The True Value Proposition of Captive Insurance Subsidiaries

Transcription

1 The True Value Proposition of Captive Insurance Subsidiaries ABC s of Captive Insurance - SIIA Richard W. Wright, SVP, Willis Captive Consulting Practice Richard (Dick) Goff, Managing Member, The Taft Companies LLC September 23, 2009 WORKING DEFINITIONS Value: (n) A fair return or equivalent in money, goods, or services for something exchanged. Vanity: (n) Something that is vain, empty or useless. 1

2 CAPTIVE INSURANCE SUBSIDIARY An insurance company in which its owners are its insureds. Value: Vehicle to drive risk management / risk finance efficiencies and Best Practices. Vanity: Because everyone has one. I think we need one. Captives are part of the standard risk management toolkit. CAPTIVE INSURANCE COMPANY A closely held insurance company controlled by its owners: Offering insurance products or reinsurance support to its owners as the principal beneficiaries. The owners-policyholders actively participate in decisions influencing underwriting, operations and investments. Incorporated, Regulated, Capitalized and Accountable May or May Not be a replacement for insurance. Depends on Form (ownership and insured relationship) Physically Unimpressive: No Buildings, Filing Cabinet, Bank Accounts, Managed by Third Party Professionals, etc. 2

3 WHERE CAPTIVES FIT INTO THE RISK FINANCE EVOLUTION Risk transfer Insurance purchasing Contract assessment Rely on broker Limited Captive Use for Risk Management Risk transfer with limited risk assumption Risk assessment Structural risk financing skills Basic Analysis Emergence of Consultants Growth of Captives as engines for risk assumption by corporate parent Growth in Group Captives for Alternative Insurance Transfer/Retention/Capital Market structure Risk evaluation Larger risk self-assumption Total Cost of Risk Portfolio approach Capital markets method EPS/P&L impact Self-relevance and new consulting Emphasis on the captive as a flexible strategic platform. Skill Sets MANY TYPES OF CAPTIVES, HOWEVER Pure Single Parent Related Business Single Parent Unrelated Business Single Parent Captive of Insurer Association Captive Multi-Owner Captive Healthcare Captive Life Insurer Single Parent Rent-a-Captive Risk Retention Group Self Insurance Groups Reciprocals Agency Captive Special Purpose Vehicles Protected Cell Captive Producer Owned Rented Captive 3

4 CAPTIVES BOIL DOWN INTO TWO GENERAL FORMS Single Parent - Non Risk Pooling Wholly-owned / Rent-A-Captive / Trusts / etc. Emphasis on Risk Funding and Cost / Funding Efficiencies Group Owned- Risk Sharing / Risk Pooling Group, Association Captive, Risk Retention Group Emphasis on Risk Transfer Replacement / Alternative insurance This distinction is critical in assessing the merits of a program. SPECTRUM OF RISK FINANCE Risk Transfer Risk Funding First Dollar Risk Transfer Guaranteed Cost Group Captives Pools RRGs Reciprocal Exchanges Single Parent Captives Rent-a-Captive / Cell Facilities Self-insurance Trusts 4

5 SINGLE PARENT CAPTIVE REALITY A Single-Parent Captive Insurance Subsidiary, insuring the risks of the parent and affiliated operating brother-sister concerns, is only self-insurance in its most sophisticated form. If a concern cannot afford to increase its risk retention levels without a captive, then they certainly cannot afford to assume more risk with one. Does anyone really need a captive insurance subsidiary? PROMISED OPPORTUNITIES The original pitch: A Captive will provide benefits by Improving coverage, capacity, cash flow and earning investment income to fund losses. Reducing or eliminating insurer operating costs and profits. Allowing greater control over claims. Providing direct access to wholesale reinsurance markets. Creating negotiating leverage with underwriters. Providing lower operating unit deductibles and incentives for loss control. Warehousing all the Company s risk in a central location. Maintaining an earnings buffer by shifting loss variability to the captive. Increasing tax planning efficiencies. Arbitraging tax to low tax jurisdictions. Facilitating the movement of funds across international borders Enhancing profitability through insurance underwriting of third party risks. Is it realistic? 5

