A Captive Primer: What they are and how they work. Educate Evaluate Elevate

Transcription

1 A Captive Primer: What they are and how they work Educate Evaluate Elevate

2 Presentation Objectives History of captives & what they are How captives are used & what makes a good prospect The Captive Wrap Program Risk Management & TCOR Key Ingredients of an Insurance Company Reinsurance Various captive structures & expense with a focus on Delaware Single Captive Platform Multi-Captive Platform Start-up vs. Annual Expense Summary of the captive process

3 History of Captives Captives first used in 1700 s in Europe Three main markets: Europe (Isle of Man, Guernsey, etc.) Offshore (Bermuda, Cayman, Nevis, etc.) USA (Delaware, Vermont, Oklahoma, etc.) 30+ states currently have captive legislation Why captives now for the small-mid sized companies?

4 The Captive Wrap Program

5 Continuum of Risk Unfunded Self Insurance Guaranteed Cost/ Fully Insured Retro Plan/ Experience Rated Deductible Plan/Stop Loss or Excess Captive P&C Benefits Equivalent Term

6 What is a Captive? An insurance company you (the insured) own and control Can be domiciled on or offshore Ownership typically defined by the captive structure NOT intended to totally replace a commercial insurance program Various captive structures include: Risk Retention Groups Associations or trade groups Groups of homogenous risk Pure (Single Parent) Reinsurance of another insurance carrier (captive or commercial) Enterprise Risk Captive (most elect 831(b))

7 What Makes for a Good Captive? Clear understanding of your own risks & loss history A belief (based on facts) that the program would be profitable over time Sufficient risk to support the captive premium rule of thumb is 10:1 sales to premium captive cannot create NOL Good analytics for quality underwriting standards & pricing Expert captive design, management & efficient operations Owners committed to paying appropriate premiums for multiple years Captives are NOT short-term options

8 Key Ingredients Pay Claims Adequate Capital Legitimate Governance Must Have Transfer Credible Service Providers Legitimate Business Reason (Real Risk) What is a Captive Insurance Company? CANNOT be just for Tax Benefit!! Legitimate Asset Investment Must Have Distribution Domicile Credibility Quality Reinsurance Conservative Parental Guarantees or Loan backs

9 How is a Captive Used? Deductible reimbursement & Difference in Conditions (DIC) Raise deductibles and retentions to retain more profit and cut commercial insurance premiums DIC - covers exclusions and deductibles in your commercial policies, as well as excess verdicts above your commercial limits Risk that is too expensive in the commercial market & uninsured exposure Key Contract/Key Employee Business Litigation Product Recall Employee Related Practice Liability/D&O Supply Chain Risk Business Interruption Provide efficient and effective asset management

10 Enterprise Risk Management (ERM): Total Cost of Risk (TCOR) Overview: TCOR is the in-depth evaluation of exposure, loss, underwriting and use of capital to reduce risk. The idea of TCOR has been around since the 1940 s. Traditionally defined: Cost of insurance Cost of the losses that are retained instead of transferring out, or as part of your organization for example, risks the policy doesn't cover, or a company's deductible Cost for administration of the risk management department (whether you think you have one or not) TCOR goes beyond just insurance it s hiring and retaining the best internal resource, cost of third party service providers (attorneys, CPA s, etc), payroll perpetuation planning, reputational risk, supply chain risk, and technology or social media risk

11 Key Factors to Determine Insurance Transfer & Distribution Adequate Capital Statutory capital vs. risk capital By end of year, 3:1 premium to surplus ratio Risk Transfer Must involve shifting of risk (not just a bank account) Must involve significant chance of a significant economic loss (use of independent, outside actuary) Risk Distribution Unrelated Risk Model ü At least 50% unrelated risk - Revenue Ruling ü At least seven unrelated entities (Group Captive) - Revenue Ruling Brother-Sister Model ü 12 or more insureds - Revenue Ruling ü Each risk must have between 5% and 15% of the overall exposure ü Limits on the types of corporate entities that can be counted

12 Reinsurance Purpose Protect captive against catastrophic loss Preserve Capital Risk Transfer Risk Distribution 51% of Premium Your Captive $650k excess of $300k is yours $300k excess of $50k is reinsurers $50k is yours Structure Cost is 6% of Ceded Premium (which is 51% of Gross Premium) On $1M limit, reinsurance pays $300,000 (see diagram) Only 10% cash is held as a deposit in trust account Captive Participants Captive Participants Reinsurance Captive Participants Stop Loss Reinsurance Policy with AM Best A-rated carrier

13 831(b) Tax Election For Actual Insurance Company s Only $1.2M or less in NET premiums written Underwriting profit not taxed ONLY taxed on investment income May be onshore or offshore (offshore requires 953(d) election) Administrative expenses not deductible (except those having to do with managing investments) Claims not deductible Net operating loss not allowed to carry over Due to attribution in a control group, structure is critical Investments are allowed like any type of captive Most effective in low frequency/ high severity risk models In our opinion, the 831b election has been seriously abused by promoters that are exclusively pushing the tax benefits of the captive. They are not focused on the insurance and risk management aspects of the captive. This will not hold up.

14 Captive Structures Educate Evaluate Elevate

15 Single Parent (Pure) Captive Use Examples Reimburse retentions Insure low frequency high severity coverage Insure risk of multiple divisions or subsidiaries of the operating business If standalone, statutory capital in DE is $250,000 If a Series, statutory capital in DE is $50,000 Individual or Company Captive Typical Coverage Examples Loss of Key Contract/Employee Difference in Conditions General Liability EPLI/D&O Business Litigation Reputational Cover Builders Risk Prop/Auto Ded Products/Comp Ops Code Change

16 The Series LLC Captive Why a Series Model? Speed of Implementation Typically more cost effective: Mgmt Fee Audit/Actuarial Fee Premium Tax Lower barrier to entry the cell may use the sponsor s statutory capital until it grows its own Great for business affiliates Insured-owned Series Captive A $50,000 in Statutory Capital International Risk Insurance Company (CORE) Insured-owned Series Captive B Reinsurance Program Each Captive cedes 51% to Reinsurer Reinsurer sends back (retrocedes) 51% back to Captive $250,000 in Statutory Capital Insured-owned Series Captive C

17 For more information, contact: Mike Spaan, CEO, InLight Risk Management Direct: Or Jerry Messick, CEO, Elevate Captives Direct: