deconstructing the value proposition of captives
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Deconstructing the Value Proposition of Captives. Charlie Woodman, CPA, CGMA Risk Finance & Analytics Willis Construction Practice Craig A. Ream Program Administrator - CS Insurance Ltd. Willis Captive Practice 20 th Annual Willis Construction Risk Management Conference - PowerPoint PPT PresentationTRANSCRIPT
Deconstructing the Value Proposition of Captives
Charlie Woodman, CPA, CGMA
Risk Finance & Analytics
Willis Construction Practice
Craig A. Ream
Program Administrator - CS Insurance Ltd.
Willis Captive Practice
20th Annual Willis Construction Risk Management Conference
Marriott Legacy Town Center – San Jacinto Room
Tuesday, September 16, 2014
Title of Presentation – edit in master | 2
Economics of Insurance: The Stage
Fixed (25%-35%)
Insurance CompanyOverhead, Taxes,Reinsurance Cost, Commissions
Profits & Investment Income
Underwriting Profit and Investment Income Accrued by Insurance Company
Profits & Losses55 -75%• Components of
Traditional Insurance:
Expected loss and ALAE
Taxes and regulatory fees
Overhead and administration
Insurer selling and distribution expense
Reinsurance and Intermediary charges
Risk Margins
Surplus charges
Risk Based Capital offsets
The Continuum of Risk Finance
HIGH
LOW
Pro
gra
m
Sop
his
ticati
on
HIGH
Assumption of Risk
Guaranteed Cost
Loss Sensitive or Retro Policy
Large Deductible Policy
• Complete transfer of risk• Commercial insurance with no deductible
• Assumption of limited risk in exchange for potential return premium
• Deferred “pay-in” premium
• Significant/complete risk assumption in exchange for deductible credit
Integrated Risk
Qualified Self Insurance w/ Risk Funding• State Qualified Self Insured• Insured is legal insurer
• Traditional Hazard lines (property, Casualty, EPL)
• Integrated layers at specified layers
Group Captives• Formed to insure member owners (shared
risks/assets)• Replication of insurance and group purchase of
excess
Program Selection Drivers are Risk Appetite
Financial Protection
Asset and Revenue Protection
Performance Certainty
Liquidity and Cash Certainty / Cost of Short-term Finance
Statutory or Counter-party Requirements
Revenue / Expense Matching
Safety & Loss Containment Services and Acquired Disciplines
Control
Negotiation & Leverage
Catastrophic Protection
Taxation
Market Opportunity
Title of Presentation – edit in master | 5
Captive Insurance Company - Defined An Insurance Company, typically owned by non-insurance parent(s), insuring the
risks or interests of its owner(s)
Incorporated, Regulated, Capitalized and Individually Accountable· May be fairly transparent
May or May not be a replacement for insurance. Depends on Form (ownership and insured relationship)
Emphasizes the ‘Insurance Transaction’
Insurance Company Operations:· Insurance Accounting and Financial Metrics· Must Always Maintain Positive Capital and Surplus (Unrestricted Net Worth I.e.,
Marketable Assets > Liabilities)
Typically administered by professional third-parties· Captive Mgt / Legal / Audit / Actuarial / etc.
Forms of Captives Single-owner or Pure
Group – Homogeneous or Heterogeneous
Association
Insurer Controlled
Agency / Sponsored
Rent-a-captive
Segregated account (cell) captives
Captive pools
Risk retention groups
Trusts
Special Purpose (Re)insurer
Etc…
6Feasibility Prerecorded
Lecture/ 6
Title of Presentation – edit in master | 7
Boil It Down – Two Real Types
Single Parent
Wholly-owned (and can include Rent-A-Captive “Cells” & Trusts)
Emphasis on Risk Funding and Cost / Funding Efficiencies
Underwrites ‘related’ risks to single economic interest as insureds are commonly parental operations
Will consolidate operating and financial position with publicly-held parent; may deconsolidate under certain circumstances in closely-held.
