Captives

1
Captives Alternative or ObstacleBusiness Case

• Charlie Woodman, CPA
• SVP, Risk Finance
• Marsh
• CAS Annual Meeting
• November, 2003

2
Captive Insurance Company - Forms

• Single Parent - Non Risk Pooling
• Wholly-owned / Rent-A-Captive / Trusts / etc.
• Emphasis on Risk Funding and Cost / Funding
  Efficiencies
• Group Owned- Risk Sharing / Risk Pooling
• Group, Association Captive, Risk Retention Group
• Emphasis on Risk Transfer replacement /
  Alternative insurance
• This distinction is critical in assessing the
  merits of a program.

3
Current Captive Insurance Program Emphases

• Cost Savings
• Risk Management Facilitation
• Business Enhancement
• Insurance / Risk Transfer Replication (Group
  Emphasis)

4
Cost Savings

• Long-term Seasoning / Risk Management Point
  Facility
• Short-term Business Case

5
Seasoning

• Seasoning / Risk Management Point Facility
• Extends the Corporate Risk Management
  Commitment to Its Own Risks
• Engages in Insurance under the Insurance
  Industrys Mechanisms and Measurements
• Regulated and Grounded
• Reinforces Relationships with (Re)insurance
  Markets
• Hard to quantify / Theoretical in Many
  Instances

6
Business Case

• NPV of Cash Flows - Short Term Business Case cost
  Savings
• Accelerated Tax Benefits - Qualified Insurer
• State ( International) Tax Arbitrage
• Operating Costs
• Opportunity Cost of Capital
• Other Quantitative Qualitative

7
Tax Reality

• The underlying issues which define whether an
  insurance transaction has occurred or whether a
  transaction is self-funding are
• Insurance Risk - Insurer must assume a
  reasonable possibility of incurring significant
  loss.
• Notions of Risk - Form
• Risk Transfer / Risk Distribution - Risk of loss
  must be legally transferred from one legal entity
  to another, which pools the risk among other
  risks so as to increase predictability, and
  reduce adverse loss uncertainty.

8
Accelerated Tax Benefits - Qualified Insurer

• Insurance Premiums are Deductible over the policy
  term
• Casualty losses are subject to Economic
  Performance for tax
• Accounts and set-asides are not economic
  performance
• Incurred Basis (incl. IBNR) vs. Paid Basis
• SubChapter L of the IRC
• Accelerated Recognition, not an accelerated
  realization
• i.e. Already recognized for financial reporting
• No above the line accounting benefit
• Consolidated Cash Flow Benefit
• Note Basis of tax benefit is actual premium
  deduction from insured to Group Captive

9
Tax Facts Circumstances
10
Tax Facts Circumstances
11
Other Business Case Components

• State ( International) Tax Arbitrage
• Operating Costs
• WACC / Opportunity Cost of Capital
• Capitalization
• Losses as Premiums
• Discount rate on enhanced cash flows
• Other Quantitative Qualitative
• (Re)insurance
• Internal Costs Resource Commitment
• Recognitions and Materiality

12
Captive Operating Costs

• Start-up
• Fronting, if applicable.
• Management
• Measurement Audit Actuarial
• Legal Regulatory
• (Re)insurance
• Pools and Participations
• Premium-based Taxes
• Direct / Reinsurance
• Federal Excise Taxes
• Self-procurement / Direct placement.

13
Design Components and Issues

• Coverages
• Structure
• Direct Writer
• Reinsurer
• Capitalization Collateral
• Domicile
• Cost
• Regulatory
• Other
• Premiums Operating Expenses
• Premium Taxation

14
Underwriting

• Traditional risk
• Professional Liability/Medical Malpractice
• Workers compensation, auto and general liability
• Products/completed operations, errors
  omissions, environmental
• DO, Surety, Property?
• Employee Benefits

15
Program Evaluation or Feasibility

• Risk Assessment / Self-Assessment
• Insurance Marketplace
• Risk Quantification
• Qualitative Issues
• Pro Forma
• Structure Design
• Time - Urgency versus Commitment
• Capital
• Cultural