, including newly acquired businesses:  Emphasize and ensure that at RPPC Dynasty risk management is a process of continual improvement.  Reinforce our risk independence and our three-lines-of-defense approach to managing risk across the enterprise. Recent Achievements RPPC achieved the roll-out of our five step message on our value based approach to enterprise risk management:  Understand and manage  Protect our reputation  Diversify. Limit tail risk  Maintain strong capital and liquidity  Optimise Risk Return RPPC established and formalised the role of Risk Champion to ensure strengthened engagement between the office of the CRO and Business operating groups.

Value-Based Enterprise Risk Framework RPPC risk governance has three pillars. I The first line of defense at RPPC is the Business operating group, which are responsible for ensuring that products and services adhere to the approval process and profit guidelines of their business. Their mandate is to pursue suitable business 7

II

III

opportunities within the Risk Appetite, and to adopt strategies and practices to optimize return on capital employed. RPPC officers must act within delegated risk taking authority, and must have effective processes and controls in place to enable it to operate within its delegated risk authorities and limits. The second line of defense is the office of the CRO, along with Enterprise Risk Officers (ERO’s) and Subject Matter Experts (SME’s) as assigned for specific risk categories or sub categories, which provide oversight, challenge and independent assessment of risk. The third line of defense is the Corporate Audit Division which in conducting the internal audit process will provide assessment as to the effectiveness of internal control including control, risk management and governance processes that support the Enterprise, its objectives and the Board of Directors’ discharge of its responsibilities.

The CEO is responsible for the business operating groups. This is known as the first line of defense. The second line is made up risk officers (ERO’s and SME’s) who work collaboratively with the business operating groups and are engaged through corporate policies that support ERM & Portfolio Management (EPM). These risk officers are governed by the CRO and the risk management committee. The second line has a direct line to the Board and therefore meets “in camera” with the Board. The third line, the Audit officers, also has an “in camera” with the Board.

RPPC Board Board Risk Committee

  

CEO

Board Audit Committee

Risk Management Committee

Operating Groups

ERM & Portfolio Management

ERO's and SME's

Capital Management Reputational Risk Operational Risk

1st line of defense

2nd line of defense

2nd line of defense

Corporate Audit Group

3rd line of defense

Risk Culture Every employee is responsible for risk management at RPPC. The three lines of defense model promote engagement and dialogue between the Business Operating Groups (first line) and the risk office (second line) within the protocols of the Corporate policies that support EPM. The key facilitator of this engagement process is the Risk Champion. The role of the Risk Champion is critical to ensuring that there is buy-in to the process among both business managers and risk officers alike, and ultimately the success enterprise risk management (ERM). This engagement is central to a value based ERM approach as it promotes understanding and alignment with our risk appetite leading to sound decision making. In support of an overarching goal of continual improvement, the company has two human resource corporate policies that improve risk management: (1) two-way rotation policy TWRP: 8

allow employees to rotate between risk roles and business management roles; (2) continued professional development policy CPDP: obligate employees to attend training on risk management principles and techniques at least once every two years. Risk Principles All material risks to which the enterprise is exposed are identified, measured, managed, monitored and reported. Risk awareness must be demonstrated to drive all decision-making within the enterprise. For any risk, a risk based approach is used to calculate its reported Economic capital. Economic Capital is used to measure and aggregate all risks. Risk Appetite The Risk appetite is at the centre of our value-based enterprise risk management approach. The clear communication of risk appetite at all levels within each line of business is critical to effective risk-taking in decision making. This is achieved with a business specific risk appetite statements that are aligned with the RPPC risk appetite statement approved by our Board of Directors. The following RPPC Risk Appetite Statement is a clear articulation of the value creation principles of RPPC. The Board of Directors of RPPC and its executive officers declare that the business operating groups with the support of risk officers will: 

Do not take risks that are opaque, not well understood or that cannot be well managed.



Identify and quantify low probability tail events.



Limit exposure to low probability tail event risks that could jeopardize RPPC’s credit rating, capital position or reputation.



Subject all new products or services to a rigorous review and approval process.



Ensure that the performance management system incorporates risk measures.



Protect and enhance the RPPC brand by exceeding expectation in the products and services that we deliver to our clients.



Promote focused differentiation on products and services that leverage RPPC’s core competencies to build client trust and to surpass expectations.



Maintain strong capital and liquidity and funding positions that exceed regulatory requirements.



Maintain compliance standards, controls and practices that prevent regulatory exposures that could adversely affect our reputation.

Incentive Compensation and Risk Appetite The business management of RPPC is governed by Key Performance Indicators (KPI) and Key Risk Indicators (KRI). All officers of the company will have their compensation dependent on the following: 9

 



For any risk, the return on its economic capital must exceed the cost of the capital acquired to fund that risk. The CEO of each business operating group must identify and report KPI that indicate that this requirement is being met. The payback period on capital invested in a business operating group must not exceed 10 years from the date that capital is first employed. Each operating group CEO must report KRI that indicate for the aggregate of all risk underwritten, that if the business group were to suffer a 1-in-100 year tail event that the capital thereafter would still be able to withstand another 1-in-100 year event. This is referred to redundant capital. This is critical to RPPC’s market discipline, because client relationship management and sustainability is promoted over price leadership. Through the identification of KPI and KRI, the business management indicates whether the risk being underwritten is within the group’s risk appetite. The KPI and KRI are recommended by the business CEO and are approved by a Risk Appetite Consensus Meeting that includes the business executives, CRO, the appropriate risk and business Subject Matter Experts (SME’s).

When reporting business plans and KPI, the financial projection must be based on a complete business cycle inclusive of severe market conditions rather than simply best estimate assumptions. When reporting KRI, scenario results and any stress testing must be demonstrated in the context of the business and directly related to its business driver. Such KRI value based results must be reported, well understood and action-ed at all levels of management within each business group and in all risk decision-making. Scenarios and stress tests are based on transparent deterministic scenarios recommended by the Business and approved by the Risk team. Only actual past events are deemed relevant in communicating the financial impact of a KRI. Severity is assessed when economic events or business impact are greater than three standard deviations from the average. Risk Review and Approval Policy This policy outlines the procedures for the development, review, and procedures for the approval of new products and services within the RPPC conglomerate. The policy is important because it balances the goal of delivering new products in a timely and efficient manner with the need to manage pricing and product development risk. Pricing and product development risk is the risk of financial and/or reputational loss as a result of the unexpected performance of a product or where the costs incurred are greater than those assumed in the pricing of the product. This policy requires the establishment of product pricing guidelines that describe profit targets for RPPC and performance metrics that must be calculated for all new products and services. This policy also requires the establishment of a product pricing committee that meets

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periodically to examine the profitability of current and future sales as compared to the product pricing guidelines.

The Role of Risk Champion The Risk Champion is a critical role which facilitates the Risk Review and Approval Process (RRAP). The Risk Champion is responsible for identifying the relevant business managers, risk managers and SME’s which are needed to complete the required risk assessment and risk analysis. In this way, the Risk Champion serves the role of arbitrator for finding the appropriate forum to resolve areas of dispute between the business and the risk review. The purpose of fostering dialogue and collaboration is to build and maintain the buy-in of all stakeholders throughout the RRAP. The Risk Champion is the key communication bridge between the first line and the second line of defense in the risk framework. This policy involves the following stages: Feasibility – For all new products and services, a report assessing the feasibility of the new product or service must be created. This report will provide high-level business rationale and risk assessment for the product or service, and must be presented to the product pricing committee before any further development is undertaken. In this phase, all key stakeholders must be identified and interviewed, and any key issues would be identified and further information may be required before proceeding with development. Product Assessment – All aspects of the product design must be assessed including the marketing analysis and supporting research, the distribution plan, pricing estimates, sales projections, risk adjusted return on capital, and tax implications. Risk Assessment – All aspects of the risks of the product or service must be assessed, including exposures and ratings as compared to the risk appetite statement. The assessment should also include a summary of the appropriate procedures and controls to be implemented, or already in place, that are required to manage the new product or service once it is launched. Sign-off and Approval – Sign-off and approval of the new product or service is required by the office of the CRO, the product pricing committee, and the operational head of the business unit. This approval is gained through initial feasibility study and the product and risk assessments and any resulting subsequent discussion and analysis. Documentation – An official record must be kept of the feasibility study, product and risk assessments, and the approval and sign-off forms. These could be reviewed the internal audit function, external auditors, or regulators as evidence of appropriate due diligence and compliance with internal procedures, as well as providing the rationale for the assessments and decision making.

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Risk Monitoring There are three disciplines to the risk monitoring approach:  Post implementation review  Risk based capital assessment  Stress testing Post implementation review is the core discipline within the engagement approach that embodies our three lines of defense model. Whenever a business operating group has launched an initiative, the group business managers are obligated to develop and report Key Performance Indicators (KPI) and Key Risk Indicators (KRI) that are specifically related to the initiative and that speak directly to the risk appetite of the enterprise. The assessment of risk based capital within an Economic Capital framework is one of the key metrics in the measurement and communication of any risk taken on. Economic capital is determined by the Risk Management Committee and is underpinned by the Redundant Capital philosophy. Capital is determined to withstand a 1-in-100 year event, after which the capital position is still sufficient to meet another 1-in-100 year event. Economic capital is also compared with regulatory capital to ensure compliance Allied with the Economic Capital framework, strong risk management and good business management relies on identifying “what-ifs”. Stress testing is the use of historical extreme economic events and/or periods of poor market conditions to quantify and to communicate the impact on the financial results of a given business operation. Scenarios based on historical events are easy to communicate and to get engagement when assessing value based impact. On an on-going basis, key risk factors are identified on a global basis by the Risk Management Committee. These key risk factors are developed from on-going global market research and outlook studies which identify global market trends and areas of emerging risks. Exhibit 1A provides an executive summary of the recent global market outlook completed by the Risk Management Committee.

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1A RPPC Dynasty Corporation Exhibits Exhibit 1 Global Market Outlook Key factors for the global market outlook are summarized as follows: 1. Change in demographics a. World population is growing by around 2.0 billion every 15 years. About 95% of this growth is accounted for by developing countries while 5% by developed countries. b. The world population is also aging, mainly due to greater life expectancy and to declining birth rates. Life expectancy doubled from 30 to 60 years in the 20th century. At the same time, the global average age has risen from 23 years to 30 years. c. Increasing global migration flows where people are migrating from south to north and between developed countries. Industrialized countries are reliant on immigrants to maintain their economy and competing with one another. 2. Increasing complexity and accelerating globalization a. Increasingly complex and international trade flows. The increase in global movements of goods has been 2.0 times and the increase in capital transactions is three times the increase of global GDP. b. Increasing value chains. Multinational companies are on the rise, from 7,000 in the 1990s and to some 65,000 parent companies today, with 85,000 foreign subsidiaries. c. Increasing the degree of complexity where the complexity is measured by number of parties involved and all of their connections, stability of connections, networking of systems etc. These measures increase significantly as globalization process fasten in the 1990s. d. Transport and travel are expanding. Increasing risk of pandemic risk. 3. Growing demand in micro-insurance a. About 3 billion of the world population are in the target group for microinsurance, mostly in the South Asia, east Asia and pacific regions. b. Premium volume is currently in range of USD $1 to $2 billion and the market is estimated to have potential up to $60 billion in premium.

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c. Micro-insurance is strongly supported by government of developing countries and emerging countries, aids agencies and NGOs as a means to tackle poverty. 4. Advancing climate change a. Rising number of weather-related natural catastrophes b. Changes in the availability of fresh water c. Higher losses from weather-related natural catastrophes d. Accelerated climate change could lead to a significant decline in the global GDP level.

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2

Blue Jay Air

Other services are customer-oriented. The airline industry is increasingly anti-consumer. It’s become a real hassle to travel. That is our opportunity - as long as we are given a chance to compete fairly. John Feather, CEO of Blue Jay Air, was sitting in his newly renovated executive office and pondering the future strategic direction of his company. Blue Jay Air was acquired by RPPC two years ago and had undergone a major corporate reorganization. With a newly appointed Board and a total replacement of the senior management the company had a completely new face. It was time to rebuild its image and re-position itself in the highly competitive local airline market and reconsider expanding into the international arena. Blue Jay Air had made substantial investments that included major infrastructure. Change couldn’t come fast enough for John. Every aspect of service and operations needed to get better. It was the only way. Changing infrastructure was hard up to a point. Changing attitudes and behavior and winning customers – that was hard. How fast and how hard should he push? Some wanted reams of data to move forward. Stay local? Go international? Which routes? Which planes? Remodel or new? Did they have enough capital? Access the capital markets? Sell Blue Jay Tire? He had a good team. He recalled one of Warren Buffett’s comments he applied to his management style, “Give a person or a nation a fine reputation to live up to and they will live up to it.” John was establishing Blue Jay Air’s reputation. He was confident his team would meet the challenge.

2.1

Background

Blue Jay Air was originally incorporated in the United States in the early 1970s. It was a small local commercial passenger carrier, operating only in the Eastern region of the United States. Its target market was high-end business clientele located in major cities along the east coast of the United States. Since then, Blue Jay had gone through three mergers and two significant acquisitions over the last 30 years. The company had been transformed from a focused highend regional company to an expanded price-competitive commercial carrier, covering the full geographical region of United States as well as major cities in Canada. During the past 30 years, the airline industry had gone through several significant cyclical business cycles, with each earning cycle trending lower than the preceding cycle, which resulted in significant pressure on the business margins and profits. In addition, with the deregulation in the airline industry during the Reagan administration, the number of commercial carriers had exploded exponentially, thereby had materially decreased consumer prices and also reduced the service level of the airline industry. Due to reduced margins, most companies had severely curbed its operating costs by reducing staff level or restraining salary increases. As a result, labour disputes and disruptions had become a major concern in the industry. The negative impact on the industry was compounded with an aging workforce and insufficient training for

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the new staff especially for the pilots. Frequency of accident occurrences had trended upwards due to lack of qualified manpower and insufficient compensation level. Despite all the perils in the industry, Blue Jay Air was resilient in surfing the destructive waves through different reorganization and restructuring efforts. The latest acquisition by RPPC was viewed positively by shareholders and investors. In 2010, the Wall Journal quoted that “the takeover is a step forward for Blue Jay Air.” John Feather, who has over 20 years of airline experience, is viewed as a “turnaround” CEO by the industry. Thus the parent company has high expectation in John’s new strategic vision.

2.2

Strategies

Blue Jay Air’s new strategic vision is to become the most customer-oriented airline company in the world, providing the best services to the marketplace. Comfort, punctuality and safety are the three important virtues that the company has adopted. Thus the number one priority for Blue Jay is to rebrand the company and image. In order to successfully rebrand the company, the company has done an extensive study on its customer base and identified its customers. John believes that understanding and knowing the customers is an important step to improve profitability for the company in the long run. Based on the customer base study, the company found that more than 55% of its customers are travelling for business reasons. This founding could stem from the fact that the company was originally a commercial passenger carrier catering to business travelers and so its relationship with the business community was deep-rooted. In fact, the expansion to leisure travel over the last 15 years did not increase the profit margin as the number of business travelers declined from over 80% to 55% due to reduced services. The rebranding and the change of business model may improve the company’s profitability over time. At the time of acquisition, the company reconsidered its market operations including the expansion to international operations due to increased demand for international travel caused by globalization of the business world. In order to make this strategy possible, the company has been negotiating with several international airport authorities in several European and Asian financial centres and major cities over the last two years to secure a boarding space. Some of these negotiations are close to fruition. Cost control is a key element in this industry. Labour relationship management is a key cost control element for Blue Jay Air as the labour force is not currently unionized. Blue Jay requires an effective management team to foster a cultural change without damaging the relationship with the employees and ensure that their needs are addressed to reduce the desire to unionize. In the past few decades, the company had implemented profit sharing schemes, regular salary scale and benefit reviews, frequent employee networking events, employee suggestion boxes and an employee diversity team to foster communication and pay equity between management and regular staff. These efforts have been working as unionization has not materialized. Thus the company would like to maintain its current employee relationship strategy. The only caveat is that in order to stay competitive, the company has to continue 16

taking further significant expense control measures particularly in these areas of staff count, staff expenses and information technology expenditures. As a result the company has started to cut back on most training programs except the current pilot and safety training programs in order to foster our vision of being the “safest” airline in the industry. The company also imposes tougher standards to qualify for the “top-scaled commercial pilot” category in order to ensure Blue Jay pilots are of highest quality.

2.3

Risk Management

Blue Jay Air, being a highly leveraged capital intensive company, ability to raise debt and servicing the debts are crucial to the survival of the company. Thus a key risk management objective is to maintain the credit rating of the company within the investment grade categories, i.e., BBB- or higher. As Blue Jay Air has significant pension liabilities for its existing labour force, ability to fund the pension liabilities has become a crucial issue for the company, especially in today’s low interest rate environment. Blue Jay Air has increased exposure to interest rate volatility due to the significant amount of long-term debt and finance leases that it has entered into since incorporation. Since being acquired by RPPC Dynasty, Blue Jay Air has established a risk management committee headed by a well-known risk manager, Jim Peters. Jim was formerly the Chief Risk Officer (CRO) of a major Canadian bank and he was recruited by John under the recommendation from Howard Creston, former CRO of RPPC Dynasty. Jim was a hedge fund manager before he became the CRO of the bank and thus he has extensive knowledge in implementing risk management strategies. Over the last two years, Jim has put together a dynamically hedged portfolio that handles the commodity exposures that the company has been facing as well as the interest rate risks. In addition, Jim has established a Treasury role under the risk management committee to centralize the long-term and short-term fund raising activities of the company and deal with the liquidity and credit risks of the company. This role is headed by Elaine Saunders who was a former Treasurer of a New York based investment bank. Elaine has a significant network with venture capitalists, pension fund managers as well as private equity fund managers. Elaine has also worked in the Investor Relations area of a major US Commercial Bank and thus has dealt with credit rating agencies such as Standard & Poor’s, Moody’s, A.M. Best and Fitch. Over the last two years, she has implemented a liquidity model and a credit model to monitor the company’s ongoing liquidity and credit needs. The Risk Management roles and functions are still in the progress of refinement and adjustments. The staffing requirement in these areas is highly specialized and will take time to establish a full staff complement. As a result, the staff workload is currently intensive and turnover rate is slightly higher than the other areas. 17

