captive insurance: risk & financial implications
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Captive Insurance: Risk & Financial Implications. Ryan Erickson McGriff, Seibels & Williams, Inc. Trey Tasker, ACAS, MAAA McGriff , Seibels & Williams, Inc . Geoff Welsher Marsh, Fleet Solutions - PowerPoint PPT PresentationTRANSCRIPT
McGriff, Seibels & Williams, Inc.
Captive Insurance:Risk & Financial Implications
Ryan Erickson McGriff, Seibels & Williams, Inc.Trey Tasker, ACAS, MAAA McGriff, Seibels & Williams, Inc.
Geoff Welsher Marsh, Fleet SolutionsKevin Doyle Artex Risk Solutions
The Value Equation of Captives◦ The impact of risk information◦ In comparison to commercial insurance◦ Real vs. advertised value
Value by Type of Captive◦ Single Parent
Pure - 831(a) or 831(b) Sponsored - 831(a) or 831(b)
◦ Group Parent Group Captive Risk Retention Group
Success Stories/Panel Discussion
Agenda
Overview - Risk Financing Options
RiskFinancingOptions
Share
Retain
Transfer
Unfunded -------------------
Pre-Loss Funding ---------
Post-Loss Funding --------
Group Captive
Risk Retention Group
Group Dividend Program
Non-Insurance Contracts -
Insurance -------------------
Derivatives -----------------
• Indemnification Agreements• Hold-Harmless Agreements
• Guaranteed Cost• Loss-Sensitive Programs
• Futures and Forwards• Options
• Self-Insurance• Deductible Programs
• Captive Insurance Company• Limited Risk Programs
• Line of Credit• Contingent Capital
Insurance Pricing Continuum
Self-insuranceGuaranteed Cost
Und
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Sche
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Ra
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Clas
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Expe
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Rati
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Less Information
More Information
What happens when the retention grows?
This is when captives can be useful.
Commercial insurance offers certain benefits
Some of these benefits can be achieved by◦ Self-Insurance◦ Single-Parent Captives◦ Group Captives◦ Risk Retention Groups
Commercial insurance offers some benefits that captive insurance does not offer
Captive insurance offers some benefits that commercial insurance does not offer
Captives vs. Commercial Insurance
The Benefits of Commercial InsuranceBasic View
RiskTransfer
CatastrophicHazard Events
Uncontrollable Hazard Events
ProtectDir & Ofc
CostReductions
Efficiency of Diversification
Accelerated Tax Deduction
DocumentedExpense
External Demands
Debt-Related Covenants
Regulatory Requirements
Customer Expectations
Service Expertise
Assessment of Hazard Risks
Prevention of Hazard Losses
Handling of Hazard Claims
The Benefits of Commercial InsuranceBasic View
RiskTransfer
CatastrophicHazard Events
Uncontrollable Hazard Events
ProtectDir & Ofc
CostReductions
Efficiency of Diversification
Accelerated Tax Deduction
DocumentedExpense
External Demands
Debt-Related Covenants
Regulatory Requirements
Customer Expectations
Service Expertise
Assessment of Hazard Risks
Prevention of Hazard Losses
Handling of Hazard Claims
1. This perspective is very Hazard-focused.
The Benefits of Commercial InsuranceBasic View
RiskTransfer
CatastrophicHazard Events
Uncontrollable Hazard Events
ProtectDir & Ofc
CostReductions
Efficiency of Diversification
Accelerated Tax Deduction
DocumentedExpense
External Demands
Debt-Related Covenants
Regulatory Requirements
Customer Expectations
Service Expertise
Assessment of Hazard Risks
Prevention of Hazard Losses
Handling of Hazard Claims
2. A case study of large companies suggested that they could easily
replace all but two of these benefits.
The Benefits of Commercial InsuranceBasic View
RiskTransfer
CatastrophicHazard Events
Uncontrollable Hazard Events
ProtectDir & Ofc
CostReductions
Efficiency of Diversification
Accelerated Tax Deduction
DocumentedExpense
External Demands
Debt-Related Covenants
Regulatory Requirements
Customer Expectations
Service Expertise
Assessment of Hazard Risks
Prevention of Hazard Losses
Handling of Hazard Claims
3. These items are valuable.How do we replace these items?
The Benefits of Captive InsuranceBasic View
RiskTransfer
Frequency ofHazard Events
Uncontrollable Hazard Events
CostReductions
Better LocalKnowledge
Accelerated Tax Deduction
DocumentedExpense
External Demands
Customer Expectations
Service Expertise
These items are among the benefits of captives.
