Captive 201After the Feasibility and Implementation

Captive 201

After the Feasibility and Implementation

Presented by:

Kathleen Bibbings, EVP, Aon Insurance Managers (Bermuda) Ltd.

Traver Alexander, Research Officer, Policy, Research and Risk Assessment Department, Bermuda Monetary Authority

Craig S. Melnick, Manager, Global Insurance, Eaton Corporation

Robert Paton, EVP, Aon Insurance Managers (Bermuda) Ltd.

Agenda – After the Feasibility and Implementation • Overview of the Bermuda Captive Insurance Market

• Review – Feasibility and Implementation

• Day-to-day Captive Operations– Captive owner– Captive manager

• The Renewal process– Pre-renewal planning– Captive renewal pricing

• The Audit– Commencement of audit– Completion of audit– Statutory financial return filing

• Other Activities/Actions – Financial reporting - actual vs. budget– Board meeting– Business plan changes – Captive review

Overview of the Bermuda Captive Insurance Market

Sources

• Annual Market Survey on Captives– Administered jointly by:

• Bermuda Monetary Authority • Bermuda Insurance Managers Association

• Statutory Financial Returns

• All figures for 2008 are provisional

Bermuda Captive Insurer Classification System

• Class 1 Captives– Single parent Captives insuring only the risk of

that parent or affiliate

• Class 2 Captives – Single parent or multi-owner captives with

allowance to insure 3rd party risk up to 20% of NWP

• Class 3 Captives– Captives with allowance to insure 3rd party risk

over 20% but less than 50% of NWP

Topics

• Gross Written Premiums – Regional location of underlying risk– Property and Casualty coverage overview

• Main lines of business written

• Balance Sheet Size and Composition – Asset side overview

• Quoted investment detail – Liability side overview

• Profitability Indicators

Bermuda Captive Market Premiums

Bermuda Captives: Gross Written Premiums (US$ billions)

4.41 4.41 4.78 4.7 4.09

8.26 8.08 8.66

5.77

7.11 6.947.71

6.07

6.79

9.03

0

5

10

15

20

25

2008 2007 2006 2005 2004

Class 1 Class 2 Class 3

19.419.821.5

19.4

16.7

Premiums by Region of Underlying Risk

Bermuda Captives: Geographical Distribution of Underlying Risk Insured (2008)

5%

21%

10%

13%

43%

54%

4%

9%

9%

8%

43%

14%

7%

18%

72%

58%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

Europe North America Caribbean and South America Global All Other Regions

Assumed Premiums by Region of Underlying Risk

Bermuda Captives: Geographical Distribution of Underlying Risk Assumed from Insurance Carriers (2008)

Global 34%

Caribbean and South America

4%

North America 48%

All Other Regions 3%

Europe 10%

Types of Coverage

Bermuda Captives: Types of Business Written (2008)

40%

29%

30%

32%

59%

70%

63%

65%

2%

1%

3%

7%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

Property Casualty Financial and Other

Major Property Lines of Business

Bermuda Captives: Main Property Lines of Business (2008)

14%

49%

60%

81%

64%

17%

6%

11%

13%

11%

9%

1%

2%

6%

3%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

Marine Hull and Cargo Auto P D

Property Damage and Business Interruption Aviation Hull and CargoAll Other Lines

Major Casualty Lines of Business

Bermuda Captives: Main Casualty Lines of Business (2008)

13%

26%

29%

31%

29%

5%

11%

46%

14%

31%

45%

9%

3%

9%

5%

18%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

General Liability Medical Malpractice

Workers Compensation/Employers Liability Professional Liability (other)All Other Lines

Bermuda Captive Market Assets

Bermuda Captives: Assets (US$ billions)

18.09 17.29 16.37 16.15 15.04

40.59 45.135.4 33.66

25.4426.39

16.9613.46 16.63

38.77

0

25

50

75

100

2008 2007 2006 2005 2004

Class 1 Class 2 Class 3

88.884.1

72.165.0 65.3

Assets Detail

Bermuda Captives: Asset Composition (2008)

2%

4%

2%

48%

33%

20%

6%

5%

5%

5%

12%

19%

20%

28%

1%

45%

50%

30%

13%

23%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

Cash Unquoted Investments

Quoted Investments Investment in/Advances to Aff iliatesPremium Receivables Other Assets

Inside Quoted Investments

Bermuda Captives: Quoted Investment Profile (2008)

