McGriff, Seibels & Williams, Inc.
Ryan Erickson
Trey Tasker, ACAS, MAAA
Geoff Welsher
Kevin Doyle
McGriff, Seibels & Williams, Inc.
McGriff, Seibels & Williams, Inc.
Marsh, Fleet Solutions
Artex Risk Solutions

The Value Equation of Captives
◦ The impact of risk information
◦ In comparison to commercial insurance
◦ Real vs. advertised value

Value by Type of Captive
◦ Single Parent
 Pure - 831(a) or 831(b)
 Sponsored - 831(a) or 831(b)
◦ Group Parent
 Group Captive
 Risk Retention Group

Success Stories/Panel Discussion
Retain
Unfunded -------------------
• Self-Insurance
• Deductible Programs
Pre-Loss Funding ---------
• Captive Insurance Company
• Limited Risk Programs
Post-Loss Funding --------
• Line of Credit
• Contingent Capital
Group Captive
Risk
Financing
Options
Share
Risk Retention Group
Group Dividend Program
Transfer
Non-Insurance Contracts -
• Indemnification Agreements
• Hold-Harmless Agreements
Insurance -------------------
• Guaranteed Cost
• Loss-Sensitive Programs
Derivatives -----------------
• Futures and Forwards
• Options
Less Information
More Information
Fronted Program
Large Deductible
Small Deductible
Experience Rating
Self-insurance
Classification Rating
Schedule Rating
Underwriting
Guaranteed Cost
What happens when the retention grows?
This is when captives can be useful.

Commercial insurance offers certain benefits

Some of these benefits can be achieved by
◦
◦
◦
◦


Self-Insurance
Single-Parent Captives
Group Captives
Risk Retention Groups
Commercial insurance offers some benefits
that captive insurance does not offer
Captive insurance offers some benefits that
commercial insurance does not offer
Risk
Transfer
Cost
Reductions
External
Demands
Service
Expertise
Catastrophic
Hazard Events
Efficiency of
Diversification
Debt-Related
Covenants
Assessment of
Hazard Risks
Uncontrollable Accelerated Tax Regulatory
Hazard Events
Requirements
Deduction
Prevention of
Hazard Losses
Protect
Dir & Ofc
Documented
Expense
Customer
Expectations
Handling of
Hazard Claims
Risk
Transfer
Cost
Reductions
External
Demands
Service
Expertise
Catastrophic
Hazard Events
Efficiency of
Diversification
Debt-Related
Covenants
Assessment of
Hazard Risks
Uncontrollable Accelerated Tax Regulatory
Hazard Events
Requirements
Deduction
Prevention of
Hazard Losses
Protect
Dir & Ofc
Documented
Expense
Customer
Expectations
Handling of
Hazard Claims
1. This perspective is very Hazard-focused.
Risk
Transfer
Cost
Reductions
External
Demands
Service
Expertise
Catastrophic
Hazard Events
Efficiency of
Diversification
Debt-Related
Covenants
Assessment of
Hazard Risks
Uncontrollable Accelerated Tax Regulatory
Hazard Events
Requirements
Deduction
Prevention of
Hazard Losses
Protect
Dir & Ofc
Documented
Expense
Customer
Expectations
Handling of
Hazard Claims
2. A case study of large companies
suggested that they could easily
replace all but two of these benefits.
Risk
Transfer
Cost
Reductions
External
Demands
Service
Expertise
Catastrophic
Hazard Events
Efficiency of
Diversification
Debt-Related
Covenants
Assessment of
Hazard Risks
Uncontrollable Accelerated Tax Regulatory
Hazard Events
Requirements
Deduction
Prevention of
Hazard Losses
Protect
Dir & Ofc
Documented
Expense
Customer
Expectations
Handling of
Hazard Claims
3. These items are valuable.
How do we replace these items?
Risk
Transfer
Cost
Reductions
Frequency of
Hazard Events
Better Local
Knowledge
External
Demands
Service
Expertise
Uncontrollable Accelerated Tax
Hazard Events
Deduction
Documented
Expense
Customer
Expectations
These items are among
the benefits of captives.
Commercial
Insurance
Regulatory
requirements
Expertise
in risk
Frequency of
hazard risks
Captive
Insurance
(Single-Parent)
Debt-related
covenants
Severity of
hazard risks
Protect
Dir & Ofc
Customer
Expectations
Restores full
tax deduction
Better local
knowledge
Documents
full expense
Cost
Coverage
Capacity
Control
• Cash Flow
• Availability
• Increase
• Regulation
• Reinsurance
• Broaden
• New Risks
• Claims
• Cost Savings
• Tailored
• Build Limits
• Reserves
• Formal Cost
Documentation
• Uninsurable
Risks
• Access to
Reinsurance
• Profit Center
Potential
• Investment
Income
• Focus Risk Mgt
Efforts
• Tax Deduction
Restoration
• Enhance Loss
Prevention
• Stabilization
Cost
Coverage
Capacity
Control
• Cash Flow
• Availability
• Increase
• Regulation
• Reinsurance
• Broaden
• New Risks
• Claims
• Cost Savings
• Tailored
• Build Limits
• Reserves
• Formal Cost
Documentation
• Uninsurable
Risks
• Access to
Reinsurance
• Profit Center
Potential
• Investment
Income
• Focus Risk Mgt
Efforts
• Tax Deduction
Restoration
• Enhance Loss
Prevention
• Stabilization

