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Captive Fuel Growth for Agency Owners

Captives Create Income and Growth for Agencies

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Captive insurance companies provide an excellent format from which an insurance agency, MGA or other insurance intermediary, can achieve income and enhanced revenue opportunities in both a soft and hard market.

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Page 1: Captives Create Income and Growth for Agencies

Captive Fuel Growth for Agency Owners

Page 2: Captives Create Income and Growth for Agencies
Page 3: Captives Create Income and Growth for Agencies

The time to repair the roofis when the sun is shining.

John F. Kennedy

Page 4: Captives Create Income and Growth for Agencies

Captives Fuel Growth and Income for Agency Owners

Page 5: Captives Create Income and Growth for Agencies
Page 6: Captives Create Income and Growth for Agencies

3rd largest independentcaptive manager w/ 150captives*

$.250 billion in premiums

Fee-based only

US, Cayman, BVI, Anguilla,Nevis, Bahamas

3 rental captives for client use.

Enterprise solution w/ vastresources for fronting,reinsurance, 3rd party providers

Senior management owns firm.

. Independent Captive Manager Survey, 2009, Captive Review

Chris Kramer, MBA

SVP, Atlas Insurance, Ohio, with offices in Washington, DC

Former insurance agency owner.

XL Insurance (now X L Capital)

FM Global

Neace Lukens, Captive Insurance

MBA, Case Western Reserve University

BS/BA, Ins. & Risk Management, BGSU

Page 7: Captives Create Income and Growth for Agencies

First, some history…

How “old” are today’s modern captives? Youngstown Sheet & Tube’s captive formed in Ohio in mid-1950s andthen Bermuda in 1961. Who came up with the term “captive”? Fred Reiss, an insurance agent from Ohio. Why did Reiss form a captive? To reinsure a Lloyd’s property Insurance program. He was going to lose hisaccount and a captive would also use his expertise in risk management. Why Bermuda?Met a couple of lawyers from Bermuda at a meeting inSussex, England. What’s changed since then?Most everybody has heard of a “captive”. Originally used as expense/riskmanagement entities, today’s captives are increasingly used as profitcenters & by privately held businesses to help protect assets and transferwealth

Page 8: Captives Create Income and Growth for Agencies

Captives are making the news…

Captives to escape haven crackdown (BI 5/11/09)"There's nothing specific in the concepts that would seem

to impact offshore captives in any particular manner…"

Kentucky captive licenses increase by a third in Q1 (Captive Rev. 5/09)

“Kentucky has reported an excellent start to 2009, licensing 23 new captive insurance companies since 31 December 2008.”

Self-insurance cell captives a viable option for small firms (Bus. Day. 4/09)

“…used by medium and even some small companies - they are not there just for the major corporations.”

Page 9: Captives Create Income and Growth for Agencies

What is a Captive?

Definition 1960’s

An insurance company formed by its parent for thesole purpose of insuring the risks of the non-insuranceparent.

Currently

A limited purpose, licensed re/insurance company tomainly insure the risks of the captive’s owners, participants, or affiliates.

Page 10: Captives Create Income and Growth for Agencies

-10%

-5%

0%

5%

10%

15%

20%

25%1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006F

2007F

2008F

2009F

2010F

Note: Shaded areas denote hard market periods.Source: A.M. Best, Insurance Information Institute

1975-78 1984-87 2001-04

Captive Strategy

Why are Captives so popular? 5,500+

Captive Strategy

$50-60 Billion in premiums$150-60 Billion in Assets

Page 11: Captives Create Income and Growth for Agencies

Reasons are not always insurance cycles:

Provide Profits from UW and Investments

• Competitive advantage – Financial efficiency.

• Access to reinsurance

• Control or reduce claims costs

• Create asset protection strategies

• Facilitates flexible risk financing

• Tailor protection to unique risks

• Owners are getting access to education

• Transfer of wealth

Why are Captives so popular?

Page 12: Captives Create Income and Growth for Agencies

Captive Coverages

Traditional

• General Liability

• Workers’ Comp.

