Daniel Keough & Martin Brauch, CFA Innovative Captive Strategies, Inc. (ICS)

Transcription

1 Daniel Keough & Martin Brauch, CFA Innovative Captive Strategies, Inc. (ICS)

2 Alternative Insurance Markets: Assessing New Risk Management Tools

3 Agenda 1. Introduction to Innovative Captive Strategies (ICS) 2. Understanding risk financing (aka insurance) and the use of alternative risk financing strategies 3. Alternative Insurance Market Trends 4. Types of Captive Insurance Companies 5. Group Captives 6. Summary / Questions & Discussion

4 Innovative Captive Strategies (ICS) Founded in partnering with an independent agency in Des Moines, Iowa Focused on building national network of elite, privately-held agencies to deliver value and solution driven services Agency partners deliver traditional & some alternative insurance solutions ICS delivers independent consulting and alternative insurance solutions

5 Scope of Services Create and manage member-owned group captives, working with agency partners Homogeneous and heterogeneous Placement of over $100M of premium to the market annually Consulting and ongoing management for Single Parent Captives Rental Captives Association Programs Utilization of Non-Controlled Foreign Corporations for capacity accumulation programs Formed Mutual Fund owned by captives under management

6 ICS Clients Industry Sectors include Construction Manufacturing Convenience stores Health care (for profit and not for profit) Insurance agents Utilities Transportation

7 Understanding Risk Financing and the use of Alternative Risk Financing strategies

8 What is Risk Financing? A key component of risk management Ensuring that funds are available to pay losses Identifying risk taking capacity before losses occur The most common form of risk financing is insurance

9 Why is Risk Pre-Financed? To ensure ongoing ability to operate To stabilize product/service pricing To comply with statutory mandates Government encourages pre-financing risk it is in the public interest and has a legitimate business purpose

10 Why use Insurance to Pre-Finance Risk? Insurance allows for risk pooling Improved predictability of future losses Develop a premium to pay losses, expenses Distribution of loss costs between insureds Earn underwriting & investment profits Accumulation of risk bearing capacity Stabilize the cost of risk for pool participants Insurance also provides tax benefits..

11 The Tax Acceleration Effect Insured deducts premium as customary and normal business expense Self insured deducts loss when paid Premium insures losses that may be reported and paid in a future period The insurer is allowed to deduct reserves from income Discounted based on expected loss payout

12 The Value of Tax Acceleration Insurance Incurred Loss $100 Paid loss 20 Reserve 80 Discounted reserve 72 Current deduction 92 Value of deduction $36.80 (assuming 40% rate) Deferred tax asset $8 Non-Insurance Incurred Loss $100 Paid loss 20 Reserve 80 Current deduction 92 Value of deduction $8 Deferred tax asset $80 A timing difference but a permanent temporary benefit

13 Non-Tax Reasons To Use Insurance Fixed and allocable premium instead of paying an unknown amount of losses and expenses Cash flow and budget control Ability to charge ultimate loss costs in period incurred Premium includes provision for incurred but not reported losses Support for contract reimbursement, product/service pricing and management bonuses

14 Why Not Use Commercial Insurance? 3 concerns with fully insured (guaranteed cost) programs Cost High expense ratios and profit margins Control Claims Data Capacity Unavailability of coverage for unpredictable risks

15 What Are The Risk Financing Alternatives? Loss sensitive programs offered by commercial insurers Large Deductibles Self Insured Retentions Retrospective Rating Plans Other Loss Sensitive Programs Qualified Self-Insurance Captives

16 Large Deductible Plan Deposit premium based on exposure with a deductible credit (60% - 80%) paid at policy inception Losses under the deductible are reimbursed by the Insured after the Insurance Company pays the claim Potential elimination of premium taxes on losses Costs under deductible can be capped with an annual aggregate retention limit

17 Commercial Insurer Loss Sensitive Programs - Advantages Lower net cost than guaranteed cost plan, assuming favorable losses Incentive for Loss Control Programs Potential cash flow advantages and regulatory expense savings Insured programs backed by insurance company Security for employees, customers etc. Services (Claims Handling, Filings, Safety, etc.) handled by the insurer Unless mutually agreed to use a Third Party Administrator

18 Commercial Insurer Loss Sensitive Programs - Disadvantages The total cost may be higher if the claims are not managed The total cost may not be known until several years after the policy term ends (budgeting/accrual issue) Collateral Requirements Requirement to provide bank Letter of Credit (LOCs) or funded trusts in an amount equal to ultimate losses No tax deduction for collateral, only for paid losses and expenses

19 What Are The Risk Financing Alternatives? Loss sensitive programs offered by commercial insurers Large Deductibles Self Insured Retentions Retrospective Rating Plans Other Loss Sensitive Programs Qualified Self-Insurance Captives

20 Qualified Self-Insurance Insured does not purchase insurance or only excess stop -loss Insured assumes all responsibility for Claims Handling, Filings, Safety, etc. Maximum assumption of risk and services Subject to state approval Regulatory filings and collateral or bond requirements in each state where risks are located

21 Captive Insurance A captive insurer is a special purpose insurance company that has as its primary purpose the insurance or reinsurance of the retained risk of its owners or participants. Captive insurance is a risk financing mechanism used as an alternative to risk retention or commercial insurance

