Captives 101 - An Industry Primer

May 6, 2008 Arizona Captive Insurance Company Captives 101 An Industry Primer

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Captives 101 – An Industry Primer

William Powell – Risk Manager SRPMark Tabler – COO - Innovative Physician Solutions, RRG, Inc.Christina Urias, Arizona Director of Insurance S. David Childers, Esq., - Low & ChildersAnn W. Wick, CPA - Strategic Risk Solutions AZ


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Introduction

• Captive Basics

• Feasibility Study Process

• Meet the Lawyers

• Meet the Regulators

• Meet a Single Parent Captive Representative

• Meet a Risk Retention Group Representative


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Captive Basics

• What is a captive?

• What are the characteristics of captives?

• What types of captives are in Arizona?

• What is the Arizona statutory capital?

• Why do companies form captives?


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Definition of a Captive

• An insurance company that provides coverage to its owners– A form of self-insurance

• (From AICPA Audit and Accounting Guides) – Captive Insurance Companies are WHOLLY OWNED SUBSIDIARIES CREATED TO PROVIDE INSURANCE TO THE PARENT COMPANIES


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Characteristics of Captives• Licensed Insurance Company• Formed to insure or reinsure the risk of its owners

or unrelated parties of their choosing• Regulated under special legislation regulating

captives (regulated less stringently than state insurance laws which govern fully admitted insurance companies)

• Located offshore or onshore• Admitted only in its domicile and non-admitted in

all other jurisdictions.


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Types of Captives• Pure Captive Insurer

– insures only the risks of its affiliates and controlled unaffiliated business

• Branch Captive Insurer

– An alien captive insurer that is licensed to transact the business of insurance through a business unit

• Agency Captive Insurer

– Owned by one or more business entities that are licensed in any state as insurance producers or mga’s and that only insure risks on policies placed through their owners


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Types of CaptivesGroup Insurers

• Risk Retention Group

– Operates similar to a group captive yet is regulated under federal legislation

– Can operate in all fifty states yet only required to be licensed in its state of domicile

– Insureds must be owners and owners must be insureds

– Can only write liability lines of risk


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Types of CaptivesGroup Insurers

• Industry Group Captive

– Two or more businesses or activities similar or related with respect to the liability they are exposed to by virtue of a related, similar or common business, trade, product, services, premises or operations

• Association Captive

– A captive that is completely under the direct or indirect voting control of an association


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Types of Captives (continued)

• Protected cell captive

– Capitalization is provided by one or more sponsors– Insures the risks of participants through participant

contracts– Segregates liability under a participant contract– A sponsor is an entity that the Director has approved

and meets the requirements under 20-1098.06


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Statutory Capitalization• Pure Captive Insurer - $250,000

• Agency Captive Insurer - $500,000

• Risk Retention Group - $500,000

• Group (Industry or Association) - $500,000

• Protected Cell - $1,000,000

• Pure or Group Reinsurers – 50% of the above noted statutory capitalization i.e.$125,000/$250,000

• Branch Captive Insurer - Not an incorporated entity


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Why Form a Captive?• Reduce/stabilize cost of risk funding • Provide access to coverage and the ability to

customize coverage• Take advantage of or add focus to proactive risk and

claims management; create a team approach with policyholders

• Creation of profit center• Permit access to better negotiating power with

reinsurance markets• Improve cash flow timing and investment returns


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Successful Captives Have• A good spread of risk• Predictable losses • Long-term commitment from management

– Risk management – loss control and safety programs

– Treasury and accounting support

• Strong business partners– Captive manager, broker, claims handler, actuary, insurance

and reinsurance markets, attorneys and accountants


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Captive Pre-Feasibility

• Conceptual review• Funding and risk appetite• Commitment to alternative market solution• Parameters of program (lines of coverage,

limits, etc.


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Feasibility Work StepsSample Flow chart of the Process

Commitment to Feasibility Study

Data Collection(Historical Loss &

Exposure)

Draft Feasibility Study Economic

and Financial Analysis

Meeting with Commercial Insurance Market(s)

Final Feasibility Study

Client Review ImplementationGoDecision

Project Termination

No Go


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Captive Feasibility

• Define objectives• Project loss costs• Estimate non-loss costs & premiums• Develop program structure• Analyze tax issues• Compare and select domicile• Determine ownership structure• Identify service providers including fronting insurers

and reinsurers


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Captive Feasibility Results• Actuarial loss projection• Financial model demonstrating flow of funds and complete

financial statements• Five Year Pro-forma financial under various loss scenarios • Structure and program review including fronting and

reinsurance recommendations with special focus on collateral• Proposed ownership structure and potential alternatives.• Detailed individual member premium and capital projections –

for a group• Domicile analysis and recommendation• Legal, tax and regulatory review• Potential exit strategy(ies)• Conclusion and recommendation


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Implementation

• Business plan development• Pro-forma financial development• Meeting with the regulators• Preparation and filing of captive application• Captive incorporation & capitalization• Formalize fronting and reinsurance placement• Formalize engagement of service providers upon

licensing• Creation of governance structure


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Formation of Arizona Captive Insurers

Legal Aspects

Presented by:

S. David Childers, Esq. Low & Childers, P.C.


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Pre-Incorporation: Initial Client Meeting Initial Client Meeting

• Obtain input from client regarding the goals, objectives and scope of the proposed captive insurance program.