• Automobile

• Professional Liability

• Property

• Medical Stop Loss

• Directors & Officers

• Employee Benefits

Retained & Asset Protection• Deductible & SIRs• Legal Expense Reimbursement.• Loss of Key Client/Account• Administrative Action• Business Interruption• Intellectual Property• Machinery Breakdown• Political Risk• Patent Infringement• Employment Practices

Page 13: Captives Create Income and Growth for Agencies

Source: Marsh Survey Group

Manufacturing10%

Financial Institutions20%

Construction6%

Chemicals3%

Aviation and Aerospace

2%

Other7% Automotive

2%

Health Care11%

Life Sciences3%

Mining, Metals and Minerals

3%

Power & Utilities8%

Real Estate3%

Retails and Consumer Products

10%

Technology & Telecom

6%

Transportation6%

Captives by Industry

Fastest growing business segment using captives are the “Small and Medium Sized Business” (SMB)

• 99% percent of all independent businesses employ fewer than 500 people. Small (up to 100 employees) and Medium-sized (up to 500)

• Businesses are increasingly using a captive to manage risk, control insurance costs, create wealth and use pre-tax premium dollars to fund future liabilities.

Page 14: Captives Create Income and Growth for Agencies

Types of Captives

• Single Parent Captives - single owner, for whom they provide insurance coverage (70% of all captives are pure).

• Association/Group Captives - formed by an association or group to provide insurance coverage for members and/or policyholders.

• Agency Captives – business is produced by

agency. Owned by an agent, MGA or group of agents. These are formed by brokers or intermediaries for their clients or book of business.

Page 15: Captives Create Income and Growth for Agencies

Why an Agency Captive?

• Increase revenues in soft markets• Share in underwriting profits• Recover contingency income• Generate investment Income• Stabilize/establish insurer partnership• Keep key employees via equity in captive• Consolidate small books• Create new products/ancillary lines• Best Investment is your book

Why not? Agencies are businesses, too!)

Page 16: Captives Create Income and Growth for Agencies

The Good

Captive shares in the UW profit with carrier Gains investment income Captives access reinsurance/specialty cover Control expenses Gain leverage on

claims/administration/mitigation Can transfer wealth from business Can be used for funding buyouts

Page 17: Captives Create Income and Growth for Agencies

The Not So Good

Captive may require more capital for growth May require additional collateral Stress on scarce human resources

(governance) Underutilize possibilities/strategies Long (er) term commitment Accounting oversight

Page 18: Captives Create Income and Growth for Agencies

Agency

Agency-Carrier Organizational Chart

Policy Issuing Carrier

Captive

Policyholder

Captive Manager

Collects Premium

Underwrites Issues Policy Pay Claim

Captive Owner

Agency-Carrier-Captive Organizational Chart

Pay Commission

Reinsures to Captive

CaptiveProfits

FRONT Carrier

Investment Income

} Negotiable

Page 19: Captives Create Income and Growth for Agencies

50/50

Quota Share

Typical Agency Captive Structure

(1) Specific XS Reinsurance Layer

(2)Agg XS(3)GAP

Collateral

(1) The specific XS attaches above the captive’s retention per occurrence

(2) Aggregate XS (aka “stop loss”) provides accumulation protection

(3) “GAP” represents difference between Loss Fund and Agg attachment

1,000,000

$250,000

$125,000 $125,000

50/50

Quota Share

$250,000 of Risk

Agency Captive

Skin In the game

Skin In the game

Capital

Page 20: Captives Create Income and Growth for Agencies

Product Development… last hard cycle

• 2004 - Agency Captive for nursing homes.

• 10,000 beds, occ. form.• Capital by agency, clients,

investors.• MGA Commission 28%

– Producers 15%• Payback – 3 years

MGA Captive

Board of Directors

TPA

Risk Mgmnt

Admin

UW

Risk Purchasing

Group

Financial Summary*12/31/2008

Assets - $45,878,948 Surplus - $8,268,536 Premium - $18,527,828

CaptiveInsurer

Agency

Page 21: Captives Create Income and Growth for Agencies

Captive ExpensesCommission 15%

Reinsurance (100% net to captive) nil

Claims Administration (to MGA) 3%

Loss Control (to MGA) 1%

Taxes 3%

MGA management fee 15%

Total Expenses 37%

Loss Fund 63%

Total 100%

Losses estimated at 40%

Manage “fixed” expenses

23% est. profit margin

Page 22: Captives Create Income and Growth for Agencies

Agency Captive IllustrationProgram Pro forma (number rounded to highest 000s):