2.4

Operations

Planes It has been 10 years since Blue Jay Air purchased the current fleet of planes. The current fleet of planes is starting to age. Limited passenger capacity renders most of the fleet as unsuitable for international flights. In order to implement an international expansion strategy, the company will have to order or refurbish some larger planes with updated features such as Wi-Fi, expanded business classes, flat beds, bars, and stronger engines with additional safety features to be delivered over the next few years. These planes are catered for added comfort, safety and shorter flight time. They are the ideal planes for international travel. However, the costs of these new planes and refurbishments are significant and will require capital injection or debt guarantees from RPPC Dynasty as Blue Jay Air alone cannot bear these costs without jeopardizing the credit rating of the company. Even for the short haul planes, the current fleet requires updates such as Wi-Fi capability, individual TV screens and stronger engines to provide additional comfort for business travelers. This will also require additional funding and support from the parent company, RPPC Dynasty. Given the current business needs, the majority of aircrafts owned by Blue Jay Air are X730 manufactured by Xolar Aircraft. X730 is a twin-engine short- to medium-range wide body jet airliner which can typically seat 280 passengers in a two-class layout, with a maximum range of 8000 km when fully loaded. Other than Blue Jay Air, only 5 airlines possess this type of aircraft. Four of them use X730 as well for short to medium distance. The remaining ones use S999 manufactured by Skylite Aircraft for medium distance. S999 is a twin-engine medium-range wide body jet airliner which is comparable to X730. Xolar Aircraft has a very long history and is more famous than Skylite Aircraft. As of today, the stock price for Skylite Aircraft is substantially depressed due to its high book-to-market value. Blue Jay Air is considering acquiring one of the two aircraft manufacturers above in order to extend the presence into another stage of the industry chain. They will not have enough cash for either of the companies, therefore they need to bring in new investors or sell Blue Jay Tire in order to complete the acquisition. Rebecca Gibbs, VP of Operations, submitted the following information and considerations for both Aircraft manufacturers. Xolar Aircraft is a United states-based corporation with a very long history that designs, manufacture and sells fixed-wing aircraft. The company produces X730 which is among the most recognizable aircrafts for many years. X730 was involved in 27 accidents in 40 years of services, including a very famous incident named the 306 Air Disaster. Xolar has been profitable for over 10 years until last year where they lost a number of new orders to competitor Skylite Aircraft and thus resulted in an unprofitable position. Considering the result of past 10 years, Rebecca believes that last year was just a bad experience and Xolar will perform back to the normal level next year. In particular, Xolar aircraft is having a cost-cutting campaign and expects to see some positive trends in cost control. Rebecca believes that the campaign would be 18

effective. Therefore she included some cost reduction in her forecast, the result being that Xolar Aircraft would be profitable. Skylite Aircraft is an aircraft manufacturing subsidiary of a global aerospace and defense corporation. The company produces and markets S999 which has been a direct competitor of X730 in last 20 years. S999 was only involved in 11 accidents in this period. Rebecca is in favour of Skylite for safety reason since safety is very important to airlines. On the other hand, due to its substantial operations, Skylite has had significant cost overrun issues. Thus the company has not been profitable for a 5 year period. However, last year Skylite engineered a turnaround due to the new marketing strategic which led to a number of new orders during the year. Using the newest data collected over last year, Rebecca forecasted a profitable position for Skylite Aircraft in coming years. Loyalty Program As part of the change in marketing strategy, a business travel loyalty program is being considered to encourage frequent business travels. Blue Jay Air is considering progressive bonus point systems as flight frequency increases over a short period of time. In addition, Blue Jay Air would like to expand its reward systems by partnering with other business partners and its affiliated companies. This will substantially increase the incentive of business travels by business executives. For example, Blue Jay Air is partnering the loyalty card with its affiliated bank’s bank credit and debit cards to introduce a combined credit card with an “enhanced air points reward system.” This partnership should further increase the value of the loyalty program. A modification to the existing application form is required to accommodate the expansion of this new enhanced loyalty program. The current application is an online form which is an electronic version of a paper form. The paper form is currently five pages long with 30 different questions related to the customers’ personal information and preferences. The customer data is crucial for current and future marketing analysis. However, the current completion rate is much lower than the target rate due to the extensive information required to be filled out. Booking System enhancements With the technological advancements over the last few decades, Blue Jay Air is considering revamping its booking system to enhance its internet booking capability as well as introducing different mobile phone apps for the major mobile phone systems. The new system will automatically link up with the loyalty and credit cards for ease of use of loyalty points. It will include tracking of flight schedules, weather systems, time zones and other pertinent information. It will incorporate many added features that will make business travel enjoyable.

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Business Lounges Blue Jay Air will renovate all its business lounges in major cities to enhance its business travel strategy to stay competitive. New business lounges will offer free Wi-Fi, free internet access and amenities such as gourmet Frenz coffee and specialty teas, snacks, massage chairs with music selection and flat beds. The goal is to make business travelers as comfortable as possible while waiting for their flights. Baggage and Baggage Systems Blue Jay Air will incorporate a charge for each piece of luggage being checked-in since most business travelers do not check-in their luggage and in response to their competitors’ pricing. Free luggage check-in is no longer available except for international flights for which Blue Jay Air will reduce its free luggage check-in policy from two pieces to one piece with no change to the current weight limit. The current Baggage Tracking system seems to be adequate and Blue Jay Air has no plan to upgrade its systems. Other Cost Measures Blue Jay Air has decided to discontinue its travel agency programs with different travel agencies as part of the continuing effort to keep the company as cost efficient as possible. Instead the company will establish direct business relationships with its business client base. Blue Jay Air will negotiate direct contractual arrangements with its business clients in order to customize client needs and leverage long-term client business relationships. A referral program will also be offered to its business clients in order to expand its customer base in the most direct and efficient manner. This referral program will be combined with the loyalty program to optimize value for existing customers. Financial Statements Detailed financial statements are shown in the Section 2A Exhibits 1 to 3. Recent News on Competitors Recently, several airline companies have appeared on the headlines news in US and Canada as shown in Exhibit 4.

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2A Blue Jay Air Exhibits Exhibit 1 Blue Jay Air Corporation NON-CONSOLIDATED STATEMENTS OF OPERATIONS (US Dollars in millions) Fiscal Year Ended Operating revenues: Passenger Other Total revenues Operating expenses: Aircraft fuel Wages, salaries and benefits Capacity purchase agreements Airport and navigation fees Depreciation, amortization & impairment Aircraft maintenance Sales & Distribution costs Aircraft rent Food, beverages and supplies Communications and Information technology Other Total operating expenses Net Operating income

Dec 31, 2012

Dec 31, 2011

Dec 31, 2010

1,074 207 1,281

864 105 969

702 74 776

401 251 120 110 67 77 51 34 29 23 13 1,176

325 194 106 95 72 78 92 34 27 19 12 1,054

268 149 105 90 80 79 98 34 28 19 11 961

105

(85)

(185)

Non-operating income (expenses) Foreign exchange gain(loss) Interest income Interest expense Interest capitalized Net financing expense relating to employee benefits Loss on financial instruments recorded at fair value Other Total non-operating expense

11 5 (31) 2 (2)

(5) 5 (34) 1 (2)

(8) 4 (40) 0 (2)

(3) (1) (19)

(7) (2) (44)

(10) (2) (58)

Income (loss) before income taxes Income taxes

86 (30)

(129) 45

(243) 85

56

(84)

(158)

Net income (loss)

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EXHIBIT 2 Blue Jay Air Corporation NON-CONSOLIDATED STATEMENT OF FINANCIAL POSITION (US Dollars in millions) Fiscal Year Ended ASSETS Current: Cash and Cash equivalents Short-term investments Total cash & Short-term investments Restricted cash Accounts receivable Aircraft fuel inventory Spare parts and supplies inventory Prepaid expenses & other current assets Total current assets

Dec 31, 2012

Dec 31, 2011

Dec 31, 2010

136 83 219 15 127 48 33 70 293

140 75 215 7 68 29 20 50 174

88 111 199 6 95 15 8 17 141

474 21 31 1 1,039

509 21 31 2 952

558 31 31 5 965

70 181 61 312

107 124 59 290

95 160 51 306

Long-term debt and finance leases Pension & other benefit liabilities Maintenance provisions Other long-term liabilities Total liabilities

320 580 60 43 1,315

370 556 55 48 1,319

398 541 50 53 1,348

EQUITY Shareholders’ equity Share capital Contributed surplus Deficit Total shareholders’ equity

90 45 (411) (276)

90 10 (467) (367)

90 10 (383) (283)

Total liabilities & equity

1,039

952

965

Property and equipment Intangible assets Goodwill Deposit and other assets Total assets LIABILITIES Current: Account payable & accrued liabilities Advance ticket sales Current portion of long-term debt & finance leases Total current liabilities

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EXHIBIT 3 Blue Jay Air Corporation NON-CONSOLIDATED STATEMENT OF CASH FLOW (US Dollars in millions) Fiscal Year Ended Cash Flows from (used for) Operating: Net income (loss)

Dec 31, 2012

Dec 31, 2011

Dec 31, 2010

56

(84)

(158)

67 (6)

72 (6)

80 (2)

(32) (59) (37) 57 24 5 (20) 54

(26) 27 12 (36) 15 5 (33) (54)

11 10 5 (40) 13 (1) 38 (44)

125 (104)

45 (46)

30 (8)

(74) 35 (18)

(24) 0 (25)

(14) 0 8

Investing Short-term investments Additions to property, equipment & intangible assets Proceeds from sale of assets Foreign exchange gain(loss) Other Net cash flows used in investing activities

(8) (36) 4 (3) 2 (40)

36 (15) 2 1 2 26

(11) (4) 15 8 4 12

Decrease in cash & cash equivalents Cash & cash equivalents, beginning of year Cash & cash equivalents, end of year

(4) 147 151

(53) 94 147

(24) 70 94

Adjustments to reconcile to net cash from operations: Adjust for non-cash items: Depreciation, amortization & impairment Fuel & other derivatives Adjust for Changes in non-cash working capital items: Change in inventories Change in account receivable Change in Account Payable Change in advance ticket sales Change in pension & other benefit liabilities Change in maintenance provisions Other Net cash flow from operating activities Financing Proceeds from borrowings Reduction of long-term debt obligations Reduction of finance lease obligations & Distributions related to aircraft special purpose leasing entities Contributed Surplus Net cash flows used in financing activities

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EXHIBIT 4 Headline News Excerpts on Competitors 4.1 Southwest Airlines Key Revenue Measure Is Flat for Southwest Airlines DALLAS -- Southwest Airlines Co. said Friday that a key revenue measure was flat in March, another sign that airlines are struggling to sell more high-fare tickets. Southwest, which owns AirTran Airways, said that traffic on the two carriers rose 4 percent last month compared with a year earlier, as passengers flew 9.44 billion miles. Despite the increase in traffic, Southwest said that passenger revenue for each seat flying one mile was unchanged from March 2012. That statistic is a closely watched indicator of pricing power in the airline business. Airlines are leaving fewer empty seats on their planes _ occupancy is at levels not seen since 1945 _ but they appear to be selling fewer seats at the highest fares or discounting more tickets. Earlier this week, Delta Air Lines Inc. and US Airways Group Inc. reported weaker-than-expected figures for the same revenue-per-mile statistic and said that last-minute bookings were disappointing. That's important because passengers usually must pay more for last-minute tickets. Delta and US Airways blamed the weakness in late bookings on automatic federal spending cuts, which presumably would result in less travel by government employees. Dallas-based Southwest, the nation's fourth-largest airline, raised passenger-carrying capacity in March by 3.8 percent. Airlines can increase capacity by adding flights or making longer trips, which Southwest did. With traffic rising slightly faster than capacity, planes were a bit more full. Southwest said average occupancy was 82 percent, up from 81.8 percent in March 2012. In late morning trading, shares of Southwest fell 16 cents, or 1.3 percent, to $12.64 _ about double the rate of decline in the Standard & Poor's 500 index. 4.2 Virgin America Virgin America: More Elite Fliers Wanted In a bid to attract coveted elite frequent fliers from other airlines, Virgin America on Tuesday extended its status match program. Virgin America first introduced the program last November. Certain American and United road warriors holding elite status were matched to Virgin's Silver or Gold Elevate status. (Read more: Virgin America Woos Elite American, United Fliers) The program was scheduled to end April 30. But Virgin has extended it until June 30 and is inviting Southwest Airlines elites to participate.

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Travelers who fly at least 25,000 miles annually on American or United will be matched to Virgin America Elevate Silver status. Those who fly 75,000 miles or more on United—or 100,000 miles or more on American—will be given Elevate Gold status. (Read more: How Flying, Just For the Miles, Can Pay Off) For Southwest fliers, those who hold A-List or A-List Preferred status—25 or 50 qualifying oneway flights annually—will be matched to Elevate Silver status. Southwest Companion Pass holders—100 or more one-way flights annually—will be given Elevate Gold Status. The matched status upgrade will be valid until June 30. Travelers can extend their status through the end of 2013 by accumulating either 8,000 status points for Silver, or 12,000 status points for Gold by June 30, 2013. … 4.3 Air Canada Air Canada confirms novel financing for new planes By Ross Marowits, THE CANADIAN PRESS April 25, 2013 MONTREAL — Air Canada confirmed Wednesday that it plans to tap into a novel way — at least in Canada — of financing the purchase of five new Boeing 777 aircraft. The Montreal-based airline announced the private offering of three tranches of enhanced equipment trust certificates (EETC) worth US$714.5 million. The aircraft are scheduled for delivery between June 2013 and February 2014. Loxley Aviation Ltd. has been created to facilitate Air Canada’s inaugural offering, Moody’s Investors Service said in assigning ratings of Baa3 to tranche A, B1 to tranche B and B3 to tranche C. The aircraft, configured with 458 seats in economy, premium economy and premium classes, will be used as collateral. Air Canada (TSX:ACB) uses the largest planes in its fleet on long-haul routes. … Chris Murray of PI Financial Corp. had predicted the carrier would become the first Canadian airline to tap into a new way to finance aircraft purchases that reduces interest rates. Ottawa’s approval in December of an aircraft protocol opens the doors effective April 1 to the EETC trust market that has been used by U.S. carriers for nearly 20 years. Murray added in a report last week that Air Canada may also consider the same financing arrangement for its new Boeing 787 planes set to begin delivery next year. …

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Air Canada's poor punctuality could cost customers, expert warns Carrier ranked last of 28 major international airlines CBC News Posted: Apr 5, 2013 7:31 PM ET. Last Updated: Apr 5, 2013 7:29 PM ET Air Canada has the worst on-time arrival performance of any major international airline, a CBC Marketplace investigation has found. Numbers from travel information group FlightStats showed just 60.89 per cent of the Canadian carrier’s flights landed on time in 2012, the worst on-time performance record of 28 international airlines. Air Canada’s record worsens on the popular Vancouver-Toronto corridor where only 55 per cent of flights arrived on time in 2012. Air Canada competitor WestJet landed on time 70 per cent of the time on that same route. The airline’s performance is “not good,” says Anming Zhang, professor of air transportation at the University of British Columbia. He speculates that the airline’s poor punctuality will cost it customers. “If you can arrive on time, it is considered by passengers as a quality of service,” he said. “Unhappy customers are not willing to take your flight if there's a competitor flight [that’s on time].” Zhang says many factors can cause late flights, including poor weather and international connections. He points out that WestJet has the advantage of being a largely domestic airline, while Air Canada flies to Europe and Asia, long-haul flights that are more prone to delays. He also says Air Canada’s fleet could be a problem, since the variety of aircraft types can slow maintenance and repairs. “If the airline works with a single aircraft type, it's much easier, you know the aircraft inside and out,” he told Marketplace co-host Erica Johnson. “Once you mix with different aircraft types and parts, there will be more complicated operations.” WestJet uses just one aircraft type. “[Using one model] is much simpler,” he said. “If you have seven or eight aircraft types, versus just one aircraft type, the parts are uniform and mechanics know exactly what happened. It’s much faster.” Top-ranked Japan Airlines, which lands more than 90 per cent of flights on time, has 10 different aircraft types. Air Canada responded to Marketplace’s investigation with a written statement saying, in part, “Air Canada is now engaged in a company-wide, on-time-performance initiative that is resulting in continuous improvement in this area.” Starting April 10, Air Canada will require customers on most flights to check their bags 45 minutes before departure time, instead of the current 30 minutes. 26

Zhang says checking bags earlier is a positive step that should save time, but he also encourages Air Canada to be more transparent about its delays. “Customers pay for this service and they have the right the right to consume the product as the company has advertised,” he said. “They have a scheduled departure time [and] a scheduled arrival time, and they are entitled to see why there is a deviation from the product you provide and the product you declared in terms of quality aspects.” 4.4 Porter Airline Porter aims to become Canada's 3rd national airline CBC News Posted: Apr 10, 2013 10:25 AM ET. Last Updated: Apr 10, 2013 3:53 PM ET Porter Airlines confirmed today it plans to buy up to 30 CS100 jets from Montreal-based Bombardier, which would expand the regional carrier's reach from coast to coast, and take direct aim at Air Canada and WestJet. "We believe it is time to spread our wings," president and CEO Bob Deluce said at a news conference at Billy Bishop Toronto City Airport, where Porter is based. "And so I present to you our vision for the future of Porter Airlines — a vision with service to destinations across North America, from Calgary and Vancouver, to Los Angeles, Miami and Orlando." The move pushes Porter into direct competition with Air Canada and WestJet as a national carrier, while setting up a potential political standoff over expansion of the island airport in downtown Toronto. 'We believe the CS100 is the perfect aircraft for the next stage of our growth for many reasons, not the least of which is that it is the quietest commercial jet in production.'—Bob Deluce, Porter CEO The conditional deal is to buy 12 Bombardier CS100s, with options on 18 more. The deal also includes purchase rights for six of Bombardier's Q400 turboprop aircraft, currently the mainstay of the Porter fleet. The total purchase could reach $2.29 billion US if all the options and purchase rights are exercised. Delivery of the first jet, which has seating for 107 passengers, is expected in 2016. The conditional purchase agreement signed on Tuesday is a coup for Bombardier, and ushers in a change in Canadian aviation. That's because the CSeries jets can fly 5,400 km without refuelling, much farther than the current fleet of Q400 turboprop planes that Porter flies to connect 19 cities across Eastern Canada and the U.S. The airline said the expansion could mean 1,000 new employees, which would bring the total to 2,400.

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Potential price war Joseph D'Cruz, a University of Toronto business professor and aviation expert, said the move could be good news for consumers. The announcement could lead to a political dispute over the airport, which is near residents on the island and the city's heavily populated downtown. (Marivel Taruc/CBC) "It's going to be interesting to watch how WestJet and Air Canada react once Porter starts biting into their business," he told CBC News. "They're going to retaliate, and the only way they can retaliate is lower prices." "This may trigger a vicious price war," D'Cruz said. Air Canada said that before it takes a position on further investment at the island airport, it wants assurance that takeoff and landing slots will become available for other airlines that have been seeking increased access. Canada's largest airline currently has only enough landing and takeoff slots to offer service between Montreal and the airport on the Toronto waterfront. WestJet Airlines did not directly address Porter's plans, but said it remains focused on keeping its own business. "We expect competition to increase and are preparing accordingly," WestJet spokesman Robert Palmer said in a statement. … In a separate interview with The Canadian Press, Kokonis noted that Porter's planes have been flying less full while load factors at WestJet and Air Canada have been improving. "In a zero sum game where they're all sort of chasing the same passenger, it does give one pause for concern that Porter might be struggling in some areas." Despite the expansion, Deluce said taking the privately held airline public and raising money through an initial public offering is not a priority right now. The company had planned to issue shares on the public markets in the past, but shelved them for various reasons. "We've not thought about an IPO in most recent times," Deluce said. "Sometime in the future it's a possibility."

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3

Blue Jay Tire Co

“Who said any publicity is good publicity,” wondered Pierre Beaudry, CEO of Blue Jay Tire Co (BJT). He further reflected that it was paradoxical that leaders who live during severe crises get the most press and thus the highest rankings from historians and the popular public – ministers, presidents, mayors and civil leaders. Blue Jay Tire Co. was experiencing both publicity and a crisis. Pierre was confident his team would navigate the recall crisis successfully. It was not the first challenge they had faced nor would it be the last. Pierre knew the press would show no mercy. He knew the Board would demand change. What went wrong? They had risk governance policies, they had risk dashboards, they performed policy audits, they had training programs and they had a well-staffed risk management function. How would the crisis alter their plans and growth strategies? Before the crisis they had tough choices to make. Now the choices would be even tougher. How should he reshape their plans?

