the role of the captive manager...– protected cells / segregated cells / segregated portfolios /...

Captive Academy of the 14th Annual Executive Educational Conference

The Role of the Captive Manager

Linda Danna

Senior Vice President

Marsh Management Services, Inc.

Charleston, SC


Conception – What is a Captive?

• An insurance vehicle formed by an organization, not otherwise generally involved in insurance, to participate in its insurance arrangements

• Ultimately a self-funding mechanism for retained risk

• Not a quick fix and should be part of a long term risk financing strategy

“a captive insurance company is a bona fide insurance or reinsurance company owned by a non-insurance company and

which insures or reinsures the risks of its parent or affiliated companies”


3 September 13, 2013

3,0263,196 3,086

3,2853,417

3,6243,812

4,0024,247

4,512

4,843 4,882 4,9365,119 5,211

5,5255,745

5,587

0

1000

2000

3000

4000

5000

6000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Number of Captives Worldwide 6,052


Conception – When to Think Captive? • Financial:

– Annual captive premium funding at $2.5 million and up – Annual captive premium funding at $1.2 million or below for 831(b) IRS option – Commercial rates unaffordable or not competitive

• Operational: – Coverage not available – Proof of insurance needed (non-admitted or rated) – Manuscript form or broader coverage – Negotiating power – Seeking formalized risk funding and tracking protocol – Desire for a profit center

• Tax: – Federal – No state income tax on captives, premium tax only – Self Procurement Tax (SPT)


5

Potential Captive Structures

Owner / Insured

Fronted Reinsurance Captive

Admitted Fronting Insurer

Captive

Reinsurer

Direct Issue Captive

Fronting insurer issues policies and arranges claims handling service

Reinsurance cessions to captive; captive retains risk at agreed level

Captive retrocedes risk in excess of its desired retention

Owner / Insured

Reinsurer

Captive

Captive insurer issues policies and arranges claims handling service and retains risk at agreed level

Captive reinsures in excess of its desired retention


6

Domicile Analysis Active Captives by Domicile for Year-End 2012

Cayman, 13%

Hawaii, 3%

District of Columbia, 3%

Turks & Caicos, 1%Luxembourg, 4%

Barbados, 5%

Bermuda, 15%

Arizona, 2%

Utah, 5%

Nevada, 2%

Dublin, 1%

Isle of Man, 2%

Kentucky, 2%

Singapore, 1%

Delaware, 3%

Switzerland, 1%

Other US domiciles, 4%

British Virgin Island, 3%South Carolina, 3%

Rest of the world, 10%

Vermont, 10%

Guernsey, 6%

Total Active Captives: 6,052


7

U.S. Domestic Captive Domiciles 2013

No specific captive statutes

Captive statutes

WA

OR

CA

WY

NV

MT

ID

AZ

UT

MN

SD

ME

TX

CO

NM

ND

OK

KS

NE IA

MO

AR

LA

WI

MI

IN IL OH

KY

NC

AK

TN

AL SC

MS GA

FL

WV VA

RI

MA

NH

NY

VT

NJ CT

PA

DC

MD

DE

HI

Alabama 23 Arizona 101 Arkansas 1 Colorado 5 Connecticut 2 Delaware 190 DC 170 Florida 0 Georgia 13 Hawaii 179 Illinois 1 Kansas 1 Kentucky 139 Louisiana 0 Maine 3 Michigan 6 Missouri 28 Montana 114 Nevada 133 New Jersey 5 New York 50 North Carolina 0 Oklahoma 5 Oregon 0 South Carolina149 South Dakota 4 Tennessee 20 Texas 0 Utah 287 Vermont 586 Virginia 0 West Virginia 1

Captive Domicile / Number of Captives


8

What Are Companies Doing With Their Captives? Casualty/Liability Third Party Insurance Property

• Employers liability/WC

• Public/General liability

• Auto liability

• Professional liability

• Products liability, Product recall

• Environmental liability

• Excess liability/umbrella

• Banker’s blanket bond

• Credit

• Medical malpractice

• Crime

• Employment practices

• Cyber risk

• Terrorism insurance: – U.S. TRIA policy

with NBCR – Pool Re

• Quota share reinsurance

• Shipping, cargo, and transit insurance

• Marine cargo

• Motor

• Aviation

• Residual value

• Pooling facilities

• Customer related insurance

• Extended warranty

• Customer, vendor, and joint-venture business

• Service contracts

• Employee benefits: – global, voluntary,

and ERISA benefits


Conception – Why Establish a Captive?