(A) Premium expected (1st year) - $10,000,000 @15% comm. or $1,500,000(B) Reinsurance costs (reinsurance provided by the carrier) – 20% of GWP or $2,000,000(C) Premium ceded to the captive (after reinsurance) – 2,000,000 (25%QS of $8,000,000)

(D) Captive expenses:

Commission paid to agency (was 15%) 18.0 % $ 360,000Claims, Loss Services 4.0 % 80,000Premium Audit, Taxes 3.5 % 70,000Fronting, Cell Mgmt 9.0 % 180,000 Total 36.5 % 690,000

(E) Premium allocated to Loss Fund (C minus D) 1,310,000(F) Losses incurred/IBNR(A times 35%) x (25% QS) ( 875,000)(G) Underwriting Profit (E minus F) 435,000 less 152,000 Tax(H) Investment Income (3% times E) 40,000 less 6,000 Tax(I) Total Income (G plus H) 475,000 Tot. 158,000(J) Net Income after taxes 317,000

Summary: (1) Commission Increase - $300,000, (2) underwriting profit - $435,000 (3) investment income - $40,000. Total ADDITIONAL income is over $775,000

Page 23: Captives Create Income and Growth for Agencies

BONUS - Business Owner IRC § 831(b)Uncle Sam offers one of the best tax benefits

for owners of small non-life insurance

companies - created onshore or offshore!

Federal Tax exemption on underwriting profits

subject to:

• $1.2 million in premium or less • Taxed only on investment income

Page 24: Captives Create Income and Growth for Agencies

Agency Captive Illustration – 831(b)Program Pro forma (number rounded to highest 000s):

(A) Premium expected (1st year) - $5,000,000@15% commission or $750,000(B) Reinsurance costs (reinsurance provided by the carrier) – 20% of GWP or $ 1,000,000(C) Premium ceded to the captive (after reinsurance) – 1,200,000 (25% QS of $4,000,000)

(D) Captive expenses:

Commission paid to agency (was 15%) 18.0 % $ 180,000Claims, Loss Services 4.0 % 40,000Premium Audit, Taxes 3.5 % 35,000Fronting, Cell Mgmt 9.0 % 90,000 Total 36.5 % 345,000

(E) Premium allocated to Loss Fund (C minus D) 655,000(F) Losses expected (A times 35%) x (25% quota share) ( 438,000)(G) Underwriting Profit (E minus F) 217,000 Zero Tax(H) Investment Income (3% times E) 19,000 less 2,850 Tax(I) Total Income (G plus H) 236,000 Total 2,850

233,150

Summary: (1) Commission Increase - $150,000, (2) underwriting profit - $217,000 (3) investment income - $19,000. Total ADDITIONAL income is over $386,000

Page 25: Captives Create Income and Growth for Agencies

Reinsurance Strategy

Taxed as US Tax Payer

$10M GWP w/ 25% QS

Premium Ceded to Captive: $2,000,000

(E) Loss Fund 1,310,000

(F) Losses incurred ( 875,000)

(G) UW Profit x .35% 283,000

(H) Investments less tax 36,000

(I) Total Income 319,000

Taxed as US Tax Pater w/ 831(b) election

$5M GWP w/ 25% QS

Premium Ceded to Captive” $1,000,000

(E) Loss Fund 655,000

(F) Losses Incurred ( 438,000)

(G) UW Profit x ZERO 217,000

(H) Investments less tax 16,000

(I) Total Income 233,000

Difference of $86,000Questions to Ponder:

How much capital will the captive needed to support each strategy?

What are the collateral requirements of the fronting carrier – hint: Stop loss aggregate attachment point or the “gap”

Page 26: Captives Create Income and Growth for Agencies
Page 27: Captives Create Income and Growth for Agencies

Reinsurance Strategy

Taxed as US Tax Payer

$10M GWP w/ 25% QS

Premium Ceded to Captive: $2,000,000

(E) Loss Fund 1,310,000

(F) Losses incurred ( 875,000)

(G) UW Profit x .35% 283,000

(H) Investments less tax 36,000

(I) Total Income 319,000

Taxed as US Tax Pater w/ 831(b) election

$5M GWP w/ 25% QS

Premium Ceded to Captive” $1,000,000

(E) Loss Fund 655,000

(F) Losses Incurred ( 438,000)

(G) UW Profit x ZERO 217,000

(H) Investments less tax 16,000

(I) Total Income 233,000

Difference of $86,000Questions to Ponder:

How much capital will the captive needed to support each strategy?