3.1

Background

Early History The Durable Tire Corporation (also referred to as Durable) has been operating in Canada since 1920. The company has a small and loyal customer base in rural areas. The high quality product proved to be very well suited to the rugged Canadian frontier. Durable built tires for farmingrelated vehicles and small planes intended to be used on dirt roads or off-road on farms and small community towns. The company founders, the Eastern family, were also farmers. Durable also manufactured specialty sold in niche markets. The Easterns always focused on providing the best quality tires that would live-up to the family name and brand. When the family patriarch passed away in 2000, the family decided to sell its interest in the company. The company was acquired by Blue Jays Air (BJA). BJA had been one of Durable’s clients for specialty tires in small aircrafts that flew in the Northern reaches of Canada.

Under BJA Since 2001 Under BJA management, Durable Tire was re-branded for broader appeal. The BJA group felt that it could leverage the capabilities of the manufacturing process to develop a broader range of tires. The tire company re-branded within the BJA group to become Blue Jay Tire (BJT). In 2001, the BJA team initiated a 5 year plan to expand sales and its distribution reach into commercial vehicles across the USA. The BJA management team increased its focus and oversight towards the BJT venture and its ever-improving financial results as Blue Jay’s struggles worsened due to increased competition and squeezed margins.

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In 2006, having successfully met and surpassed the 5 year plan objectives set out in 2001, the BJA board directed the Eagle Tire division to pursue an even more ambitious growth strategy . With funding, BJT purchased two manufacturing plants in the southern USA and re-fitted the operation with direction from their Canadian operations. An executive team under the banner of Blue Jay Tire USA (BJT-USA) was setup by the BJA board. This company operated with oversight from its Canadian head office. BJT-USA engineers were asked to set targets at double their pre-acquisition production levels or about triple the level of the Canadian manufacturing plant. BJT-USA surpassed it sale targets each and every year from 2006-2012. BJT-USA, despite its size, achieved a 3rd place market position in tire sales for compact cars and small SUV vehicles in the southern U.S.A. By 2010 BJT dominated the earnings of the Blue Jays Air group. BJT in early 2010 accounted for 20% of the revenue and an astounding 80% of the profit of the Airline group. BJT management was heralded by the executive team, the board and its shareholders as the “star” of the Airline group. Financials Detailed 5 year financial statements are shown in Appendix 3A Exhibits 1 to 3.

3.2

Risk Factors

The following risk factor excerpts are taken from the 2012 Annual Report. Commodity Risk Although there is a large amount of synthetic rubber used in the manufacturing process, the company still depends a great deal on natural rubber. Typically that is sourced in countries somewhat less stable than the developed world. Natural rubber production is subject to weather related risks. In the Tire Industry rubber represents 52% of total manufacturing purchases. A $0.10 per kilogram increase in natural rubber prices would lead to an estimated $10M increase in manufacturing costs. BJT has maintained the same supplier for over 30 years. The relationship is very strong and BJT benefits from stable pricing. In the past decade BJT has achieved the lowest prices on its commodity purchases because its growth strategy has also benefited the supplier. Volume discounts have been passed on to BJT in the form of better pricing. For BJT rubber now represents only 48% of company purchases down from 60% at the start of the millennium. Commodity risk is considered to be lower for BJT than its competitors. Manufacturing Risk The process of making tires involves chemicals and flammable ingredients. This poses concerns for the workers and the risk of fire is large. In addition, the size of the finished product increases the risk of worker disabilities.

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A lost-time injury is defined as an occurrence that resulted in a fatality, permanent disability or time lost from work of one day/shift or more. The Lost Time Injury Frequency Rate (LTIFR), the number of lost-time injuries per million hours worked, is calculated as:

Overall, the BJT manufacturing plants have reported a LTIFR of between 2.16 and 2.69 in recent years. This compares reasonably well to the industry average of 2.38. In particular, the LTIFR for the Canadian BJT plant has had best in class safety records at less than 2.0 since inter-company surveys began. In comparison, the U.S. plants have been between 2.56 to 2.99 since being acquired by BJT. The manufacturing process had been established by the company founders and has had proven success over many decades. The same process and standards are used in both Canadian and U.S. plants. The core competences for quality assurance are in the people who manage the process and the culture of quality management is passed on within the operations team from experienced staff to new associates. Quality management is considered by Executive Management to be a grass-roots competence of the company. Manufacturing risk is currently considered to be below or at industry standards. Management focus recently has been to return to the historical Canadian operational level of 1.92. A program recently implemented invites retired Canadian and former BJT plant operators to conduct quality management training for existing staff. Labor Risk Tire manufacturing plants typically have unionized labor forces. The company might face contentious labor issues in a number of manufacturing plants with unionized labor. Historically the Canadian operation has not had unionized labor. However 35% of the employees working in the two U.S. plants are Union members. The current Union contract expires in 2014. After normalizing for standard of living differentials between geographical locations, the labor cost in the Canadian operation is 20% lower than similar operations in the U.S. There has not been any disruption in the workforce at any plants. Labor risk is currently considered by Executive Management to be low. However, the number of staff that elect for Union representation has been increasing. Legal Risk The possibility of class-action lawsuits exists, particularly in the US. A large risk stems from the chances of paying out large claims and/or having wide-spread product recalls. BJT has not experienced any litigation action in its history.

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Distributor Risk BJT sells almost all its tires through independent distributors. BJT has long standing relationships with several Canadian car dealerships as their sole or primary tire supplier. Insurance Risk The key risks in a tire operation are product liability and product recall. Some companies use a captive insurance company to handle this exposure. Historically BJT has retained its risks. The board has requested a feasibility report to examine the solution to effectively mitigate this exposure. Environmental Risk Tires are an easy target for environmental groups. Billions of tires are produced each year and billions are discarded. The materials to produce tires and the manufacturing process can be the subject of environmental concerns. BJT maintains a recycling plant for the rubber in its discarded tires. This plant is only able to support operations in Canada due partly to subsidies available from the Canadian government. Efforts in the U.S. for a similar plant are not likely to be economical. Environmental risk is considered to be low due to operation size and overall market share. Economic Risk The number of miles driven has a large impact on the demand for tires. The state of the world economy has a direct impact on the company’s ability to grow and expand. BJT has chosen to target compact cars and small SUVs which experienced increased sales during the financial crisis (2008 – 2010). It is anticipated that the increased gasoline prices will continue the trend towards the small vehicles. This strategy has been proven to be effective as a counter-cyclical impact on sales. BJT experienced market share growth from 5% to 8% during the financial crisis. Economic risk for BJT is considered medium. Reputational Risk One of the company’s primary strengths is its brand name. BJT must constantly assure that its products are of the highest quality and invest in research & development to continually improve its products. BJT has growing brand awareness within the U.S. market. BJT uses social media monitoring tools to assess its brand awareness. Brand awareness is considered to be a critical determinant of BJT’s growing presence in its chosen target market. BJT monitors 5 media channels (e.g. newspapers, television stations and websites) for their positive/negative ratio. Media channel Blog Internet Forum Newspaper Online newspaper Associated Press (AP) Newswire All media combined

Positive/negative ratio 1.8 2.0 2.3 2.2 3.7 2.2 32

If the outlier of 3.7 corresponding to the AP Newswire is omitted, then the average positive/negative ratio is 2.1 with a standard deviation of 0.2. Pro-BJT information is generally about twice as persuasive as con-BJT messages. The ratio has grown from 1.8 to 2.2 since BJT began monitoring its brand. This is held to be a sign of BJT’s growing reputation in its chosen market. Reputational risk is considered to be low. Political Risk The company is exposed to political risk through import/export quotas and price controls. The North American Free Trade Agreement (NAFTA) between U.S.A., Canada and Mexico gave birth to the U.S. operations of BJT. BJT is exposed to future changes in this agreement. During the crisis, U.S. interest lobby groups demanded stronger nationalist policies. There continues to be strong political support for NAFTA, in the current US administration. However, when political leadership is to change in the U.S. and the poor economic growth to persist, NAFTA might be revisited. The supply chain is also exposed to political risk due to the geographical location of the suppliers which are primarily in Malaysia. Political risk is considered a medium risk for BJT as a small Canadian firm operating in the U.S. Currency Risk Manufacturing costs and the revenue generated are in different currencies resulting in a possible loss. BJT Canadian operations and sales are in Canadian dollars and the U.S operations and sales are in U.S. dollars. 85% of the raw materials are sourced from Malaysia.

3.3

Recall

Recent Tire Recall Issue Below are the headline news and a series of emails uncovered by the investigative journalist that led to the recent tire recall.

Blue Jay Tire quality or quantity, you decide by Jennifer Truth Smallville, Arizona (Associated Press – August 2nd 2013): The Blue Jay Tire Co (BJT) reported in May 2013 that a tire defect which caused a single car accident was an isolated incident. Bradley Johnson, CEO, issued a statement saying “Blue Jay Tire has a long history of manufacturing excellence but on behalf of our employees we extend our condolences to the Franklin family for their loss. We regret that a BJT tire was responsible for this accident. On behalf of our engineers, line managers and production team, I can assure the Franklin and any family in the 33

USA that we do everything in our power to ensure our tires are the highest quality on the road”. The tire involved on the day in May, was the RU42WD model. Over 40 million of these tires have been sold in the USA. The official report on the accident disclosed that the defective tires exploded causing a sudden loss of driver control. In July, this reporter uncovered a number of email record related to RU42WD tires in BJT’s manufacturing process. In an email dated Aug 8th 2009, the BJT (Canada) head engineer, Paul Gosling indicated reservation with the speed of the production line resulting in uneven rubber density to a BJT (USA) executive, Jack Tavares. The follow up responses indicate that some corrective action was taken to redress the situation. When contacted, the BJT (USA) head engineer, Chris Carpenter, at the time reported to this paper: “The production process always ran within its design limits. But we did notice tire density variations. We never did test the possible impact of low density tires on automobiles travelling at speed. Instead we relied on the fact that the tire thread wear tests were always within the tolerances commonly used by all tire companies at the time”. Chris Carpenter now works for a rival firm. BJT (USA) refused to comment when contacted about these internal memos and the comments of Mr. Carpenter.

Below are series of emails that were uncovered by AP journalists: From: Paul Gosling To: Jack Tavares Date: August 8, 2009 Subject: Sticky valves and rubber density on tires Jack – After visiting ET-USA plant, I did not feel that enough Quality Assurance is in place. In general, I think production is too fast to match demand and not enough checks are being made. Specifically, I have noticed two items: sticky valves on model RU42WR and uneven rubber density on RU42WD. I recommend the line managers to monitor these issues more closely and to tighten the allowed defects – even though this may slow production – so as to correct these issues. Although the valve is more of a nuisance, the density is more of a safety issue, but to be clear, the low density areas are still within prescribed density limits – there are just some noticeable variations within the tires. I will keep you posted. Paul Gosling 34

Head Engineer Blue Jay Tire (Canada) From: Jack Tavares To: Paul Gosling Date: August 12, 2009 Subject: RE: Sticky valves and rubber density on tires Paul Good catch – I will follow up with Chris regarding both RU42WR and RU42WD. Hope you enjoyed your visit Jack Tavares Chief Risk Officer Blue Jay Tire (USA)

From: Chris Carpenter To: Jack Tavares Date: September 9, 2009 Subject: Tire production Jack This is to summarize our calls over the past month. I think we have both issues solved: as I mentioned on the phone, the sticky values on RU42WR were easily fixed by increasing the lubricant on the silicon machine. RU42WD required more effort and took longer. We discovered a small inconsistency on the centrifuge console. My staff recalibrated it and we have eliminated the density issue. We also increased our spec inspections from 1 in 200 to 1 in 20 until we were confident the fix took. We are back up to regular production levels again. We are actually considering increasing the product speed. Thanks again, Chris Chris Carpenter Head Engineer Blue Jay Tire (USA)

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3A

Blue Jay Tire Exhibits EXHIBIT 1

Blue Jay Tire Corporation NON-CONSOLIDATED STATEMENTS OF OPERATIONS (US Dollars in millions) FISCAL YEAR ending 12/31/YYYY Total Gross Sales Cost of Sales (1) Cost of Raw Materials Production Costs (2) Depreciation & Amortization Shipping Costs Other Total Costs of Sales Net Revenue

2012 23,463

2011 21,928

2010 20,494

2009 19,153

2008 17,900

2007 8,967

(3,519) (6,570) (1,500) (3,754) (409) (15,753) 7,711

(3,289) (6,798) (1,500) (2,960) (514) (15,061) 6,867

(3,074) (6,558) (1,500) (2,254) (605) (13,991) 6,503

(2,873) (6,704) (1,500) (1,628) (683) (13,388) 5,765

(2,685) (6,086) (500) (1,074) (751) (11,096) 6,804

(1,345) (2,869) (500) (314) (377) (5,405) 3,562

Operating Expenses Research Development Selling General & Administrative (3) Non-Recurring (4) Foreign Exchange Gain(Loss) Other (5) Total Operating Expenses

939 4,981 323 11 60 6,314

1,096 4,609 398 (6) 49 6,147

1,230 4,265 295 (8) 50 5,832

1,341 3,947 23 15 100 5,425

1,432 3,652 27 20 27 5,158

807 1,811 173 14 10 2,815

Operating Income or Loss

1,397

720

671

340

1,646

746

Income from Continuing Operations Total Other Income/Expenses Net (6) Earnings Before Interest & Taxes Interest Expenses Income Before Taxes Income Taxes Net Income from Continuing Ops

3,659 5,056 1,801 3,254 651 2,604

1,982 2,702 1,765 938 188 750

2,501 3,172 1,457 1,715 343 1,372

1,940 2,280 1,165 1,115 223 892

1,439 3,085 880 2,205 441 1,765

1,673 2,419 350 2,069 414 1,655

Notes: (1) Includes cost of material & production with overhead (2) Includes salaries & overheads directly related to production (3) Includes salaries other than production related (4) Includes operational process upgrades (5) Predominantly injury claims (6) Performance of the tire warranty program and Sales from travel & restaurant guide books

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EXHIBIT 2 Blue Jay Tire Corporation NON-CONSOLIDATED STATEMENT OF FINANCIAL POSITION (US Dollars in millions) FISCAL YEAR ending 12/31/YYYY ASSETS Current Assets Cash and Cash Equivalents Short Term Investments Receivables Inventory Total Current Assets

2012

2011

2010

2009

2008

2007

5,413 2,457 2,095 607 10,572

1,294 8,154 995 598 11,041

1,185 8,023 913 532 10,654

1,087 6,205 851 576 8,719

996 193 754 582 2,525

489 5,113 322 2,815 6,296

Long Term Investments Property Plant and Equipment Accumulated Amortization Intangible Assets Other Assets TOTAL ASSETS

21,689 20,500 2,500 1,005 56,266

16,236 22,000 200 2,500 755 52,732

8,213 23,500 400 2,500 431 45,698

2,008 25,000 2,500 375 38,601

93 26,500 2,500 369 31,986

4,509 8,000 500 178 19,483

LIABILITIES and EQUITY Current Liabilities Accounts payable Short/Current Term Debt Other Current Liabilities Total Current Liabilities Long Term Debt Other Liabilities TOTAL LIABILITIES

109 5,550 40 5,699 28,476 450 34,625

41 6,400 23 6,464 26,890 340 33,694

42 5,000 22 5,064 22,142 200 27,406

35 5,000 29 5,064 16,298 316 21,678

23 4,500 30 4,553 11,097 300 15,950

15 17 32 5,000 178 5,210

Equity Retained Earnings Capital TOTAL EQUITY

16,641 5,000 21,641

14,038 5,000 19,038

13,292 5,000 18,292

11,923 5,000 16,923

11,036 5,000 16,036

9,273 5,000 14,273

TOTAL LIABILITIES and EQUITY

56,266

52,732

45,698

38,601

31,986

19,483

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EXHIBIT 3 Blue Jay Tire Corporation NON-CONSOLIDATED STATEMENT OF CASH FLOW (US Dollars in millions) FISCAL YEAR ending 12/31/YYYY Net Income

2012 2,603

2011 746

2010 1,369

2009 887

2008 1,763

2007 1,653

Operating Activities, Cash Flows Provided By or Used In Depreciation Amortization of deferred expenses Adjustments To Net Income: Changes In Accounts Receivables Changes In Liabilities/Account Payables Changes In Inventories Changes In Other Operating Activities Total Cash Flow From Operating Activities

1,500 200

1,500 200

1,500 200

1,500 0

500 0

500 0

(1,100) 68 (9) 0 3,262

(82) (1) (66) 0 2,297

(62) 7 44 (600) 2,458

(97) 12 6 0 2,308

(432) 8 (210) 0 1,629

(72) 10 (66) 0 2,025

Investing Activities, Cash Flows Provided By or Used In Capital Expenditures Investments Foreign exchange gain(loss) Other Cash flows from Investing Activities Total Cash Flow From Investing Activities

0 5,697 0 (5,703) (6)

0 (131) 0 (8,347) (8,478)

0 (1,818) 0 (6,261) (8,079)

0 (6,012) 0 (1,921) (7,933)

(21,000) 4,920 0 4,225 (11,855)

0 (2,113) 0 (687) (2,800)

Financing Activities, Cash Flows Provided By or Used In Dividends Paid Sale Purchase of Stock Net Borrowings Other Cash Flows from Financing Activities Total Cash Flow From Financing Activities

0 0 736 127 863

0 0 6,148 141 6,289

0 0 5,844 (123) 5,721

0 0 5,701 15 5,716

0 0 10,597 135 10,732

0 0 719 45 764

1,294 5,413 4,118

1,186 1,294 108

1,087 1,186 99

996 1,087 91

489 996 507

500 489 (11)

Cash & cash equivalents, beginning of year Cash & cash equivalents, end of year Change In Cash and Cash Equivalents

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4

Frenz Corporation

David Gillet, CEO, was looking forward to the screen adaptation of the musical Les Misérables to hit movie theaters in a few weeks. He associated the musical and its worldwide success with the success of Frenz and his own career. He had first seen the musical a few months after it opened on the West End in 1985 shortly after joining Frenz. David recalled, “In our early days what we we're doing was new - specialty coffee for the worker on the move. We’ve always been in front of the curve – we were early pioneers of store Wi-Fi. Our customers were on the move via the internet. With each passing year competition gets fiercer. Each success is copied. We are expanding globally and expanding product lines but our competition is moving into our markets.” David wanted to accelerate Frenz’s expansion. His perspective on future growth was global. How well did Frenz’s advantages travel globally? What was the best way to grow especially in the emerging markets? Frenz had an opportunity to secure its supply of coffee beans to fuel its growth. He wanted to increase the rate of new store openings and entered new countries. He was concerned about which geographic regions, whether stores should be franchisee developed or company owned. He wanted to expand product offerings. Frenz had a number of products in trial markets and cities. Which products should be expanded within a country, a region or globally? How many variations? Should they be the same globally or customized for local tastes? He wanted to increase brand recognition and increase customer traffic especially in recently entered countries. What was the most effective means of marketing and how should marketing costs be allocated? How should Frenz leverage its relationship with other sister companies in promoting its brand through other channels? Existing stores generated cash. Opening new stores was capital intensive. How would Frenz fund growth? What were the risks associated with franchising? How do Frenz manage the licensees? Could Frenz continue to be choosey about site selection and new managers? Would corporate support and quality or service suffer with rapid expansion and new locales? New products had lower profit margins. Should they have promotional sales discounts upon introduction? Would new products sabotage sales of higher margin products? High unemployment and high gas prices had hindered sales and growth. Was this the new norm? The competitors were offering products at lower price points. How should Frenz respond? The parent company, RPPC Dynasty wanted a global risk management framework for all its subsidiaries. How did Frenz fit in this framework? Was the current global funding allocation from RPPC Dynasty adequate for the future growth of Frenz? Should Frenz continue to rely on debt to fund its growth or request more equity investment from RPPC? Would capital be an issue with Frenz’s expansion plan?

