Alternative Regulatory Structures for Pools What If Being A JPA Isn t Enough? Patrick Theriault, Managing Director, SRS Shawn Bubb, Director of Insurance Services, MSGIA Joel Kress, Underwriting Manager, GEM The full presentation can be viewed on Prezi.com at the following link: http://prezi.com/aee2ef0k3p6a/?utm_campaign=share&utm_m edium=copy&rc=ex0share 1
Captives 101 Definition: A closely held insurance company that is owned and controlled primarily by its insureds 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 Types of Captives Single Parent (Pure) Captive Group Captive Rent A Captive (condo captive) Agency Captive Branch captive Special Purpose Financial Captive 2
Types of Captives Single Parent (Pure) Captive Wholly owned by one parent company Formed primarily to insure or reinsure the risks of the corporate parent or unrelated parties of their choosing Group Captive Owned by two or more companies, often times affiliated through a trade association or homogenous group of companies Heterogeneous group captives are also available Formed to insure or reinsure the risks of the group Captive Risk Placement Structures Addresses most operational and regulatory issues Possible turnkey solutions More expensive Collateral concerns Exit strategy constraints Lower cost alternative No collateral requirement Possible distribution issues Tax considerations 3
Group Captive Structure Why a Captive? The main reason captives are formed is to increase the level of control over all facets of insurance. Increased control over: Ultimate Cost Premium Stability; Reduced cost/increased tax efficiency; Coverage Breadth; Claims Handling/Settlement; Loss Control; and Embedded Insurance Program Profit. Access wholesale reinsurance markets Complete insulation/separation from the commercial insurance market is challenging due to capital requirements. 4
Workers Compensation Employment Practices Liability Product & Professional Liability General Liability Auto Liability All Risk Property/Cargo Windstorm Captive Risk Uses Captive Risk Uses (continued) Errors & Omissions Liability Employee Benefits Long Term Disability Group Life Medical Stop Loss Any risk that can be quantified and is fortuitous with caveat that not all business risk is insurable. 5
Captive Decision Making Process Where Are Captives Formed? Leading Domiciles 2013 Active Licenses* Other Onshore Domiciles 2013 Active Licenses* Bermuda 831 Nevada 148 Cayman Islands 759 South Carolina 145 Vermont 588 Kentucky 128 Guernsey 344 Arizona 106 Utah 342 New York 48 Delaware 298 Missouri 35 Anguilla 295 Tennessee 32 Nevis 276 Alabama 27 Barbados 264 New Jersey 15 Luxembourg 225 Georgia 13 Hawaii 184 Oklahoma 11 Washington DC 172 South Dakota 9 Montana 150 Michigan 7 6
Key Domicile Decision Factors Regulator Experience / Consistency Regulator Accessibility Regulatory Flexibility willingness to listen and work collaboratively Frictional Cost Capital Requirements Physical Accessibility Eliminate Perception Issues Formation & Annual Operating Cost Cost of implementation post feasibility ranges from $10,000 - $25,000 and typically takes 30-60 days Management cost range based on complexity of structure, captive type, frequency of financial reporting and number of participants. 7
Captive Insurance Company vs. Pools Captive may be licensed by any domicile with enabling legislation Captive may insure risk anywhere Most domiciles allow captives to offer P&C, Life, and Employee Benefits Captive s may offer insurance to third parties Top captive domicile regulators want your business Common Misconceptions Captives are only setup for tax purposes Captives are a Risk Manager toy Captives = too much or not enough regulation Captives are very expensive to form and operate Captives require a significant man power commitment Captives are for large companies only 8
Potential Benefits of Using a Captive Increased investment flexibility Obtain a level of risk transfer for difficult to insure risks or layer of risks the market is not interested in Access to reinsurance market and group purchasing power Access to coverage not otherwise available (TRIA participation) Protection against political risk through management of risk via a regulated entity Tax Considerations for Not For Profits Opposite of For Profit Structures Interested in captive not being treated as an insurance company for tax purposes Avoidance of Unrelated Business Taxable Income Avoidance of premium tax Premium paid to captive treated as a capital deposit 9