What are the collateral requirements of the fronting carrier – hint: Stop loss aggregate attachment point or the “gap”

$435,000

$471,000

Difference of $238,000

Page 28: Captives Create Income and Growth for Agencies

Case Example

Fronting Carrier

CAPTIVERetained Risk

Asset ProtectionProvides insurance

Pays claimsProduces profitBuild surplus

Owner Benefits

• Estate Planning

• Retirement

• Tax Planning

• Asset Protection

• Buy-Sell

Case Example - IRC § 831(b)

captive captive captive

Owner EmployeePartner

Business Partner

Key Employee

Clients

$1.2 million $1.2 million $1.2 million

Agency

Premiums from controlled group are aggregated.

Page 29: Captives Create Income and Growth for Agencies

Captive Manager (that’s us!)

We perform re/insurance, accounting,

underwriting, and claims functions, including:

Annual reports and filings for regulators

Bind coverage and issue insurance or reinsurance contracts

Perform banking functions

Rate and underwrite risk exposure

Issue Policies

Page 30: Captives Create Income and Growth for Agencies

Getting Started

• 1. Pre-feasibility strategy session

Which book(s) of business should you consider? Specialty, carrier, geography or premium size Heterogeneous or homogeneous Coverage lines – WC, GL, AL, Inland Marine, etc.. Frequency is always favored over severity DO NOT FORGET – Ownership

wealth creation, preservation & transfer

Page 31: Captives Create Income and Growth for Agencies

FAQ 1 - Feasibility Study

Set expectations (internal hurdle rate? ROI?)

Look at your contingency agreements Gather your data – min. of 3 – 5 years Results should include: Multi-year financial and loss pro forma Tax and accounting analysis – 953(d), 831(b),

others? Domicile considerations Coverage, limits and estimated premiums Ownership & structure of the captive Business Plan!

Page 32: Captives Create Income and Growth for Agencies

FAQ 2 - Domicile my captive?

US or Non-US– Many agency captives offshore because

of low(er) capitalization. – Washington, DC good onshore.

• Premium Taxes• Regulatory oversight• Board meetings• Captive statutes• Investment strategies

Page 33: Captives Create Income and Growth for Agencies

FAQ 3 - Cost of Forming a Captive

Pre-feasibility session – free for TMPAA Members √

Feasibility Study $ 5,000 - 50,000+

Actuarial Study/Loss Analysis $ 8,000 - 20,000+

Tax Advisory always a good idea

Captive Advisor/ Manager $ 10,000 - 50,000+

Gov’t fees/application $ 2,000 – 10,000

Legal $ 2,000 – 8,000

Est. Totals $ 27,000 - 138,000+

Page 34: Captives Create Income and Growth for Agencies

FAQ 4 – Managing a Captive

Captive Manager $ 20,000 - $50,000+*

Audit $ 8,000 - $20,000+

Tax Advisory still always a good idea

Legal $ 1,000 - $10,000+

Premium Taxes** $ 2,000 -$25,000+

Gov’t fees/application $ 2,000 – 10,000

• Est. Totals $ 35,000 - 115,000+

*Many agree to a min fee or 1.5% of premium

***Some domiciles offer a 1st year credit of no taxes - max $7500 credit

Page 35: Captives Create Income and Growth for Agencies

Captive Formation & Timeline

• Captive strategy session with Atlas• Feasibility Study – 30 to 45 days

– Determine type of cover, limits– Financial pro forma– Capitalization– Domicile analysis– Business Plan

• Application - 30 to 60 days• Implementation – 30 days• Ongoing

Page 36: Captives Create Income and Growth for Agencies

Chris Kramer, SVP                               

1991 Crocker RoadSuite 600Westlake, Ohio 44145Office:      +1 (440) 892-3314Fax:         +1 (440) 892-3396Toll Free:  +1 (877) 242-4358

Martin Eveleigh, ChairmanNick Leighton, Managing Director

3rd Floor, Sagicor House198 North Church StreetGeorge Town, Grand CaymanCayman Islands, KY1-1107Tel:     +1 (345) 945-5556Fax:    +1 (345) 945-5557

 www.atlascaptives.com

Page 37: Captives Create Income and Growth for Agencies

Q&A

Page 38: Captives Create Income and Growth for Agencies

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