4.1

Background

Frenz Corporation (also referred to as Frenz) is a wholly owned subsidiary of RPPC Dynasty. It is a global premier roaster, marketer and retailer of specialty coffee in the European and 39

American countries, incorporating in Belgium. It has operations in most major cities of Europe and America, including all developed countries and some developing countries. Other than company-operated stores, Frenz also sells a variety of coffee and tea products and licenses its trademarks through many other channels such as franchises, groceries, private clubs, hotels, cruise ships and national foodservice accounts. Frenz is one of the most recognized and respected brand in the “premier” coffee houses as well as household brand in the developed world. Its main competitors in the coffee houses market include Starbucks, McDonald’s, Douwe Egberts, Delta Cafés, Genovese Coffee and Markus Coffee. Its household brand’s main competitors include Nescafè, Folgers, Maxwell House, Jacobs, Douwe Egberts and Starbucks. Two aspects of its main objective is to maintain its competitive standing and to continue its disciplined expansion of the store base, primarily focused on growth in developing countries. Mission Statement Frenz’s mission statement is: One person, one cup, one community, one world. We care about our family. This mission statement focuses on our objective of being the most recognizable coffee brand in the world. Board of Directors Frenz’s Board consists of 8 members. Three board members are Chief Executive Officers or Board Chairmen in leading public companies in Belgium, two are Board members of our holding company and the remaining Board members are executive officers of Frenz. In recent years RPPC Dynasty Corporation, the holding company of Frenz, has adopted a global company risk management mandate in order to ensure consistent and unified risk management policies, strategies and processes among the conglomerate groups of companies. In conjunction with the new mandate Dynasty recently hired a Global Chief Risk Officer to oversee implementation. In response to the new risk management strategy Frenz’s Board hired an experienced Chief Risk Officer, Robert Kaplan, to develop the risk management strategies for Frenz and to ensure that these strategies fit in Dynasty’s global risk management mandate. Robert Kaplan’s responsibilities include proper integration of risk management strategies and policies with the global strategies and policies, smooth and controlled implementation of these strategies and cultivation of an acceptable risk management culture for Frenz facilitating its ultimate goal of becoming the top coffee company in the world. With this new mandate the Board members have some disagreements as to which Board Committee should be given the responsibility of overseeing the work of Robert Kaplan. Some Board members believe that the Audit Committee’s role should be expanded to oversee this new risk management mandate. Some Board Committee members believe that this new mandate involves significant strategic changes and should be the Executive Committee’s role. Some believe that it should be the role of Related Party and Conduct Review Committee Role’s 40

as the strategies will involve significant related party transactions. The Board of Directors has requested Robert Kaplan consult with the Global Chief Risk Officer and provide a recommendation. Market Strategies Frenz is dominant in the high-end specialty coffee market especially through its premier coffee house outlets which have over a 40% market share in Europe. However, its market shares in North America, Latin America, developing countries and household coffee constitute only about 18%, 11%, 5% and 16% respectively. There is significant growth potential in these countries where the customer base is still expanding and represents a chance to increase market share without the pressure to take customers from competitors. Frenz’s current market strategies are as follows:  Continue its dominant market position in the coffee houses by organic expansion of its company-operated coffee houses in the developed countries through building more of these company-operated coffee houses in financial districts and high socio-economic areas;  Further nurture relationships with and loyalty from other distributors such as high-end hotels, private clubs, universities, cruise-liners and upscale grocery and retail outlets such as bookstores and department stores;  Expand into more developing countries through acquisition of local coffee house chains, franchising and organic growth into more cities and financial districts of the developing countries especially the fast growing Asian market;  Target local advertising in certain countries to expand its household brand recognition as well as more endorsements with certain significant events such as the World Cup, the Olympics, the World Exhibition and events of regional significance.  Maintain a significant budget devoted to Frenz’s renowned marketing capability which due to investments over many years has achieved significant economies of scale;  Further enhance the company’s ability to quickly develop and roll out new and innovative products which helps defend against potential coffee substitutes as well as serving to further differentiate Frenz from its competitors. Frenz is also exploring vertical integration by owning and controlling its sources of key ingredients such as coffee beans plantations and tea plantations in order to enhance its quality control as well as developing its own niche products. Risk Profiles Frenz faces significant supply-chain risks such as commodity price risks and shipping costs and demand risks such as significant competitive pressures and change in consumer markets. It also faces operation risks, litigation and reputational risks and other market risks which include foreign currency exchange risk, equity security prices, and interest rates. It also faces staff turnover, litigation and reputational risks. Each of these risks is described in detail in Appendix 4A.

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Financial Statements Detailed financial statements are shown in Exhibits 1 and 2.

4.2

Growth

Growth is never easy as the following examples of external and internal growth pains illustrate. External Challenges During the financial crisis in 2008 Frenz suffered significant losses due to reduced market demand as well as significant investment losses. Some Board members were unhappy with the geographical market concentration which caused Frenz’s losses. The Marketing Vice President, Anthony Pirot, is being empowered to implement the recent market strategic goals set by the Board. Anthony Pirot’s first priority is to expand into the fast growing Asian market. Anthony Pirot currently leads a team of twenty experienced and mature marketing staff whose experience is predominantly targeting the higher socio-economic clientele in the developed countries in Europe and United States. This expansion strategy will require significant capital. The new Chief Risk Officer, Robert Kaplan, is uneasy with the expansion strategy as cash flow in Frenz will greatly be strained without additional debt financing which in turn increases the Company’s leverage ratio above the conglomerate mandated threshold. In addition Anthony is expanding its product lines such as the super-premium coffee market and bubble teas and specialty fruit and mixed coffee and tea drinks that have given Frenz a reputation as a product innovator in the market. To this end Frenz is exploring offering coffee made from exotic coffee beans and special tea leaves. There are very few areas that can produce such high–quality premium coffee beans. The best coffee beans are from Costa Rica the Finca Palmilera but they are very expensive. However, through market research Frenz has determined that its customers often cannot distinguish between the premier super-premium coffee bean, Costa Rica Finca Palmilera, and its cousin the Vietombia Finca Palmilera, whose popularity is not as great, but whose flavor is considered comparable to Costa Rica Finca Palmilera. The Asian country of Vietombia is the largest producer of Vietombia Finca Palmilera. Although Vietombia is a major producer of coffee, its domestic consumption is very small. Vietombia has a growing, export-driven economy. The historical statistics on Vietombia is summarized in Appendix 4A. Despite Vietombia’s increased participation in international trade, 10 years ago Vietombia put in place a policy to peg its currency to that of its neighboring countries. The effect of this has been to effectively deflate the value of Vietombia’s currency, the Rubiaceae, and as a consequence bolster Vietombia’s export-driven economy. Independent economic analysis has suggested the deflation of Vietombia’s currency has been instrumental to the growth of the 42

Vietombia economy. However, the banking system in Vietombia has been slow in modernizing, and all domestic banks primarily engage in domestic thrift activity, and as a consequence their risk management and hedging programs are in their early stages. Further, the central banking system performs largely a symbolic role. As a result of Vietombia government’s eagerness to stabilize its economy, the government is willing to give an exclusive dealership of the premium coffee beans produced there to Frenz provided Frenz sets up exclusive production facility for these super-premium coffee beans in Vietombia. This presents a significant opportunity for Frenz to gain favorable access to its key ingredient not easily duplicated by competitors, to reduce its reliance on other coffee suppliers, and to control costs as well as influence and control the quality of future coffee bean production. However, this vertical integration strategy presents significant upfront cost requirements which may substantially increase the company’s leverage ratio and lower the overall credit rating for Frenz.

Overhead Allocation Jeff Bemowski, Frenz Division head of Non-Coffee Product Marketing slunk down in the guest chair in the office of Kitty Dunn, Frenz’s Chief Accounting Officer. “You are killing me with your overhead,” Bemowski begins. “I’m not sure what you mean,” replies Dunn. “Our policy for allocating corporate overhead is pretty straight forward and hasn’t changed in several years. Overhead costs such as corporate advertising, executive salaries, the rent on this home office building, and so on are accumulated. Then that bucket of corporate overhead is spread over all sales on a uniform basis.” “That’s exactly the problem!” retorts Bemowski. “I think we need to change and we need to change it now before.....” “Wait a minute,” says Dunn. “We have worked very hard to keep our overall corporate overhead under control. In fact, corporate overhead has increased at only a 5% rate per year over the last five years. That’s at a time when the company has grown by over 250% in those same five years. Every summer, we review the overhead allocation ratio and, well, with all our growth, it has gone down every year.” “I know that,” responds Bemowski. “What I’m talking about is HOW corporate overhead is allocated. Look, a big part of my bonus is dependent on the profitability of Frenz’ non-coffee products. You know, the music CDs, greeting cards, coffee cups, etc. that we sell. I’ve been pushing our store managers to move these products but your allocation method for corporate overhead disguises the true profitability of my part of the operation.” 43

“Well it is a zero sum game. The overhead is the overhead and it all has to be allocated somewhere, “ replied Dunn. “Yeah but a CD costs more than a cup of coffee,” argued Bemowski. “When Frenz does something like run a commercial, we are advertising the whole brand. We want to get customers to come into our stores to have the whole Frenz experience. We get them to come in to our store regularly for coffee. Eventually, they may buy our other products in addition to their coffee. Why should the one CD be saddled with more overhead than all those cups of coffee? It just feels wrong to me!” “Again,” began Dunn, “each product gets an allocation of corporate overhead based on its standard price. That keeps it the same from market to market, where prices might be different and it negates the impact of sales and discounts on items. That seems like a fair system to me but if you don’t want to do it that way, what would you suggest?” “Well I believe our model is that each store is a profit center,” says Bemowski. We tell our store managers that corporate supports them but once they are part of the Frenz family, they can make their shop as profitable as they want it to be. The upside is unlimited, their hard work will pay off.” “Wait,” interjects Dunn. “There are rules for how the stores must be set up and how the product is displayed. Not to mention quality…” “I know all that,” Bemowski cut in. “But we are allocating overhead in a way that punishes our most successful store managers. Take that corporate overhead and allocate it as $X per store. Corporate supports the store; the store manager is the one who determines how much business the store does.” Better yet, allocate Corporate overhead to each store based on smoothed, budget amounts. That way each store manager knows just how much Corporate overhead he has to cover in his store at the start of the year.” “I suppose we could look at it,” concedes Dunn. “We have most of the data and we could collect some…….” “You financial-types always want more data. You are afraid to make a decision! It is obvious, change and you are going to get a better look at what stores are on top and which are on the bottom,” sputtered Bemowski. “And you will see how important my non-coffee products are to making those top stores, top stores. I can feel it in my bones; you need to get on board or get out of the way.” “We are most certainly not going to change anything without studying it first,” responded Dunn calmly, “and there are channels to go through making any expense allocation change. We need to weigh the pros and cons.”

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“You can’t save your way to greatness,” said Bemowski getting up and heading toward the door. “Call me when this company is serious about making real money.” And with that, Bemowski was gone. Dunn rubbed her temples. “Marketing,” she murmured under her breath.

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4A Frenz Corporation Exhibits EXHIBIT 1 Board of Directors Felix Hermans is the Chief Executive Officer of Genie Bank of Belgium. He holds a Master of Science in Business Econometrics/Operations Research degree from Tilburg University and has completed professional programs at the Netherlands Institute for Banking, Amsterdam Institute of Finance, Oxford University and INSEAD. He is currently the Chairman of the Frenz’s Board and has been a director since 2005. Fred Coppens is the Chief Executive Officer of Vedegu Chocolate, which is a chocolate manufacturer in Belgium. He holds a Master of Science degree in automation engineering and has been a director since 2009. Abram Lemaire is a Vice Chairman, Chief Executive Officer, Managing Director and a Member of Management Board at VESET Group SA, an affiliate of Ora Construction Industries Company. He has been a director since 2000. Gilroy Clyde is the Chief Executive Officer of RPPC, the holding Company of Frenz. He has been director since 2000. Olivier Collignon is the Deputy Chairman of the Board of RPPC. He has been director since 2000. Julien Jacobs joined Frenz in April 2000 and has served as Chief Executive Officer since October 2005. He was the CEO of Frenz US, which a subsidiary of Frenz from April 2003 to October 2005. He has been director since 2003. David Gillet is the Chief Executive Officer of Frenz US since 2005 and has served as president, Frenz China and Asia Pacific, which a subsidiary of Frenz since November 2003. He has been director since 2005. Vincent Jansen is the Chief Financial Officer of Frenz Corporation and has been a director since 2005. There are no family relationships among any directors or executive officers. The mandate of the Board was established at the time of incorporation to supervise management of the business and affairs of the Corporation on a broad scale rather than daily management. Its responsibility includes approving strategic goals and objectives, review of operations, disclosure and communication policies, oversight of financial reporting and other internal controls, corporate governance, Director orientation and education, senior management compensation and oversight, and Director nomination, compensation and assessment. 46

In order to ensure that the responsibility is carried out on a cohesive manner, the Board has established the sub-committees to aid in carrying out its responsibilities. Executive Committee The Executive Committee has and may exercise all or any of the powers vested in and exercisable by the Board, including approval of the annual strategic plan. Currently the Executive Board comprises of 5 board members with the Chairman of the Board, Felix Hermans also acts as Chairman of this Committee and the following Board members: • Fred Coppens • Olivier Collignon • Abram Lemaire • Julien Jacobs Audit Committee The primary mandate of the Audit Committee is to review the financial statements of the Corporation and public disclosure documents containing financial information and to report on such review to the Board, to be satisfied that adequate procedures are in place for the review of the Corporation’s public disclosure documents that contain financial information, to oversee the work and review the independence of the external auditors, and to review any evaluation of the Corporation’s internal control over financial reporting. The Audit Committee comprises of 4 Board members with Vincent Jansen, the CFO of Frenz acting as the Chair of this Committee and the following Board members: • Gilroy Clyde • Abram Lemaire • David Gillet Compensation Committee The primary mandate of the Compensation Committee is to approve compensation policies and guidelines for employees of the Corporation, to approve compensation arrangements for executives of the Corporation, to recommend to the Board compensation arrangements for the Directors and to oversee the management of incentive compensation plans, and to review succession plans for senior management. The current Chair of this Committee is Gilroy Clyde with the following 3 Board members: • Felix Hermans • Abram Lemaire • Olivier Collignon Related Party and Conduct Review Committee The primary mandate of the Related Party and Conduct Review Committee is to recommend to the Board procedures for the consideration and approval of transactions with related parties of the Corporation and to review and, if deemed appropriate, to approve such transactions. Fred Coppens is the Chair of this Committee with the following 3 Board members: • Olivier Collignon 47

• David Gillet • Vincent Jansen Governance and Nominating Committee The primary mandate of the Governance and Nominating Committee is to oversee the Corporation’s approach to governance issues, to recommend to the Board corporate governance practices consistent with the Corporation’s commitment to high standards of corporate governance, to assess the effectiveness of the Board of Directors, of Committees of the Board and of the Directors, and to recommend to the Board candidates for election as Directors and for appointment to Board Committees. This Committee is also responsible in recommending the Board on the “Code of Business Conduct and Ethics” policies to ensure and maintain a culture of integrity throughout the Corporation. This Code is applicable to Directors, officers and employees of the Corporation. Julien Jacobs, the current CEO of Frenz is the Chair of this Committee and the Committee is comprised of the following Board members. • Olivier Collignon • Gilroy Clyde • David Gillet

48

EXHIBIT 2 Risk Profiles Supply-Chain Risks Commodity price risk is the primary supply-chain risk for Frenz. Price volatility of key ingredients such as green coffee, tea leaves and dairy products, etc. presents a substantial exposure to the stability of the product prices as well as profit margins. This is mitigated somewhat by the ability to keep coffee and tea for long periods of time, thus reducing storage costs. In addition, oil prices also have a direct impact on shipping costs. Frenz incurs substantial shipping costs in transporting the key ingredients to its worldwide retail outlets. Therefore, oil price increases over recent years has eroded Frenz profit margin. Supply and price can be affected by multiple factors in the producing countries, including weather, political and economic conditions. Price for coffee is also impacted by trading activities in the Arabica coffee futures market, including hedge funds and commodity index funds. Furthermore, green coffee prices may be affected by actions of certain organizations and associations that have historically attempted to influence prices of green coffee through agreements establishing export quotas, increased tariffs, embargoes, customs restrictions or by restricting coffee supplies. Similar influence also exists for prices of tea leaves. Relationships with the producers (coffee, tea & diary), outside trading companies, suppliers and exporters are also pertinent in assessing the risk of non-delivery on purchase commitments and quality of ingredients delivered. Demand Risks Competition can be fierce as the capital required to enter the industry is low. The company is facing competition not only from the specialty beverage shops such as Starbucks, Timothy’s, Second Cup etc., but also from quick-service restaurants such as McDonald’s, donut shops such as Tim Hortons, dessert shops, high-end restaurants and other specialty retailers, etc. Thus the need for the company to keep expanding and differentiating its product lines and venture into unfamiliar territories is being inevitable. Customer loyalty is pertinent in this trade. As a result, the company will continue to expand its popular loyalty card program, which has been effective in preventing other companies from stealing away Frenz’s customers, to include products from other sister companies in the conglomerate group. Adverse economic conditions may cause declines in general consumer demands for these highend products, driving the increase in costs and pressure for reduced quality of products, which in turn, may increase impacts from negative publicity. 49

Adverse impacts resulting negative publicity regarding business practices or health effects of consuming products, etc., may lead to reduction in demand and profitability and increase in litigation. Operational Risks As company is facing expansion, risks are associated with each expansion plan that the company is exploring and implementation of these plans can be very challenging and risky as these plans are disruptions to the ongoing business. Delays in store openings for reasons beyond control, exposure to increased construction costs associated with new store openings and lack of desirable real estate locations availability would also negativity impact the net revenues and profit margins. Degree to which the company enter into, maintain, develop, and are able to negotiate appropriate terms and conditions and enforce, commercial and other agreements could have significant impact on company financing and operation. Loss of key personnel or difficulties in recruiting and retaining qualified personnel and labour discord, political instability and natural disasters could cause significant business interruption which, in turn, adversely impacts the business and financial results. Adverse public or medical opinions about health effects, food tampering, food contamination, regional or global health pandemic could severely and adversely impact the company’s business. As the company relies heavily on information technology, any material failure, inadequacy, interruption or security failure of the technology could harm the ability to effectively operate the business. Litigation and Reputation Risks Success depends substantially on the value of the brands especially in the specialty business. Thus the company has to maintain quality of product and be able to consistently deliver positive consumer experience and engage in corporate social responsibility programs to enhance the company reputation. Brand value is based on in part consumer perceptions on a variety of subjective qualities. Thus even isolated business incidents that erode consumer trust, such as contaminated food or privacy breaches particularly if the incidents receive considerable publicity or result in litigation can significantly reduce brand value. Reputation may be harmed by actions taken by third parties that are outside of the company’s control. Third parties may include business partners, licensee and partnership relationships, suppliers, vendors and any business associates that the company has engaged in past or current dealings.