Benefits Overlap
Commercial Insurance
CaptiveInsurance(Single-Parent)
Restores full tax
deduction
Better local knowledge
Documents full expense
ProtectDir & Ofc
Debt-related covenants
Severity ofhazard risks
Frequency of hazard
risks
Regulatory requirement
s
CustomerExpectations
Expertise in risk
Cost Coverage Capacity Control• Cash Flow • Availability • Increase • Regulation• Reinsurance • Broaden • New Risks • Claims
• Cost Savings • Tailored • Build Limits • Reserves
• Formal Cost Documentation
• Uninsurable Risks
• Access to Reinsurance
• Profit Center Potential
• Investment Income
• Focus Risk Mgt Efforts
• Tax Deduction Restoration
• Enhance Loss Prevention
• Stabilization
“Advertised” Benefits of CaptivesFinancial and Non-Financial
Cost Coverage Capacity Control• Cash Flow • Availability • Increase • Regulation• Reinsurance • Broaden • New Risks • Claims
• Cost Savings • Tailored • Build Limits • Reserves
• Formal Cost Documentation
• Uninsurable Risks
• Access to Reinsurance
• Profit Center Potential
• Investment Income
• Focus Risk Mgt Efforts
• Tax Deduction Restoration
• Enhance Loss Prevention
• Stabilization
“Advertised” Benefits of CaptivesFinancial and Non-Financial
Sufficient knowledge of loss potential to identify insurance cost savings by adjusting retaining liabilities that are overpriced in the insurance market;
Opportunity for owners of private companies to transfer wealth to later generations on a tax-efficient basis for estate planning purposes;
Sufficient volume of annual losses to generate accelerated tax deductions in excess of the costs required to capitalize and maintain the captive;
Sufficient volume of annual losses to create annual cost stability by adjusting self-insured liabilities in reaction to the insurance market;
Sufficient capitalization and long-term commitment to self-insure uninsurable or prohibitively expensive exposures;
Create a profit center for external marketing to change the customer dynamics by offering insurance enhancements to customer contracts, rather than unilaterally pushing risk at customers; and/or
Internal marketing to elevate awareness of the self-insurance program throughout the financial and operational culture of the parent company.
“Real” Benefits of CaptivesFinancial and Non-Financial
The Value Equation of Captives◦ The impact of risk information◦ In comparison to commercial insurance◦ Real vs. advertised value
Value by Type of Captive◦ Single Parent
Pure - 831(a) or 831(b) Sponsored - 831(a) or 831(b)
◦ Group Parent Group Captive Risk Retention Group
Success Stories/Panel Discussion
Agenda
Overview - Risk Financing Options
RiskFinancingOptions
Share
Retain
Transfer
Unfunded -------------------
Pre-Loss Funding ---------
Post-Loss Funding --------
Group Captive
Risk Retention Group
Group Dividend Program
Non-Insurance Contracts -
Insurance -------------------
Derivatives -----------------
• Indemnification Agreements• Hold-Harmless Agreements
• Guaranteed Cost• Loss-Sensitive Programs
• Futures and Forwards• Options
• Self-Insurance• Deductible Programs
• Captive Insurance Company• Limited Risk Programs
• Line of Credit• Contingent Capital
Pros◦ Avoids “add-on costs” for small losses◦ Avoid excessive carrier loss estimates◦ Increases incentive for loss control◦ Facilitates unbundling of services
Cons◦ Defers premium expense and its tax reduction◦ Retains frequency risk◦ Increases capital requirement◦ Creates need for fronting insurer◦ Creates need for LOCs
Impact of Self-InsuranceRisk-Taker
Pros◦ Avoid frequency risk◦ Reduces surplus requirement◦ Allocates capital to high margin layers◦ Benefits from client’s incentive for loss control◦ Improves flexibility in reserve adjustments
Cons◦ Loss of premium revenue◦ Potential loss of service revenues
Impact of Self-InsuranceInsurer
Insurance Flow of Funds
Self-InsuredRisk
Guaranteed CostInsurance Program
Large DeductibleInsurance Program
Client
Claimant
Demand Payment Carrier
Claimant
Demand Payment
Client
Promise Premium
Carrier
Claimant
Dem
and Paym
ent
Client
Prom
ise
Premium Pa
per
Payment
Insurance Flow of Funds
Carrier
Claimant
Dem
and Paym
ent
Client
Prom
ise
Premium Pa
per
Payment
ReinsurerPromise
Premium
Large DeductibleInsurance Program
“An insurance company formed under special purpose insurance laws to insure the exposures of its owners and/or affiliated companies.”
