Cayman Captive Forum
Presentation 2013
Captive / Actuarial 101
Julie E. Robertson
Partner
Joseph A. Herbers
Managing Principal
Fiona J. Moseley
President & Director
2
" Everything you wanted to know and were afraid to
ask… An introductory session to cover practical
guidelines on legal, actuarial and regulatory matters
during the formation and operational stages of a
new captive."
3
What is a Captive?
• The most simple definition: a licensed insurance company
formed to insure the risks of its owners
But the world is more complicated
-
RRGs; cell companies (SPCs), agency captives, rent-a-captives, micro captives,
branch captives, reciprocals, series LLCs, portfolio insurance companies (PICs)
• If you’ve seen one captive . . . you’ve only seen one captive!
• Array of models provides flexibility, but creates the need for
expertise and evaluation of the options in formation
4
What is a Captive?
• A licensed insurance company
• Regulated in a state or country (domicile) that has
unique laws for captives
− They typically vest a great deal of authority in the regulator and are
less stringent than laws regulating commercial carriers
• Owners/insureds involved in governance
• Often have no employees but are managed by
contracted service providers
5
Why form a Captive?
Coverage isn’t available commercially
Coverage is unaffordable
Flexibility
Tax advantages
Access to reinsurance markets
Desire to provide coverage to third parties
Need for stable source of coverage
Need for uniform program across borders
Generate profits
Beat the market
Control of claims
Heightened focus on loss prevention
Keep investment income on premiums
Eliminate coverage gaps
Design coverage to meet insurance needs
Drive organizational change
6
7
Captive Feasibility Studies - Outline
•
•
•
•
•
What is a Captive Feasibility Study
What are Actuaries?
Actuarial Involvement in Captive Feasibility Study
Dealing with Uncertainty
Predicting the Future
8
Captive Feasibility Studies
•
•
•
•
•
•
•
•
•
•
Data Analysis
Loss Estimates
Capitalization Requirements
Domicile
Tax Issues
Coverages, Retentions, Limits
Expenses
Reinsurance Costs
Regulatory Issues
Pro forma Financials
9
Actuaries & Captive Feasibility Studies
• Projecting the future as regards:
–
–
–
–
Premiums
Losses
Loss Adjustment Expenses
Captive expenses
• Acquisition, general, taxes
• Reinsurance costs
• Capitalization Requirements
• Investment Returns
10
What is an Actuary?
• Insurance professional skilled in measuring and
quantifying risk
• Typically a math or statistics major in college
• Schooled in all aspects of insurance operations
- Claims
- Underwriting
- Marketing
- Legal
- Accounting
- Ratemaking
- Reinsurance
- Systems/IT
11
What does an Actuary do?
• Quite simply – Predict the Future
• Ratemaking – Figure out what premiums to charge for
variety of coverages, limits and deductibles
• Loss Funding Studies – Projecting future costs so insurer
or self-insured entity can budget costs
• Loss and loss adjustment expense reserve accruals for
financial reporting purposes
• Retention Level Analysis
• Exposure Modeling (CAT)
• Risk Transfer in Reinsurance
12
Essential Background Information
• Business Plan
• Historical premium, losses, claim counts & exposures
for entity being considered
• Domicile, Service Providers being considered
13
Captive Business Plan
• Key management of enterprise
– Owner(s), officers, roles
•
•
•
•
•
Nature of underlying business being insured
Coverages
Retentions - both per occurrence and aggregate
Limits
Service Providers
14
Data Analysis
• Projecting Ultimate Losses
– Start with current reported incurred losses
•
•
•
•
Adjust for retentions
Adjust for expected future loss development
Adjust for future trend
Adjust for changes in statutory benefit levels (WC)
– Use multiple methods to project ultimate losses
– Rely on a point estimate or reasonable range of ultimate
losses
• Project Ultimate Loss Ratio
15
Lags
• Property/Casualty insurance business is
• Projecting Ultimate Losses
characterized by lags (which give rise to need for
– Start with current reported incurred losses