50

Proper handling of customers’ complaints is very important in protecting the company’s reputation and preventing potential litigation. Foreign Currency Risk Frenz has operations in many different countries. Frenz has currency exchange risk due to having the currencies of generated revenues being different from the currencies of expenses. Currency volatility has caused significant costs in operation due to timing differences. Real Estate Risk Frenz has significant exposure in real estate markets due to investments in commercial properties and operation plants. Interest Rate Risk Frenz has debt issuances and fluctuation in interest rates could result in significant impacts on refinancing costs. Capital Risk In order to maintain the company’s growth rate, Frenz is facing increasing capital risks.

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EXHIBIT 3 Financial Statements and Supplementary Data Frenz Corporation Ltd. CONSOLIDATED STATEMENTS OF EARNINGS (In millions, except per share data) Fiscal Year Ended Net revenues: Company-operated stores Licensed stores CPG, foodservice and other Total net revenues

Dec 31, 2012

Dec 31, 2011

Dec 31, 2010

Dec 31, 2009

Dec 31, 2008

$ 960 100 106 1,166

$ 890 85 88 1,063

$ 650 50 60 760

$ 400 45 100 545

$1,360 200 100 1,660

495 366 40 52 65 0 1,018

445 355 29 51 56 53 989

375 320 25 50 30 100 900

255 300 20 50 28 200 853

760 400 100 50 80 0 1,390

Gain on sale of properties Income from equity investments Operating income

30 18 196

0 15 89

0 10 (130)

0 (175) (483)

0 125 395

Interest income and other, net Interest expense Earnings before income taxes

11 (3) 204

5 (3) 91

5 (3) (128)

4 (3) (482)

10 (4) 401

(63) $141

(28) $63

14 $(114)

144 $(338)

(121) $280

$0.28 $0.005 $2.52

$0.13 -

$(0.07) -

$(0.68) -

$0.56 $0.01 $5.00

Cost of sales including occupancy costs Store operating expenses Other operating expenses Depreciation/ amortization expenses General & administrative expenses Restructuring charges Total operating expenses

Income taxes Net earnings (loss) Earnings per share—basic Cash dividends declared per share Cash Dividends Paid

52

EXHIBIT 4 Frenz Corporation Ltd. CONSOLIDATED BALANCE SHEETS (In millions, except per share data) Fiscal Year Ended Dec 31, YYYY ASSETS Current assets: Cash and cash equivalents Short-term investments —available-for-sale securities Short-term investments —trading securities Accounts receivable, net Inventories Prepaid expenses & current assets Deferred income taxes, net Total current assets

2012

2011

2010

2009

2008

$138 85 5 60 96 16 23 423

$116 24 5 30 54 16 30 275

$90 15 2 35 70 20 35 267

$20 5 2 30 160 15 40 272

$200 100 15 40 95 30 50 530

Long-term investments —available-for-sale securities Equity and cost investments Property, plant and equipment, net Goodwill Other intangible assets Other assets Total Assets

10 37 235 25 5 44 $779

19 34 245 25 5 23 $626

10 15 205 25 5 5 $532

5 8 200 25 5 25 $540

30 50 300 35 15 30 $990

LIABILITIES AND EQUITY Current liabilities: Accounts payable Accrued compensation & related cost Accrued occupancy costs Accrued taxes Insurance reserves Other accrued liabilities Deferred revenue Total current liabilities Long-term debt Other long-term liabilities Total liabilities

$24 36 15 10 15 32 43 175 120 52 $347

$28 40 17 10 15 26 41 177 110 45 $332

$35 35 20 5 15 22 40 172 95 38 $305

$40 10 15 2 15 15 25 122 55 22 $199

$50 50 20 10 15 25 60 230 55 92 $377

Shareholders’ equity: Common stock ($0.001 par value) —authorized, 500 shares; issued & o/s Additional paid-in capital Other additional paid-in-capital Retained earnings Accum. other comprehensive income Total shareholders’ equity

$0.5 44.8 34 347 5 $432

$0.5 44.8 34 209 6 $294

$0.5 44.8 34 146 2 $227

$0.5 44.8 34 260 2 $341

$0.5 0.3 4 598 10 $613

TOTAL LIABILIATIES AND EQUITY

$779

$626

$532

$540

$990

53

EXHIBIT 5 Vietombia Statistics

INFRASTRUCTURE Economy GDP (2008) % exports (2008) Population and employment Total population Total employment in the coffee industry % adult literacy Average school level for workers in the coffee industry (farms) % of workers who are landowners Number of workers associated to a cooperative % workers with permanent contract Forms of workers representation Association of coffee providers % of employees who are part of a trade union Geographical aspects Total area of production (hectares) Number of farms History of the coffee industry Date of creation Management system/style Number of owned farms Number of owned thresher Economic indicators of coffee industry (net profit, sales, etc.) Exports (total exports, % exports against total production)

54

USD 70.1 billion USD 62.9 billion FOB 89.73% 86 million 600,000 coffee growers 30% Grade 6 n/a 20,000 5% None None Cultivated area: 506,000 ha 300,000 First coffee plantation in 1857 in French colony n/a n/a n/a Total production: 57.6 million bags (2007) Total exports: 53.8 million bags (2007) Total production 961 million tons (2007) Total export 897 million tons (2007) % participation of exports in total production: 93.34%

5

Blue Ocean P&C Company

Ruth Green, Chief Actuary, was watching the year in review shows frequently broadcast as the year came to a close. She watched the replays of the national hero at the Games. Mo Farah took gold in both the 5000 and 10,000 metres. Mo was fast, Usain Bolt was faster but Blue Ocean moved with greater speed. Blue Ocean had been built on innovation and speed to opportunity and speed to market. They saw a niche and filled it. Everyone looked at the same information. Not everyone saw the same things. Others saw only dots. They made connections. There were always questions. Other companies choked from paralysis. Blue Ocean underwriters didn’t just sit on ideas ignored by management too busy to be persuaded. Instead management asked what action to take. She had several new ideas come across her desk in the past years and in the past week. How could she make it happen? How would they underwrite the risks? Manage the risks? Which segments should they target? Would these most recent niche offerings add value? Why might Blue Ocean fail? What should she do to remove or mitigate those risks?

5.1

Background

Mission Our mission is to strengthen the brand identity as a dominant innovator in the UK market and maximize sustainable long-term growth in shareholder value. History Asian-Russian Parent Company acquired Blue Ocean, the 5th largest property and casualty insurance company in the United Kingdom (UK), in 2009. This acquisition gave Parent Company access to Blue Ocean’s lucrative insurance market in UK and continental Europe. Products include marine, property catastrophe and retrocession. Since then, Blue Ocean continued to expand and develop its insurance businesses worldwide. In September 2011, Blue Ocean began writing Pet and Travel insurance business in North America. As of the beginning of 2012, the capital base stands at $3 billion. Ratings Guided by experienced management and backed by an impressive team of underwriters, actuaries and catastrophe risk modelers, Blue Ocean earned an A.M. Best rating of A (Excellent) and quickly established itself as a market leader. Management Team CEO Edward Blue CFO Michael Tan Chief Actuary Ruth Green

CLO Jerome Black

CRO Geoff Olive

55

Business Ops Andrew Grey

CAO Michelle Rouge

Strategy The traditional business arena for Blue Ocean has been the marine insurance market. This focus has been very successful in the company’s traditional geographical market, the United Kingdom. With the expansion into a new region, company management decided to expand its focus into Pet and Travel Insurance. In keeping with its mission to be an innovative leader the executive team is considering an offering within the emerging Renewable Energy sector. Within the Pet and Travel insurance lines, the goal is to establish a dominant market share in this relatively young insurance field. The financial goals are to generate as much profit and premium from this new risk arena as currently generated in the core Marine business. Travel Insurance Travel insurers faced steep revenue declines during the recession. The recession from 2008 to 2009 caused consumer discretionary spending and, therefore, consumer spending on travel to plummet However, since 2010 industry revenues have grown. The recession and associated turmoil in the international airline industry boosted demand for travel insurance: consumers were more sensitive to protecting their investments in travel expenditures due to higher risk of flight cancellations and delays. The industry is expected to continue growing over the next five years and expand into niche markets catering to students and business travelers. The Travel Insurance industry has a low level of market share concentration. Pet Insurance While pet insurance remains a relatively underdeveloped product in North America, with less than 1% of all pets being insured, European levels of insured pets range from 12% to 50%. In many European countries insuring your pet is just as common as insuring your home or car. It's second nature. The UK pet insurance industry is a mature industry. 50% of dogs and 30% of cats are insured with a population estimated at 8.3 million dogs and 11.9 million cats. The industry is diverse and provides consumers with a multitude of choice in terms of products and types of cover available. Three clear strategies have appeared. The first is the ‘menu-based’ proposition, where customers are provided with the standard ‘vet fees’ only product and allowed to choose various cover options to produce a product that meets their needs. The second option, which the majority of providers offer, is a ‘multiple cover’ offering, where customers are able to choose products based on set cover limits. These types of products are often displayed as ‘bronze, silver or gold’, reflecting the levels of cover offered. The third option is a ‘one size fits all’ product that offers a static veterinary fees limit and does not allow for flexibility to increase or decrease this limit. In continental Europe there are 120 million dogs and cats. The percent insured varies by country. For example, in Sweden 55% and 35% of dogs and cats are insured respectively. The U.S. pet insurance industry is in its infancy. Approximately 1% of a population of 155 million cats and dogs is insured. The U.S. industry has grown 18% compounded annually on a premium basis since 2003.

56

Marine Pet Travel * (millions)

5.2

2012 Premium Income* 1,600 400 300

2012 Reported profit* 120 25 30

Opportunity

Outlook for Property & Casualty [General ] Insurance in 2013: 

Condition of the Economic and Investment Markets For 2013, Property and Casualty companies will continue to experience a low interest rate environment and a slow recovery of the global recession. Companies should expect limited investment income and will need to rely on improving underwriting margins as a major income source. Notwithstanding the low interest expectations, companies will be compelled to strengthen their investment portfolios regarding desired levels of risk and return. This will particularly be the case in Europe, where companies face high uncertainty on their sovereign debt. European insurers have already reduced their exposures to Greece, Ireland, Italy, Portugal, and Spain (GIIPS) holdings in order to increase lower-risk assets. To increase portfolio returns, more resources and awareness will need to be allocated to risk management. Companies will need to better understand how these additional risks affect their overall risk profiles. Larger companies should try to develop a competitive advantage, through their greater access to and capacity of available asset classes.



Available Areas for Growth Growth for Property and Casualty companies will need to come from a variety of sources, as organic growth becomes more challenging. Particularly in the U.S. and Canada, the absence of a clear, hard market will compel companies to seek alternative ways to grow. Diversification and expansion by geographic location, by product, and by distribution source will become important areas of growth in 2013. Mergers and Acquisitions may prove to be one opportunity for this type of growth. Important geographic areas for expansion include emerging markets in Asia-Pacific and Latin America. Expansion into these areas, though, encompasses integration issues (differing cultures, systems, accounting, and reporting) and will amplify currency and political risks. Overall, however, companies must be aware of how any type of expansion will create new risks and understand how these new risks may change their overall risk profile.

57

Additionally, Product & Casualty insurers have the opportunity to insure new and emerging exposures through additional product development. Potential product areas include cyber liability, nanotechnology, and new energy sources. Offering new products for new areas improves client relationships and attracts and retains new customers. Finally, the existing customer base must be utilized as a mechanism of growth. Cross-selling to this base will be an important source of increased profitability and persistency. Like developing new products for new exposures, holding multiple policies and insuring multiple items with the same customer improves the client relationship and will improve the likelihood additional products will be purchased in the future. 

Customer Preferences Societal factors including technology and the growth of social media are leading to marketing changes. However, the use of the internet as a resource is growing more slowly than expected. Research1 has shown that those using the internet to research insurance and those using quote comparison websites are still in the minority. Though this growth is slow, the internet as a resource cannot be ignored. It will be imperative that online and non-online channels are integrated, and that companies carefully assess emerging customer preferences. Also, insurance companies will need to develop and maintain ways to protect their image in the expanding digital world. Customers will also seek more sophisticated levels of customer service and protection. Providing these services can become a fundamental competitive advantage. In addition, customers will expect to be rewarded for insuring multiple products with one insurer as well as their continued loyalty. Pricing models must be flexible to these expectations. Furthermore, items that will continue to be of particular importance to the policyholder include price, product flexibility, the simplicity of the sales and the renewal processes, and good claims experience. In Europe, regulatory changes will reflect the customers’ desire for simpler, more transparent products.



The Changing Character of Data The volume of available data is rapidly expanding. As data becomes more large and complex, the importance of extracting meaningful information becomes a requirement. In this era of Big Data, a competitive advantage will exist for those who are able to capture, analyze, and integrate data from multiple sources with existing systems and information. As technology improves, additional sources of data emerge. Property and Casualty companies will more commonly used vehicle telematics, video monitors, security systems, and gaming systems to gather data. These new methods of obtaining information, however, will place further demands on IT.

1

Research was from the USA and Canada. 58

Innovation through the increased availability of data will be a key differentiator in 2013. Companies will have the potential to use historic data for a myriad of decision-making purposes. Insights on cross-selling and customer retention can be obtained by using data. Moreover, insurers will be propelled to update their infrastructure (focusing on claims and billing) as consumers desire a value-added service experience through technological means. Again, an emphasis will be placed on the successful integration of historic and new data from multiple sources. Furthermore, outsourcing may become less utilized, as more enterprises find that the cost savings may come at the cost of better customer service as well as data integration. More and more available data may create a shortage of data management talent. Companies will demand new skill sets and will more commonly utilize a Chief Data Officer to oversee data integration, storage, use, etc. In addition, the customer will demand that data will remain secure and personal information will remain private. 

The Regulatory Environment Property and Casualty insurers must also be mindful of significant regulatory changes that will occur in 2013 and beyond. Overall, regulatory changes will attempt to improve capital management and allocation regarding product mix and geographic presence. Solvency II, regarding capital adequacy, is scheduled to go into effect January 1st, 2014. It will be necessary to review and refine capital management strategies in order to be Solvency II compliant. Through the year, companies must finalize the testing and integration of Solvency II systems. These costs will have an effect on income statements, and companies must be prepared to speak to concerns from their stakeholders. Some European countries will also be requesting companies to supply their Solvency II capital positions throughout the year. Likewise, the NAIC Solvency Modernization Initiative (SMI) and Own Risk Solvency Assessment (ORSA) seek improve capital adequacy for companies operation in the USA. Issues and projects which remain to be completed by SMI include changes regarding Capital requirements, Governance and Risk Management, Group Supervision, Statutory Accounting and Financial Reporting, and Reinsurance. The Risk Management and Own Risk and Solvency Assessment Model Act was adopted in September of 2012. Changes to the ORSA Guidance Manual are expected to be enacted in 2013, with full implementation of ORSA among the states is anticipated in 2015. Insurers will also be preparing for changes brought on by IFRS 9 (asset accounting) and IFRS 4 Phase II (liability accounting.) It is anticipated that these changes will be implemented at the beginning of 2015 and between 2017 and 2018, with respect to the above. Once again, addressing these implementations involves modifications to data, systems, and processes.

59

Other regulatory concerns by region are as follows:  Europe o The large degree and complexity of emerging tax law o European ban on gender-based pricing o Anticipate upcoming non-bank recovery and resolution planning o Actions of the 2013 European Parliament, including,  Markets in Financial Instruments Directive (MIFID II)  Packaged Retail Investment Products (PRIPs)  Insurance Meditation Directive (IMD)  Proposed revisions (2015F) could challenge existing distribution models while creating opportunities to develop new models  Improved transparency  USA o Addressing enterprise risk / accountability of management and the board through changes to SOX and SEC rules, for instance o A broader focus on financial services and enhanced capital levels, including concerns with run-on-the-bank risk, may affect Property & Casualty Insurers.  Canada o B9 guideline, Earthquake Exposure Sound Practices o The new Corporate Governance guideline, with full implementation no later than January 31, 2014. 

Other Regions The preceding sections have placed an emphasis on insights in Europe, the US, and Canada. Areas of importance for other regions are as follows:  Asia-Pacific o Top-line growth opportunities (emerging health & pensions markets) o Selective in entering / exiting o Far-reaching implications of changing regulations on operations, structures, and business models o Increasing severity and frequency of natural disasters o Technological investment o Mobile technology  Latin America o Real economic growth rates o Sustainable profitability o Emerging middle class o Opportunities in Brazil and Chile to integrate advanced risk and capital management with regulatory reforms 60

o Substantial CAT loss exposures o Mobile technology’s effect on consumer behavior o Flexibility, innovation, strategic alliances  Nordic Countries o Varied economic climate o Effects of European regulation (capital and risk management, distribution, product design) o Transparency regarding product pricing, costs, and consumer benefits crucial to growth o Focus on risk selection and pricing when it comes to developing an investment portfolio Renewable Energy Insurance Business profile Renewable energy and its associated technologies are an emerging industry. There are considerable uncertainties for companies operating in this industry to predict their income generation capabilities. There are two key sources of uncertainty: 1) the productivity of a given technology to generate given units of energy, and 2) market price of selling units. The intended focus of our insurance solution for this industry is to offer protection on the income generated by energy suppliers. The renewable energy lines of business segments include: Types Solar Wind Water Commercial and personal Overview of Solar Personal Energy Insurance The target homeowner for this insurance program has over 1,000 sq. ft. available roof space for mounting solar panels. The typical client has purchased solar panels that can generate between 7,000 to 12,000 khw of energy per year and depending on the cost of the panels can be enticed into a fixed contract to sell the energy generated for between 30c to 60c per khw (c = cents). A solar personal contract would either guarantee the number of units that are generated (7000 khw), or the sale price per unit (30-60c), or both (4000 khw sold at 40c). In exchange Blue Ocean would receive the actual units of energy generated and would sell them in the energy market via electrical companies. Some of the electric companies would be either privately owned or government regulated or run by the state department. There is a trend in North America for families to purchase their own personal solar grids. Our five year plan is to become the face of the insurance to this group.

61

Blue Ocean Feasibility Study Blue Ocean hired Able Energy Consulting Group. Exhibit 1 provides Market Data on the number of detached homes in the U.S., energy production per solar panel and electric company seasonal prices and volatilities.