Group Owned
No common ownership among insured participants
Group, Association Captive, Risk Retention Group
Emphasis on Risk Transfer as an insurance market alternative
Will pool certain retention layers among participant insureds
Common services and emphasis on the health of the group as a whole.
Primary Focuses of Single Parent Captive Programs Cost Savings
· Long Term - “Seasoning” of a Property & Casualty Insurance Company:- Platform and enhance the placement of insurance coverage, terms and conditions- Access or contract with alternative markets or reinsurers- Effect optimal balance of risk retention and transfer, glean greater control over risk
process- Projected performance is difficult to quantify
· Short Term - “Business Case” / Cash Flow Efficiencies: Highly Quantitative / Heavy Tax
Risk Management / Program Facilitation· Provide rapid liquidity· Buy Down Deductibles of Subsidiaries or Operating units
- Stabilize or enable allocations and budgeting / contracting processes
Business Enhancement: “Profit Center”· Controlled Insurance Programs· Sub Contractor Default Insurance· Extended Warranty / Service Contracts
Asset Facilitation / Wealth Strategies – Closely-helds
8
Title of Presentation – edit in master | 9
Business Case: Assessment and Short-term ViabilityNPV - Short Term Business Case cost Savings
Accelerated Tax Benefits
State Tax Arbitrage
Operating Costs
WACC / Opportunity Cost of Capital
Other Quantitative & Qualitative
Capital Commitment / Operating Cost
Internal Costs & Resource Commitment
Recognitions and Materiality
Corporate Culture
Group Captive Value Proposition
Control over insurance “destiny”
Unbundled service providers
Retain underwriting profits and earn investment income
Disciplined loss funding in a tax favorable structure
Access to capacity and economies of scale
Reduce and stabilize costs
Improve risk management through accountability
Customized and focused loss control services
Improved long term premium stability
Best in class coverage
Captive benefits on shared platform – reduced expense
Group Captive Value Proposition
Unbundling the Insurance Transaction
Group Captives
How do they do it?
Assumption of a high level of risk Cost of risk transfer significantly reduced Insurance market volatility minimized
Proven risk sharing structure Reduces volatility in claims experience for participants Provides needed risk shifting and distribution
Volume purchase #61 on ENR top 400 - $900M in combined revenues Shock claims are diluted
Investment income
Enhanced loss prevention and claims management Avoid exposure to cat risks
Member selection - “Best in Class” controlled growth Assures health of program over time Reduces cost of risk transfer Enhances peer group best practices exchange
How do they do it?
Case Study
Construction Solutions
Construction Solutions
Contractors Group Captive Established in 2001
100% Member Owned and Controlled
Domiciled - Cayman Islands
Prospective Members: Moderate/High hazard contractors generating between $500,000
and $3,000,000 in combined WC, GL and Auto Standard Premium Contractors with a strong senior management commitment to safety Contractors with loss and incident rates superior to average for class Contractors with a formal loss control and safety program Contractors with solid financials
Construction Solutions
Common January 1st renewal date $136,000,000 of payroll insured 1,700 power units insured $10,000,000 in annualized captive premium Renewals presented in October and bound in November Strict loss control covenants and annual CORR analysis Bi-Annual Loss Control Meetings:
September 15, 2014 Dallas May, 2015 Pittsburgh
Bi-Annual Board & Shareholder Meetings: October 19-21, 2014 Toronto May 17-19, 2015 Cayman
Construction Solutions
Workers’ Compensation Statutory Coverage & 1M Employers Liability
General Liability 1M per occurrence 2M aggregate per project/per location aggregate
Automobile 1M Liability Physical Damage
Insured Coverage
Construction Solutions
Current Membership 2 Masonry Construction 2 Commercial Roofing & Sheet Metal Fabrication 1 Machinery Installation, Rigging, and Transportation 1 Road/Street Construction and Paving 1 Road/Street & Bridge Construction 2 Asphalt Distribution and Paving 1 Aggregates and Precast Concrete Products 1 Pipeline Construction
Construction Solutions
Current Members Peckham Industries – White Plains, NY The Hamlin Companies – Garner, NC Franco Associates – Pittsburgh, PA Cost Company – Pittsburgh, PA Energy Services of America (ESA) – Huntington, WV Valley Group – Fishersville, VA Suit-Kote – Cortland, NY Economy Paving – Cortland, NY Diamond Materials – Wilmington, DE Greenwood Industries – Millbury, MA LC Whitford – Waterville, NY
Construction Solutions
Internal Structure
Severity Fund B
$ 375,000 XS $ 125,000
One Time Capitalization: $ 30,000 Share Purchase
Experience Adjustment Assessment equal to one times A Fund
In a multi coverage occurrence the total clash retention is $ 500,000.
