Deconstructing the Value Proposition of Captives
Charlie Woodman, CPA, CGMA
Risk Finance & Analytics
Willis Construction Practice
Craig A. Ream
Program Administrator - CS Insurance Ltd.
Willis Captive Practice
20th Annual Willis Construction Risk Management Conference
Marriott Legacy Town Center – San Jacinto Room
Tuesday, September 16, 2014
Economics of Insurance: The Stage
Profits & Losses
55 -75%
• Components of Traditional
Insurance:
Expected loss and ALAE
Taxes and regulatory fees
Overhead and administration
Insurer selling and
distribution expense
Reinsurance and Intermediary
charges
Risk Margins
Surplus charges
Risk Based Capital offsets
Fixed (25%-35%)
Insurance Company
Overhead, Taxes,
Reinsurance Cost,
Commissions
Profits & Investment Income
Underwriting Profit and Investment
Income Accrued by Insurance
Company
1
The Continuum of Risk Finance
HIGH
Integrated Risk
• Traditional Hazard lines (property,
Casualty, EPL)
• Integrated layers at specified layers
Qualified Self Insurance w/ Risk Funding
• State Qualified Self Insured
• Insured is legal insurer
Group Captives
• Formed to insure member owners (shared risks/assets)
• Replication of insurance and group purchase of excess
Large Deductible Policy
• Significant/complete risk assumption in exchange
for deductible credit
Loss Sensitive or Retro Policy
• Assumption of limited risk in exchange for potential return premium
• Deferred “pay-in” premium
Guaranteed Cost
• Complete transfer of risk
• Commercial insurance with no deductible
LOW
Assumption of Risk
HIGH
Program Selection Drivers are
Risk Appetite
Financial Protection
Asset and Revenue Protection
Performance Certainty
Liquidity and Cash Certainty / Cost of Short-term Finance
Statutory or Counter-party Requirements
Revenue / Expense Matching
Safety & Loss Containment Services and Acquired Disciplines
Control
Negotiation & Leverage
Catastrophic Protection
Taxation
Market Opportunity
Captive Insurance Company - Defined
An Insurance Company, typically owned by non-insurance parent(s), insuring the
risks or interests of its owner(s)
Incorporated, Regulated, Capitalized and Individually Accountable
May be fairly transparent
May or May not be a replacement for insurance. Depends on Form (ownership and
insured relationship)
Emphasizes the ‘Insurance Transaction’
Insurance Company Operations:
Insurance Accounting and Financial Metrics
Must Always Maintain Positive Capital and Surplus (Unrestricted Net Worth I.e.,
Marketable Assets > Liabilities)
Typically administered by professional third-parties
Captive Mgt / Legal / Audit / Actuarial / etc.
4
Forms of Captives
Single-owner or Pure
Group – Homogeneous or Heterogeneous
Association
Insurer Controlled
Agency / Sponsored
Rent-a-captive
Segregated account (cell) captives
Captive pools
Risk retention groups
Trusts
Special Purpose (Re)insurer
Etc…
Feasibility Prerecorded Lecture/
5
5
Boil It Down – Two Real Types
Single Parent
Wholly-owned (and can include Rent-A-Captive “Cells” & Trusts)
Emphasis on Risk Funding and Cost / Funding Efficiencies
Underwrites ‘related’ risks to single economic interest as insureds are commonly parental
operations
Will consolidate operating and financial position with publicly-held parent; may deconsolidate
under certain circumstances in closely-held.
Group Owned
No common ownership among insured participants
Group, Association Captive, Risk Retention Group
Emphasis on Risk Transfer as an insurance market alternative
Will pool certain retention layers among participant insureds
Common services and emphasis on the health of the group as a whole.
