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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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Captive Fuel Growth for Agency Owners
The time to repair the roofis when the sun is shining.
John F. Kennedy
Captives Fuel Growth and Income for Agency Owners
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
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
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.”
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.
-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
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?
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
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.
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.
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!)
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
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
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
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
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
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
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
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
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
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”
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
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.
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
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
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!
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
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+
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
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
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
Q&A
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