Types of Captives◦Pure (Owner’s Capital)◦Sponsored (or Rent-a-Captive)◦Shared (or Group)
Captive Insurance CompanyDefined
Captive Flow of Funds “A”
Insuring Agreement Indemnity
Agreement
Large DeductibleInsurance Program
Carrier
Claimant
Dem
and Paym
ent
Client
Prom
ise
Premium
ReinsurerPromise
Premium
CaptivePremium
Promise
Payment
Pape
r
Captive indemnifies the deductible.
Captive Flow of Funds “B”
ExcessCarrier
Claimant
Dem
and Paym
entCaptive
Prom
isePrem
ium
Reinsurer
Promise
Premium
Client
Prom
ise
PremiumCaptive directly insures, with
support.
Captive Flow of Funds “C”
FrontingCarrier
Claimant
Dem
and Paym
entCaptive
ReinsurerPr
omise
Premium
Reinsurer
Promise
Premium
Client
Prom
ise
PremiumCaptive reinsures the direct
insurer.
Greater knowledge and understanding of insurance buyers on the value a captive program can bring to an organization
Trends toward higher deductibles, higher premiums, more coverage exclusions, and less need for commercial insurance
Favorable changes in the tax environment, including precedent-setting case law
Desire by risk-takers to grow capacity for uninsured exposures
Pro-active moves in anticipation of “hard market” pricing
Desire of risk management to become a profit center
Desire for greater flexibility in program design
Captive Insurance CompanyDrivers of Growth
The “pure” captive is capitalized by its owner and insures only the risks of its shareholder or affiliated companies.
The “sponsored” captive is a fully capitalized captive facility available to a single owner for a fee.
Group captives may be formed as stock or mutual companies, but they require willingness to share risks with other insureds.
Captive Insurance CompanyTypes
831(a) is the insurance company tax regs for most insurance companies◦ More than $1.2 million in premium per annum◦ Taxes on both underwriting income and investment
income
831(b) is the insurance company tax regs for small insurance companies◦ Up to $1.2 million in premium per annum◦ Taxes on investment income only
Captive Prospect Profile831(a) vs. 831(b)
TaxCode Pure Sponsored Group Captive RRGs831(a) Yes Yes Yes Maybe831(b) Yes Yes NO NO
Single-Parent Owner Group Ownership
Financially strong parent
$5 million or more in premium for 831(a) or $1.2 million or less in premium for 831(b)
Willingness and capital to retain risk
Senior management commitment to risk management objectives
Desire for “real” benefits as discussed
Captive Prospect ProfilePure Captives
Financially strong parent
$1 million or more in premium for 831(a) or $1.2 million or less in premium for 831(b)
Willingness and cashflow to retain risk
Senior management commitment to risk management objectives
Desire for “real” benefits as discussed
Captive Prospect ProfileSponsored Captives
Frictional fixed costs
Unfavorable loss experience
Increased regulatory requirements◦ Captive jurisdiction◦ IRS Safe Harbor tax position
Time commitment of corporate staff
Opportunity cost of capital investment
Without reinsurance◦ Substantial additional capital needed◦ Risk-bearing capacity limited to parent’s balance sheet
Captive Challenges
Captive Players (Cash Flow “C”)
Fronting Insurer
Reinsurer
Captive Reinsurer
InsuredPremium
Premium
Premium
Claims
Claims
Claims
Consultant/Broker
Manager/Sponsor
Third-Party Admin
Insurance Broker
Reinsurance Broker
Insurance Market
Reinsurance Market
Feasibility Study Cost of Capital Business Plan Design Financial Pro-Formas Actuarial Projections Legal Incorporation Regulatory
Licenses/Fees
Additional Capital Management Salaries Actuarial Reserves Actuarial Pricing Legal Review Auditor Services Regulatory Fees Premium Taxes Claims Services Investment Mgt Fees Reinsurance Premiums
Captive Planning Issues
• Incorporation and Operating Costs: The formation and operation of a captive entails various expenses including:
Start-Up CostsAnnual Operating Costs
Overview - Risk Financing Options
RiskFinancingOptions
Share
Retain
Transfer
Unfunded -------------------
Pre-Loss Funding ---------
Post-Loss Funding --------
Group Captive
Risk Retention Group
Group Dividend Program
Non-Insurance Contracts -
Insurance -------------------
Derivatives -----------------
• Indemnification Agreements• Hold-Harmless Agreements
• Guaranteed Cost• Loss-Sensitive Programs
• Futures and Forwards• Options
• Self-Insurance• Deductible Programs
• Captive Insurance Company• Limited Risk Programs
• Line of Credit• Contingent Capital
Group Captive – Summary Risk sharing built in the structure
◦ Less control of shared loss experience◦ All members share in reinsurance limits◦ Benefits of portfolio theory
Cost sharing built in the structure◦ Homogeneity of the membership◦ Lower admin costs than pure captives◦ Lower cost for shared reinsurance
Risk reduction through◦ Underwriting◦ Loss control
Group Captive – Basics #1 Control
◦ Premiums paid to insurance entity owned by insured◦ Superior loss control, claims handling and other unbundled
services◦ Premium costs heavily weighted toward member loss
history
Financial◦ Insured shares in underwriting profit and investment
income, via dividends paid to policyholders/owners◦ Group purchase of reinsurance and services can reduce
operating costs◦ Collateral requirements (usually Letters of Credit) for
(i) capitalization of the captive, and (ii) collateral support of each member’s retention.
