The Feasibility Process

Transcription

1 The Feasibility Process Moderator: Derek Freihaut Principal and Consulting Actuary; Pinnacle Actuarial Resources Panelists: Patrick Theriault Managing Director; Michael Meehan Consultant; Milliman Strategic Risk Solutions

2 Agenda Refresher Captive Pre-Feasibility to Feasibility Study Actuarial Analysis Q & A 2

3 What is Captive? A Refresher Definition: A closely held insurance company that is owned and controlled by its insured(s) Characteristics A licensed insurance company Formed to insure or reinsure the risks of its owners or related parties of their choosing Regulated under special legislation regulating captives Located onshore or offshore Generally licensed in only one domicile non-admitted in all other jurisdictions Ø What a captive truly is: - A formalized form of self insurance 3

4 Why Captives are Formed - Reduce Cost of Risk - Underwriting Profits and Expense Reduction - Increase Control - Rates, coverage, policy wording, claims admn. - Lack of Available Coverage - Entrepreneurial Opportunities (third party risk) - Industry Bias (medical malpractice, trucking, etc ) - Tax Liability Management - Acceleration vs. Permanent Deferral - Estate Planning and Wealth Transfer 4

5 Captive Feasibility Process The steps in considering and forming a captive are: 1. Prefeasibility Discussion Are goals realistic any fundament issues? (Few hours to a couple of weeks) 2. Formal Feasibility Does it make sense for us? (60 days to more than a year) 3. Implementation Making the concept a reality! (30-90 days) 4. Begin Operations The steps should be considered sequentially and estimated costs range from: Pure Group 1. Prefeasibility Free $ 5,000 Free $10, Feasibility Study $15 50,000 $25-100, Implementation $10 30,000 $25-100, Ongoing Operation $80 200,000+ $100,

6 Prefeasibility Discussion/Meeting Many captives should not get past Step 1! Unrealistic client expectations/goals Traditional Insurance is a good deal Availability and cost of capital Bad tax fact pattern Need and cost of fronting Getting a decision or consensus 60% of prefeasibility calls/meetings result in decision not to proceed with feasibility study 6

7 Key Feasibility Concepts Economic benefit provided through use of a captive. Focus on materiality of benefit from captive. Regulatory impact of captive need to avoid subsidization and maintain arms length approach. Access direct or reinsurance and the implications of each approach. Rating or other insurance requirements. Study combination of tax benefits, if any, and cost of allocated risk capital and captive operating costs. Funding method impact on corporate budgets. Efficient use of funds investment approaches, including loanbacks, for captive assets and the impact on feasibility. Viability: study how captive facility will function under various loss and investment scenarios. 7

8 Common Deal Breakers Insufficient funding available or higher than expected expense ratio Differential between parent s rate of return on invested capital ( hurdle rate ) and lower rate of return on captive s investments Change in focus at the parent level Change in personnel Not getting buy-in of senior management early in the process Inability to achieve insurance tax status and premium deductibility or creation of taxable transaction for tax exempt organizations 8

9 Overall Feasibility Review The Foundation What risks is my organization facing? How best to manage my risks Retain, Finance, Transfer Best way to manage retained risks Pure self insurance, pure captive, group programs. Captive solution review Financial results, capital, domicile, tax, etc 9

10 Probability of loss Retention Strategy Insurable Risk Tolerance Level Insurable Risk Confidence Level MUST RETAIN CAN TRANSFER SHOULD TRANSFER IDENTIFY BOUNDARY Markets won t Insure or will charge excessive premium Earnings & working capital can sustain losses in this range Earnings & Equity Capital are sensitive to losses in this range Equity holders may be willing to chance a loss in this range Loss Value ($) Risk Retention Strategy Risk Transfer Strategy 10

11 Consider Alternatives How much to retain and what is the most efficient method of financing retained risk? Single Parent Captive Long-term Control Ownership Separate legal entity How much risk to retain Risk Financing Options Sponsored/Rent-A- Captive/Group Captive Turnkey operation No legal entity Ease of use Lack of control Based on: Financial Strength Market realities Long-term goals Self-insurance Utilize working capital Ease of use Can be capital efficient Exposure to volatility Collateral requirements 11

12 Actuarial Analysis Formal Feasibility Why is an Actuarial / Feasibility Study Necessary? What Goes into / Comes out of a Study? Evaluation of Results Ongoing Captive Needs 12

13 Why is an Actuarial / Feasibility Study Necessary? Forms the basis for measuring the financial viability of the proposed captive Helps to identify potential advantages and the potential risks of operating a captive insurance company» Risk Identification» Risk Quantification May be required for licensing/application process May be required for presenting to the reinsurance market 13

14 What Goes into a Feasibility Study? Basic Information Company specific» Goals» Constraints Operational» Account background» Management (claims and risk) Loss Information Electronic Detailed claim run Large loss listing (outliers) Exposures Historical and prospective (payroll, vehicles, sales, etc.) Descriptions/locations 14

15 What Goes into a Feasibility Study? Expense Analysis Will vary by» Type of program» Domicile Other Assumptions Challenges Single Entity Versus Group Program 15

16 Loss Analysis Review of Past Loss Experience Actuarial Adjustments Internal Factors (e.g. loss control) External Factors (e.g. laws) Loss Rate = Losses per unit of Exposure Expected Losses = Loss Rate x Expected Exposures Confidence Levels 16

17 Loss Analysis - Example Loss Accident Incurred Development Ultimate Exposures Adjustment / Loss Year Losses Factor Losses (in 00's) Trend Rate , , , , , , , ,000 1,000, Total 1,200,000 1,800,000 2,700, Selected Projected Exposures 1,200,000 Expected Losses 840,000 17

