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Future-Proofing Your Captive August 7, 2018 Karin Landry, CEBS, ACI, CLTC, Spring Consulting Group Tracy Hassett, edhealth Andrew Baillie, The AES Corporation 2018 VCIA; Speaker materials used by VCIA under license.
Future-Proofing Your Captive 4
Live Content Slide When playing as a slideshow, this slide will display live content Poll: Do you have a captive? 5
Live Content Slide When playing as a slideshow, this slide will display live content Poll: What are the factors that concern you most about your captive's future? 6
Is The Captive Well Positioned? Recommend each captive be reevaluated for its risk appetite & exposure at least every 5 years to answer the following: Are we still writing the right lines in the captive? Are we still in the right domicile? Would a different structure be more appropriate? Have our claims changed significantly? 7
Live Content Slide When playing as a slideshow, this slide will display live content Poll: How long has your captive been in operation? 8
Refeasibility Driver: Tax Reform & Changes Tax rate reduction has had a direct impact A consolidated tax return that includes a captive insurance company should have its tax sharing agreement reviewed Payments to a foreign captive should be reviewed to determine if the BEAT is applicable US persons that own an interest in a foreign insurance company should review their holdings IRS Notice 2016-66 9
Refeasibility Driver: Emerging Risks Cybersecurity Terrorism Geopolitical Climate / Natural Disasters Technological Advancements (i.e. Blockchain) 10
Refeasibility Driver: Case Law on Insurance Relevant, recent cases: Avrahami Reserve Mechanical Insights on what the IRS and the courts believed would meet the criteria for being an insurance company Backlog of other new cases 11
Refeasibility Driver: Regulations Factors to consider Is the transaction, an insurance in the common sense of the word? Is the captive created for non-tax business reason? Is there no circularity to the flow of funds? Is comparable coverage available in the market? Does the captive face actual exposures and insurance versus business risk? Is the captive adequately capitalized? Does it meet the regulatory and statutory requirements? Premiums? Are the policies valid and binding? Claims process and other key points 12
Refeasibility Driver: Regulations Domicile review Existing domiciles are continuing to update regulations essential to stay up to date New domiciles are being established evaluate benefits of redomiciling? Consider implications of Dodd Frank self procurement tax 13
Achieving Risk Distribution 14
Risk Distribution - Revenue Rulings Revenue Ruling 92-93 concluded that certain employee benefits program, specifically Life insurance, written in a captive is unrelated business (third party) since it is insurance for the employees and their beneficiaries and not for the company Revenue Ruling 2002-89 indicated a captive with 50% of its risk in third party business qualifies as an insurance company [Safe Harbor] Captives writing less than 50% may still qualify Revenue Ruling 2002-90 validated the insurance status of brother-sister arrangements The IRS confirmed that premiums paid by 12 operating entities to a captive are deductible Only a small portion (from 5% to 15%) of the captive s total risk should be from any one entity 15
Risk Distribution - Relevant Case Laws Rent-A-Center (RAC) Tax Court Decision U.S. Tax Court opined that payments which are made by a parent company to a subsidiary insurance company in lieu of premium to insure other wholly owned subsidiaries shall be considered a deductible expense The judgment is a milestone in captive insurance as it sets precedence in accepting risk sharing among members of a consolidated group. A majority of the judges in the case of RAC accepted the Brother- Sister relation among entities sharing risk 16
Risk Distribution Relevant Case Laws cont. Securitas Holdings Inc. U.S. Tax Court issued a memorandum opinion, that payments made to a brother-sister insurance company were deductible as insurance premiums It was held that related corporations were entitled to deduct as insurance premiums the amounts that their parent paid on their behalf to a sister entity The Court re-emphasized its view that risk shifting for a subsidiary is not vitiated by its parent s guaranty of the captive s performance and that risk distribution requires a multitude of statistically independent risk exposures, not a multitude of separate corporate insureds 17
Live Content Slide When playing as a slideshow, this slide will display live content Poll: Have you given a fresh look at your loss control program? 18
edhealth: A Case Study 19
edhealth Overview 14 educational institutions ~12,000 covered employees 24,000+ total lives Benefits paid exceed $149 million annually Retained over $5.2 million in savings in the captive that would have gone to commercial carriers $4.4 million in Rx rebates in the first year of carveout 20