Below is an excerpt from the business plan pro-forma that was created to gain funding approval to enter this line of business. 2014

2015

2016

2017

2018

1,200

2,600

4,200

6,000

8,000

5

11

17

25

33

9,000

13,500

20,250

30,375

45,563

Fees paid per khw (cents)

60

50

40

30

20

Energy Co resale rate (cents)

80

70

60

50

40

Contingency liability (MM)

1.08

1.62

2.43

3.65

5.47

Target capital (MM)

2.16

7.02

17.01

36.45

72.9

No. of homes insured No of electric co contracts Energy (khw) gen per home

Reserve methodology Below is an email thread discussing the reserve methodology for the renewable energy business. From: Michael Tan th Sent: March 28 , 2013 9:00pm To: Ruth Green Subject: Risk capital

Hi Ruth, How are you? Thanks for sending me the draft plan. I have reviewed the high level financial projections. I noticed that the contingency liability increases faster than the fee income line. Can we have a meeting to discuss the results? I am reviewing the corporate level capital figures. I would also like to discuss capital for this line of business. Thanks, Michael Tan CFO, Blue Ocean Inc. Telephone: 44 (0) 20 7545 8888 ============================================================================== 62

From: Ruth Green th Sent: March 28 , 2013 9:08pm To: Michael Tan Subject: Re: Risk Capital

Hi Michael, I am doing well. Hope all is well with you. Thanks for your note. I am also reviewing these figures in more detail and recently engaged with an external actuarial firm. I will set up a meeting as soon as this review is completed. Thank you, Ruth Green Chief Actuary,, Blue Ocean Inc. Telephone: 44 (0) 20 7545 9999 ============================================================================== From: Edward Blue th Sent: March 29 , 2013 12:01am To: Geoff Olive cc: Ruth Green Subject: Risk factors Remind me the risk factors within capital calculation ============================================================================= From: Geoff Olive th Sent: March 28 , 2013 7:05am To: Edward Blue cc: Ruth Green Subject: Re: Risk factors Here is the list of risk factors: Weather Mechanics Default rate Energy conversion ratio Counterparty ==============================================================================

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5A SOLAR ENERGY STATISTICS (SOUTHERN USA)

Blue Ocean P&C Company Exhibits Year 2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

71

84

79

67

76

97

84

83

79

81

77

19

27

9

29

31

67

39

14

37

40

35

1

1

1

2

2

3

3

6

6

7

7

1%

1%

2%

3%

5%

10%

12%

13%

15%

17%

20%

0

1

4

8

10

15

20

22

23

25

27

1

1

2

3

3

4

5

5

5

6

7

Cost of photovoltaic cells (key component)

113

103

90

70

66

63

62

50

49

47

45

Energy production capacity 10sq.ft.panel (KwH)

426

679

893

951

1235

1678

1931

2391

2538

2897

3256

10%

10%

9%

8%

10%

7%

6%

8%

6%

5%

4%

125

110

105

95

90

85

80

75

70

65

60

45,129

55,891

67,901

75,462

105,087

129,971

145,923

170,798

189,321

190,908

195,133

70

85

57

87

80

105

88

65

81

85

77

1%

2%

1%

3%

3%

5%

5%

5%

6%

6%

7%

Weather Related Number of Rainy days Number of severe weather (storms) Political Support States with energy rebate programs % of voters considered candidates record on environmental issue Manufacturing Base Number of panel provider companies Number of panel manufacturers

Components reported defective as rate per active units Consumer Reports Cost of 10khw panel system (USD 000's) Number of homes with more than 1000 sq. ft. roof Electric Company Solar energy usage Average purchase rate for solar energy per khw (cents) % of Total grid energy that is Solar powered

Able Energy Consulting Group copyright 2012 64

6

Big Ben Bank

Maggie Crawley, Chief Risk Officer, looked across the table. She wondered when to bring the intense ongoing debate to a close. Such forthcoming dialogue was a sought after dimension in the risk management process. However, unless the management team came up with successful ideas and effective market positions, opportunities would fade away like the morning dew. Sophisticated products and services need considerable time for development and securing commitment from partners. Was Big Ben identifying the right risk metrics? How should the risk profile behave and evolving over time? Were they simply monitoring business intelligence or was risk information forming their decisions? How could they leverage the expertise of their insurance group, Darwin? How could they cross sell to Dynasty’s high-end clientele? New regulations and scrutiny seemed never-ending.

6.1

Overview

The banking group was formed in 2001 under the directorship of Mr. Patel. Mr. Patel gained his wealth as a self-directed fund manager using fundamental asset selection and key insights into the business models of his investments. The initial focus of Mr. Patel’s banking group was finding best in class funds for its high net worth clients. Mr. Patel’s fund management business was formed in 1990 and its success was primarily built within European financial centres. The key growth differentiator in the initial years was primarily an existing network of relationships in Mr. Patel’s fund management business circle. This circle had significant wealth and the Assets Under Management (AUM). The banking group grew quickly. However, the financial crisis presented some unexpected challenges. The AUM fell dramatically and some of the investors experienced hardships in their own businesses. The fund performance was dramatically negative and the subsequent increase in redemptions severely impacted overall AUM and forced a revision in the strategic approach. The executive group following strong direction from the four partners has been asked to re-engineer the business focus away from fund performance towards holistic wealth management and financial planning. As a result the holding company decided to acquire an insurance group in 2009. Revised strategy Our vision is to be the wealth management solutions provider that defines great client experience by integrating and strengthening our wealth management and insurance offerings and building global platforms for new growth.

65

Our path to differentiation is to deliver a personalised and unique financial planning experience to our clients, by building a culture of innovation. Products / Services Since inception the critical profit driver has been the excess of the MER (management expense ratio) charged on the AUM over the operational costs of fulfilling the fund management mandate. Big Ben Bank is a world leader in the ETF market, and has a strong brand and a loyal investor base. But MERs for ETF’s are coming under increased downward pressure as more competitors come into this fund arena. Traditional personal and commercial banking has been a lower but significant component of the revenue pie. The operational model is primarily online rather than physical branches. In particular, the approach was meant to meet the needs of a globally mobile clientele. Fund transfer and foreign exchange transactions were once the majority of transactions but the travellers’ cheque business is slowing. Transfers and transactions are now dominated by an ultra-high limit VISA card program. Foreign exchange transactions and “best rates” are an attractive feature of the VISA program. Foreign exchange risk exposures are currently managed through a third-party. The banking group currently has no capital markets capabilities. The physical distribution model is almost non-existent and cannot support broad-based banking but expertise exists on emerging technologies and connectivity with a time-critical customer base. Risk Management Big Ben Bank has from the beginning prided itself on a strong risk culture and risk management has proved its worth during the financial crisis. The bank group remains a highly capitalized organization. The product set has previously been admittedly vanilla and the product development approach and policies reflect a strong governance mindset. With a greater focus on innovation-based solutions and wealth management solutions intertwined with the Insurance group, the risk management function will need to evolve and adapt its strengths to a more agile environment. The Executive mindset has been to increase focus on the financial planning sales approach, to leverage the wealth management capabilities within insurance contracts and to formulate a one-stop shopping interface to our globally mobile clientele. The key is still our private club; our brand; our family!! Regulatory Challenges The Basel Committee issued in December 2010 the Basel III rules text, which presents the details of global regulatory standards on bank capital adequacy and liquidity agreed by the Governors and Heads of Supervision, and endorsed by the G20 Leaders at their November 2010 Seoul summit. 66

The rules text presents the details of the Basel III Framework, which covers both micro-prudential and macro-prudential elements. The Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build-up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards. Through authorities provided in the Dodd-Frank Act, the Federal Reserve Board (FRB) regulates at the holding company level a number of companies that are primarily life insurers. The Dodd-Frank Act also authorized the FRB to supervise nonbank financial companies designated as systemically important by the Financial Stability Oversight Council (FSOC), some of which may be insurers. In addition, Section 171 (the Collins Amendment) of the Dodd-Frank Act authorizes the FRB to establish capital standards for these insurance companies. The FRB exercised these new authorities on June 7, 2012, issuing three proposed rules which collectively implement Basel III capital standards and Section 171 of the Dodd-Frank Act.

6.2 Recent Development Adrian Roger, Big Ben CEO, has been looking enviously at the performance of the Canadian Banks during the financial crisis. The banking industry globally suffered through a period of instability and distrust that was prevented from a run-on-the-bank scenario by the timely intervention of central banks and government led bailouts. This morning Adrian Roger was reviewing the strategic playbook of the five largest banks in Canada. Just a week after earnings season, one would assume Canadian Banks don’t have much else to say about their operations. However, the banks’ current and incoming CEO’s all spoke at a banking conference on Wednesday and they all laid out their growth strategies for the coming year, with the hope of luring investors. Royal Bank of Alberta (RBAC) – after a campaign to somewhat distance the bank from capital markets, CEO John Holmes has changed his tune. Now wholesale banking, particularly in the United States, is marketed as a growth driver. There is good reason for this: Before, the capital markets division was boosted by a major trading operation. That still exists, but isn’t nearly the same size. RBA, and other banks, had to scale back because of regulatory changes and new capital rules. Today, the capital markets arm is driven by lending and origination; the US lending book has doubled in size since 2008, after spending the previous eight years shrinking. Wealth management is another major focus. Vancouver Bank (VB) – After a record quarter for its Canadian personal and commercial arm, VB hopes to replicate the success in the United States. The US economy is on the mend, and the bank’s deposits south of the border are climbing. The key task now is finding people and businesses to lend to. VB’s U.S. deposits total about $185 billion (USD), but its loans add up to $100 billion. The bank has done some buying to increase lending but incoming CEO Carter Lai said he will “seriously look” at other assets that become available. Expenses are another major focus. 67

First Bank of Manitoba – No matter how hard you push CEO Patrick Wong, he refuses to say his bank relies on one unit over another: At Manitoba Bank, it’s all about diversity. Though Mr. Wong acknowledged loan growth is moderating in Canada, credit metrics such as delinquencies and loan losses are all in solid shape. Internationally, Latin America is still the major hope, but it’s a long term bet Manitoba Bank isn’t trying to ramp up in countries such as Columbia and Chile too quickly. Instead, it will keep offering safer products, such as auto loans, credit cards and insurance. Bank of Toronto (BTMO) – Having just reported record quarterly earnings in Canadian personal and commercial banking, BTO’s major focus is to get its U.S. equivalent firing on all cylinders. The bank recently launched a major marketing campaign in the Midwest to get U.S. households familiar with the BTO brand, and CEO John Connor hopes that will help the bank expand in urban markets. While U.S. deposit growth is healthy, “it’s the commercial banking, the mid-market business that for the next couple of years is going to be the real strong source of growth”, he said. In Canada, BTO is pushing to expand its retail operation. CrownBank (CB) – Wealth management is where it’s at. After buying American Investments and Pacific Trust Private Wealth Management, CB is on the hunt for more wealth management assets – particularly south of the Canadian-U.S. border. “Much of the growth that we are planning will come from the U.S.,” CEO Goeff MacDonald said. CB has set a target of getting 15 percent of its earnings from wealth management, and now the bank’s at the 11 per cent mark. It is also investing $134 million (CAD) – spread over many years – to revamp its retail arm’s back office systems. Laurent National Bank – Investors have long punished National for its almost singular provincial focus (Quebec) and its strength in wholesale banking. CEO Francois Boucher said recent record earnings prove he has no reason to change course. The bank’s fundamentals in these areas are strong, too. Quebec has lower household debt levels than the rest of Canada, in large part because its housing markets outside of Montreal aren’t too hot, so buyers don’t need massive mortgages. Plus, more than half of its wholesale banking revenues come from outside Quebec, so it helps to diversify the bank’s overall earnings mix. Adrian Roger pondered his notes, and thought about the business divisions: (1) personal and commercial, (2) wealth management, (3) asset management and (4) investment banking. Big Ben had come a long way in a short period of time. The strategy to focus on the very high net worth globally active business traveler had proven to be a wise choice. But was the growth trajectory about to slow simply because the number of potential clients in this market is small. What new services could sustain the growth of Big Ben’s businesses? Were there other markets that could be penetrated by leveraging the existing operational systems and distribution to grow organically? What emerging financial crisis or regulatory changes might be a hindrance to future plans?

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6A Big Ben Bank Exhibits EXHIBIT 1 Big Ben Bank Financial Data I. Year End Balance Sheet Percent of Portfolio Assets Treasury / Agency Sovereign Treasury (Government X) Corporate > B+ Total Dollar

2012 40% 50% 10% 7.5 Billion

Liabilities Deposits Borrowed funds Equities Total Dollar

2012 50% 10% 40% 7.5 Billion

II. Liquidity Risk Policy The following data are the 3 liquidity measures the bank had used to monitor their liquidity exposures for the past 5 years (mm denotes millions). Measure Liquidity Index (%) Financing Gap ($mm) Net Liquidity ($mm)

2008 80% $1,500mm -$1,250mm

2009 82% $1,050mm -$750mm

2010 83% $1,150mm -$250mm

2011 86% $800mm $500mm

2012 90% -$500mm $1,200mm

The bank also has a liquidity crisis plan that outlined the roles and responsibilities of each executive during a liquidity crisis. Furthermore, the plan also defined a mandatory decision-making process and communications that need to take place during the crisis. The plan also defined the criteria to trigger the liquidity crisis plan. These are the only measures or tools the bank used to manage and monitor their liquidity risk up to this point. The bank came out from 2008 financial crisis unscratched. The bank stayed solvent and did not have severe liquidity problem and the executives of the bank are very happy with the performance of the bank after looking at these historical measures and comfortable with the current liquidity risk mitigation policy. III. Investment Limits and triggers Criteria Fixed Income Real Estates Equities Derivatives

Instructions Permitted Not Permitted Not Permitted Not Permitted

FI Category Treasury / Agency Sovereign Treasury Corporate / Credit <= B+ Corporate / Credit > B+

Limit per issuer 5% of portfolio Market Value n/a n/a n/a

Limit (% of portfolio Market Value) 100% 100% 0% 50%

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7

Darwin Life Insurance Company

CEO Brandon Kaladin got to the office early Monday on a crisp cold January morning to get in a short work-out on the elliptical. Over the weekend he finally had a chance to read his favorite historian Paul Johnson’s new book on the company’s namesake – Darwin: Portrait of a Genius. On the TV monitor were NFL playoff highlights – some games went down to the wire - exciting back and forth lead changes up to the last play – and some NCAA basketball highlights of the weekend’s close games and upsets. An AT&T ad had children stating obviously that two things were better than one. Brandon wondered if several dozen things were better than a few. Brandon had a breakfast meeting with the CFO, CRO, Chief Actuary and Chief Marketing Officer at 8:00 a.m. It was a follow up to one held last September. Darwin had tremendous top line growth in its Term, Universal Life (UL) and Variable Annuities (VA) over the past 5 years. Life sales had grown at a 30% rate in an industry with flat life sales. VA sales for the industry had rebounded since the financial crisis. Darwin had not been a player pre-crisis but since the crisis VAs became attractive and reasonable. Pre-crisis, insurance companies had aggressively priced products with rich benefits by, in the view of many, by taking on too much risk. The crisis had resulted in many companies exiting or greatly reducing the benefits. Breakfast last September was a pregame kick-off to a series of all-day meetings split into a series 30 or 45 minutes meetings to evaluate numerous initiatives and opportunities the company could pursue. These meetings were just a prelude to the business planning and budgeting activities to occur in November. A team from Dynasty visited a few weeks later. It was a good exchange during a few intense days. Since 2011 his team had been in overdrive working on a few large initiatives. 2013 seemed to pose even more challenges. The external environment created headwinds from low interest rates to new regulations and accounting requirements to less consumer disposable income to fierce competition. There was a lot of turbulence in the industry. Since the crisis companies had been and were continuing to exit product lines and markets and shedding distribution capacity. Were they doing enough? Did the front line have enough authority and resources to do the little things? How could Darwin continue its extraordinary growth? What would be the limits of that growth? How could the company take advantage of its position to extend its reach? Or, were they doing too much? Every time you turned around the Wall Street Journal’s front-page seemed to cover yet another high-risk meltdown. No industry, especially the financial sector, was immune. Darwin had aggressive plans. Did they have a handle on the risks they were taking? One thing he did know, standing still was a risk he wasn't going to take. Brandon needed the front-line business managers to see and grab opportunities, opportunities that weren't planned for or one of their objectives at the beginning of the year.

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Background Darwin Life is a mid-size life insurer headquartered in Albuquerque, New Mexico with an increasing presence in the domestic U.S. market. Life sales are distributed primarily through an agency system and annuity sales are distributed primarily through financial institutional channels (e.g., banks and broker-dealers). Darwin has experienced an era of success since embarking on a new strategic direction under new leadership ten years ago. Success tangibly measured by growth in earnings, revenue and distribution capacity. Recent growth has been fueled by core competencies - distribution relationships and product/service development. Prior to the strategic change, Darwin lacked focus with little to no differentiation, high costs and stagnant sales. Prior management’s view was that the customer was the agent not the policy holders. There was no focus on profitability or growth. Operations lacked discipline with frequent exceptions to administrative and underwriting standards. Products included traditional whole life, level term and current assumption Universal Life (UL). Although Darwin offered fixed and variable annuities there was no focus on asset accumulation products, specifically variable annuities or distribution capacity within the financial institutional markets. Ten years ago, new management shifted strategy to be focused on wealth management and a customer focus targeting middle to upper income individuals, professionals and small business owners with estate planning, tax-deferred accumulation, traditional income preservation and retirement income protection needs. This strategic focus and management’s solid execution through the early 2000’s caught the eye of RPPC Dynasty. Dynasty thought Darwin was an attractive property and it became affordable when the market and financial industry stocks in particular, nose-dived. In hindsight the acquisition was a bargain. At the time there had been much heated debate. Darwin’s focus on wealth management was a great strategic fit with RPPC’s financial division – products, distribution and development. Core product segments are universal life, high cash value traditional life and variable annuities. Noncore segments include group annuities, individual fixed annuities and term life. Darwin enhanced its universal life products to better suit the consumers' insurance, estate and business planning needs and also introduced UL with secondary guarantees. Darwin has pursued an aggressive organic growth strategy focusing on individual life and individual variable annuities through expanding and enhancing distribution channel and sales growth. Darwin distributes life primarily through career agents, banks, and direct marketing channels. The traditional agency channel utilizes a variable cost structure with compensation incentives which promotes strong persistency. Bank-owned life insurance (BOLI) products are marketed through independent marketing organizations that specialize in the BOLI market. In 2008 they expanded annuity distribution into financial institutions. Their distribution strategy has been to add major new outlets, penetrate existing outlets and to expand the agency distribution by 2-3 regional offices per year. Both the agent and institutional distribution expansions required a significant investment.