18 Expense Analysis Fronting Fees Reinsurance Claims Administration, Loss Prevention Commission & Brokerage Management Fees Legal, Audit, Actuarial, & Consulting Letter of Credit Other (Travel, Board Meeting, D&O) Taxes & Assessments 18

19 Expense Analysis - Example Expense Amount Fronting Fees 10.0% Reinsurance 10.0% Claims Administration, Loss Prevention 5.0% Commission & Brokerage 5.0% Management Fees 50,000 Legal, Audit, & Actuarial 40,000 Letter of Credit 10,000 Other (Travel, Board Meeting, D&O) 10,000 Taxes and Assessments & Fees 6,000 Note: Expenses expressed in % form represent % of premium 19

20 Other Assumptions (for Pro Forma Financial Projections) Premium Growth Capitalization - Amount and Form Rate of Return on Investments Loss Payout Pattern Income Taxes Adverse Scenario 20

21 What Comes Out of Feasibility Study Loss Rates/Loss Ratios/Premiums Expected Adverse Pro Forma Financial Statements Typically 5 Year Including loss payout projections Evaluation of Results 21

22 Premium and Loss Ratios Required Premium = Losses + Expenses + Contingency Margin Actual Premium: Based on Rates and Rating Plans Loss Ratio = Expected Losses Estimated Premium 22

23 Pro Formas Financial Analysis Various loss scenarios Various attachment points Various reinsurance structures Prospective pro forma financial statements 5 year prospective financial statements including income statement, balance sheet and cash flow Actuarially determined payout patterns Expected incorporation and ongoing expenses Investment modeling Surplus and capital contributions Reflect specific domicile(s) 23

24 Pro Forma Financials Income Statement 1/1/2014-1/1/2015-1/1/2016-1/1/2017-1/1/ /31/ /31/ /30/ /30/ /31/2018 UNDERWRITING INCOME Gross Written Premium 1,400,000 1,428,000 1,456,560 1,485,691 1,515,405 Net Earned Premium 1,260,000 1,285,200 1,310,904 1,337,122 1,363,864 UNDERWRITING DEDUCTIONS Loss and Loss Expense Incurred 840, , , , ,243 Expenses 396, , , , ,924 Total Underwriting Deductions 1,236,000 1,263,700 1,292,113 1,321,262 1,351,167 Net Underwriting Income 24,000 21,500 18,791 15,860 12,697 INVESTMENT INCOME Net Investment Income 20,345 38,866 50,069 57,983 64,388 Profit (Loss) Before Tax 44,345 60,366 68,860 73,843 77,085 Federal Income Tax (including deferred) 15,077 20,525 23,413 25,107 26,209 Net Income 29,268 39,841 45,447 48,736 50,876 SURPLUS Opening Surplus 1,000,000 1,029,268 1,069,109 1,114,556 1,163,292 Income for Period 29,268 39,841 45,447 48,736 50,876 Capital Contributions Ending Surplus 1,029,268 1,069,109 1,114,556 1,163,292 1,214,167 Net written premium/surplus Reserves/Surplus

25 Pro Forma Financials Balance Sheet 1/1/2014-1/1/2015-1/1/2016-1/1/2017-1/1/ /31/ /31/ /30/ /30/ /31/2018 ASSETS Cash and Short-term Investments 932,943 1,326,842 1,584,355 1,786,962 1,956,678 Letter of Credit 750, , , , ,000 Deferred Federal Income Taxes 30,732 53,455 69,239 81,005 89,988 TOTAL ASSETS 1,713,675 2,130,297 2,403,594 2,617,967 2,796,666 LIABILITIES Outstanding Loss and Loss Expense Reserve 638,598 1,017,940 1,249,841 1,417,802 1,547,306 Federal Income Taxes Payable 45,809 43,248 39,197 36,873 35,192 Unearned Premium Reserve TOTAL LIABILITIES 684,407 1,061,188 1,289,038 1,454,675 1,582,499 CAPITAL Initial Capital 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 Capital Paid In Income Earned 29,268 69, , , ,167 TOTAL CAPITAL 1,029,268 1,069,109 1,114,556 1,163,292 1,214,167 TOTAL LIABILITIES AND CAPITAL 1,713,675 2,130,297 2,403,594 2,617,967 2,796,666 25

26 Evaluation of Results Adequacy of Capital Adequacy of Reserves (for LPT) Adequacy of Premium Minimum Number of Participants Solvency Measurements Premium / Surplus Reserves / Surplus 26

27 How Much Start-Up Capital Is Needed? Will Be a Function of: Type of risk insured and limits provided Loss projections credibility Confidence funding level selected Collateral needs (fronted programs) Whether policies are assessable Access to additional capital funding sources (i.e. who is the captive s parent) Investment philosophy 27

28 Domicile Selection Consideration Domicile Reputation and Political Stability Domicile Regulatory and Service Provider Infrastructure Type of Risk Insured Tax and Accounting Consideration Cost of Operation Tax, Fees, Other Location and Ease of Access Relationship of Service Providers With Domicile Regulators 28

29 Ongoing Captive Issues Annual Loss Reserve Opinion Change in Business Plan Updated Premium Projections New Coverage Analyses Loss Layers / Reinsurance Analysis Capital Analysis Cost Allocation / Dividend Analysis 29

30 Questions? Patrick Theriault, CPA, CPCU, AIAF Mike Meehan, CIC, CRM Managing Director Consultant Strategic Risk Solutions Milliman, Inc

31 Thank You! 31