IBNR)
•
•
•
•
Adjust for retentions
Adjust for expected future loss development
Adjust for future trend
Adjust for changes in statutory benefit levels (WC)
– Use multiple methods to project ultimate losses
– Rely on a point estimate or reasonable range of ultimate
losses
• Project Ultimate Loss Ratio
16
Uncertainty in Projecting Ultimate Losses
•
•
•
•
•
Changes in rate of claim payments
Changes in case reserving practices
Changes in mix of exposure
Changes in retention limits
Changes in claim reporting procedures
17
Data Analysis
• Projecting Expenses
–
–
–
–
–
–
–
–
Commissions/Brokerage
Fronting
Taxes, Licenses & Fees
General (audit, actuarial, legal)
Claims Handling
Reinsurance
Loss Control
Federal Excise Tax
Usually stated as % of either WP or EP
18
Data Analysis
• Underwriting Profit
• Investment Returns
– Investment Income
• Mix of investments by type (stocks, bonds, cash, other)
• Expected returns by type
– Realized Capital Gains/Losses
• FIT
• Dividends
19
Pro Forma Financials
Run Pessimistic, Base and Optimistic scenarios
• Underwriting Exhibit
–
–
–
–
–
Projected premiums (direct / ceded / net)
Projected losses (premium x loss ratio)
Projected expenses
Dividends
Underwriting profit (by subtraction)
• Balance Sheet
– Assets, Liabilities & Surplus
20
Pro Forma Financials
Run Pessimistic, Base and Optimistic scenarios
• Income Statement
– Underwriting Income, Investment Income, Other Income
– Change in Surplus
•
•
•
•
•
Beginning Surplus
Capital Paid In
Net Income
Change in unrealized gains
Stockholder dividends
• Cash Flow Statement
– Beginning Cash
– Inflows (premiums, investment income, paid-in capital)
– Outflows (losses, expenses, taxes, dividends)
21
Consideration of Uncertainty
• Reliance on actual data versus benchmarks and/or
external data – less uncertainty if we have reliable
data for entity being studied
• Nature of historical data (# of years, consistency
between years)
• Examine reasonable range versus point estimate
22
Predicting the Future
• We know our projections will not be absolutely
correct
• Objective is to have projections “in the right
neighborhood” close to reality
• Systematic pessimism or optimism is not good
• With feasibility studies, we provide a range from
pessimistic to optimistic
23
Captive Models
Single Parent Captive
Wholly owned insurance company established to insure/reinsure
the risks of the single parent and/or its affiliates.
SINGLE PARENT NO AFFILIATES:
COMPANY X
Insurance
CAPTIVE
24
Captive Models
SINGLE PARENT CAPTIVE SERVING AFFILIATES:
COMPANY X
CAPTIVE
COMPANY X
COMPANY X
COMPANY X
Subsidiary 1
Subsidiary 2
Subsidiary 3
25
Captive Models
Group Captive
Two or more owners form an insurance company to
insure/reinsure risks of its owners (or their affiliates)
GROUP CAPTIVE:
COMPANY X
COMPANY Y
COMPANY Z
CAPTIVE
26
Captive Models
Cell Captive (aka Segregated Cell Captive, Sponsored Captive, Segregated Portfolio Company)
One insurance company with separate “cells,” each cell with a
separate insurance program and possibly a shareholder.
Preferred X Shares
Cell X
Ownership of Voting Stock of
the Captive, Appoints Board
CAPTIVE
Cell Y
Preferred Y Shares
Cell Z
Preferred Z Shares
27
Captive Models
Risk Retention Group
Similar in structure to a group captive, but formed in a U.S. state
under authority of Liability Risk Retention Act. All insureds must
be owners, and all owners must be insureds – only authorized to
write liability risk.
COMPANY X
COMPANY Y
COMPANY Z
RISK RETENTION
GROUP
28
Domicile Selection
• Driving factors
– Structure/Coverage Needs
– Regulatory environment;
history
– Tax considerations
• Onshore and offshore
• Premium taxes
• Other factors
–
–
–
–
–
–
–
–
–
Capital/surplus requirements
Operating costs
Political stability
Infrastructure
Domicile meeting requirements
Local director requirements
Operating costs
Ease of travel
Perception, particularly for
nonprofits
– Availability of home state as a
domicile
– Unique characteristics of the
domicile
29
Tax
• From the insured’s perspective
− Is the premium deductible?
