Tuesday, March 17, 2015 Houston, TX. 3:45 5:00 p.m. CAPTIVATING RISK: ART MARKET AND CAPTIVE SOLUTIONS

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1 Tuesday, March 17, 2015 Houston, TX 3:45 5:00 p.m. : ART MARKET AND CAPTIVE SOLUTIONS Presented by Michael O Neill, CPCU, ARM President and CEO American Contractors Insurance Group Many companies look beyond the comfort of guaranteed cost insurance programs to alternative risk financing mechanisms that can be particularly valuable to provide specialized coverage or coverage that may become constricted, to provide higher limits than may be available in the traditional market, and to control the cost of risk. This session will provide an overview of the alternative risk transfer (ART) marketplace and how it can be used, particularly captives. It will look at why captives can be an effective solution to meeting availability and pricing issues, explain the types of captives that can be utilized along with the pros and cons of each, and discuss how captives work with regard to the types of coverage that can be underwritten, domiciles, and fronting and reinsurance issues. Copyright 2015 International Risk Management Institute, Inc. 1

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3 Michael O Neill, CPCU, ARM President and CEO American Contractors Insurance Group Michael O Neill has been involved in the construction insurance industry for more than 38 years. He is president and chief operating officer of American Contractors Insurance Group, a construction industry owned insurance organization in Dallas. He joined ACIG in August of 1984 and is responsible for the overall operations of ACIG and its subsidiary companies. Mr. O Neill is a frequent speaker for construction industry trade associations; he has spoken 24 times at the International Risk Management Institute, Inc. (IRMI), Construction Risk Conference and is a recipient of the IRMI Words of Wisdom speakers award. His expertise lies in the areas of captive management, risk management, retention analysis, contractual risk transfer, development of specialized coverage, and risk funding programs. Mr. O Neill has written many articles for construction industry publications, including Associated General Contractors, Construction Financial Management Association, and Engineering News Record. He received his Chartered Property and Casualty Underwriter designation in 1978 and his Associate in Risk Management designation in

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5 ART Market and Captive Solutions Michael J. O Neill, CPCU, ARM, CRIS President & CEO American Contractors Insurance Group 40+ years specializing Alternative risk transfer Retro plans Self-insurance Captives Risk retention group (RRG) Risk purchasing group (RPG) ART and Captive Experience 2 5

6 Forty members operating in the United States, Canada, Mexico, and other foreign countries Payroll of $2.0 billion American Contractors Insurance Group Manhours of 60 million Premiums are $175 million Investments are $398 million A.M. Best rating of A (Excellent) VIII ($ MM) 3 Risk Financing Manages the sources and uses of funds to finance the recovery from accidental losses Decision methodology for making, implementing, and monitoring choices for cost-efficient funding of losses Captive insurance companies are a sophisticated risk financing program. 4 6

7 The Risk Financing Process Five Key Steps 1. Identifying and analyzing exposures to loss 2. Examining alternative risk financing technique(s) 3. Selecting the best technique(s) 4. Implementing the selected technique(s) 5. Monitoring the results 5 Step 1: Identifying and Analyzing Exposures Risk quantification statistical concepts and techniques used in developing a loss forecast. Data sources needed: Loss history Loss development patterns Payout profiles Exposures Trending 6 7

8 Step 1: Loss Forecasting Loss forecasting is useful in a number of applications: Determining appropriate retention levels Identifying, evaluating, and selecting risk financing options Allocating risk financing costs and risk bearing capital Determining premium adequacy and fairness Budgeting organizational expenses 7 Loss data Workers compensation and auto liability for past 5 years General liability for past 10 years Historical exposures for past 5 or 10 years Ground-up losses Loss stratification Loss Forecasting: Data Requirements 8 8

9 Loss Data: General Liability 5-Year Example Policy Year Loss & ALAE x Trend Factor = Trended Loss & ALAE x LDFs = Ultimate Loss & ALAE 2009 $ 450, $ 603, $ 786, , , ,207, , , , , , , , , ,940 $1,788,627 $2,238,023 $4,003,221 9 Historical Payrolls Policy Year Audited Payroll Loss Rate Per $100 Payroll 2009 $ 21,372, ,349, ,890, ,352, ,736, $120,701,

10 Loss Pick Choices 2015 Policy Year Loss Rate Averages Estimated Payroll Projected Losses Weighted Avg. Last 3 Years $23,000,000 $624,665 Worst Rate ,000,000 1,095,914 Best Rate ,000, ,286 Weighted Avg. All Years ,000, ,828 Avg. Excl. Best & Worst ,000, , Risk Retention An integral part of a risk financing program Retain losses for several reasons Reduce cost of risk Retention encourages loss control Risk retention is looked upon favorably by the insurance markets Skin in the Game 12 10

11 Risk Retention Analysis Guidelines 1. Working capital method 2 5% of working capital 2. Total asset method 1 5% of total assets 3. Earnings/surplus method 1 8% of average pre-tax earnings over a 5-year period 4. Sales budget method 1/2 2% of annual sales 5. Annual premium method 10% of annual premium 6. Operating cash flow method 2 5% of operating cash flow Source: IRMI Risk Financing. 13 Qualitative Risk Map Source: IRMI Risk Financing