Sufficient knowledge of loss potential to identify insurance cost savings by
adjusting retaining liabilities that are overpriced in the insurance market;

Opportunity for owners of private companies to transfer wealth to later
generations on a tax-efficient basis for estate planning purposes;

Sufficient volume of annual losses to generate accelerated tax deductions in
excess of the costs required to capitalize and maintain the captive;

Sufficient volume of annual losses to create annual cost stability by adjusting
self-insured liabilities in reaction to the insurance market;

Sufficient capitalization and long-term commitment to self-insure uninsurable
or prohibitively expensive exposures;


Create a profit center for external marketing to change the customer dynamics
by offering insurance enhancements to customer contracts, rather than
unilaterally pushing risk at customers; and/or
Internal marketing to elevate awareness of the self-insurance program
throughout the financial and operational culture of the parent company.

The Value Equation of Captives
◦ The impact of risk information
◦ In comparison to commercial insurance
◦ Real vs. advertised value

Value by Type of Captive
◦ Single Parent
 Pure - 831(a) or 831(b)
 Sponsored - 831(a) or 831(b)
◦ Group Parent
 Group Captive
 Risk Retention Group

Success Stories/Panel Discussion
Retain
Unfunded -------------------
• Self-Insurance
• Deductible Programs
Pre-Loss Funding ---------
• Captive Insurance Company
• Limited Risk Programs
Post-Loss Funding --------
• Line of Credit
• Contingent Capital
Group Captive
Risk
Financing
Options
Share
Risk Retention Group
Group Dividend Program
Transfer
Non-Insurance Contracts -
• Indemnification Agreements
• Hold-Harmless Agreements
Insurance -------------------
• Guaranteed Cost
• Loss-Sensitive Programs
Derivatives -----------------
• Futures and Forwards
• Options

Pros
◦
◦
◦
◦

Avoids “add-on costs” for small losses
Avoid excessive carrier loss estimates
Increases incentive for loss control
Facilitates unbundling of services
Cons
◦
◦
◦
◦
◦
Defers premium expense and its tax reduction
Retains frequency risk
Increases capital requirement
Creates need for fronting insurer
Creates need for LOCs

Pros
◦
◦
◦
◦
◦

Avoid frequency risk
Reduces surplus requirement
Allocates capital to high margin layers
Benefits from client’s incentive for loss control
Improves flexibility in reserve adjustments
Cons
◦ Loss of premium revenue
◦ Potential loss of service revenues
Client
Client
Carrier
Payment
Demand
Payment
Claimant
Paper
Carrier
Payment
Claimant
Premium
Promise
Promise
Payment
Demand
Large Deductible
Insurance Program
Premium
Client
Guaranteed Cost
Insurance Program
Demand
Self-Insured
Risk
Claimant
Large Deductible
Insurance Program
Client
Paper
Promise
Payment
Premium
Carrier
Payment
Premium
Demand
Reinsurer
Promise
Claimant
“An insurance company formed under special
purpose insurance laws to insure the
exposures of its owners and/or affiliated
companies.”