10%

18%

6%

13%

6%

86%

80%

77%

82%

7%

8%

8%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

Bonds and Debentures Equities All Other Quoted Investment

Liabilities Detail

Bermuda Captives: Liability Composition (2008)

31%

48%

44%

43%

56%

32%

34%

37% 6%

9%

7%

5%

8%

2%

3%

4%

3%

1%

12%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

Unearned PremiumsLoss and Loss Expenses ProvisionsInsurance and Reinsurance Balances PayableStatutory Capital and SurplusAmounts due to Aff iliatesOther Liabilities

Profitability Indicators

Bermuda Captives: Profitability Indicators (2008)

7%

11%

16%

11%

80%

71%

74%

51%

0% 20% 40% 60% 80% 100%

Class 1

Class 2

Class 3

All Captives

Expense Ratio Loss Ratio

Highlights

• Small growth in gross written premiums in 2008– Continued regional diversity in the location of

risk

• Stability in balance sheet positions – Nearly two-thirds of assets in cash and quoted

investments– Capital and surplus positions well in excess of

regulatory requirements

• Bermuda remains the largest captive domicile

Review – Feasibility and Implementation

Captive Feasibility• Sell to senior management the business reasons for the captive

• Get approval to do feasibility study

• Partner with a good consultant

• Demonstrate the advantages

• Optimal ownership structure

• Select your insurance or reinsurance markets

• Domicile

• Service providers

• Capitalization and form – cash vs. LOC vs. assets

• Obtain approval to implement the captive

Captive Implementation• Select name – not as easy as it sounds!• Identify directors and officers• Obtain latest actuarial study• Get market quotations to derive pricing• Prepare proformas• Complete the narrative Business Plan• Select law firm to incorporate the entity• Complete the captive application• Attend pre-application meeting• Always be honest and forthright with the regulators• Submit application• Obtain license• Finalize arrangement with insurer or reinsurers• Commence business

Day-to-Day Operations

Day-to-Day Operations• Who is responsible for what

• Claims management/TPA management

• Claims reserve setting (actuaries)

• Receipts and payables

• Reporting requirements (monthly/quarterly)

• Investment management

• Operations Manuals – what should be included?

Roles and Responsibilities –Document in Procedures Manual

CONTENTS CONTINUED… Page No.

4 RESPONSIBILITIES Purpose 26 Chair 26 Manager 26 Claims Committee 28 Underwriting Committee 29 Investment Committee 31

5 UNDERWRITING PROCEDURES Purpose 32

6 INTERNAL CLAIMS PROCEDURES Purpose 33 Notification of claims 34

7 FINANCIAL REPORTING PROCEDURES Purpose 40 Responsibilities 40 Processing of Premium Cessions 40 Collection of Cash for Premium Cessions 40 Processing of Reinsurance Policies 41 Payment of Reinsurance Premiums 41 Reporting and Paying Claims 42 Day to Day Operations of Financial Services 40 Reporting Financial Results to ESM Reinsurance Limited. 43

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CONTENTS Page No.

1 INTRODUCTION

Purpose of Manual 4 Role of ESM Reinsurance Limited 4 Queries or Unusual Circumstances 6 Manual Pages Filing Instructions 7 2 GENERAL CORPORATE DATA Company Information 8 Registered Office and Details of Incorporation 9 List of Current Directors 10 List of Current Officers 11 Legal Counsel 11 Auditors 11 Agents 11 Committees & Members 12 Risk Management Consultant 12 Investment Managers 12 Investment Custodians 13 Banking Information 13 TPA Details 13 Letter of Credit Issuer 14

3 POLICY – SUMMARIES (Examples) Primary Property Damage / Business Interruption Policy 15 Primary General Liability Reinsurance Policy 21 Transit Risks Policy 24

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Day-to-Day operations - Captive Manager• Act as Principal Representative in Domicile

• Co-ordinate activities of Domicile legal representatives, brokers, actuaries and other service providers, provision of financial services– Preparation of Financial Statements and Forecasts – Year end audits (independent approved auditor,

assisted by Captive Manager)– Statutory filings

• Treasury Service Activities – Financial transactions (Captive Manager and

Investment Manager)– Monitoring and processing cash and investment

activities – Assist implementing of collateral requirements

Day-to-Day operations - Captive Manager Continued

• Insurance Services– Policy documentation – Mid-term endorsements – Claims handling (TPA with reports to captive manager)

• Business Development– Periodic reviews of captive utilization and development

possibilities (Captive Manager/Consultant/Broker)

– Implementing new programs

Day-to-Day operations - Captive Owner• Provide leadership

• Determine the strategic use of the captive

• Set and Manage operational expectations

• Be the ultimate decision maker

• Approve filings

• Approve financials

• Provide necessary data

The Renewal Process

Pre-renewal planning• When should the captive enter the renewal

discussions? As early as possible!