6 CAPTIVE FOCUS / APPLICATION Cost Savings Long Term - Seasoning of a Property & Casualty Insurance Company to: Platform and enhance the placement of insurance coverage, terms and conditions Access or contract with alternative markets or reinsurers Short Term - Business Case / Cash Flow Efficiencies Discussed Later Risk Management / Program Facilitation Through risk retention, a dedicated subsidiary to avoid the cyclicality of traditional market Provide a vehicle for specialized coverages, custom forms Buy Down Deductibles of Subsidiaries or Operating units Stabilize or enable allocations and budgeting processes Help to insure to the organization s overall risk retention capacity rather than the various, smaller operating companies Business Enhancement: Profit Center Warranty / Service Contracts Credit-based SEASONING Seasoning / Risk Management Point Facility Extends the Corporate Risk Management Commitment to its own risks Engages in Insurance under the Insurance Industry s Mechanisms and Measurements Regulated and Grounded Reinforces Relationships with (Re)insurance Markets Hard to quantify 6

7 BUSINESS CASE NPV 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 INSURANCE TAXATION: BASIC Corporations can t deduct loss reserves Deduct fixed costs, risk transfer premiums, and only losses paid in the policy year Future losses deducted as paid in year paid Insurance companies can deduct loss reserves Advantage: take current year deductions for all losses paid, loss reserves & IBNR (reduced by IRS-imposed discount of 5.71%) What is the difference worth? NPV, after tax $2,000,000 $1,800,000 $1,600,000 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 $0 Timing of Tax Deductions Captive Insurance Co. vs. Self-Insurance Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Self-Insurance Captive Ins. Co. 7

8 TAX PLANNING The captive must qualify as insurance company for tax purposes Insurance Risk Nuance & Common Notions (Insurance Form) Risk Shifting & Risk Distribution Tax deductibility hinges on whether or not the captive is a bona fide insurance company Although there is no bright line test, case law suggests that at least 30% of the captives risk must be unrelated to the employer in order for the employer to take a deduction for premiums paid to the captive Alternatively, a captive that meets IRS requirements as a brother/sister captive (i.e., Humana structure) does not require unrelated risk Unrelated Risk / 3 rd Party Parent Sub Sub Sub Sub Sub Sub Outside Business Captive Deductible Balance Sheet Fact Pattern / Humana Parent Sub Sub Sub Sub Sub Sub Captive Not Deductible Deductible BUSINESS CASE NPV - 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 8

9 WHAT WERE THOSE PROMISED OPPORTUNITIES? The original pitch: A Captive will provide benefits by Improving coverage, capacity, cash flow and earning investment income to fund losses. Reducing or eliminating insurer operating costs and profits. Allowing greater control over claims. Providing direct access to wholesale reinsurance markets. Creating negotiating leverage with underwriters. Providing lower operating unit deductibles and incentives for loss control. Warehousing all the Company s risk in a central location. Maintaining an earnings buffer by shifting loss variability to the captive. Increasing tax planning efficiencies. Arbitraging tax to low tax jurisdictions. Facilitating the movement of funds across international borders Enhancing profitability through insurance underwriting of third party risks. Was this ever realistic? PROVIDING DIRECT ACCESS TO WHOLESALE REINSURANCE MARKETS. CREATING NEGOTIATING LEVERAGE WITH UNDERWRITERS What s Implied: Creating a captive opens the door to a whole new marketplace populated by magical reinsurers who shower coverage and broad terms and conditions at wholesale prices. Joining this fraternity will drive the traditional market nuts and they ll beg, borrow and steal to handle your programs. Reality: Time to wake-up Dorothy, Kansas is coming up on the right. Over time the captive becomes your commitment and your relationship to the marketplace. Comment: This takes time and commitment to Best Practices and longterm planning. 9