6
Primary Focuses of Single Parent Captive Programs
Cost Savings
Long Term - “Seasoning” of a Property & Casualty Insurance Company:
Platform and enhance the placement of insurance coverage, terms and conditions
Access or contract with alternative markets or reinsurers
Effect optimal balance of risk retention and transfer, glean greater control over risk
process
Projected performance is difficult to quantify
Short Term - “Business Case” / Cash Flow Efficiencies: Highly Quantitative / Heavy Tax
Risk Management / Program Facilitation
Provide rapid liquidity
Buy Down Deductibles of Subsidiaries or Operating units
Stabilize or enable allocations and budgeting / contracting processes
Business Enhancement: “Profit Center”
Controlled Insurance Programs
Sub Contractor Default Insurance
Extended Warranty / Service Contracts
Asset Facilitation / Wealth Strategies – Closely-helds
7
Business Case: Assessment and Short-term Viability
NPV - Short Term Business Case cost Savings
Accelerated Tax Benefits
State Tax Arbitrage
Operating Costs
WACC / Opportunity Cost of Capital
Other Quantitative & Qualitative
Capital Commitment / Operating Cost
Internal Costs & Resource Commitment
Recognitions and Materiality
Corporate Culture
8
Group Captive Value Proposition
Control over insurance “destiny”
Unbundled service providers
Retain underwriting profits and earn investment income
Disciplined loss funding in a tax favorable structure
Access to capacity and economies of scale
Group Captive Value Proposition
Reduce and stabilize costs
Improve risk management through accountability
Customized and focused loss control services
Improved long term premium stability
Best in class coverage
Captive benefits on shared platform – reduced expense
Group Captives
Unbundling the Insurance Transaction
How do they do it?
Assumption of a high level of risk
Cost of risk transfer significantly reduced
Insurance market volatility minimized
Proven risk sharing structure
Reduces volatility in claims experience for participants
Provides needed risk shifting and distribution
Volume purchase
#61 on ENR top 400 - $900M in combined revenues
Shock claims are diluted
How do they do it?
Investment income
Enhanced loss prevention and claims management
Avoid exposure to cat risks
Member selection - “Best in Class” controlled growth
Assures health of program over time
Reduces cost of risk transfer
Enhances peer group best practices exchange
Construction Solutions
Case Study
Construction Solutions
Construction Solutions
Contractors Group Captive Established in 2001
100% Member Owned and Controlled
Domiciled - Cayman Islands
Prospective Members:
Moderate/High hazard contractors generating between $500,000 and
$3,000,000 in combined WC, GL and Auto Standard Premium
Contractors with a strong senior management commitment to safety
Contractors with loss and incident rates superior to average for class
Contractors with a formal loss control and safety program
Contractors with solid financials
Construction Solutions
Common January 1st renewal date
$136,000,000 of payroll insured
1,700 power units insured
$10,000,000 in annualized captive premium
Renewals presented in October and bound in November
Strict loss control covenants and annual CORR analysis
Bi-Annual Loss Control Meetings:
September 15, 2014
May, 2015
Dallas
Pittsburgh
Bi-Annual Board & Shareholder Meetings:
October 19-21, 2014
May 17-19, 2015
Toronto
Cayman
Construction Solutions
Insured Coverage
Workers’ Compensation
Statutory Coverage &
1M Employers Liability
General Liability
1M per occurrence 2M aggregate
per project/per location aggregate
Automobile
1M Liability
Physical Damage
Construction Solutions
Current Membership
2 Masonry Construction
2 Commercial Roofing & Sheet Metal Fabrication
1 Machinery Installation, Rigging, and Transportation
1 Road/Street Construction and Paving
1 Road/Street & Bridge Construction
2 Asphalt Distribution and Paving
1 Aggregates and Precast Concrete Products
1 Pipeline Construction
Construction Solutions
Current Members
Peckham Industries – White Plains, NY
The Hamlin Companies – Garner, NC
Franco Associates – Pittsburgh, PA
Cost Company – Pittsburgh, PA
Energy Services of America (ESA) – Huntington, WV
Valley Group – Fishersville, VA
Suit-Kote – Cortland, NY
Economy Paving – Cortland, NY
Diamond Materials – Wilmington, DE
Greenwood Industries – Millbury, MA
LC Whitford – Waterville, NY
Construction Solutions
Internal Structure
One Time Capitalization:
$ 30,000 Share Purchase
Experience Adjustment Assessment equal to one times A Fund
In a multi coverage occurrence the total clash retention is $ 500,000.