22 Alternative Risk Financing Summary Large Deductible Risk Increased Cost Can be lower Control Can be agreed upon with insurer Capacity Insurer Determines Qualified Self-Insurance Risk Highest Cost Can be lower Control & Capacity Yes, within state and other government/union regulations & contracts Captive Insurance Risk Increased Cost Can be lower Control Unbundled Capacity Captive & Insurers Determine Captive Types for various company sizes, coverage needs, cost/risk and control preferences

23 Alternative Insurance Market Trends

24 Alternative Insurance Market Trends Growth in Alternative Markets continues even with Softening insurance market Roughly 5000 captive facilities worldwide with steady growth in the past 20 years Domestic domiciles are seeing strongest growth RRGs continue to be popular (i.e. mature captives writing direct and healthcare opportunities) Reinsurance & fronting markets are becoming more competitive

25 Alternative Insurance Market Trends Build it and they will come group captive strategies have been largely unsuccessful Coastal properties (wind), silica, pollution, construction defect, and other uninsurable risks, continue to gain captive popularity Deductible Reimbursement Policies are very popular Longer buying cycle for group captive prospects, but still strong demand

26 Types of Captive Insurance Companies

27 Another Definition of a Captive An alternative form of insurance used to Reduce and/or stabilize the insured s long term cost of risk Increase the insured s control and access to capacity Will be the preferred alternative to risk retention or commercial insurance if insureds/owners have: Ability to retain risk Motive (and ability) to pre-fund losses

28 Types of Captive Regardless of size, captive owners/insureds need: Entrepreneurial spirit Desire to take control Financial ability to take risk - at least $250,000 per occurrence Commitment to loss control and safety improvement

29 Is Captive Insurance Tax Deductible? Tests established by tax courts, and IRS revenue rulings Is there risk transfer to the captive? Is there risk pooling and distribution? Does the captive operate like an insurance company? The accounting test FAS 113 Is there a 10% chance of a 10% loss under the policy or reinsurance agreement?

30 Types of Captives Owned by or affiliated with the insured Single Owner Captives Group Owned Captives Non-affiliated Rental Captives Segregated Cell Captives Questions to Consider Cost Premium vs. Net Risk Financing Cost Premium Size to support captive operating costs Ability to earn underwriting/investment income Control & Capacity Owner vs. Renter/Non-affiliated Premium Deductibility

31 Reasons For Feasibility Study Determine whether a captive will reduce costs, increase control or provide capacity Find out which type of captive and which domicile will best meet your objectives Explain what ownership and program structure will work All this is needed even for a rental captive

32 Group Captives

33 What is a Group Captive? A group of companies join together to form their own (re)insurance company. Members are both shareholders and policyholders. Ideal premium size is from $300,000 to $2,000,000.

34 Group Captive Flow $ $ $ Shareholder/Policyholder Agency Partner Retains: - - Cash Cash Flow Flow --Investment Investment Income Income --Profits Profits $ Policy Issuance Captive Insurance Co. Reinsurance Loss Control Service Claims Administration

35 Group Reinsurance Structure Umbrella $1,000,000 + $1,000,000 Workers Compensation & Employers Liability General Liability Automobile Liability/ Phys Dam Reinsurance Captive Insurance Company $250,000

36 Group Captive Structure Each Company has their own cell to fund for their own losses Severity Severity Claims Claims $75k-$250K $75k-$250K S e v e r i t y $250,000 A B C E F G H I J $75,000 Frequency Frequency claims claims $0-$75K $0-$75K F r e q u e n c y $0 $ per claim

37 Group Captive Company Structure Board of Directors Risk Control Committee Finance Committee Underwriting Committee

38 Premium Structure Captive Premium Fixed Expenses Fronting Reinsurance Taxes Claims\Loss Control Operating Expenses Captive Management Loss Fund Actuary Determines Exposure / History

39 Underwriting Risk for Reward Potential Assessment Second Frequency Fund Additional Dollars Paid The Risk Annual Premium Paid Loss Fund + Underwriting Profit The Reward Fixed Costs Operational Expenses 2FF + SF + FC = Maximum Premium

40 LOC & Capitalization Financial Considerations Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 LOC $25,000 Year 1 & 2 LOC Year 1,2 & 3 LOC Three Year Stack LOC Capitalization

41 Group Captive Considerations Capital Contribution Collateral Required Potential to Share Risk Potential for Assessment

42 Group Captive Underwriting & Investment Income Timeline Year 1 Year 2 Year 3 Year 4 Year 5 Ledger PY1 UW Income PY2 UW Income PY3 UW Income PY4 UW Income PY5 UW Income Ledger + Investment Income PY1 + Investment Income PY1&2 + Investment Income PY1-3 + Investment Income PY1-4 + Investment Income PY1-5 Cash Flow (PY1 Premium) (PY2 Premium) (PY3 Premium) (PY4 Premium) + Dividend % Per PY1 UW & PY1 Investments (PY5 Premium) + Dividend % Per PY1&2 UW & PY1&2 Investments

43 Summary Why Consider Alternative Risk Financing? Cost Control Capacity Additional Reasons for Group Captives Constant spotlight on risk management with accountability Group dynamics How Can You Proceed? ICS Consulting Two Phases: 1. Risk financing analysis 2. Implementation

44 QUESTIONS & DISCUSSION