10 HOW (RE)INSURERS EVALUATE CAPTIVES AS RISK MARKETS Where domiciled How long in existence Strength of captive s financials Who manages captive Insurance program dynamics Actuarial support Owner proactivity and commitment PROVIDING LOWER OPERATING UNIT DEDUCTIBLES AND INCENTIVES FOR LOSS CONTROL. WAREHOUSING ALL THE COMPANY S RISK IN A CENTRAL LOCATION. What s Implied: Using a captive will now allow you to use formal allocation / internal transactions to operating subs. All the Company s exposures can be funded through a the captive effectively. Reality: You can already do that. Some coverages do not work well in captives without substantive planning and consideration. Comment: This is actually a very real benefit for many of our clients, however it s a soft dollar approach, and must be weighed against commitment costs. 10

11 MAINTAIN AN EARNINGS BUFFER BY SHIFTING LOSS VARIABILITY TO THE CAPTIVE What s Implied: Transferring loss exposures to a captive will shift the threat to earnings off balance sheet. Or The captive can create buffers or shock absorbers within its reserves. Reality: A captive subsidiary will consolidate for reporting purposes. SFAS 5 defines the parameters of contingency recognition and reserve maintenance. Comment: Any loss recognized by the captive, will be recognized as a period expense. INCREASING TAX PLANNING EFFICIENCIES. ARBITRAGING TAX TO LOW TAX JURISDICTIONS. FACILITATING THE MOVEMENT OF FUNDS ACROSS INTERNATIONAL BORDERS. What s Implied: The tax benefits afforded insurance as an active trade or business is a cornerstone to captive feasibility and should be a part of any comprehensive total tax minimization portfolio. Move income outside the US taxing jurisdiction. Reality: Accelerated tax benefits based on discounted cash flows. Forming a captive solely for tax avoidance is a no-no. Come on back, Rover. You can t hide from Uncle Sam easily. Some complexity to every strategy. Should be considered as part of the short term cost benefits in developing a Business Case. Comment: Real longevity. These can be very real depending on the facts and circumstances. The Service will look for abuse and target the benefits. Growth especially in State and Local Tax. 11

12 ENHANCING PROFITABILITY THROUGH INSURANCE UNDERWRITING OF THIRD PARTY RISKS. What s Implied: Insuring others can be a great source of new profits. Reality: Be very cautious Opportunities do exist for companies that can incorporate insurance offerings with enhance or augment customer value or relationships. Warranty / Equipment maintenance / Service contracts Comment: Coverages that are in your control. THE REAL VALUE PROPOSITION A seasoned insurance company / corporate-wide risk management vehicle to allow non-insurance concerns to opportunistically navigate the (re)insurance arena and nurture long-term relationships. A Risk Warehouse of containing and comprehensively executing organization-wide risk strategies. A manifestation of corporate commitment to new risk management thinking and disciplines. A Risk Bank A profit center for diversifying and / or differentiating its operating affiliates by offer value-added services / insurance products to customers. 12

13 THREE QUESTIONS 1. Can or has the captive delivered on its promised opportunities? 2. Can the captive undertake new opportunities? 3. What are the captive s future opportunities? WHAT ARE OUR CAPTIVE S FUTURE OPPORTUNITIES? Captives Should Be Opportunistic Entities A captive s return may be quantifiable, but it must be against realistic metrics More than just a going concern Some Areas to Always Keep An Open Eye Toward: Channeling Can we include more? Isolating Can we protect against? Sharing the wealth and risk empowerment Can we motivate? Access Can we reach more? Platform Can we support? Relationships Can we enhance? 13

14 WARRANTY (AND CYA STATEMENT) These discussions were meant to be general in nature. We at Willis, as risk management professionals, do have a layman s working knowledge of the tax and accounting issues associated with many risk financing arrangements. However, we do not provide legal, tax or financial reporting advice. Therefore, none of our comments in this area may be relied upon to be either accurate or indicative of probable outcomes when applied to specific facts and circumstances. QUESTIONS AND THANK YOU 14

15 Richard W. Wright Senior Vice President Willis Captive Consulting Practice 25B Vreeland Road Florham Park, NJ office: (973) cell: (973) Richard (Dick) Goff Managing Member The Taft Companies 901 Dulaney Valley Road, Suite 610 Towson, MD Office: (410)