Types of Captives
◦ Pure (Owner’s Capital)
◦ Sponsored (or Rent-a-Captive)
◦ Shared (or Group)
Large Deductible
Insurance Program
Promise
Client
Paper
Promise
Promise
Captive
Indemnity Agreement
Carrier
Payment
Premium
Demand
Reinsurer
Premium
Insuring Agreement
Premium
Claimant
Captive indemnifies the deductible.
Promise
Promise
Captive
Premium
Payment
Demand
Excess
Carrier
Client
Premium
Premium
Promise
Reinsurer
Claimant
Captive directly insures, with support.
Promise
Promise
Client
Premium
Premium
Promise
Reinsurer
Payment
Demand
Captive
Fronting
Reinsurer Premium Carrier
Claimant
Captive reinsures the direct insurer.



Greater knowledge and understanding of insurance buyers on
the value a captive program can bring to an organization
Trends toward higher deductibles, higher premiums, more
coverage exclusions, and less need for commercial insurance
Favorable changes in the tax environment, including
precedent-setting case law

Desire by risk-takers to grow capacity for uninsured exposures

Pro-active moves in anticipation of “hard market” pricing

Desire of risk management to become a profit center

Desire for greater flexibility in program design



The “pure” captive is capitalized by its owner
and insures only the risks of its shareholder or
affiliated companies.
The “sponsored” captive is a fully capitalized
captive facility available to a single owner for a
fee.
Group captives may be formed as stock or
mutual companies, but they require willingness
to share risks with other insureds.

831(a) is the insurance company tax regs for
most insurance companies
◦ More than $1.2 million in premium per annum
◦ Taxes on both underwriting income and investment
income

831(b) is the insurance company tax regs for
small insurance companies
◦ Up to $1.2 million in premium per annum
◦ Taxes on investment income only
Tax
Code
831(a)
831(b)
Single-Parent Owner
Pure
Sponsored
Yes
Yes
Yes
Yes
Group Ownership
Group Captive
RRGs
Yes
Maybe
NO
NO





Financially strong parent
$5 million or more in premium for 831(a) or
$1.2 million or less in premium for 831(b)
Willingness and capital to retain risk
Senior management commitment to risk
management objectives
Desire for “real” benefits as discussed





Financially strong parent
$1 million or more in premium for 831(a) or
$1.2 million or less in premium for 831(b)
Willingness and cashflow to retain risk
Senior management commitment to risk
management objectives
Desire for “real” benefits as discussed

Frictional fixed costs

Unfavorable loss experience

Increased regulatory requirements

Time commitment of corporate staff

Opportunity cost of capital investment

Without reinsurance
◦ Captive jurisdiction
◦ IRS Safe Harbor tax position
◦ Substantial additional capital needed
◦ Risk-bearing capacity limited to parent’s balance sheet
Insured
Consultant/Broker
Premium
Insurance Market
Claims
Fronting Insurer
Premium
Manager/Sponsor
Claims
Insurance Broker
Captive Reinsurer
Premium
Reinsurance Market
Third-Party Admin
Claims
Reinsurer
Reinsurance Broker
• Incorporation and Operating Costs: The formation and
operation of a captive entails various expenses including:







Start-Up Costs
Feasibility Study
Cost of Capital
Business Plan Design
Financial Pro-Formas
Actuarial Projections
Legal Incorporation
Regulatory
Licenses/Fees
Annual Operating Costs
 Additional Capital
 Management Salaries
 Actuarial Reserves
 Actuarial Pricing
 Legal Review
 Auditor Services
 Regulatory Fees
 Premium Taxes
 Claims Services
 Investment Mgt Fees
 Reinsurance Premiums
Retain
Unfunded -------------------
• Self-Insurance
• Deductible Programs
Pre-Loss Funding ---------
• Captive Insurance Company
• Limited Risk Programs
Post-Loss Funding --------
• Line of Credit
• Contingent Capital
Group Captive
Risk
Financing
Options
Share
Risk Retention Group
Group Dividend Program
Transfer
Non-Insurance Contracts -
• Indemnification Agreements
• Hold-Harmless Agreements
Insurance -------------------
• Guaranteed Cost
• Loss-Sensitive Programs
Derivatives -----------------
• Futures and Forwards
• Options

Risk sharing built in the structure
◦ Less control of shared loss experience
◦ All members share in reinsurance limits
◦ Benefits of portfolio theory

