Captives 301
Peter A. Joy, ARM
Aon Captive & Insurance Managers
Executive Vice President
Jim Kasprzyk
McDonald’s Corporation
Senior Director Corporate Insurance
1
Purpose of this Session
 Give an appreciation of the advanced uses of captives
 Cell captive
 Branch
 RRGs
 Special Purpose Financial Captives
 Domicile Selection
 Tax
 Pooling Arrangements
 831(b) Small Insurance Companies
 Case Study – McDonald’s Corp
2
What is a Captive?
 A captive is an Alternative Risk Transfer vehicle
 It transfers premium from the insurance marketplace to an
alternative vehicle
 It is a special form of insurance company that insures or
reinsures the risks of related entities and closely managed
business partners.
3
Types of Captives
 Pure
 Multiple captives
 Domicile importance
 Cell Captives
 Branch
 Risk Retention Groups
 Special Purpose Financial Captives
4
Cell Captives

Various names, eg segregated cell, protected cell, etc
Core is owned by one entity, and ‘cells’ are rented to others
Activity in cell is governed by contractual agreement or preferred
share arrangement
‘Capital’ (in the form of cash, LOC, parental guarantee,
reinsurance) must cover the maximum risk written by cell
Usually formed for a specific purpose and can be a short-term
reaction to the marketplace
Easy exit if the market softens or a pure captive is pursued

Can be incorporated or non-incorporated





5
Typical Cell Structure
Management
Shares
Insurance Shares (clients)
Cell
Cell Cell Cell Cell Cell Cell
Bust Cell Cell Cell Cell
Cell Cell
11
2
3
4
5
66
7
8
9 10
10 etc...
PROTECTED
PROTECTED
1. Each cell has legal segregation and protection of
assets and liabilities
2. Legal segregation and contractual segregation
3. Management shares MAY be at risk
6
Cell to Access Reinsurance
INSURED
Insurance Shares (clients)
Management
Shares
Cell Cell Cell Cell Cell Cell
1
2
3
4
5
6
Cell Cell Cell Cell
Cell Cell
7
8
9 10
10 etc...
REINSURER
7
Cells to Segregate Liabilities
Separate Insurable Risks
Management
Shares
Cell
Cell Cell Cell Cell Cell Cell
Cell Cell Cell Cell Cell
Cell Cell
11
New owners
Captive
1
2
3
4
5
66
Captive
6
7
8
9
10
10 etc...
Captive
10
Each cell holds a separate liability, eg a physician
practice, a property subject to legal challenges, etc
8
Branch
Formed by a pure-captive for a specific purpose in another
domicile
 It is not an incorporated entity and so the D&O’s are the
same as the parent

9
Typical Branch Structure
Parent
Majority of lines of
insurance
Captive
Specific line of
insurance
Branch Captive
Branch results are reflected in
captive since the branch is not
an incorporated entity
10
Branch to Write Employee Benefits
Parent
Employee Benefits
Insurance
Life or LTD
Insurer
Reinsurance
Majority of lines of
insurance
Captive
Branch Captive
Branch results are reflected in
captive since the branch is not
an incorporated entity
11
Branch to Write Surety
Surety insurance
Parent
Certificates
of
Insurance
Majority of lines of
insurance
Captive
HI or NV
Branch Captive
Branch results are reflected in
captive since the branch is not
an incorporated entity
3rd-party
12
Risk Retention Group







Operates similar to a group captive yet is regulated under federal
legislation
Can write direct – no front company needed
Can operate in a state after it ‘registers’
Can only write liability lines of risk – no WC or property
It is regulated very similar to a regular insurance company
Subject to a great deal of scrutiny
Insureds must be owners and owners must be insureds
13
Typical Risk Retention Group
Members
Reinsurers
One Time
Owner
A
Capital
Annually
Owner
B
Owner
C
Risk
Retention
Premiums
If necessary
Surplus
Assessments
A
Reinsurance
(if any)
B
Group
C
14
Physician RRG
Members
Reinsurers
One Time
Doc
A
Capital
Annually
Doc
B
Doc
C
Risk
Retention
Premiums
If necessary
Surplus
Assessments
A
Reinsurance
(if any)
B
Group
C
Profit/Dividends
15
Closed Trucking RRG
Members
One Time
Sub
A
Capital
Annually
Sub
B
Sub
C
Risk
Retention
Premiums
If necessary
Surplus
Assessments
FMCSA
Evidence
Insurance
State
DMV
Group
Customers
16
Special Purpose Financial Captive
 Primary example is the XXX Securitization Captive
 Highly valued by Life Insurers
 Efficient way to remove redundant statutory
reserves from balance sheet
 Many states have specific laws to attract such
transactions
 Some states have simpler, similar laws that
allow the captive to reinsure unrelated
business
 Used to capture another source of income!
17
Domicile Selection
 Domicile decision criteria:








Capitalization requirements
Costs – premium taxes vs license fees
Receptiveness & stability of regulatory environment
Quality of local infrastructure & expertise – or can I use outside
vendors?
Flexibility as respects investment portfolio, loan backs, etc
Ease of doing business
Convenience of travel if an annual domicile Board meeting is
mandated
Acceptance of non-admitted reinsurance
 Geographic Convenience
 Dodd Frank Act – Self Procurement Tax
18
WA
VT NH
MT
ND
ME
OR
MN
IO
WI
SD
WY
MI
RI
IA
NE
NV
UT
IL
IN
PA
NJ
VA
DE
MD
DC
OH
CO
CA
MA
NY
WV
KS
AZ
MO
KY
NM
NC
TN
OK
AR
SC
MS
TX
CT
AL
GA
LA
HI
FL
Captive Legislation
No Captive Legislation
Alaska is not shown, but does not have legislation
19
Tax: to Achieve Insurance Company Status
 There must be risk shifting and risk distribution
 The risk is shifted from the balance sheet of one entity to the




balance sheet of another
A loss passed from the parent to the captive is not shifted,
because upon consolidation the loss is returned
A loss passed from one subsidiary to another is shifted, because
the subsidiaries are not consolidated together - known as the
Brother-Sister Structure
A loss passed from a 3rd-party entity to the captive is shifted
because clearly the entities are not consolidated together
Risk distribution invokes the law of large numbers – the
premium collected from many is used to pay the losses of the few
20
Third Party Business
50%
30%
Case Law
Humana/
Kidde
IRS
Safe Harbor
RR2002-89
21
Sources of Third Party Business
 Unaffiliated Sources (potentially high risk and may
be discouraged by captive regulator)
 Affiliated Business


Minority owned joint ventures
Suppliers
 Customer Programs
 Employee Programs
Pooling
22
Brother/Sister Model
Safe Harbor – 12 entities
RR2005-40
(5% - 15% premium range)
Proportion of parent risk
insured is not deductible
CAPTIVE
SUB
SUB
SUB
Case Law – 8 entities
Malone & Hyde
Parent
SUB
SUB
SUB
SUB
SUB
SUB
SUB
SUB
SUB
All must have separate balance sheets
No single member LLCs
Subsidiary premiums
are deductible
23
Pooling
 Sharing in risks of others
 Controlled
 Reduces volatility
 Source of third party business
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Pooling
$10m
$15m
$2m
$5m
$5m
$8m
$30m
$25m
Captives
Pay in first party
premiums
Pool
$100m
Own proportion of pool:
Premium
Total Pool
10%
15%
2%
5%
5%
8%
30%
25%
25
Pooling
$10m
$15m
$2m
$5m
$5m
$8m
$30m
$25m
Captives
Pay in first party
premiums
Pool Value
$100m
Receive reinsurance
premiums
First Party & Third Party
3rd Party %
$1m
$9m
$2.25m
$12.75m
$10m
$15m
2%
85%
98%
90%
$0.04m
$1.96m
$0.25m
$4.75m
$0.25m
$4.75m
$0.64m
$7.36m
$9m
$21m
5%
5%
8%
95%
95%
92%
$6.25m
$18.75m
30%
70%
25%
75%
26
Federal Tax Accounting
Insured
Premium Deduction
Captive
($10)
($10)
Premium Income
$10
Loss Reserve Deduction
($ 8)
Net Captive Income
Consolidated
$2
$2
Net Consolidated Deduct
($ 8)
Tax Benefit @ 40%
$3.2
27
831(b) Election - Example
Insurance Company
Without Election
Premium
Insurance Company
With Election
$1,200,000
$1,200,000
$200,000
$200,000
$1,000,000
$1,000,000
$10,000
$10,000
Total Income
$1,010,000
$1,010,000
Taxable Income
$1,010,000
$10,000
Tax @ 35%
$353,500
$3,500
Net Income
$656,500
$1,007,500
Claims
Underwriting Profit/Loss
Investment Income
Difference = $351,000
28
Wealth Transfer
Pops Co. 1
Insured deducts
premium as expense
(Tax Saving $350k)
Trust 1
Pops Co. 2
Grandson
Pops Co. 3
Pops Co. 4
Pops Co. 5
Pops Co. 6
Trust 2
Inheritance
Insurance
Granddaughter
$1m
Captive
Takes
831(b)
election
No Claims
$1m
Dividend
Auntie Mabel
Shareholders pay
tax at their applicable
rate
Pops Co. 7
Pops Co. 8
29
Putting all the Pieces Together
McDonald’s Corp - a Case study
 The size of the insurance needs
 Differing stakeholder needs
 Multiple Captives
 Multiple Domiciles
 Nothing stays the same…..
30
McDonald’s Corporation Inc.
 $75 Billion in System-wide Sales
 32,500 Stores
 Operations in almost 120 Countries
 81% of locations franchised
 % of Profits by Area of the World
 47% US
 37% Europe
 16% APMEA
31
Scope of RM Operations
 Property & Casualty Coverage for: US &
International Company, Owner Operator and JV
Stores
 Corporate Insurance Programs such as excess
liability, aviation, D & O, Fiduciary etc.
 US Owner / Operator Health & Welfare Plan
 Estimated Total Insurance Cost: $500 Million
Multiple Captives
 Golden Arches Insurance Limited ( GAIL )
 Golden Arches Re-Insurance Limited ( GARL )
 McDonald’s Owner Operator Insurance Company (
MOOIC )
 BRS Insurance Company
33
Creativity Needed for Health Insurance
 MIP offers a ‘ limited benefit ‘ plan with three
medical options: Basic, Mid 5 and Mid 10
 Mini Med Plan
 Basic Plan


Maximum Annual Benefit $2,000 per person
$150 Annual Outpatient Deductible
 Mid 5 Plan has $5,000 per person benefit
 Mid 10 Plan a $10,000 per person benefit
34
The Latest: BRS Insurance Company
 Arizona captive
 A new ‘ Risk Management Tool ‘ for use on future
employee benefit programs such as MIP
 In the meantime, US Property Insurance Program
and re-insurance for US Ronald McDonald House
Charity: “package insurance policies”
35
Nothing stays the same…..
 Solvency II impacting Dublin captives
 New capital requirements, new costs
 New Treasurer asking “Why?”
 Justify purpose and domicile all over again
 Stay ahead of the curve
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ANY QUESTIONS
37