• Provide feedback and advice on the suitability of the captive insurance framework to the proposed insurance program.

• Provide counsel and guidance on the general plan of operations for the proposed captive which includes, for example:

• 3-year financial projections• Rate and Price Guidelines• Explanation of Reinsurance Program• Investment Policy• Types of risk to be Insured by line of coverage • Retained Risk• If Association Captive: history, purpose and size of membership

• Provide recommendations for the captive’s other service providers such as captive managers, statutory accountants, actuaries, etc.


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Pre-Incorporation: Initial Client Meeting (Continued) • Based on the parameters of the proposed insurance program, provide advice on the

type of captive and legal entity most appropriate• Arizona law allows four types of captives

1. Pure captives which may be formed as ao stock corporationo non-profit corporation (please see below)o limited liability company

2. Agency Captives which may be formed only as a stock corporation3. Protected Cell Captives which may be formed only as a stock corporation4. Group Captives (including Association Captives and Risk Retention Groups) may be formed as a

o stock corporationo mutual insurero unincorporated reciprocal insurero non-profit corporation (see below)

• Effective August 25, 2004, non-profit organizations can form an Arizona non-profit captive either as a pure or group captive insurer.

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Meeting With Arizona Department of Insurance Schedule and Participate in Meeting with Arizona

Department of Insurance The sponsors of each captive insurer are required to

meet with the Arizona Department of Insurance on or about the time the captive application is submitted to the Department.

Topics to be covered at this meeting include:• General summary of the proposed captive insurance

program• Discussion of the company’s projected business volume• Background and qualifications of the captive’s service

providers.


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Incorporation of Captive Determine availability of corporate name for the captive with the Arizona Department of

Insurance and the Arizona Corporation Commission Prepare organizational documents for captive

• Incorporation Questionnaire• Articles of Incorporation

• Three Incorporators, one of whom must be an Arizona resident• One Director must be an Arizona resident• Must maintain its principal place of business in Arizona• Must appoint a resident statutory agent

Bylaws• Must have at least one Board of Directors meeting in Arizona annually• Pure captive must have at least one director and all other types of corporate captive

insurers must have at least three directors Board and Shareholder Resolutions approving formation and licensure of captive insurer Obtain federal employer identification number Act as a liaison with the Arizona Department of Insurance to expedite the review and

approval of the captive application

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Incorporation of Captive (Continued) Arizona Application Process

• Two Phases1. Completeness Review Phase

– Arizona Department of Insurance reviews Application and related information to determine that all documentation has been provided, is complete and accurate

– Applicant will receive a Notice of Administrative Completeness from Arizona Department of Insurance

2. Substantive Review Phase– Arizona Department of Insurance may request more

information and documents on which to base licensing decision

– If approved, Applicant will receive a Notice of Granting License

– Risk Retention Groups must secure an NAIC Number


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Incorporation of Captive (Continued) Prepare other supplemental legal documents as needed

• Subscription Agreement• Shareholder Agreement• Policy Forms and Endorsements• Confidential Disclosure Document/Private Placement

Memorandum• Loan Agreements/Surplus Notes• Reinsurance Agreements• Service Provider Agreements• Issue Stock Certificates and Maintain Stock Ledger

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Post-Licensure Act as the captive’s general counsel and

provide ongoing representation with respect to the captive’s corporate, transactional and regulatory affairs

Assist in the preparation and submission of periodic regulatory filings

Prepare notices, attend and record minutes of annual Shareholder and Board of Directors meetings and other meetings as needed

Maintain the captive’s corporate minute book and act as the captive’s statutory agent


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Arizona

Christina Urias

Director

Arizona Department of Insurance


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• Arizona Outlook & Developments

• Arizona Captive Reference Guide

• Arizona Captive Market

• 2008 Arizona Captive Legislation


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Arizona Outlook & Developments

• Attitude/Philosophy:

Provide a public service to encourage economic development of the captive insurance industry

• Experience:

Of all active US domiciles, Arizona regulates the most insurance companies and largest premium volume


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Arizona Outlook & Developments• Pro-business Governor, Legislature & Director

• Law

Flexibility for all types of captives, including branches, reciprocals, non-profits, etc. New provisions allow groups as well as pures to insure controlled unaffiliated entities

• Accessible, desirable, attractive destination for both professional & personal objectives.