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Agent service remains important. Customer focus creates a change in perspective that is critical in administrative and underwriting practices which translate into consumer value and expected higher profits. A disciplined operation strategy was split into separate operational strategies for pricing, underwriting, investments, financial reporting, claims, reinsurance, technology, corporate governance and risk management. Over the past decade Darwin had become an innovator in service - providing wealth management solutions to individuals - including expertise in design and distribution of tax-sheltered or tax minimizing strategies such as estate planning and small business owner succession planning. Darwin invested in technology and staff to service both the customer and distribution channels such as new administrative and reporting platforms, implemented an imaging and automated workflow system, and established a team so that a human answers the phone within four rings 95% of the time. This attention on customer focus and attention to service sets them apart from their peer group and supports an aggressive organic growth strategy. Darwin offers a broad array of competitive products with customization for specific distribution channels. Darwin has not pursued a first to market strategy but has developed competency to be a fast follower and replicate new product designs in the market. Darwin sometimes lacks the expertise to replicate processes and infrastructure. They have invested heavily in front end distributing, issuing and processing of new business. They have built strong relationships with the agency and institutional distribution channels. Darwin utilizes a variable cost distribution structure and had a growing sales force in geographic breadth and depth. Darwin has had high costs partly due to misaligned resources. Legacy products and systems have drained resources. As a result not enough resources have been devoted to infrastructure or in force management. Resources are devoted to new products and new business and priority placed on customer service and growth in distributions. Dedicated resources to manage in force business have been insufficient. Darwin was slow relative to its peer group in actively managing its spread compression due to low interest rates. Time constraints and lack of expertise in some cutting edge product areas resulted in less than effective back end areas including risk mitigation and management operational monitoring and reporting. Greater speed is needed to respond to business problems including risk monitoring and escalation. Operational areas are silo-based resulting in less effective collaboration and cross-functional continuous improvement processes. Darwin is moving towards a disciplined operational focus in underwriting, investments and diversified competitive products. Darwin has solid ratings from every major rating agency – A.M. Best, Standard and Poor’s, Moody’s, Fitch, and Insight Ratings. Financial Analysis Darwin has outperformed the industry over the past 10 years regarding growth in life sales, annuity sales, equity, assets, and distribution capacity. Relative to the industry and similarly rated companies, Darwin unfavorably has higher leverage, lower interest coverage and lower liquidity and favorably has higher return on capital and lower expenses. Relative to its peer group, Darwin has had a lower operating income margin and a lower net income margin, a higher investment yield, a higher expense 72

ratio, higher growth in life insurance in force, higher growth in equity, and average mortality and persistency. The Market The 55-75 age group has $7 trillion in investable assets and within a decade the 401 (k)/IRA rollover market will exceed $1 trillion per year. The shift from life protection to pre-retirement accumulation to post-retirement income protection and retirement asset management will accelerate. As protection moves from pre-mature death to protection from longevity there are opportunities for companies with product, distribution, and service (trust, process and advice). Variable deferred annuities have transformed from tax-deferred mutual fund investments to guaranteed retirement vehicles. Protection is the differentiator versus other financial services (e.g., 85% of all variable annuity sales have living benefit riders). Successful companies will have well positioned defensible market positions, pricing power, advanced technology and systems to enhance service and process and lower costs, operational efficiencies, experienced management, high-quality financial reporting and corporate governance, strong assetliability management, investment and risk management, a focused and balanced growth strategy, the ability to innovate products and distribution by partnering with other services (financial planners, estate attorneys, tax experts, and healthcare advisors), and the ability to build customer relationships. Risk Management Darwin formalized its risk management function with the creation of an ERM Committee in 2007 followed by a new a CRO position and a Risk Management department in 2008. The Committee meets quarterly. Its purpose is to build sustainable competitive advantages by fully integrating risk management into daily business activities and strategic planning. Excerpts from its Charter charge the Committee to:  Increase the enterprise’s value through promotion of robust risk management framework/processes.  Align risk preferences, appetite and tolerances with strategy  Monitor Darwin‘s overall risk exposure and ensure risks are measured and well-managed.  Anticipate risk exposure and recommend action where exposures are deemed excessive or where opportunities exist for competitive advantages. The Charter also specifies the Committee’s Composition, Authority, Meetings and Responsibilities. Darwin’s risk appetite statement is: I. Capital The probability of a 15 percent loss of Statutory equity in one year is less than 0.5 percent. II. Earnings The probability of negative GAAP earnings in one year is less than 5 percent. III. Ratings Maintain an AA financial strength rating. Maintain capital 10% above minimum AA capital requirements. Maintain an A rating on senior unsecured debt.

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Risk tolerances are based on the estimated impact of quantified risks on statutory capital since the core mission is policyholder protection. Market risk, credit risk, underwriting risk, operational risk, strategic and liquidity risks are quantified using a variety of metrics to capture multiple perspectives. Investment Policy and Strategy The investment department manages the general account investments. The Chief Investment Officer (CIO) reports to the CFO. Investment policy and strategy is reviewed and approved by an internal management committee consisting of the CEO, CFO, CIO, and SVPs (or VPs) of its major business lines. Internal management committee decisions are subject to review by the board’s investment committee. The internal management committee meets quarterly and is responsible for reviewing investment results and approving the use of new investment instruments. Day-to-day decisionmaking authority is delegated to the CIO, up to specified limits. The CIO may delegate approval authority to his or her subordinates. Transactions in excess of the CIO’s approval limit require approval by the CEO and CFO. The company’s general account is invested primarily in fixed-income assets. Within the general account there are separate investment portfolios for each of the main product lines. Variable annuity investment accounts are held in a separate (segregated) account and are managed by a third-party investment advisor.

Risks Credit Risk Darwin invests in investment grade quality bonds (S&P at or above BBB-). Fixed-income securities in the general account have exposure limits at individual obligor (issuer) and sector levels. Obligor-level limits vary according to asset type and credit quality, as determined by external rating agencies. The investment department monitors compliance of the exposure limits. For each portfolio, there are weighted average credit quality targets. Portfolio credit quality is measured by converting each asset’s external credit rating into a numerical score. Scores are a linear function of credit ratings (AAA = 1, AA = 2, etc.). Sub-category ratings (i.e. + or -) are ignored in the scale. The company prefers to maintain a score above 3.5 for each line of business. Market Risk Semi-annually within each block of business, Darwin measures the effective duration of the assets and liabilities. If the asset and liability durations are further apart than 0.5, the asset portfolio is rebalanced such that its new effective duration equals that of the liabilities. The VA hedging program uses a semi-static hedge updated for market factors weekly and for in force changes monthly. The key risk measures are the market greeks. Darwin currently hedges delta and rho. The program purchases derivatives so that at least 90% of liability delta and 50% rho are hedged. Existing hedges are not sold if the hedge ratio exceeds these thresholds. Gamma, vega and cross greeks are self-insured due to system complexity, the cost of hedges, the tendency of equity volatility to mean revert and other factors. Hedge effectiveness is measured using a rolling twelve-month average of program gains and losses. 74

Liquidity Risk The liquidity policy requires Darwin to hold sufficient liquid assets to meet demands for cash in a liquidity crisis. One scenario considers a reputational liquidity crisis where markets continue to operate normally and the liquidity crunch affects only the company. The liquidity stress test anticipates situations where the company’s ability to sell assets to meet cash needs from its liability products is hindered by the market taking advantage of the company during the crisis. Another scenario considers a crisis in which the entire market is not able to sell assets at a reasonable value. Operational Risk The CRO is responsible for collecting and disseminating risk information. A report is prepared monthly and distributed to executive management. Stress Testing Stochastic testing is supplemented with deterministic scenario-based stress tests, performed annually. Each test is applied as shocks to the model assumptions (for example, mortality, lapse and market assumptions). Interest rates have a floor of 0.10% Additional risk factors are described in Appendix 7 Exhibit 3.

Liquidity and capital Vin Atium’s PC beeped as a new e-mail arrived. It was the agenda for tomorrow’s 10 a.m. - 12 p.m. meeting. Vin was a new member of the Liquidity and Capital Committee and it would be her first meeting. A recently adopted ERM policy charged the committee with an annual review of Darwin’s Liquidity Plan and Capital Plan. The recent financial crisis taught the importance of liquidity and capital - managing in normal conditions is one thing, managing in a crisis is another! Like many companies during the crisis Darwin responded by building large cash balances far exceeding pre-crisis maximum cash limits per Darwin’s Investment Policy. At its peak cash represented 10% of general account assets. Management and the Board wanted to demonstrate financial strength to policyholders, rating agencies and analysts that under no conditions would they need to sell assets at the sale prices. Darwin had historically used standard accounting liquidity ratios to measure liquidity and a maturity ladder to analyze their ability to fund cash outflows over time. RBC was the primary capital measure. Various stress scenarios were tested although until the financial crisis the focus was on the liability side and some event such a downgrade resulting in high surrender rates. The business and financial forecasts provided by the Actuarial Reporting and Accounting departments were key tools in managing appropriate levels. In 2008-09 she had always wondered what was the right cash level. Darwin had stopped buying new investments until its cash levels were extraordinarily high (she felt too high). However it was better that no analyst could question whether it was enough. No company wanted to be downgraded. 75

Protecting the policyholders and Darwin’s ratings was worth the cost. But if resources had been marshaled and the models had produced better information, could Darwin have demonstrated a lower cash level was sufficient? Holding cash was a costly drag on earnings due to the foregone investment income. Earnings represented future capital. Today’s capital problems were created by yesterday’s solution to liquidity. In reviewing the Liquidity Plan and Capital Plan and how they were put into practice, she asked, Were the timeframe dimensions being appropriately addressed? Were all sources and uses of liquidity identified? Were they using the right metrics to measure of liquidity position? In a liquidity crisis were responsibilities, possible actions and action criteria clearly defined? Were capital allocations and returns on capital appropriately risk-adjusted? RBC was a constraint but what was the right capital measure? Economic capital? Were they considering the appropriate stress and what-if scenarios? She thought Darwin’s liquidity and capital management was good but could be better. However she was hesitant to ask any questions during the meeting. Being a team player meant not asking questions. Her role would be to carry out any marching orders. The Committee was evaluating a number of initiatives to improve Darwin's liquidity and capital position. To improve liquidity and capital the agenda items included:  Securitizing redundant term and ULSG reserves,  Reinsuring 20 and 30 year level term  Modifying and expanding lines of credit and other credit facilities  Becoming a member of the Federal Loan System which provided an alternative to banks  Changing product designs and to improve liquidity  Revisiting capital intensive products including 15/20/30 year term, ULSG, fixed annuities and VAs reduce Guarantees and increase Rates.  Hedging un-hedged liabilities  Implementing renewal/replacement product strategies As she looked over the Agenda, she reflected: This is a good list … Securitizations are complicated and expensive. She had to find a Memo and White Paper – it had a high level view of redundant reserves, securitization flows, costs, risks. With no firsthand experience Darwin lacked expertise. They would have to put together the right team, a team that could identify and work through the issues … timely. What would the curve be? It would take resources from many departments to pull that off Reinsurance was a good way to manage capital but what would the earnings trade-off be? How do we determine the right levels for credit facilities – stress tests? Stochastic tests – what CTE? Capital intensive products? That pretty much covers everything we sell except whole life – did they leave anything out - marketing will be super receptive … 76

I wonder what liabilities and hedging they have in mind? I wonder what product strategies they are considering? The committee wouldn’t be able to push everything through the initiative and budget process. She wondered if they would only discuss what needed to be done or if they would also discuss how to make things happen. A New Product Anne Kofsky, VP Life Insurance Division had made a proposal to expand the offering of life insurance product into Universal Life with Secondary Guarantees (ULSG) to appeal to the middle to upper income clientele. The proposed product introduced a market value adjustment (MVA). Initial product development efforts indicated that the product will produce a Statutory internal rate of return (IRR) at 15% which is above the hurdle rate set by the holding company. The new product design reflects general account investment supported by a portfolio of investment grade corporate bonds supplemented by interest derivatives and credit default swaps (CDS) to manage the interest and credit risk, competitive pricing in the guaranteed provisions as well as moderate assumptions in shadow account projections and a financial reinsurance agreement to reduce the onerous capital requirement. Below is an e-mail excerpt from the CEO. From: Brandon Kaladin, CEO Sent: Monday, March 25 2013 7:36 PM To: Josie Brennan, CRO cc: Anne Kofsky, VP Subject: Re: ULSGMVA

Anne’s report on the proposed ULSG with MVA looks very promising both in terms of revenue and profit. I see the actuaries used new stochastic models with multiple interest scenarios and dynamic consumer behavior. Josie, I know your team has been involved and is still reviewing. As aggressive as our 3-year UL sales growth are I don't want to have a misfire on launching a UL product like ABC Life and XYZ which withdrew products from the market within a year after introduction. Their agents were not happy. Could you perform a more comprehensive review than usual to evaluate if the models are adequate to capture all the major risk categories and if the additional risk-taking is aligned with our risk appetite? Have you settled on new risk metrics and what will be on the risk dashboard? The target launch is still June 17.

Rating agency preparation Before the meeting started, Becky and Stanley were discussing last night’s episodes of Downton Abbey and Sherlock Holmes on PBS. Senior VP and Chief Corporate Actuary Roger Heilman entered and conducted the weekly meeting for the Corporate Department. Towards the end of the meeting Roger said, “Today I received the agenda and discussion points from Insight Ratings. They always ask for a lot. You never know what will end up being discussed so we need to be over prepared. They might not cover everything on the list but you never know. What they do discuss they grill you on so we need to be prepared. And our preparation for Insight last year was of tremendous value when Dynasty folks 77

visited us last fall. This will be similar to last year – we need to anticipate and be able to answer 99% of what they could ask. In addition to the discussion points we will use the list I developed of additional or follow-up questions they could ask. Any questions? Good, I’d like to see everything in two weeks.” On the way back to their desks Becky and Stanley groaned. “Becky, last year's list had over 100 extremely detailed analysis items, for which none of the data was readily available.” “Yeah, Stanley, nor do we have decent analytical tools to analyze the data. It’s all manually intensive. The data is not standardized, it has inconsistent formatting and scattered across the four corners of the building. Last year Roger said he was going to make quality data for analysis and decision making a priority for management.” He said, “well garbage in and garbage – oh we need to get something useful out.” She said “we could take the resources and time spent on developing a footnote to a footnote that is buried in a file cabinet or running from crisis to crisis and devote them to material issues that would make a difference/impact.” Excerpts from Insight Ratings email and Discussion Points are in Appendix 7A Exhibit 1.

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7A Darwin Life Insurance Company Exhibits EXHIBIT 1 Rating Agency

Insight Ratings 1 Insight Drive, Capital City phone 123/555-6500

www.InsightRatings.com

March 7, 2013 Roger Heilman Senior VP and Chief Corporate Actuary Darwin Life Insurance Co 123 Main Street Albuquerque, NM

Dear Roger: The following are a list of items that we would like to discuss for our upcoming 9 am – 4 pm April 12th, 2013 meeting. An item of particular concern that we will spend time on will be your investment portfolio and your capital levels. With the current low interest rate environment, our rating committee is examining closely investment portfolios and the effect investment performance has and will have on earnings and capital. As part of our year round rating process, we will look to determine the rating for the company shortly after the completion of the rating meeting and the management discussions that will follow. As a result, we would appreciate a comprehensive response to the items noted in the attachment. If you have any questions regarding our request please call me. Please supplement this request with any additional information that you feel would be helpful to our review. In order for us to fully review your information, submit two copies of this information at least one week prior to the meeting date to allow time to review the material. I look forward to meeting you and the management team. Regards, Morgan Hubbard Financial Analyst Life/Health Division 79

Below are excerpts from the Insight Ratings Discussion Points attachment. Meeting Agenda  Strategy Overview  Corporate Governance and Audit Committee Update  Business Line Review  Individual Life  Individual Annuities  Distribution  Financial Projections (split by product and by distribution)  Investments  Asset/Liability Management and Liquidity Investments  Capital Management  Enterprise Risk Management Information Requests  Audited (if available) 2012 Statutory and GAAP Financial Statements  3-year Plan: Statutory and GAAP statements  Updated bank facility agreements  Cash flow testing summary  Product brochure and illustration for top selling life products, VA and fixed annuity.  LIMRA sales information on different products; also show persistency  Holding company only IS and BS that shows asset details  Business with Big Ben Bank: life insurance in-force and life and annuity sales  Profitability measures  Retail fixed annuity and variable annuity flow information including net sales and spreads Questions Overview  Review Darwin’s Corporate Strategy and capital allocation in the organization.  Review the most recent Board of Directors presentation materials.  Discuss the synergies of Darwin’s current business segments.  Provide updates on any recent/potential acquisitions, sales or strategic affiliations.  Discuss ventures with Big Ben Bank.  Discuss plans for maintaining long-term top line growth (i.e. revenue) as well as plans to improve operating performance (specifically statutory earnings performance) and your capital and surplus position.  How will Darwin maintain its competitive advantage in the market place? 80

Corporate Governance and Audit Committee Update … several bullet points Business line review  Review marketing/business plan for the company including changes in product, market, or geographic focus/expansion.  Discuss current business plans by line of business including current product development plans and how trends in product design and technology are incorporated.  Discuss the impact of the current interest rate environment on your core business lines.  Review your claims experience versus pricing assumptions.  Discuss the company’s use of mortality reinsurance.  Discuss the pricing on fixed annuity and life products. Quantify target pricing spreads; quantify annuity gross and net spreads – historical and projected. Distribution  Discuss agent retention statistics  Discuss sales promotions - quantify costs and impact on sales  Discuss competition in the UL and VA markets  Review your distribution channel strategy and growth plans. Financial Projections  Discuss any material variances including margins, direct and net premiums, expenses, benefits and commission levels.  Provide a by-line analysis of performance/profitability including the sources of earnings.  Discuss the company’s different products including profit targets, anticipated emergence of statutory earnings, acquisition costs and sensitivities to different risk factors such as expense, interest rate, equity markets, mortality and lapse. Investments  Provide impairments in 2012 and 2013 YTD.  Provide current portfolio yields and new money rates in aggregate and for different classes.  Discuss any changes to the investment strategy.  Review alternative assets and sub-prime mortgage / alt-A and CMBS exposures.  Discuss developments in portfolio credit quality and expected investment related realized and unrealized losses.  Provide your investment policies and a narrative on investment strategies. Discuss your investment strategy and any expected changes in the near term. ALM  Review of asset/liability management, cash flow testing/sensitivity analysis. Were there any changes to pricing assumptions because of investment performance?  Describe the VA hedging strategy and the risks being hedged. Which risks are not hedged?

81

Capital Management  Quantify the impact of redundant reserves in term (XXX) and UL (AXXX). How does the company intend to deal with the reserve strain?  What was the reserve impact of AG 38 effective in 2012? Any product changes?  Discuss securitization plans.  Discuss the company’s use of reinsurance. Any changes in reinsurance program/retention?  Discuss capital adequacy as measured by the company and future access to capital. Enterprise Risk Management … several bullet points Miscellaneous  Update and summary of outstanding litigation, market conduct and/or compliance issues.  Discuss any expense control initiatives. … several additional bullet points

82

EXHIBIT 2 Business Intelligence Product Comparisons Darwin tracks market position within each business segment. Considerations include premiums paid, benefits, features, credited rates and guarantee period, other guarantees, fees, surrender charges, service, and policy cash values over time (under current assumptions and under guarantees). Competitors tracked vary by segment and product. Distribution Capacity Darwin tracks Agency distribution growth by number of agents, by geographic penetration, total sales by agents, sales over prior year sales for same agents banded by years of service, retention rates and training costs. Darwin tracks Institutional distribution growth by distributor count, number of wholesalers, number of appointed representatives, ranking within each partner, change in percentage share and dollar volume within each partner and number of appointed Reps. Financial Growth Darwin measures financial growth using the following KPIs: GAAP earnings, Statutory equity, total assets under management, life insurance sales (first year premium), variable annuity sales and fixed annuity sales, RBC ratio and debt ratio. Darwin vs. Industry vs. Peer Group Darwin uses the following to benchmark itself. 1. NAIC Risk Based Capital (RBC) Ratio 2. Capital Growth Sharpe Ratio 3. Financial Leverage 4. Earning Interest Coverage 5. Cash Flow Interest Coverage 6. Return on Capital 7. Expense Ratio 8. Liquidity Ratio 9. Individual Life Premium as a % of Total

83

EXHIBIT 3 Risk Factors In addition to the risks outlined in the Background material in Section 7 numerous other risks include: Risk Factors Economic conditions may materially adversely affect our business and results of operations. The Company's strategies for mitigating risks arising from its day-to-day operations may prove ineffective resulting in a material adverse effect on its operational results and financial condition. The development and maintenance of our various distribution systems are critical to growth in product sales and profits. A ratings downgrade or other negative action by a rating agency could materially and negatively affect our business, financial condition and results of operations. The Company's results and financial condition may be negatively affected should actual experience differ from management's assumptions and estimates. The Company could be forced to sell investments at a loss to cover policyholder withdrawals Interest rate fluctuations or significant and sustained periods of low interest rates could negatively affect the Company's interest earnings and spread income or otherwise impact its business. Equity market volatility could negatively impact the Company's business. The Company's use of derivative financial instruments within its risk management strategy may not be effective or sufficient. The use of reinsurance introduces variability in the Company's statements of income. The Company is highly regulated and subject to numerous legal restrictions and regulations. Changes in regulation may reduce our profitability and growth. New accounting rules, changes to existing accounting rules, or the grant of permitted accounting practices to competitors could negatively impact the Company. Financial services companies are frequently the targets of legal proceedings, including class action litigation, which could result in substantial judgments. Changes to tax law or interpretations of existing tax law could increase our tax costs. Companies in the financial services industry are sometimes the target of law enforcement investigations and the focus of increased regulatory scrutiny. Litigation could result in substantial judgments against us or our affiliates. The Company's ability to maintain competitive unit costs is dependent upon the level of new sales and persistency of existing business. The Company's investments are subject to market and credit risks. These risks could be heightened during periods of extreme volatility or disruption in financial and credit markets.