• Who should be involved? Broker and insured with ‘skin in the game’

• Review objectives

• Primary in captive and excess as insurance?

• Full limits in captive and excess as reinsurance?

• What is the best form of collateral?

• Policy writing and issuance. Standard or customized?

• Do not be afraid to forego use of the captive when capacity is cheap and security is good!

Captive renewal pricing• Three usual methods of calculating premium

1. Market rates2. Experience rating3. Other premium pricing techniques

Market Rates

Advantages

Evidence of “arms length” pricing

Usually produces higher premium – good if trying to build war chest

Remove the need for captive to calculate

Accepted by Captive Regulators

Disadvantages

Hard to persuade insurers to give rates/quotes each year

May take more funds out of operational use than necessary

Take into account industry data, not just insured data

Include substantial administrative loadings

Can be difficult to obtain in writing

Can be far more volatile

Experience Rating

Advantages

Based on own experience, not industry

Addition of “overhead” is usually much lower than commercial

Premiums more palatable to insureds

Gives better long-term cash flow

Disadvantages

Do not usually allow for profit margin, although can do

Usually rely on investment income to address any adverse development.

May not have sufficient data – revert to industry data.

Other Premium Pricing Techniques• Mean (or Expected) Loss + Expenses

• Loss Ratio (using mean loss estimate, pricing to achieve a desired loss ratio)

• Targeted Return on Equity (pricing required to achieve targeted ROE, considering mean loss + expenses)

• Mean Loss + Risk Premium (percent of standard deviation)

• Confidence level

• Last year +/- inflation/growth percentage

The Audit

Commencement of Audit• Audit planning meeting several months in advance

• Agree upon timeline and how this will be achieved

• Ensure other service providers agree with the timeline

• Prepared by Client customized request list issued well in advance

• Inform auditors of any major changes in the program or in the process

• Have documentation supporting the main processes

• Avoid Material Weaknesses or Control Deficiency

Completion of Audit• Be ready for the start of the audit and ensure items

requested are available to the auditors

• Inform the auditors of any changes between planning and field work

• Early completion means less ‘subsequent events’

• Recommend frequent communication with auditors to ensure the audit is progressing smoothly

Statutory Financial Return Filing• Specialized reporting format required by domicile

• Required 4 months or 6 months after fiscal year end depending on class of license

• Must be opined upon by an approved auditor

• May require a Loss Reserve Specialist Opinion prepared by an approved actuary depending on class of license

Other Activities/Actions

Financial Reporting – Actual vs. Budget• Compare written premium closely to actual cash received

• If exposure changes , issue addendum to policy and associated invoice

• Are expense deductions taken by the front company the same as appears in the contract? Check carefully!

• As premium is recorded and earned, adjust IBNR so budgeted loss ratio is achieved

• As claims and reserves are recorded, adjust IBNR

• Compare claims with expected and take action!

• Is cash being received in a timely manner?

• Interest income in-line with expectations?

• Are general and administrative expenses in line with budget? If not, why not?

Board Meeting• Get it on everyone’s calendar early

• Consider special invitees such as:– regulator, investment managers, claims, auditor,

actuary, reinsurance broker, etc

• Present the important topics such as premium, claims, investments, dividends, etc.

• Encourage meaningful debate

• Review compliance check-list and ensure adherence

• This may be a once a year opportunity to make an impression – don’t waste it!

• Afterwards….. Have fun!

Business Plan Changes• Material changes to business written, limits, reinsurance,

may require prior approval from regulators

• Capital reductions, change in certain investments (loan backs) may require prior approval from regulators

• Such actions are best recorded as Board decisions

• Rationale for changes should be documented

• Material impact on the captive’s financials require revised projections and revised business plan

• Captive manager should make the risk manager aware of these requirements

Captive Review• What measures are available to review performance?

• Review of service providers – how have they performed?

• Things learned for next year

Types of Review

Utilization

GovernanceReview

FinancialPerformance

Ratios

FullAnalyticalReview

IntegratedWith

ParentFinancialImpact

The Ovation

•Questions and Answers