$ 1,000,000/Unlimited (WC)
$ 500,000
$ 125,000
General LiabilityWorkers
Compensation
Frequency Fund A
First Dollar to $ 125,000
Reinsurance – Arch
Excess of $ 500,000
Auto
Construction Solutions
Premium Distribution Example:
Captive Expenses $ 345,900
Loss Funding $ 654,100
Total Premium $1,000,000
Construction Solutions
Premium Distribution Example:
A Fund $ 490,575
B Fund $ 163,525
Loss Funding Allocation $ 654,100
Construction Solutions
Conceptual Annual Program PricingABC Construction
WC GL Auto Total
49.06% A Fund - $0 - $125,000 269,816$ 147,173$ 73,586$ 490,575$
16.35% B Fund - $125,000 - $500,000 89,939$ 49,058$ 24,529$ 163,525$
65.41% Total Loss Funds 359,755$ 196,230$ 98,115$ 654,100$
18.98% Excess & Aggregate Charge 104,390$ 56,940$ 28,470$ 189,800$
5.72% Front Administrative Charge 31,460$ 17,160$ 8,580$ 57,200$
3.50% Taxes/Boards & Bureaus Charge 19,250$ 10,500$ 5,250$ 35,000$
1.30% Loss Control Funding 7,150$ 3,900$ 1,950$ 13,000$
2.09% Claims Admin Funding 11,495$ 6,270$ 3,135$ 20,900$
3.00% Captive Expense Funding 16,500$ 9,000$ 4,500$ 30,000$
34.59% Subtotal 190,245$ 103,770$ 51,885$ 345,900$
Total Estimated Subject Premium 550,000$ 300,000$ 150,000$ 1,000,000$
Estimated Exposure 15,000,000$ 15,000,000$ 140
Estimated Composite Rate 3.67 2.00 1,071$
Share Purchase 30,000$ Retail Brokerage Fee TBDAssessment Exposure (A Fund) 490,575$ Collateral Required (2/3 A Fund) 326,723$
Construction Solutions
ABC Construction
All Lines to include General Liability, Auto Liability and Workers CompensationPolicy Term $0 - $125,000 $125,001 - $500,000 $500,001+ Total Incurred
2013 200,000$ -$ -$ 200,000$ 2012 650,000$ -$ -$ 650,000$ 2011 325,000$ 100,000$ -$ 425,000$ 2010 325,000$ 300,000$ -$ 625,000$ 2009 325,000$ 375,000$ 500,000$ 1,200,000$ 2008 125,000$ 375,000$ 1,500,000$ 2,000,000$
TOTALS 1,950,000$ 1,150,000$ 2,000,000$ 5,100,000$
Construction Solutions
ABC Construction
2013 2012 2011 2010 2009 2008 Total
Gross Subject Premium 1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$ 6,000,000$ Losses Incurred (Paid+Reserved) 200,000$ 650,000$ 425,000$ 625,000$ 700,000$ 500,000$ 3,100,000$ Losses Excess of $500,000 Reinsured: -$ -$ -$ -$ 500,000$ 1,500,000$ 2,000,000$
A FUND Net Premium 490,575$ 490,575$ 490,575$ 490,575$ 490,575$ 490,575$ 2,943,450$ Losses Incurred (Paid+Reserved) 200,000$ 650,000$ 325,000$ 325,000$ 325,000$ 125,000$ 1,950,000$
Profit/(Loss) 290,575$ (159,425)$ 165,575$ 165,575$ 165,575$ 365,575$ 993,450$ Transfer to B -$ -$ -$ (136,475)$ (165,575)$ (211,475)$ (513,525)$ A Fund Assessment -$ 159,425$ -$ -$ -$ -$ 159,425$
