- OAO «LUKOIL» - Insurance Strategy and Policy

Insurance Strategy of OAO LUKOIL and its Subsidiaries

Operating activities of OAO LUKOIL ("LUKOIL" or the "Company") and its subsidiaries, including production, refining and marketing of oil and oil products, as well as other activities, are associated with a wide range of financial, social and humanitarian risks. Existence of such risks and possibility of their occurrence should not prevent OAO LUKOIL from achieving its goal of becoming one of the leading oil companies of the world.

Therefore the Insurance System for OAO LUKOIL and its subsidiaries should become one of the most important and integral elements of the general corporate risk management system.

The basis of the Insurance System for LUKOIL and its subsidiaries (the "System") should be a set of specially developed economically proven procedures, defined in the form of corporate norms and standards mandatory for execution by all management bodies of OAO LUKOIL and its subsidiaries.

The System is currently developing, which is reflected (including others) in the following internal documents:

Regulations on HSE management system in a vertically integrated oil company, OAO LUKOIL (approved by the President of OAO LUKOIL in 1999);
Regulations on the procedure for investigation, accounting and compensation of losses resulting from the incidents, operational faults, accidents, emergencies in OAO LUKOIL's subsidiaries (approved by OAO LUKOIL Order No. 35 dated 21.01.2000);
Regulations on control and management of operational risks of OAO LUKOIL and its subsidiaries (approved by OAO LUKOIL Order No.166 dated 06.08.2001).

Integrity of insurance protection of OAO LUKOIL and its subsidiaries, independence of the System from the current status of OAO LUKOIL and its subsidiaries may be achieved provided that a certain mission becomes a basis of this System. The mission of the newly developed System should reflect its purpose, necessity and utility for the society as a whole and, in particular, for OAO LUKOIL and its subsidiaries.

The mission of the Insurance System of OAO LUKOIL and its subsidiaries can be defined as follows:

To ensure stable operation and development of OAO LUKOIL and its subsidiaries by economically effective insurance coverage against risks which have a negative effect on the business of OAO LUKOIL and its subsidiaries, health of personnel, shareholders' and investors' interests.

The System should combine:

Management bodies of OAO LUKOIL, its subsidiaries and their operating divisions
Divisions of OAO LUKOIL and its subsidiaries, which are entrusted with ensuring risk control and management, as well as insurance protection against risks which have a negative effect on the business, health of personnel of OAO LUKOIL and its subsidiaries, and shareholders' and investors' interests;
Division which implements control (calculation) of operational and environmental risks;
Insurance companies, protecting OAO LUKOIL and its subsidiaries, personnel, as well as property interests of the shareholders and investors.

The listed participants should act and co-operate on a single specially created information, procedural and regulatory basis.

The Fundamentals on the Insurance Strategy and Policy of OAO LUKOIL and its subsidiaries should be reviewed and approved by the Management Board of OAO LUKOIL.

The mission is completed through reaching the following objectives:

Identification of all risks which might present a threat to the business, i.e. to the stability of OAO LUKOIL and its subsidiaries;
Complete and timely compensation of all financial losses (including damage resulting from loss of crude oil, intermediate or end products; costs of localization of accidents and liquidation of their consequences, as well as associated mandatory costs, etc.) resulting from emergencies. Compensation shall be effected by transfer of unplanned costs (time-wise and volume-wise) for the coverage of probable losses to the category of planned and economically feasible insurance payments;
Recovery of property to the pre-accident condition;
Full compensation of legal liability for inflicting damage to the life, health and property of other persons and the environment;
Full compliance with the requirements of OAO LUKOIL's Social Code with respect to insurance of personnel of OAO LUKOIL and its subsidiaries.

The main principles of implementation of the defined mission are as follows:

Insurance protection through conclusion of relevant insurance agreements. This implies transfer for insurance premium of risks to external insurance markets. Transfer to external markets of potential losses from the risks of man-caused character, natural calamities, civil liability risks etc. shall be done for potentially large financial losses, their size being identified by the Management Board of OAO LUKOIL. Transfer of risks to the external insurance markets for insurance premium shall be done on a tender basis;
Insurance protection by self-insurance. This implies creation of reserve insurance funds of OAO LUKOIL and its subsidiaries to compensate losses associated with the effects of identified and eventual risks. These reserves shall be formed to cover the losses of the size defined by OAO LUKOIL's Management Board, with gradual increase of boarder between insured and self-insured risks;
Packaging of similar risks to minimize the insurance costs;
Allocation of costs for insurance protection of OAO LUKOIL and its subsidiaries in an annual budget as a separate line.

Insurance Policy of OAO LUKOIL and its Subsidiaries

The insurance policy is a way to implement the strategy in a specific time period and defines the following basic factors:

The list of risks which may have a negative effect on the business of OAO LUKOIL and its subsidiaries and health of personnel, as well as shareholders' and investors' interests. This implies definition of risks for the property complex, risks of civil liabilities, specific risks;
Types of insurance adequate to the risks associated with operating activities of OAO LUKOIL and its subsidiaries, including types of insurance of property, liabilities, specific risks;
Limits of required and economically feasible insurance payments for the selected types of insurance;
Franchise amounts for the risks transferred for insurance broken down by groups of assets.