84

The Company's reinsurers could fail to meet assumed obligations, increase rates, or be subject to adverse developments that could affect the Company. Adverse capital and credit market conditions may significantly affect our ability to meet liquidity and financing needs or access capital, as well as affect our cost of capital. The Company could be adversely affected by an inability to access its credit facility The amount of statutory capital that the Company has and the amount of statutory capital that it must hold to maintain its ratings and meet other requirements can vary significantly from time to time and is sensitive to a number of factors outside of the Company's control. The Company's ability to grow depends in large part upon the continued availability of capital. The occurrence of computer viruses, network security breaches, disasters, or other unanticipated events could affect the data processing systems of Darwin or its affiliates and could damage our business and adversely affect our financial condition and results of operations.

85

EXHIBIT 4 Financial Data: GAAP Income Statements (in 000s) Total

2010

2011

2012

2013

2014

2015

Premium - First Year

784,780

911,720

1,077,880

1,289,710

1,594,260

2,090,450

Premium - Renewal

222,890

255,630

293,230

329,160

365,520

401,560

1,007,670

1,167,350

1,371,110

1,618,870

1,959,780

2,492,010

REVENUES

Total Premiums Net Investment Income

597,270

595,330

606,450

624,430

647,770

685,240

Other income

42,050

51,360

61,150

73,190

85,850

103,940

Total Revenues

1,646,990

1,814,040

2,038,710

2,316,490

2,693,400

3,281,190

Claims

100,500

129,890

143,730

168,890

198,370

235,170

Surrender and other benefits

601,710

659,910

722,420

726,080

791,210

863,940

Inc. in reserves & S/A Transfers

588,460

695,250

835,020

1,052,600

1,320,810

1,776,940

1,290,670

1,485,050

1,701,170

1,947,570

2,310,390

2,876,050

83,650

100,920

119,100

138,800

161,100

193,200

(49,100)

(63,270)

(75,070)

(87,090)

(100,330)

(120,350)

34,550

37,650

44,030

51,710

60,770

72,850

BENEFITS AND EXPENSES

Total Benefits Field Compensation Change in DAC Total Acquisition Costs Total Administrative Expenses

69,280

77,220

84,090

91,700

99,740

107,750

1,394,500

1,599,920

1,829,290

2,090,980

2,470,900

3,056,650

252,490

214,120

209,420

225,510

222,500

224,540

Interest

18,000

18,000

18,000

18,000

18,000

7,375

Tax

82,100

68,600

67,000

72,600

71,600

76,000

170,390

145,520

142,420

152,910

150,900

148,540

2010

2011

2012

2013

2014

2015

561,000

669,800

812,600

1,000,000

1,280,000

1,750,000

-

-

-

-

-

-

Total Benefits and Expenses EBIT

Net Income

Variable Annuities REVENUES Premium - First Year Premium - Renewal Total Premiums

561,000

669,800

812,600

1,000,000

1,280,000

1,750,000

Net Investment Income

73,700

85,000

98,000

119,000

142,000

175,000

Other income

25,800

33,400

40,600

50,500

61,600

76,500

Total Revenues

660,500

788,200

951,200

1,169,500

1,483,600

2,001,500

16,200

28,800

36,000

46,600

59,200

75,100

Surrender and other benefits

114,650

161,100

193,650

228,100

276,450

315,700

Inc. in reserves & S/A Transfers

474,250

536,300

649,250

807,400

1,038,000

1,464,500

BENEFITS AND EXPENSES Claims

86

Total Benefits Field Compensation Change in DAC Total Acquisition Costs Total Administrative Expenses Total Benefits and Expenses EBIT

605,100

726,200

878,900

1,082,100

1,373,650

1,855,300

30,200

38,300

46,400

56,100

69,000

90,800

(13,400)

(20,900)

(24,300)

(28,500)

(36,900)

(52,300)

16,800

17,400

22,100

27,600

32,100

38,500

14,300

17,400

20,200

24,100

28,200

32,800

636,200

761,000

921,200

1,133,800

1,433,950

1,926,600

24,300

27,200

30,000

35,700

49,650

74,900

Interest Tax

8,500

9,500

10,500

12,500

17,400

26,200

15,800

17,700

19,500

23,200

32,250

48,700

2010

2011

2012

2013

2014

2015

Premium - First Year

58,780

72,420

89,480

106,810

125,360

145,650

Premium - Renewal

47,590

64,730

82,030

96,460

111,020

125,060

Total Premiums

106,370

137,150

171,510

203,270

236,380

270,710

Net Investment Income

110,770

106,530

105,850

109,730

114,170

121,040

Other income

5,850

6,760

8,450

9,490

9,750

11,440

Total Revenues

222,990

250,440

285,810

322,490

360,300

403,190

0.36

0.35

0.36

0.36

0.36

0.36

Claims

27,300

35,290

33,930

38,090

42,770

47,970

Surrender and other benefits

32,760

32,110

36,270

41,080

45,760

51,740

Net Income

Universal Life REVENUES

BENEFITS AND EXPENSES

Increase in reserves Total Benefits Field Compensation Change in DAC Total Acquisition Costs Total Administrative Expenses Total Benefits and Expenses EBIT Interest

92,310

120,250

152,270

182,600

214,410

246,440

152,370

187,650

222,470

261,770

302,940

346,150

21,450

25,220

32,200

38,500

45,100

52,400

(13,000)

(16,770)

(24,670)

(31,790)

(36,830)

(41,350)

8,450

8,450

7,530

6,710

8,270

11,050

13,780

14,820

15,990

16,900

17,940

18,850

174,600

210,920

245,990

285,380

329,150

376,050

48,390

39,520

39,820

37,110

31,150

27,140

-

-

-

-

-

-

Tax

16,900

13,800

13,900

13,000

10,900

9,500

Net Income

31,490

25,720

25,920

24,110

20,250

17,640

87

Traditional Life

2010

2011

2012

2013

2014

2015

Premium - First Year

34,000

34,000

36,400

38,500

40,200

41,700

Premium - Renewal

54,900

63,100

71,200

80,000

89,300

98,600

Total Premiums

88,900

97,100

107,600

118,500

129,500

140,300

Net Investment Income

51,200

50,500

51,700

53,000

54,500

56,700

-

-

-

-

-

140,100

147,600

159,300

171,500

184,000

197,000

Claims

15,800

15,800

17,200

18,800

20,500

22,300

Surrender and other benefits

31,900

29,800

31,200

33,000

34,900

36,800

Increase in reserves

34,400

45,400

51,300

58,300

64,800

71,300

82,100

91,000

99,700

110,100

120,200

130,400

REVENUES

Other income Total Revenues BENEFITS AND EXPENSES

Total Benefits Field Compensation

18,100

20,500

22,500

25,100

27,500

30,000

Change in DAC

(9,300)

(11,200)

(11,700)

(12,600)

(13,200)

(13,800)

Total Acquisition Costs

8,800

9,300

10,800

12,500

14,300

16,200

Total Administrative Expenses

9,200

10,300

10,900

11,500

12,200

12,700

100,100

110,600

121,400

134,100

146,700

159,300

40,000

37,000

37,900

37,400

37,300

37,700

-

-

-

-

-

-

Tax

14,000

13,000

13,300

13,100

13,100

13,200

Net Income

26,000

24,000

24,600

24,300

24,200

24,500

2010

2011

2012

2013

2014

2015

Premium - First Year

14,300

17,500

19,400

21,400

22,700

24,100

Premium - Renewal

44,700

52,800

63,000

73,700

84,200

93,900

Total Premiums

59,000

70,300

82,400

95,100

106,900

118,000

Net Investment Income

20,400

20,500

22,000

24,100

26,800

30,100

Other income

-

-

-

-

-

-

Total Revenues

79,400

90,800

104,400

119,200

133,700

148,100

22,900

28,600

35,900

44,200

53,000

65,200

400

500

500

500

500

500

10,800

11,100

12,000

13,200

14,600

15,100

34,100

40,200

48,400

57,900

68,100

80,800

8,200

10,800

11,700

12,600

12,900

13,100

(11,200)

(12,300)

(12,600)

(12,600)

(12,000)

(11,500)

Total Benefits and Expenses EBIT Interest

Term REVENUES

BENEFITS AND EXPENSES Claims Surrender and other benefits Increase in reserves Total Benefits Field Compensation Change in DAC

88

Total Acquisition Costs

(3,000)

(1,500)

(900)

-

900

1,600

Total Administrative Expenses

21,200

23,100

24,800

26,500

28,000

29,500

Total Benefits and Expenses

52,300

61,800

72,300

84,400

97,000

111,900

EBIT

27,100

29,000

32,100

34,800

36,700

36,200

-

-

-

-

-

-

9,500

10,200

11,200

12,200

12,800

12,700

17,600

18,800

20,900

22,600

23,900

23,500

2010

2011

2012

2013

2014

2015

116,700

118,000

120,000

123,000

126,000

129,000

Interest Tax Net Income

Other REVENUES Premium - First Year

75,700

75,000

77,000

79,000

81,000

84,000

Total Premiums

Premium - Renewal

192,400

193,000

197,000

202,000

207,000

213,000

Net Investment Income

341,200

332,800

328,900

318,600

310,300

302,400

Other income

10,400

11,200

12,100

13,200

14,500

16,000

Total Revenues

544,000

537,000

538,000

533,800

531,800

531,400

18,300

21,400

20,700

21,200

22,900

24,600

BENEFITS AND EXPENSES Claims Surrender and other benefits

422,000

436,400

460,800

423,400

433,600

459,200

Increase in reserves

(23,300)

(17,800)

(29,800)

(8,900)

(11,000)

(20,400)

417,000

440,000

451,700

435,700

445,500

463,400

5,700

6,100

6,300

6,500

6,600

6,900

(2,200)

(2,100)

(1,800)

(1,600)

(1,400)

(1,400)

3,500

4,000

4,500

4,900

5,200

5,500

10,800

11,600

12,200

12,700

13,400

13,900

Total Benefits and Expenses

431,300

455,600

468,400

453,300

464,100

482,800

EBIT

112,700

81,400

69,600

80,500

67,700

48,600

-

-

-

-

-

-

Tax

39,400

28,500

24,400

28,200

23,700

17,000

Net Income

73,300

52,900

45,200

52,300

44,000

31,600

Total Benefits Field Compensation Change in DAC Total Acquisition Costs Total Administrative Expenses

Interest

89

EXHIBIT 5 Financial Data: Statutory Balance Sheets (in 000s) and Debt Total

2010

2011

2012

2013

2014

2015

Cash and Invested Assets

10,222,300

10,466,400

10,671,900

11,006,000

11,404,700

11,725,300

Separate Account Assets

1,878,100

2,128,200

2,515,900

3,057,800

3,777,900

4,872,200

Deferred Tax Asset

-

-

-

-

-

-

Total Assets

12,100,400

12,594,600

13,187,800

14,063,800

15,182,600

16,597,500

Statutory Reserves

11,231,200

11,716,000

12,299,000

13,160,200

14,280,300

15,856,500

Debt

225,000

225,000

225,000

225,000

225,000

75,000

11,456,200

11,941,000

12,524,000

13,385,200

14,505,300

15,931,500

644,200

653,600

663,800

678,600

677,300

666,000

338%

333%

324%

312%

306%

287%

35%

34%

34%

33%

33%

11%

2010

2011

2012

2013

2014

2015

365,100

457,300

459,700

532,900

608,800

687,600

1,878,100

2,128,200

2,515,900

3,057,800

3,777,900

4,872,200

Total Assets

2,243,200

2,585,500

2,975,600

3,590,700

4,386,700

5,559,800

Statutory Reserves

2,086,200

2,417,400

2,797,100

3,398,700

4,198,300

5,385,700

Total Liabilities

2,086,200

2,417,400

2,797,100

3,398,700

4,198,300

5,385,700

157,000

168,100

178,500

192,000

188,400

174,100

2010

2011

2012

2013

2014

2015

1,929,200

2,001,900

2,102,300

2,237,100

2,406,800

2,617,100

Total Assets

1,929,200

2,001,900

2,102,300

2,237,100

2,406,800

2,617,100

Statutory Reserves

1,820,000

1,897,500

2,002,200

2,140,700

2,314,200

2,528,600

Total Liabilities

1,820,000

1,897,500

2,002,200

2,140,700

2,314,200

2,528,600

109,200

104,400

100,100

96,400

92,600

88,500

Total Liabilities Statutory Equity RBC Debt Ratio

Variable Annuity Cash, Invested and Other Assets Separate Account Assets Deferred Tax Asset

Statutory Equity

Universal Life Cash, Invested and Other Assets Deferred Tax Asset

Statutory Equity

90

Traditional Life

2010

2011

2012

2013

2014

2015

936,000

966,100

1,005,700

1,050,500

1,101,500

1,158,100

Total Assets

936,000

966,100

1,005,700

1,050,500

1,101,500

1,158,100

Statutory Reserves

900,000

928,900

967,000

1,010,100

1,059,100

1,113,500

Total Liabilities

900,000

928,900

967,000

1,010,100

1,059,100

1,113,500

Statutory Equity

36,000

37,200

38,700

40,400

42,400

44,600

2010

2011

2012

2013

2014

2015

442,000

478,800

530,000

598,600

687,600

798,700

Total Assets

442,000

478,800

530,000

598,600

687,600

798,700

Statutory Reserves

425,000

460,400

509,600

575,500

661,100

768,000

Total Liabilities

425,000

460,400

509,600

575,500

661,100

768,000

Statutory Equity

17,000

18,400

20,400

23,100

26,500

30,700

2010

2011

2012

2013

2014

2015

6,300,000

6,312,300

6,324,200

6,336,900

6,350,000

6,363,800

Total Assets

6,300,000

6,312,300

6,324,200

6,336,900

6,350,000

6,363,800

Statutory Reserves

6,000,000

6,011,800

6,023,100

6,035,200

6,047,600

6,060,700

Total Liabilities

6,000,000

6,011,800

6,023,100

6,035,200

6,047,600

6,060,700

Statutory Equity

300,000

300,500

301,100

301,700

302,400

303,100

Corp

250,000

250,000

250,000

250,000

250,000

100,000

Cash, Invested and Other Assets Deferred Tax Asset

Term Cash, Invested and Other Assets Deferred Tax Asset

Other Cash, Invested and Other Assets Deferred Tax Asset

Debt Issuance Issue Senior notes issue Senior notes issue

Issue Date 1 Mar 2000 15 Jun 2010

Maturity Date 1 Mar 2015 15 Jun 2030

91

Rate 8.50% 7.00%

Face Amount 150,000 75,000

EXHIBIT 6 Sensitivity Tests Term Sensitivities (in 000s) Baseline Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

2013 21,400 7,100 15,500 22,600 23,100

2014 22,700 6,900 17,000 23,900 26,500

2015 24,100 7,100 16,400 23,500 30,700

2016 25,600 6,300 26,200 32,500 33,765

2017 27,200 5,100 28,000 33,100 34,294

Lapse Up 15% Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

21,400 7,455 15,190 22,645 22,638

22,700 7,935 15,470 23,405 25,175

24,100 8,875 13,776 22,651 27,630

25,600 8,505 20,174 28,679 28,363

27,200 7,395 19,600 26,995 26,749

Lapse Down 15% Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

21,400 7,455 15,190 22,645 23,793

22,700 5,865 16,830 22,695 28,090

24,100 4,615 16,400 21,015 33,463

25,600 2,835 26,462 29,297 38,154

27,200 1,275 28,560 29,835 40,124

Sales Up 15% Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

24,610 7,100 17,825 24,925 23,562

26,105 6,900 19,550 26,450 28,090

27,715 7,100 18,860 25,960 33,770

29,440 6,300 30,130 36,430 38,830

31,280 5,100 32,200 37,300 40,810

Sales Down 15% Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

18,190 7,100 13,175 20,275 22,638

19,295 6,900 14,450 21,350 25,175

20,485 7,100 13,940 21,040 27,630

21,760 6,300 22,270 28,570 28,363

23,120 5,100 23,800 28,900 26,749

92

Variable Annuity Sensitivities (in 000s) Baseline Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

2013 1,000,000 17,400 5,800 23,200 192,000

2014 1,280,000 17,900 14,350 32,250 188,400

2015 1,750,000 18,200 30,500 48,700 174,100

2016 2,100,000 18,900 39,500 58,400 178,300

2017 2,520,000 19,200 50,900 70,100 181,900

Market Up 15% at 31 Dec 2012 Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

1,000,000 24,000 5,800 29,800 232,000

1,280,000 25,000 14,350 39,350 230,400

1,750,000 25,900 30,500 56,400 218,200

2,100,000 27,200 39,500 66,700 224,600

2,520,000 28,200 50,900 79,100 230,500

Market Down 15% at 31 Dec 2012 Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

1,000,000 10,800 5,800 16,600 112,000

1,280,000 10,800 14,350 25,150 104,400

1,750,000 10,500 30,500 41,000 85,900

2,100,000 10,600 39,500 50,100 85,700

2,520,000 10,200 50,900 61,100 84,700

Sales Up 15% Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

1,150,000 17,400 26,700 44,100 190,500

1,472,000 17,900 37,100 55,000 184,980

2,012,500 18,200 56,000 74,200 168,055

2,415,000 18,900 67,200 86,100 169,105

2,898,000 19,200 80,600 99,800 168,925

Sales Down 15% Sales GAAP Earnings: In force GAAP Earnings: New Business GAAP Total Earnings Statutory Capital

850,000 17,400 19,720 37,120 193,500

1,088,000 17,900 27,413 45,313 191,820

1,487,500 18,200 41,395 59,595 180,145

1,785,000 18,900 49,640 68,540 187,495

2,142,000 19,200 59,585 78,785 194,875

93

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CASE STUDY - Society of Actuaries

SPRING 2014 EXAM CFESDMB Strategic Decision Making Exam (Part B) CASE STUDY CFESDMB EDUCATION AND EXAMINATION COMMITTEE OF THE SOCIETY OF ACTUARIES...

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