Cost sharing built in the structure
◦ Homogeneity of the membership
◦ Lower admin costs than pure captives
◦ Lower cost for shared reinsurance

Risk reduction through
◦ Underwriting
◦ Loss control

Control
◦ Premiums paid to insurance entity owned by insured
◦ Superior loss control, claims handling and other
unbundled services
◦ Premium costs heavily weighted toward member loss
history

Financial
◦ Insured shares in underwriting profit and investment
income, via dividends paid to policyholders/owners
◦ Group purchase of reinsurance and services can reduce
operating costs
◦ Collateral requirements (usually Letters of Credit) for
(i) capitalization of the captive, and (ii) collateral support
of each member’s retention.

Stability
◦ Insured does not subsidize poor risks
◦ Insulation from cyclical marketplace
◦ Reinsurance Accounts for approximately 10% - 20%
of Total Premium
◦ Less volatility in year over year pricing – losses
capped
Approx. 18% of TCOR is subject to
Insurance Industry Swings
18%
82%

Greater risk involved in a Group Captive
◦ Member approval process – annual loss control,
financial review
◦ Collateral in place to protect bad debt exposure
◦ Fronting carrier/reinsurance provided by ‘A’ Rated
carriers

Risk Sharing – Averages 2% - 7%
◦ Allows for tax deduction of premium
◦ Reduces individual member exposure to catastrophic
claims
◦ Risk Sharing a “wash” – both absorbing and causing

Same Advantages of Group Captive
◦ Risk sharing built in the structure
◦ Cost sharing built in the structure
◦ Risk reduction through

Plus Reduced Regulation
◦ Domiciled in one state, operate in many
◦ No state guarantee fund assessments

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 owner and owners must be
insureds.

Can only write liability lines of risk, cannot
underwrite workers compensation.

No state guarantee fund assessments


Does not require a fronting insurance company.
Capital requirements serve as the collateral for
RRG. No specific collateral requirements required
for the retention since there is no fronting
company.

Insureds fund capital requirements, typically a 2to-1 ratio, in addition to premium.

Equity is based upon stock valuation which is
done by an independent party.

RRG’s access reinsurance markets to share risk.
Commercial
Insurance
Expertise
in risk
Frequency of
hazard risks
Debt-related
covenants
Captive
Insurance
(Group Owned)
Regulatory
requirements
Severity of
hazard risks
Protect
Dir & Ofc
Customer
Expectations
Restores full
tax deduction
Better local
knowledge
Documents
full expense
Program
Feature
Amount of
Risk Transfer
Amount of
Risk Sharing
Speed of
Risk Expense
Regulatory
Scrutiny
Premium
Documentation
Premium
Deductibility
Balance Sheet
Impact
Amount of
Capital Needed
Cost of
Administration
Timeline for
Implementation
Ease of
Unwind & Exit
UPPER SCALE:
Guaranteed
Cost
Full
Risk Retention
Group
Group
Captive
Moderate/Full Moderate/Full
Sponsored
Captive
Pure
Captive
Large
Deductible
Self-Insured
Risk
Some
Some
Some
None
None
Some
Some
None
None
None
None
Full
Full
Full
Full
Full
Moderate
Some
None
Minor
Minor
Some
Some
None
None
Full
Full
Full
Full
Full
Moderate
Some
Full
Full
Full
Moderate
None
None
Expected
Dividend
Expected
Dividend
Limited
Unpaid
Limited
Unpaid
Limited
Unpaid
Unpaid
$0
$0
$0
Varies
$250k or more
$0
Judgment
$0
Built in
Built in
$30k - $100k
$50k once, and
$50k - $150k
$0
$0
7 - 30 days
30-60 days
30-60 days
30-60 days
60-90 days
7 - 30 days
No time
Easy
Easy
Moderate
Moderate
Tough
Moderate
Tough
None
Minor
Some
Moderate
Significant
Major
Full
Moderate/Full Moderate/Full

The Value Equation of Captives
◦ The impact of risk information
◦ In comparison to commercial insurance
◦ Real vs. advertised value

Value by Type of Captive
◦ Single Parent
 Pure - 831(a) or 831(b)
 Sponsored - 831(a) or 831(b)
◦ Group Parent
 Group Captive
 Risk Retention Group

Success Stories/Panel Discussion