12 Incurred loss retro plan Paid loss retro plan Large deductible plan Single-parent captive Examining Alternative Risk Financing Options 15 Incurred Loss Retrospectively Rated Plan No collateral required Full standard premium paid during policy year Retro adjustments at 18 months and every 12 months thereafter Retrospective Adjustments to Policy Premium Insured Insurance Premiums Insurer Claim Payments Claimants 16 12

13 Retro Adjustments Retrospective Rating Program Elements These are calculated 6 months after the policy expiration and annually thereafter. These may be commuted by mutual agreement at a specified date e.g., 66 months with any further risk accepted by the insurer

14 Paid Loss Retrospectively Rated Plan Insured Retrospective Adjustments to Policy Premium Insurance Carrier Charges Replenishments Loss Fund Losses and Loss Adjustment Expenses Collateral = Difference between Policy Premium and Payments Insurer Claim Payments Claimants 19 Paid Loss Retrospectively Rated Plan Characteristics Insurer expenses and profit paid over 12 to 21 months Loss fund escrow = 3 months estimated paid losses Security = letter of credit or surety bond Retro adjustments at 21 months and every 12 months thereafter Tax treatment: expenses deductible as such/losses deductible when paid Letters of credit pyramid 20 14

15 Pyramiding Collateral (LOCs) Required collateral based upon insurer s calculation Large Deductible Plan Fixed costs include: Insurer profit Boards and bureaus Insurer G&A Collateral to Guarantee Payment of Losses within Deductible Fixed Costs Insured Insurer Paid Losses within Deductible Reinsurance premium Loss control costs Claim Payments Claimants 22 15

16 24 Captive Insurance Companies Reasons for Captive Formation Stability of pricing and availability Broader coverage Profit recapture Underwriting income Investment income Direct access to the worldwide reinsurance market Ceding commissions Profit sharing No claims bonus 24 16

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20 31 Single-Parent Captive An insurance subsidiary created by the insured that allows the firm to participate in the underwriting risk and investment profits associated with the firm s risk financing program. The captive is capitalized and premiums are paid to the captive. The captive will retain a level of risk and purchase reinsurance for limits in excess of its retention Single-Parent Captive: Funds Flow Capitalization & Premiums Insured Owner Insurance Premiums Return Premiums Shareholder Dividends Captive Reinsurer Fronting Security Reinsurance Premium Reimbursement of Loss Excess of Retention Claim Settlements Front/Excess Insurer Claimants 32 20

21 33 Group Captives Formed to provide the same benefits as single-parent captives Typically include a pooled layer of risk in excess of the member s retention Purchase excess insurance/reinsurance to limit risk Group purchasing power Homogenous group captives Heterogeneous group captives 33 21

22 35 Captive Utilization Top 10 Industries 1. Financial Institutions 2. Health Care 3. Retail and Consumer Products 4. Manufacturing 5. Power and Utilities 6. Construction 7. Transportation 8. Communications, Media, and Technology 9. Chemicals 10. Mining, Metal, and Minerals Source: Marsh Risk Solutions Captive Insurance Companies Line of Business Underwritten 1. Property, Business Interruption, and Supply Chain 2. Workers Compensation and Employers Liability 3. Commercial General Liability 4. Auto Liability 5. Professional Liability 6. Employee Benefits Source: Marsh Risk Solutions

23 Using Benefits To Diversify Captives Interest in funding benefit risks in captives is increasing, with significant room to grow among existing captive owners. 12.0% 8.3% 5.3% 5.3% 4.5% 4.3% 4.5% 5.3% Already writing Likely in next 3 years Medical stop-loss Disability Life Accident and health TOP EMPLOYEE BENEFIT RISKS IN CAPTIVES Source: Captive Insurance Companies Association 14th Annual Captive Market Study, March Used with permission. 37 Total Captives Worldwide 4,951 5,119 5,211 5,525 5,587 5,831 6,125 6, Source: Business Insurance, March Used with permission

24 39 Leading Captive Domiciles: (1) Restated. Source: Business Insurance, March 5, # of Captives Rank Domicile Bermuda Cayman Islands Vermont Guernsey Barbados Anguilla Luxembourg Utah British Virgin Islands Hawaii 167 (1) Leading Captive Domiciles by State: Source: Business Insurance, March 5, # of Captives Rank Domicile Vermont Utah Delaware Hawaii District of Columbia Nevada South Carolina Kentucky Arizona New York

25 Predictions for Captives Captive premiums are estimated to be 25% of the commercial market. Captive underwriting profit will continue to outpace the commercial market. Captives have proven their value over time and are a strategic tool utilized in overall enterprise risk management. 41 Contact Information Michael J. O Neill, CPCU, ARM, CRIS President & CEO American Contractors Insurance Group Tower North Central Expressway, Suite 800 Richardson, TX Phone: (972) Mike.ONeill@ACIG.com 42 25

26 Notes This file is set up for duplexed printing. Therefore, there are pages that are intentionally left blank. If you print this file, we suggest that you set your printer to duplex. 26