• To reduce the parent’s cost of risk

• To gain a strategic advantage

• To capture profits from “related” activities


Conception – What Advantages Are There? Financial Benefits • Can reduce insurance costs - by retaining the premium for expected

losses

• Can improve the parent’s negotiating position with the insurance and reinsurance markets

• Can generate underwriting & investment profits

• Can match revenue and expense - by reserving from current funds for future claim payments

• Can provide a source of additional revenue - by offering insurance to third parties

• Direct access to reinsurance markets

• Rewards good risk management practice


Conception – What Advantages Are There?

Insurance/Strategic Benefits

• Can provide coverage for risks not usually insurable

• Can reduce the dependence for commercial insurance

• Can create flexibility in program design and broader, simpler insurance contracts

• Can create a more effective and efficient risk management program, through

– designing cost allocation and claims handling systems

– generating actuarial information

– coordinating risk management activity


Conception – Other Considerations

• Capital commitment - the captive’s capital is not available for use in the parent’s business

• Adverse results - the captive’s capital can be eroded by adverse results under the insurance program

• Operating costs - a captive does incur operating costs and demands a time commitment from senior management


Types of Captives

• Single-parent (pure) captive

• Group or association captive: – Heterogeneous (Mixed/Dissimilar) – Homogeneous (Same)

• Rent-a-captive: – Protected cells / segregated cells / segregated portfolios

/ sponsored captives

• Risk-retention group (U.S. domiciles): – Reciprocal risk-retention groups

• Branch captives • 831(b) (Qualified Small Insurance Company)


Domicile Selection

• Domicile decision criteria: – Parent Ownership Structure

– Premium Taxes

– Captive Income Taxation

– Ability to Provide Intercompany Loans to Parent

– Restricted Classes of Business

– Incorporation/Annual Operating Costs

– Capitalization Requirements

– Investment Restrictions

– Regulatory Attitudes

– Infrastructure


Step One - Feasibility

Risk Management Strategy Discussion; Envisioning & Modeling:

– Capacity & Appetite to assume more risk

– Loss Analysis and Forecasts

– Market response

• Minimum deductibles / attachment points

• Premium discounts for increased deductibles / attachment points

• Fronting fees/Security Requirements

– Guidance on the most appropriate domicile

– Taxation


Strategic Feasibility Review

– Data collection

– Retained loss projection

– Federal & State tax discussion

– International Tax discussion (if applicable)

– Ownership & Structure options

– Investment considerations

– Economic analysis

– Domicile comparison

– Third Party Business opportunities

– Other lines of cover to include in the future

– Summary of Revenue Rulings and Relevant Case Law

– Final recommendations


Application Process

Captive Owner

Select Service Partners: Attorney, Actuary,

Auditor and Manager Select Directors

Biographical Affidavits Start Up Fees

Attorney

Name Reservation Articles of Incorporation

By Laws EIN

Shareholder/Operating Agreements

Captive Manager

Business Plan Financial Forecasts

Actuarial Study Application Assembly Process Coordination

Domicile Insurance

Department

License


Step Two - Formation

• Preparation of Articles of Incorporation, other Legal Documents

• Select directors for the captive

• Appoint auditors, lawyers, bankers, etc

• Business Plan Development

• Initial Meeting With Regulators

• Financial forecasts

• Actuarial Review

• Application Submission and Review

• Licensure; Stipulations letter


Timeline


Captive Formation and Operation


Step Three – Implementation & Management

• Company administration, including: maintenance of detailed and comprehensive files of legal and general administration functions of the company

• Insurance, including: administration of insurance and reinsurance programs

• Accounting, including: payment and receipt of premiums; integrate with Parent’s financials


How A Captive Operates

• Control of the captive will be by an appointed board of directors, usually a mix of professionals and parent company workers

• The board then appoints local companies for services like banking, auditing, etc

• Management company carries out all operational functions on behalf of the captive and provides insurance and other expertise that is required by the captive

Parent Company

Captive Board

Management Company Auditors

Investment Managers

Bankers

Regulators

Lawyers


The Captive’s Service Team

Banker

Captive Manager

Consultants: Tax, Employee Benefits

Claim Administrators

Investment Advisors

Insurance Brokers

Department of Insurance

Actuary

Client

Legal Counsel

Auditor


Captive Management Operations • Financial Statement Preparation (GAAP & Statutory) • Regulatory Filings • Reconciliation of Bank and Investment Accounts • Policy Issuance • Premiums • Corporate Record Maintenance • Income Tax Provisions • Premium Tax Returns • Cash Disbursements & Receipts • Regulatory Communications with South Carolina Department of

Insurance (SCDOI) and the National Association of Insurance Commissioners (NAIC)

• Budgets and Forecasts • Audit Coordination • Coordination of Statutory Examinations • Board Meetings and Books