Group Captive – Basics #2 Stability
◦ Insured does not subsidize poor risks◦ Insulation from cyclical marketplace◦ Reinsurance Accounts for approximately 10% -
20% of Total Premium◦ Less volatility in year over year pricing – losses
capped
82%
18%
Approx. 18% of TCOR is subject to Insurance Industry Swings
Group Captive – Basics #3 Greater risk involved in a Group Captive
◦ Member approval process – annual loss control, financial review
◦ Collateral in place to protect bad debt exposure◦ Fronting carrier/reinsurance provided by ‘A’ Rated
carriers
Risk Sharing – Averages 2% - 7%◦ Allows for tax deduction of premium◦ Reduces individual member exposure to
catastrophic claims◦ Risk Sharing a “wash” – both absorbing and causing
Risk Retention Group - Summary Same Advantages of Group Captive
◦ Risk sharing built in the structure◦ Cost sharing built in the structure◦ Risk reduction through
Plus Reduced Regulation◦ Domiciled in one state, operate in many◦ No state guarantee fund assessments
Risk Retention Group – Basics #1
Operates similar to a group captive, yet is regulated under federal legislation.
Can operate in all fifty states yet only required to be licensed in its state of domicile.
Insureds must be owner and owners must be insureds.
Can only write liability lines of risk, cannot underwrite workers compensation.
No state guarantee fund assessments
Risk Retention Group – Basics #2
Does not require a fronting insurance company.
Capital requirements serve as the collateral for RRG. No specific collateral requirements required for the retention since there is no fronting company.
Insureds fund capital requirements, typically a 2-to-1 ratio, in addition to premium.
Equity is based upon stock valuation which is done by an independent party.
RRG’s access reinsurance markets to share risk.
Benefits OverlapCommercial Insurance
CaptiveInsurance(Group Owned)
Restores full tax
deduction
Better local knowledge
Documents full expense
ProtectDir & Ofc
Debt-related covenants
Severity ofhazard risks
Frequency of hazard
risksRegulatory
requirements
CustomerExpectations
Expertise in risk
Compare and ContrastProgram Guaranteed Risk Retention Group Sponsored Pure Large Self-InsuredFeature Cost Group Captive Captive Captive Deductible Risk
Amount of Risk Transfer
Full Moderate/Full Moderate/Full Some Some Some None
Amount of Risk Sharing
None Some Some None None None None
Speed of Risk Expense
Full Full Full Full Full Moderate Some
RegulatoryScrutiny
None Minor Minor Some Some None None
Premium Documentation
Full Full Full Full Full Moderate Some
Premium Deductibility Full Full Full Moderate/Full Moderate/Full Moderate None
Balance Sheet Impact
NoneExpected Dividend
Expected Dividend
LimitedUnpaid
LimitedUnpaid
LimitedUnpaid
Unpaid
Amount of Capital Needed
$0 $0 $0 Varies $250k or more $0 Judgment
Cost of Administration
$0 Built in Built in $30k - $100k$50k once, and
$50k - $150k$0 $0
Timeline forImplementation
7 - 30 days 30-60 days 30-60 days 30-60 days 60-90 days 7 - 30 days No time
Ease ofUnwind & Exit Easy Easy Moderate Moderate Tough Moderate Tough
UPPER SCALE: None Minor Some Moderate Significant Major Full
The Value Equation of Captives◦ The impact of risk information◦ In comparison to commercial insurance◦ Real vs. advertised value
Value by Type of Captive◦ Single Parent
Pure - 831(a) or 831(b) Sponsored - 831(a) or 831(b)
◦ Group Parent Group Captive Risk Retention Group
Success Stories/Panel Discussion
Agenda