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Arizona Outlook & Developments• Cost Effective

No Premium or Income TaxReasonable License FeesPure captives not subject to periodic examinations; examined only as needed, possibly never examinedContract examiners for non-pure captives at reasonable costExperienced in-house actuary, lawyer and financial examiner review application and business plan changes

• Timely Approvals Most licenses issued in less than 30 days following receipt of completed application


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Arizona Outlook & Developments• Commitment to quality captive insurance industry

development• Recent “Reference Guide” changes and updates• Eliminated “yellow cover bound” Annual Statement

filing requirement• Automatic Actuarial Opinion exemption for small

companies• Automatic Audited Financial Report exemption for

small companies• Biographical Affidavit updates no longer required


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Arizona Outlook & Developments• July 2007, added new Captive Chief Financial Analyst,

Stephanie Lefkowski, BS, MHA, CPCU, with 16 years actuarial research and financial analysis experience

• February 2008, Departure of Rod Morris, the Department’s Captive Administrator; Director assumes administration role

• Reputable Experienced Regulators

• Professional Competent Captive Insurance Evaluation Team

• Efficient Cost Effective Regulatory Processes


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Arizona Captive Reference Guide

• Captive “Reference Guide” Update:

www.id.state.az.us/captives.html


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• Actuarial Feasibility StudiesMust accompany all license applications

Actuary’s letterhead

Description of all document and materials actuary reviewed

3-5 years loss history

Confidence levels, credibility, expected results, worst/best case scenarios with premium/loss components

Automatic small company exemptions Less than $1M total direct plus assumed written premium


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Arizona Captive Reference Guide• Annual Audits, Reports & Statements

Pure, Group, Agency & Protected Cell must submit:Report of financial condition verified under oath by two executive officers within 90 days of FY end

Audited financial statements within 6 months of FY end

Risk Retention Groups & Associations must report: On NAIC forms

Annual statements on/before 3/31

Quarterly statements by 5/15, 8/15 and 11/15

Audited financial statements within 6 months of FY end.


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• Annual Audits, Reports & Statements

Independent CPA required

Small Company Exemption

If less than $1M direct premiums and less than 1,000 direct

written policyholders nationwide (excluding insurers that

assumed premiums pursuant to $1M+ reinsurance

agreements)


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• Applications

• Bank Confirmations

• Board of Directors

• Books & Records

• Captive Managers


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• Reporting Material ChangesBusiness Plan, financial position, investments

Dividends (prior approval)

Policy limits (prior approval)

Reinsurance (initiated, cancelled, material changes)

Service Provider AgreementsNo prior approval unless change relates to Captive Manager or Auditor

Type of Captive


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• Confidentiality

• Conflict of Interest

• Expenditures

• Investments

• Letters of Credit

• Reinsurance Agreements


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Arizona Captive MarketLicensed Captives

75

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23

1

Pure RRG Group Agency Prot. Cell


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Arizona Captive Market

Active Captives

3953

7294

0

20

40

60

80

100

2004 2005 2006 2007


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2008 Arizona Captive Legislation•HB 2081 Captive insurers; authority

Amends the definition of "industry group" to include

individuals in addition to business entities. Both individuals

and business entities in an industry group must be "engaged

in businesses or activities similar or related with respect to

the liability that they are exposed to by virtue of any related,

similar or common business, trade, product, services,

premises or operations."


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2008 Arizona Captive Legislation

• HB 2081 Captive insurers; authority

Clarifies that captive insurers may directly insure employment

liability risk.

Clarifies that captive insurers formed as reciprocal insurers

must be organized by three or more subscribers; eliminates

one Arizona subscriber residency requirement.


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2008 Arizona Captive Legislation• HB 2081 Captive insurers; authority

Clarifies that branch captives may provide any coverage

that a pure captive may provide, and that as such, a branch

captive may not write workers' compensation insurance

unless it is approved as a self-insured plan by the AZ

Industrial Commission.

Amends Title 29 to reflect Title 20 provisions, allowing

pure captives to form as limited liability companies.


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Questions?


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Salt River Project

SRP Captive Risk Solutions, Ltd.