Sub-Total: 290,575$ -$ 165,575$ 29,100$ -$ 154,100$ 639,350$ Deficit Reallocation (Risk Share) -$ -$ -$ -$ -$ -$ -$
Final A Fund Balance 290,575$ -$ 165,575$ 29,100$ -$ 154,100$ 639,350$
B FUNDNet Premium 163,525$ 163,525$ 163,525$ 163,525$ 163,525$ 163,525$ 981,150$ Losses Incurred (Paid+Reserved) -$ -$ 100,000$ 300,000$ 375,000$ 375,000$ 1,150,000$
Profit/(Loss) 163,525$ 163,525$ 63,525$ (136,475)$ (211,475)$ (211,475)$ (168,850)$ Transfer from A -$ -$ -$ 136,475$ 165,575$ 211,475$ 513,525$ Deficit Reallocation (Risk Share) -$ -$ -$ -$ 45,900$ -$ 45,900$
Final B Fund Balance 163,525$ 163,525$ 63,525$ -$ -$ -$ 390,575$
Loss Equity Balance*: 454,100$ 163,525$ 229,100$ 29,100$ -$ 154,100$ 1,029,925$
45.4% 16.4% 22.9% 2.9% 0.0% 15.4% 17.2%
Construction Solutions
Maximum Cost: $ 1,482,510Premium + Assessment
Minimum: $ 356,654 Captive “Fixed” ExpensesLess - Investment IncomePlus - Shared Losses
Construction Solutions
(Assume A Fund $482,510 Each Year)
1st Year 2/3 of A Fund = $321,673
2nd Year 2/3 of A Fund = $321,673 $643,346 combined
3rd Year 2/3 of A Fund = $ 321,673 $965,019 combined
No Additional Collateral required at 4th renewal!!
4th Year Caps at 2/3 of 3 Year Total = $965,019
Hypothetical Collateral Requirements
Construction Solutions
Service Providers
Front and Reinsurance - Arch Insurance Program Administration – Willis Onshore Legal Counsel – Kerr, Russell & Weber, LLP Captive Manager – SRS (Cayman) Investment Manager – PRP Performa Ltd. Auditor – KPMG Actuarial – Milliman Claims Administration – Gallagher Bassett Loss Control – Willis
Construction Solutions
Insured
CS INSURANCE LTD.
Captive Flow
CS Retail Broker
Arch Insurance Company
Willis, SRS, KR&W, Milliman, KPMG, GB
Underwriting Profits!
Policy Issuance
Financial Protection
Specific and Aggregate Excess Coverage
Statutory Coverage
Meets Legal Regulatory and Customer Requirements
Underwriting Expertise
Loss Control Resources
Claims Administration – Gallagher Bassett
Construction Solutions
Construction specific focus – coverage and services
Size of program
Enhanced input and control of captive operations
Active peer group - culture of constant improvement
High average member premium size - $885,000
Low average risk sharing – 3.5%
Minimal assessments
Why Construction Solutions?
Why Construction Solutions?
Enhanced and focused risk control
Exceptional historical results – loss ratio 33%
$81 MM Premium - $22 MM paid & $3.5 MM reserves
Program Structure – flexible retention, ALAE, clash, aggregate
No automatic close-out policy
Excellent distribution history
$10 MM in distributions to date
Policy years closed – net cost was 70% of original premium
Questions?
Construction Solutions