− What are the premium taxes?
• Domicile, US federal excise tax, state premium taxes
• From the owners’ perspective
− If offshore, are the owners subject to tax annually or only
when distributions are made?
− If offshore, is there “unrelated business taxable income”
for the tax-exempt owners
30
Tax
• From the captive’s perspective
− Is it an insurance company for US tax purposes (ie, can deduct
its loss reserves)?
− If offshore, is it eligible to elect to be a US corporation for tax
purposes (a 953(d) election)?
− Is it eligible for a small company election (an 831(b) election)?
− If offshore, are there withholding taxes on its income?
− If offshore, controlled foreign corporation or not?
− If offshore, does it intend to “conduct a U.S. trade or business”?
− Are there opportunities for the captive to be a tax-exempt
entity?
31
Tax
What’s most important:
− Understand that taxable and tax-exempt organizations may have
different tax motivations
− Recognize that there is not certainty in this area and determine
owners/insureds’ risk tolerance
− Determine tax positions up front, not when returns are
prepared
− Make sure all stakeholders’ tax advisors are involved at the
beginning
− Document the business reasons for captive formation as
support in case of future audit
− Include tax calculations in pro formas and projections
32
Direct Write or Fronted Program?
• A captive typically is not licensed/approved/admitted
in the jurisdiction in which the insureds are located and
is treated as an “unauthorized insurer”
• Can the captive write coverage directly or does it need
a “front”?
− State legal and regulatory requirements
− Contractual requirements of insureds
− Patient compensation funds
• Does the captive intend to attract new insureds/have a
desire to market the program?
33
Formation
• Legal documents for formation:
− US: Articles of Incorporation/Bylaws
− Cayman: Memorandum of Association/Articles of Association
• Other legal documents:
− Shareholders agreement for group captives
− Information circular/offering documents for group captives
− Subscription agreement
• License Application:
−
−
−
−
−
Pro formas
Actuarial projections
Business plan
Identification of service providers
Applications of directors and officers
34
Initial Operations
•
•
•
•
•
•
•
Approval in principle sparks a flurry of activity
Put in place operational guidelines
Board of Directors guidance
Front Company and Reinsurance
Insurance Manager
Committees
Regulatory
35
Approval in Principle Sparks a Flurry of Activity
•
•
•
•
•
Incorporation
Subscribers Meeting
First Directors Meeting
Open Bank Account
License issued
36
Put in Place Operational Guidelines
•
•
•
•
•
Board of Directors
Front company
Reinsurers
Insurance Manager
Committees
− Claims Management, Audit and actuarial, investment etc.
37
Getting Up and Running
• Approve insurance arrangements
• Engage service providers
− Actuary, auditor, lawyer, investment manager, banker, insurance
manager
• Adopt operating budget
• Approve investment policy
• Other policies: claims payment, expense
reimbursement
Congratulations: You’re running an insurance company!
38
Board of Directors Guidance
• Frequency of meetings, circulation of contact details and
agreement of approval mechanism
• Understand business plan and laws of operation
• Mind and Management discussion
– who is driving the bus and from where?
• Discuss and declare any conflicts and process around
future conflicts
• Appointment of Secretary and define role
• Mandates for Committees
• Signing Authority
39
Corporate Governance
•
•
•
•
Role of the Shareholders
Role of the Directors
Role of the Officers
Directors Duties
− Fiduciary
− Duty of care and skill
− Minutes
− Meetings
− Engagement and oversight of service providers
40
Front Company and Reinsurance
• Review and sign agreements
• Confirm logistics and reporting
41
Insurance Manager
•
•
•
•
•
Confirm responsibilities and expectations
Reporting deadlines
Information exchange
Financial Statement prep, Actuarial and Audit
Who is driving the bus?
42
Committees
• Define make-up
• Adopt the mandate
• Review the business plan
43
Regulatory
•
•
•
•
6 month check up
Financial Statement submission
Conformity to Business Plan
What if something go wrong?
44
Success Factors
•
•
•
•
•
•
Taking the long view
Management commitment
Adequate funding and capitalization
Group captives: documentation and fairness
Focus on risk management and mitigation
Conservatism in the early years
45
Q&A
Thank you for your attention