Bill Powell CSP ARM

Manager, Risk Management


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About Salt River Project

• Salt River Valley Water Users’ Association– Formed in 1903 by Landowners pledging land

for the construction of Roosevelt Dam

– Manages a 13,000-square-mile “watershed”

– Largest Water Supplier in Valley Area with residential, agriculture and city customers


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About Salt River Project

• Salt River Project Agricultural Improvement and Power District– Formed in 1937 as Political Subdivision of state of

Arizona– Public Power system for Maricopa, Gila and Pinal

counties in central Arizona – Serve to over 900,000 customers within a 2,900

square mile service territory and growing


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Captive History

• SRP participated in a Rent a Captive in Bermuda for various years since 1996

• Emerging issues with captive management services and fees

• Post 9/11, ability to afford property TRIA for utilities created additional need for utilizing captive


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Domestic Captive Formation - Internal

• Gathered internal SRP resources – Legal, Finance, Accounting, Audit and Tax groups to discuss feasibility

• With buy-in presented idea to General Manager Staff for full support

• With Approval from GM Staff, presentation made to SRP Board in Fall 2003


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Domicile Selection

• Arizona was Easy Conclusion

• Politically Expedient

• No Premium Tax

• Low Capitalization Costs

• Ease in working with AZ DOI

• Control Transactional Cost of Captive Operation


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Domestic Captive Formation - Internal

• Once Board Approval received, Articles of Incorporation and Bylaws developed through internal Legal Services

• Investment Strategy Policy developed and managed internally

• Captive Name Selected


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Domestic Captive Formation - External

• Appointed Captive Manager

• Appointment of Legal Counsel (Internal)

• Meeting with AZ Department of Insurance to discuss business plan

• Selected Auditor and Actuary firms

• Captive Manager completed and submitted application to State


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Domestic Captive Formation - External

• Legal Counsel petitions for Certificate of General Good

• Official Incorporation of Captive

• Regulators issue a Certificate of Authority

• Bank Account and Parent Capitalization finalized


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Domestic Captive Formed

• SRP Captive Risk Solutions, Ltd officially formed

• First Captive Board Meeting held January 2004

• First TRIA policy placed February 2004


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Captive Utilization

• Property - $75M Certified Terrorism Risk Insurance

• Excess Liability - $1M excess $1M Self Insured Retention (including Commutation from Bermuda Captive)

• Property – Provided Primary Property Coverage for Subsidiary


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Pure Captive Benefits

• Ability to select Captive Service Providers– Administrative Control– Cost Efficiency

• Can Create Competitive Leverage against Incumbent Insurers

• Facilitates the efficient Use of Premium Dollars to Pay Losses


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Pure Captive Benefits

• Control over Coverage Form and Limits regardless of Insurance Market Cycles

• Creative Coverage Problem Solver for Changing Business Environment


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Innovative Physician Solutions, RRG (IPS)(Columbus, IN)

Why, When, Where, & How

RRG 101


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Innovative Physician Solutions, RRG Background

• Multi County Physicians (MCP)

390 physicians

South central Indiana

Various specialties

Value-added products/programs

Parent company


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Innovative Physician Solutions, RRG Demographics

• 200+ members

• AZ “certificate of Authority” Feb 2006

• $2M+ annual premium revenue

• Medical malpractice liability coverage

• Policies only written in state of “Indiana”

• July policy renewals

• 2008 third year of operation


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Why IPS was created…

To give our MCP physician members an alternative, outside the traditional

marketplace, in obtaining their medical malpractice insurance coverage.


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First Step

Captive Manager

• Obtain critical mass > feasibility study

• Develop business plan


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Initial Market Research

Three questions to answer

• Comparable premium rate

• Litigation representation

• Company stability


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RRG or Pure Captive

RRG disadvantages

• Liability insurance only

• Homogeneous risk

• No guaranty fund participation


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RRG or Pure Captive?

RRG advantages• Avoidance of multiple state filings and licensing

requirements• Member control over risk and litigation

management• Customization of coverage• No fronting fee expenses• Local onshore banking


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Company Formation

• Domicile selection – Arizona

• Capitalization

• Selection – “Board of Directors”

• Selection – risk, underwriting, claims committee members

• Selection – RFP process for legal, claims TPA, auditors, actuaries, banking


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Organizational Chart

Board Of

Directors

Chief Operating Officer

UnderwritingCommitteeMembers

InsuredMembers

Claims CommitteeMembers

Risk CommitteeMembers


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Initial Company Roll-Out(February 2006)

• Informational meetings with practice managers• Informational meetings with physicians• Marketing brochures and letters • Capture policy renewal dates


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Unique to Indiana

Indiana Patients Compensation Fund (PCF)• Est. 1976 to assist in compensating malpractice

claimants • Provides $1M in coverage after med mal insurer

pays up to $250K in damages, fund caps damages to $1.25M per occurrence.

• PCF acts as reinsurance• Currently $140M fund balance


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Challenges


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Company Successes

• Third renewal cycle – no premium increase

• 100% member retention

• 5 year member commitment

• Created physician ownership

• Maintain good spread of risk

• Steady growth

• Risk control

Economy & Finance

Captives 101 - An Industry Primer