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Alternative Risk Transfer/ (fronting)

Process by which a primary insurer cedes a portion of the risk it has underwritten to a reinsurer, such as a captive insurance company

•Ceding company (front) securitizes for projected losses less paid losses while working with the captive to obtain maximum risk finance leverage

•Front retains primary responsibility for regulatory and statutory compliance

•Front usually retains some amount of underwriting risk

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What is Alternative Risk?

Alternative risk in an insurance-based product where a substantial portion of the insurance risk is assumed by an entity other than a traditional insurance company.

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A closely held insurance company whose insurance business is primarily supplied by and controlled by its owners and in which the original insureds are the principal beneficiaries. A captive insurance company’s insureds have direct involvement and influence over the company’s major operations, including underwriting, claims and management policy and investments.

Definition of a Captive

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Pure captive

Single-parent captive writing only the risks of its owners and/or affiliates.

Captive writing connected business

Type 1 insurer writing the risks related to or arising out of the business or operations of its owners and/or affiliates.

Captive writing third-party business

Captive writing a portion of its net premiums for risks which are unrelated to the business of its owners and/or affiliates.

Captive of insurer

Single-parent captive owned by a professional insurer and/or reinsurer.

Types of Captives

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Association captive

Owned by members of a common industry or trade association in order to share the risks of that industry among its members.

Health care captive

Owned by a hospital or health maintenance organization and writing the risks of its owners and/or affiliates.

Multi-owner captive

Owned by two or more unrelated persons and writing the risks of its owners and/or affiliates.

Long-term (or life) insurer and/or reinsurer

Insurance company writing mainly life insurance as a direct writer and/or reinsurer.

Types of Captives

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Composite

Insurance company writing a combination of long-term (or life) business and general business.

Rent-a-captive

Owned by unrelated persons and providing captive facilities to others for a fee.

Agency captive

Owned by one or more independent insurance agents to write business that they control.

Types of Captives

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Finite insurer and/or reinsurer

Insurance company writing unrelated risks reflecting (i) clearly defined aggregate limits and (ii) anticipated investment income.

Professional insurer and/or reinsurer

Insurance company writing unrelated risks as a direct writer and/or reinsurer.

Types of Captives

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RANK DOMICILE 2000 TOTAL CAPTIVES

1 Bermuda 1,564

2 Cayman 517

3 Vermont 361

4 Guernsey 375

5 Luxembourg 264

6 Barbados 119

7 Isle of Man 168

8 Ireland 163

9 British Virgin Islands 181

10 All Other 492

WORLDWIDE TOTALS 4,204

*Totals increase when take into consideration the numerous segregated cells within various captive companies.

2000 Captives by Domicile

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Is The Market Shifting?

• The alternative market has grown from 21% of commercial premium to 33% of the last 20 years

• Throughout the last decade traditional commercial line premiums have grown 3% annually, while alternative markets have experienced a 8% annual growth rate

• The alternative risk market has expanded beyond individual employer programs to group/agency captives

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All rate, form, reporting rules apply as the standard insurance market.

Regulatory Impact

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•May not know they are in a captive

•May receive captive profits

Customer Impact

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•Defends against direct writing, retail, banks selling insurance

•Increased revenue on profitable business

•Ability to function as your own insurance company

•Control of agents own destiny

Impact on Independent Agency System

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PROS•Underwriting Profits to Agent/Insured

•Investment Income to Agent/Insured

•Direct access to reinsurance market

•Ability to separate all insurance service components

CONS•Underwriting risk born by Agent/Insured

•Possible tax implications

•Collateral may be required

Pros/Cons of a Captive Structure

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Captive Cycle

CAPTIVE

TPA

Claimant

Insured

Agent

POLICY ISSUING COMPANY

PROFITSReinsurer

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Underwriting Control

ANY SUCCESSFUL PROGRAM OPERATION ISBUILT ON SOUND UNDERWRITING PRACTICESAND INTERNAL QUALITY CONTROL. THE FRONTCOMPANY SHOULD STRUCTURE AND MANAGETHEIR CAPTIVE PROGRAMS AS IF THEY ARETAKING 100% OF THE RISK

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Underwriting

Typical PA guidelines for Program Underwriting:

Risk must be in business a minimum of three years

Five year loss ratio of 40% or less

Hazard Group I, II, or III

Risk must not have any losses in excess of $100k in the last 3 years

Workers Comp risk must have an Experience Rating Modification of1.25 or less

Specific minimum premium and state expansion requirements byprogram

Financially sound insureds

Each program is underwritten and audited as if front was taking risk

Bi-Annual Audits - process addresses problems early and often soimmediate action can be taken if necessary

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Alternative Risk – Financial Impact to Client

Gross Premium $2,000,000

Loss Fund $1,300,000

Aggregate Stop $1,625,000

Risk Assumption $ 325,000

Expense ComponentsFront 7.0%Reinsurance

8.0%Rent a Captive 1.5%Claims 5.0%Taxes 4.0%Loss Control

1.0%Commission

7.5%FET

1.0%Total 35%

Risk Assumption$325,000

Aggregate ReinsuranceCaptive$1,300,000

Stat/1M

$250,000

Aggregate Attachment: $1,625,000

Specific ReinsuranceStatutory XS 250,000 W/C750 XS 250 AL/GL/Prop

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Captive Structure

$148,000

$150,000 $150,000 $150,000 $150,000 $150,000

$220,000

$592,000$838,000

$1,085,000$370,000

$742,000

$988,000

$1,235,000

Current Income 65% Loss 50% Loss 40% Loss 30% LossLevel Ratio Ratio Ratio Ratio

$150,000

80% Loss Ratio

$2,000

100% Loss Ratio

$300,000

$150,000

$-150,000