The Management Board of OAO LUKOIL shall review in compliance with the established procedure the current insurance policy every year for the coming year. This review shall result in taking the insurance program for OAO LUKOIL and its subsidiaries as a base by OAO LUKOIL's Board for the coming year.

During implementation of the insurance policy of OAO LUKOIL and its subsidiaries, its units, which are obliged to control and manage the risks, as well as to provide insurance protection from the risks which are presenting a threat to the business and health of personnel of OAO LUKOIL and its subsidiaries, as well as property interests of the shareholders and investors, shall perform the following functions:

Analyze information on the risks which may have a negative effect on the business of OAO LUKOIL and its subsidiaries and health of personnel, as well as types of insurance adequate to such risks;
Develop proposals on the amount of losses subject to self-insurance in the current year;
Develop proposals on the limits of required and economically feasible insurance payments and franchise amounts for the risks transferred to insurance in the current year;
Organize and hold tenders associated with insurance protection of OAO LUKOIL and its subsidiaries;
Present a list of companies specially authorized to provide insurance protection of OAO LUKOIL and its subsidiaries in the specific time period;
Control the acquisition of insurances by the authorized insurance companies in the course of re-insurance;
Control the activities of corporate self-insurance structures;
Analyze current and potential status of the world insurance markets;
Control timely notification of losses of OAO LUKOIL and its subsidiaries, the status of reconciliation and payment of agreed losses.

The list of potential external insurers (re-insurers) of the risks of OAO LUKOIL and its subsidiaries was defined on the basis of assessment of their reliability, financial stability, rating etc.

The mandatory requirements to the insurance companies (in addition to the above mentioned) providing insurance protection for OAO LUKOIL and its subsidiaries (companies specially authorized to perform insurance protection for OAO LUKOIL and its subsidiaries) are:

Experience of co-operation with a large corporate client from highly risky sectors of economy (primarily from the oil industry);
Ability of the insurance company to perform constant and effective monitoring of insured risks of OAO LUKOIL.

The purchase of insurance policies from commercial international insurance companies shall be performed in case of their compliance with the current rating of Standard&Poor's.

Re-insurance of risks, insured by the authorized companies, shall become an obligation of the authorized companies. The international insurers shall comply with similar reliability requirements, used in the course of direct purchase of such companies' insurances.

Insurance coverage of LUKOIL Group companies in 2008

In 2008, insurance coverage of the LUKOIL Group companies has been arranged in accordance with the requirements of a special purpose Program adopted by the Management Committee of OAO LUKOIL.

The Insurance Coverage Program of LUKOIL Group in 2008 (hereinafter referred to as the “Program”) is aimed at ensuring economically viable insurance coverage of LUKOIL Group companies, its employees, or property interests of shareholders and investors.

In 2008 the following insurance types were singled out as those which comply with the operating activities risks of LUKOIL Group, and also the types of insurance whose realization is determined by the requirements established by the relevant financial institutions:

ü Compulsory insurance (compulsory public liability insurance of vehicle owners, compulsory liability insurance against harm inflicted during operation of hazardous production facilities);

ü Catastrophic risks insurance (property insurance of refineries and petrochemical plants, gas processing plants, property and liability insurance of vessel owners, as well as oil and gas production enterprises operating offshore, voluntary liability insurance of terminal operators and liability insurance of aircraft fuel transporters);

ü Liability insurance of directors, officers, and corporations;

ü Social insurance (voluntary health insurance of employees, accident insurance of employees);

ü Insurance of property interests of LUKOIL Group oil and gas production enterprises and marketing companies against the risks which threaten the business of these organizations, etc.

Insurance coverage is accomplished with consideration of:

ü Property appraisal for insurance purposes (the appraisal procedure is carried out by independent appraisers recognized on the international and domestic appraisal markets);

ü Surveys of high-risk facilities and control over complying with the recommendations by an independent surveyor (the survey is carried out by independent surveying organizations, international global brokers and major reinsurance companies).

The 2008 Insurance Program with coverage of LUKOIL Group companies embraces a full scope of insurance against risks specified in the 2007 Program.

Insurance coverage in certain insurance types rose in comparison with the previous year. In particular, the amount of property and liability insurance increased in the following areas:

ü Insurance of gas processing plants (reaching the level established by independent surveyors);

ü Insurance coverage of vessel-owners’ property interests (due to scheduled commissioning of two vessels);

ü Voluntary liability insurance of terminal operators (due to an increase in the transshipment volume, commissioning of a new terminal in Varandey);

ü Liability insurance of aircraft fuel transporters (due to an increase in aircraft fuel sales);

ü Insurance coverage of overseas marketing companies (due to promoting overseas marketing companies, acquiring new assets).

In 2007 prices, expenses from the implemented Insurance Program for OAO LUKOIL and its subsidiaries decreased in 2008 by approximately 14.4%.