$ 1,000,000/Unlimited (WC)
Reinsurance – Arch
Excess of $ 500,000
$ 500,000
Severity Fund B
$ 375,000 XS $ 125,000
$
125,000
Frequency Fund A
First Dollar to $ 125,000
General Liability
Workers
Compensation
Auto
Construction Solutions
Premium Distribution Example:
Captive Expenses
$ 345,900
Loss Funding
$ 654,100
Total Premium
$1,000,000
Construction Solutions
Premium Distribution Example:
A Fund
$ 490,575
B Fund
$ 163,525
Loss Funding Allocation
$ 654,100
Construction Solutions
Conceptual Annual Program Pricing
ABC Construction
WC
49.06%
16.35%
65.41%
18.98%
5.72%
3.50%
1.30%
2.09%
3.00%
34.59%
A Fund - $0 - $125,000 $
B Fund - $125,000 - $500,000 $
Total Loss Funds $
Excess & Aggregate Charge
Front Administrative Charge
Taxes/Boards & Bureaus Charge
Loss Control Funding
Claims Admin Funding
Captive Expense Funding
Subtotal
Total Estimated Subject Premium
Estimated Composite Rate
Auto
Total
269,816 $
147,173 $
73,586 $
490,575
89,939 $
49,058 $
24,529 $
163,525
359,755 $
196,230 $
98,115 $
654,100
$
104,390 $
56,940 $
28,470 $
189,800
$
31,460 $
17,160 $
8,580 $
57,200
$
19,250 $
10,500 $
5,250 $
35,000
$
7,150 $
3,900 $
1,950 $
13,000
$
11,495 $
6,270 $
3,135 $
20,900
$
16,500 $
9,000 $
4,500 $
30,000
$
190,245 $
103,770 $
51,885 $
345,900
$
Estimated Exposure
GL
$
550,000
$
15,000,000 $
3.67
300,000 $
15,000,000
$
1,000,000
140
2.00 $
Share Purchase
Retail Brokerage Fee
Assessment Exposure
Collateral Required
150,000
1,071
$
(A Fund)
(2/3 A Fund)
$
$
30,000
TBD
490,575
326,723
Construction Solutions
ABC Construction
Policy Term
2013
2012
2011
2010
2009
2008
$
$
$
$
$
$
TOTALS
$
All Lines to include General Liability, Auto Liability and Workers Compensation
$0 - $125,000
$125,001 - $500,000
$500,001+
200,000 $
- $
- $
650,000 $
- $
- $
325,000 $
100,000 $
- $
325,000 $
300,000 $
- $
325,000 $
375,000 $
500,000 $
125,000 $
375,000 $
1,500,000 $
1,950,000 $
1,150,000 $
2,000,000 $
Total Incurred
200,000
650,000
425,000
625,000
1,200,000
2,000,000
5,100,000
Construction Solutions
ABC Construction
Gross Subject Premium
Losses Incurred (Paid+Reserved)
Losses Excess of $500,000 Reinsured:
$
$
$
A FUND
Net Premium
Losses Incurred (Paid+Reserved)
$
$
Profit/(Loss) $
Transfer to B
$
A Fund Assessment
$
Sub-Total: $
Deficit Reallocation (Risk Share)
$
Final A Fund Balance $
B FUND
Net Premium
Losses Incurred (Paid+Reserved)
$
$
Profit/(Loss) $
Transfer from A
$
Deficit Reallocation (Risk Share)
$
Final B Fund Balance $
Loss Equity Balance*: $
2013
2012
1,000,000 $
200,000 $
$
1,000,000 $
650,000 $
$
2011
2010
1,000,000 $
425,000 $
$
2009
1,000,000 $
625,000 $
$
2008
1,000,000 $
700,000 $
500,000 $
Total
1,000,000 $
500,000 $
1,500,000 $
6,000,000
3,100,000
2,000,000
490,575
200,000