Captive Caveats / Key Considerations 1. Captives require capital to begin underwriting $120,000 $250,000 base capital plus risk capital depending upon volatility of the underlying risk being insured. 2. Captives have annual operating costs of between $50,000 and $150,000 or higher for management, audit, actuarial certification and regulatory fees with ultimate cost a function of the underlying program complexity and domicile location. 3. Captives require a specific fact pattern to achieve insurance company tax treatment or NOT achieve insurance company tax treatment need to define both. Keys to Successful Captives Sense of urgency problem to solve or clearly defined objective Properly funded relative to risk profile Focus on loss control and claims management Long term commitment discipline to stay the course through markets cycles Strong business partners captive manager, claims service, actuary, banking and investment advisors 10
Keys to Successful Captives Clear understanding of the benefits and operational challenges Trust and transparency if sharing risk with other parties Operational efficiency Big Sky Re The Last Best Place for A Montana Captive MSGIA s Path to a Captive Why did we start a captive? Process of Incorporation Choosing a domicile Cost Benefit analysis of Captives 11
Why did we start a Captive? Country in recession Long term bond yields held at all time lows Dow Jones at 8,447 by June 2009 Investment returns for all excess carriers and pools dropping like a Montana thermometer in December. Excess rate increases a reality for all We did we start a captive? Primary Pool Entity Type Montana options Inter local Governmental entity Joint Powers Authority Inter local Authority Takes on the characteristics of the primary pool member (a school district) Only long term investment option is governmental bonds What this meant at July 2013 10 year bond yield 2.5% Current inflation rate 2.0% Net investment interest rate.5% 12
Why did we start a Captive? Economic Climate GASB 34 mark to market accounting Lots of volatility on the financial statement for a combination of timing valuation differences due to moving inflation rates and booking adjustments for maturing bonds with discounts/premiums to account for. The steps to getting started: Opportunities Arise Montana captive industry growing (150 as of Jan 2014) Minimum capital needed to start a WC captive is $250,000 Captives regulated by the Insurance commissioner Only investment restrictions for MT captives is not purchase investments that may threaten solvency Required to hold one meeting per year in the state of domicle and have an office with books and records. Other requirements 13
Big Sky Re How we formed Actuarial Feasibility Study conducted 1st choice type of Captive Pure single parent (simplest for us) Mutual or Stock company Started discussions with MT regulators Hit a major road block broadly worded enabling legislation. Big Sky Re How we formed Selection of 2nd domicile Start discussions with Arizona regulators Establish relationship with Arizona based law firm with captive experience Developed articles of incorporations and bylaws Filed an application and business plan with AZ Ins. Division Capitalized the banking & investment accounts for the captive Selected a claims TPA and captive manager Developed a coverage document Appointed a board of directors 3 from MT and 1 from AZ Established an office in Phoenix 14
Big Sky Re How we formed MSGIA's Workers' Compensation Excess Coverage Statutory Limits Statutory Limits xs $1,000,000 Traditional Excess Carrier $1,000,000 $250,000 xs $750,000 Big Sky Re. Captive Layer $750,000 MSGIA SIR $750,000 MSGIA Primary Pool Layer $0 The Cost Benefit Analysis: The Costs $144,000 expected claim losses and IBNR $25,000 Claims TPA & Captive Manager $15,000 Annual meeting costs $5,000 Financials and audit $5,500 AZ state licensing fees $2,000 Legal fees $5,000 Actuarial fees MSGIA had money and some choices 15
The Cost Benefit Analysis: The Benefits $274,000 Captive Investment Income $70,000 Excess cost savings primary pool MSGIA WC primary pool sitting with $18 million in surplus at June 30 2013. We really had no choice but to start the captive. The Cost Benefit Analysis: The Summary $500,500 Total Revenue ($202,000) Total costs Projected 1st year net income = $298,500 After $144,000 in IBNR for future losses Impact to the primary pool $142,000 Captive Net Income $298,500 less increase for primary pool excess of $156,000 = net gain to primary pool 16
Summary How the MSGIA benefited Higher overall investment return with a more balanced portfolio overall Options down the road to utilize the Captive to provide additional benefits not available to primary pool Lower long term net costs for excess insurance costs Increased regulation for overall operations which is not always a bad thing 17