edhealth Captive Structure 21
edhealth: Correlation of Risks Regulatory Changes National Regional State Mergers and Acquisitions Containment of High Cost Claims Political 22
edhealth Evolution Started out minimizing stop-loss Then returned premiums to members Now working to minimize claims Reducing Fixed Costs is Not a Long Term Solution WE MUST CONTINUOUSLY ANALYZE OUR DATA AND ADJUST OUR PROGRAMS TO MEET THE NEEDS OF OUR MEMBERS/OWNERS 23
edhealth: Forward-Thinking Using growth in surplus and membership to keep most of the risk inside the captive moving from a $500K spec to a $750K spec for the excess stop-loss resulting in increased savings to the captive members Prescription drug carve-out and the data analytics (population health management) simpler as it was 2 carriers for dental and prescription and now there s a 3 rd carrier, some schools have moved between carriers, and now edhealth is using a national carrier Decision to put this all on the same analytic platform they are in the process of implementing that Thinking about future voluntary benefits: vision and dental 24
edhealth Case Study: Wheaton College In 2011, Wheaton s health claims ran at an 89% loss ratio, and at 83% in 2012 Data showed they could save money by moving to a self-insured, group captive structure, so they did in July 2013 Savings on administrative and stop-loss costs through economies of scale Involved an up-front fee (through premium and a capital contribution) that covered the first year of claims no matter what Five years in, it s been calculated that the decision saved Wheaton an estimated $3.8 million about 16% of their estimated fully-insured spend 25
edhealth Case Study: Wheaton College Pleased with their initial results, edhealth started looking into other cost-savings strategies Along with the other edhealth member schools, Wheaton carved out pharmacy as of January 2017 This saved them an estimated $265k, or 27% of their Rx spend in the first year Also in January 2017, Wheaton switched TPA s to save $8 PEPM - $35k annually 26
The AES Corporation 27
The AES Corporation current overview
The AES portfolio of risks
Future Direction for AES 41% of fleet MW down to 29% Workforce reduced from 25,000 to 9,000 Countries reduced from 35 to 16
AES Global Insurance Company (AGIC) Domicile Vermont, Formed 2002, started writing in 2003 Rated B++ by AM Best, acts as Reinsurer behind local fronting in all cases Large limit global program, Property Damage / Business Interruption including substantial Natural Hazard exposure and aggregation Substantial asset portfolio of over $55bn being insured Innovation in areas of Self Managed Risk Engineering program Finding efficiency in fronting arrangements Global first in coordination of damage, terrorism, and cyber perils for energy risks Other minor lines added in recent years Profitable results over 15 years
AGIC successes and challenges Successes 1. Profitable record 2. Ability to manuscript coverage form and create new cover 3. Meeting lender and stakeholder needs 4. Risk Engineering as Primary tool 5. Handling losses 6. Market reputation as primary underwriter Challenges 1. Profitable record 2. Determining risk levels in Captive and optimum reinsurance purchase (including NAT CAT and other Stop Loss tools) 3. Constantly changing fleet location and fuel types 4. Managing country regulations and currency risks 5. Internal expectations on program performance and adding more lines of cover for the same results 6. Cash management for premiums, claims, reserves etc. 7. Managing expense ratios
Miami Valley Insurance Company (MVIC) Domicile Vermont, Formed 1986, started writing in 1986 Subsidiary of a Regulated Utility asset in Ohio that was bought by AES in 2011 Multiple lines of business including property, BI, WC, casualty, Auto, D&O, environmental, T&D and replacement power Moderate limits carried for each line but also moderate premiums Gradual erosion of premium base over time with only minimal premium now remaining Substantial loan to parent on the balance sheet Profitable results in early years but more variable since Large proportion of IBNR reserves on balance sheet
MVIC successes and challenges Successes 1. Profitable record for early years built up reserves 2. Meeting cover gaps market could not fill 3. Reasonable Captive Costs accepted for Rate Case Challenges 1. Long tail risk liability in casualty, WC and environmental 2. Inflation impact on loss reserving 3. Change in regulated environment changes fundamental business models 4. Maintaining adequate spread and volume of risk 5. Managing costs as premium levels reduce 6. Balance sheet challenges due to parent debt structures
Ongoing Captive Review & Maintenance Align with Risk Management & company strategies ERM Acquisition Activity Consider BOD and officer engagement/involvement Captive usage should change with the business Challenges within the company can be solved/mitigated with the captive 35
QUESTIONS? 36
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