290,575
290,575
290,575
$
$
$
$
$
$
$
$
490,575
650,000
(159,425)
159,425
-
$
$
$
$
$
$
$
$
490,575
325,000
165,575
165,575
165,575
$
$
$
$
$
$
$
$
490,575
325,000
165,575
(136,475)
29,100
29,100
$
$
$
$
$
$
$
$
490,575
325,000
165,575
(165,575)
-
$
$
$
$
$
$
$
$
490,575
125,000
365,575
(211,475)
154,100
154,100
$
$
$
$
$
$
$
$
2,943,450
1,950,000
993,450
(513,525)
159,425
639,350
639,350
163,525
163,525
163,525
$
$
$
$
$
$
163,525
163,525
163,525
$
$
$
$
$
$
163,525
100,000
63,525
63,525
$
$
$
$
$
$
163,525
300,000
(136,475)
136,475
-
$
$
$
$
$
$
163,525
375,000
(211,475)
165,575
45,900
-
$
$
$
$
$
$
163,525
375,000
(211,475)
211,475
-
$
$
$
$
$
$
981,150
1,150,000
(168,850)
513,525
45,900
390,575
154,100 $
15.4%
1,029,925
17.2%
454,100 $
45.4%
163,525 $
16.4%
229,100 $
22.9%
29,100 $
2.9%
$
0.0%
Construction Solutions
Maximum Cost: $ 1,482,510
Premium + Assessment
Minimum:
$ 356,654 Captive “Fixed” Expenses
Less - Investment Income
Plus - Shared Losses
Construction Solutions
Hypothetical Collateral Requirements
(Assume A Fund $482,510 Each Year)
1st Year 2/3 of A Fund = $321,673
2nd Year 2/3 of A Fund = $321,673
$643,346 combined
3rd Year 2/3 of A Fund = $ 321,673
$965,019 combined
No Additional Collateral required at 4th renewal!!
4th Year Caps at 2/3 of 3 Year Total = $965,019
Construction Solutions
Service Providers
Front and Reinsurance - Arch Insurance
Program Administration – Willis
Onshore Legal Counsel – Kerr, Russell & Weber, LLP
Captive Manager – SRS (Cayman)
Investment Manager – PRP Performa Ltd.
Auditor – KPMG
Actuarial – Milliman
Claims Administration – Gallagher Bassett
Loss Control – Willis
Captive Flow
Underwriting Profits!
Insured
CS Retail Broker
Arch Insurance Company
CS INSURANCE LTD.
Willis, SRS, KR&W, Milliman, KPMG, GB
Construction Solutions
Policy Issuance
Financial Protection
Specific and Aggregate Excess Coverage
Statutory Coverage
Meets Legal Regulatory and Customer Requirements
Underwriting Expertise
Loss Control Resources
Claims Administration – Gallagher Bassett
Why Construction Solutions?
Construction specific focus – coverage and services
Size of program
Enhanced input and control of captive operations
Active peer group - culture of constant improvement
High average member premium size - $885,000
Low average risk sharing – 3.5%
Minimal assessments
Why Construction Solutions?
Enhanced and focused risk control
Exceptional historical results – loss ratio 33%
$81 MM Premium - $22 MM paid & $3.5 MM reserves
Program Structure – flexible retention, ALAE, clash, aggregate
No automatic close-out policy
Excellent distribution history
$10 MM in distributions to date
Policy years closed – net cost was 70% of original premium
Construction Solutions
Questions?