a captive primer: what they are and how they work
TRANSCRIPT
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A Captive Primer: What they are and how
they work
Educate – Evaluate – Elevate
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• History of captives & what they are
• How captives are used & what makes a good prospectØ The Captive Wrap Program™Ø Risk Management & TCORØ Key Ingredients of an Insurance CompanyØ Reinsurance
• Various captive structures & expense with a focus on DelawareØ Single Captive Platform Ø Multi-Captive PlatformØ Start-up vs. Annual Expense
• Summary of the captive process
Presentation Objectives
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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?
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The Captive Wrap Program™
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Continuum of Risk
Unfunded SelfInsurance
Captive
DeductiblePlan/StopLoss or Excess
Retro Plan/Experience Rated
GuaranteedCost/Fully Insured
P&C
Benefits Equivalent Term
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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:Ø Risk Retention Groups
§ Associations or trade groups§ Groups of homogenous risk
Ø Pure (Single Parent) Ø Reinsurance of another insurance carrier (captive or commercial)Ø Enterprise Risk Captive (most elect 831(b))
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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
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What is a Captive
Insurance Company
?
Legitimate Business Reason
(Real Risk)
Must Have Distribution
CANNOT be just for
Tax Benefit!!
Must Have Transfer
Legitimate Asset Investment
Pay Claims
Legitimate Governance Quality Reinsurance
Credible Service Providers
Conservative Parental Guarantees or Loan backs
Adequate Capital Domicile Credibility
Key Ingredients
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How is a Captive Used?
• Deductible reimbursement & Difference in Conditions (DIC)Ø Raise deductibles and retentions to retain more profit and cut
commercial insurance premiumsØ 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 exposureØ Key Contract/Key EmployeeØ Business LitigationØ Product Recall Ø Employee Related Practice Liability/D&OØ Supply Chain RiskØ Business Interruption
• Provide efficient and effective asset management
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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:
Ø Cost of insuranceØ 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
Ø Cost for administration of the risk management department (whether you think you have one or not)
Ø 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
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Key Factors to Determine InsuranceTransfer & Distribution
Adequate CapitalØ Statutory capital vs. risk capitalØ By end of year, 3:1 premium to surplus ratio
Risk TransferØ Must involve shifting of risk (not just a bank account)Ø Must involve significant chance of a significant economic loss (use of
independent, outside actuary)
Risk DistributionØ Unrelated Risk Model
ü At least 50% unrelated risk - Revenue Ruling 2002-89ü At least seven unrelated entities (Group Captive) - Revenue Ruling
2002-91Ø Brother-Sister Model
ü 12 or more insureds - Revenue Ruling 2002-90ü Each risk must have between 5% and 15% of the overall exposureü Limits on the types of corporate entities that can be counted
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Reinsurance
PurposeØ Protect captive against
catastrophic lossØ Preserve CapitalØ Risk Transfer Ø Risk Distribution
StructureØ Cost is 6% of Ceded
Premium (which is 51% of Gross Premium)
Ø On $1M limit, reinsurance pays $300,000 (see diagram)
Ø Only 10% cash is held as a deposit in trust account
Stop Loss Reinsurance
Policy with AM Best A-rated
carrier
Captive Participants
Captive Participants
Captive Participants
Reinsurance
Your Captive
51% of Premium
$650k excess of $300k is
yours
$300k excess of $50k is reinsurers
$50k is yours
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831(b) Tax ElectionFor Actual Insurance Company’s Only
Ø $1.2M or less in NET premiums writtenØ Underwriting profit not taxed – ONLY taxed on investment incomeØ May be onshore or offshore (offshore requires 953(d) election)Ø Administrative expenses not deductible (except those having to do with
managing investments)Ø Claims not deductibleØ Net operating loss not allowed to carry overØ Due to attribution in a control group, structure is criticalØ Investments are allowed like any type of captiveØ 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.
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Captive Structures
Educate – Evaluate – Elevate
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Single Parent (Pure) Captive
Captive
Individual or Company
Typical Coverage Examples
Loss of Key Contract/Employee
Reputational Cover
Difference in Conditions
Builders Risk
General Liability Prop/Auto Ded
EPLI/D&O
Business Litigation Code Change
Products/Comp Ops
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
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The Series LLC Captive
Why a Series Model?
• Speed of Implementation• Typically more cost
effective:Ø Mgmt FeeØ Audit/Actuarial FeeØ Premium Tax
• Lower barrier to entry – the cell may use the sponsor’s statutory capital until it “grows its own”
• Great for business affiliates
International Risk Insurance Company
(CORE)
Insured-ownedSeries Captive “A”
Reinsurance ProgramEach Captive cedes 51% to Reinsurer
Reinsurer sends back (retrocedes) 51% back to Captive
Insured-ownedSeries Captive “B”
Insured-ownedSeries Captive “C”
$50,000 in Statutory Capital
$250,000 in Statutory Capital
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For more information, contact:
Mike Spaan, CEO, InLight Risk ManagementEmail: [email protected]: 405.443.2012
Or
Jerry Messick, CEO, Elevate CaptivesEmail: [email protected]: 405.769.8659