Group Captive
&
Actuarial 101
Chad Kunkel
Artex Risk Solutions
Division Executive Vice President
Joe Herbers
Pinnacle Actuarial Resources, Inc.
Managing Principal
TC Leshikar
KPMG
Director, Tax
What is a Captive?
• A licensed insurance company formed to insure the risks
of its owners
• Regulated by the Country or State the company is
licensed in
• Captives are not all the same
Why form a Captive?
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Ability to retain underwriting profits
Underwriting flexibility
Lower insurance costs over the long term
Control over claims
Opportunity to receive investment income
Direct access to reinsurance and carriers
Incentives for loss control
Tax advantages
Insure coverage gaps
Types of Captives
• Single Parent Captives
– Pure captives insuring only their own risks or affiliates
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Rent-A-Captives
Agency Captives
Association Captives
RRG – Risk Retention Groups
Group Captives
Single Parent Captive
Types of Captives
• Single Parent Captives
• Rent-A-Captives
– Captive “rents” its facility to an outside organization
• Agency Captives
– Insures risks of its customers
• Association Captives
• Group Captives
Rent-A-Captive or Cell Captive
Captive
Cell 2
Cell 1
Cell 4
Cell 3
Cell 5
Cell 8
Cell 6
Cell 7
Types of Captives
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Single Parent Captives
Rent-A-Captives
Agency Captives
Association Captives
– Insures risk of the members of its association
• Group Captives
– Insures risk of its members or shareholders
Group Captive
Group
Premiums
Business 1
Business 5
Business 2
Business 6
Business 3
Business 7
Business 4
Insurance
Policies
Captive
Group Captive Considerations
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Reason for the Group Captive
Need for Critical Mass
Historical Data
Capital and Carrier LOC requirements
Retentions of the Captive
Sharing Risk
Captive Structure
Reason for forming a Group Captive
• Myth – taking risk does not always equal cheaper
insurance
• Need for long term approach
• Hard and soft market cycle consideration
Critical Mass
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Important for viability of Group
Premium volume typically equals lower costs
Need for Reinsurance/Carrier support
Law of large numbers
Need to overcome start up costs
Historical Data
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Important to determine feasibility
Historical Losses by Line of Coverage
Historical Exposures
Historical Premium information
Projected Exposures
Need for Carrier/Reinsurance Support
Need for Actuarial Study
Capital Requirements
• Captive will need Capital in addition to Premium paid in
• If Fronted Program – Carrier Collateral considerations
need to be contemplated
Captive Retentions
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Risk appetite of group needs to be contemplated
High retentions could create concern for new insureds
Low retentions could prevent carrier support
Lower retentions can help with stability in early years
Can increase retentions over time to assist in lower costs
Sharing Risk
• Number of ways to share risk
– Pooling or Quota Share
– Sharing occurs after premiums exhausted
– Layer Approach
• Reduces Sharing of Risk
• Holds Insureds more accountable
Captive Structure
• Stock or Mutual Company
• Ownership
– 1 Vote Per Insured
– Based on Premium or Capital
• Return of Premium Considerations
• Tax
Captive Process
Captive Feasibitliy Studies - Outline
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What is a Captive Feasibility Study
What are Actuaries?
Actuarial Involvement in Captive Feasibility Study
Dealing with Uncertainty
Predicting the Future
Captive Feasibitliy Studies
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Data Analysis
Loss Estimates
Capitalization Requirements
Domicile
Tax Issues
Coverage, Retentions, Limits
Expenses
Reinsurance Costs
Regulatory Issues
Pro forma Financials
Actuaries & Captive Feasibitliy Studies
• Projecting the future in regards to:
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Premiums
Losses
Loss Adjustment Expenses
Captive expenses
• Acquisition, general, taxes
• Reinsurance costs
• Capitalization Requirements
• Investment Returns
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
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Claims
Underwriting
Marketing
Legal
- Accounting
- Ratemaking
- Reinsurance
- Systems/IT
What does an Actuary do?
• Quite simply – Predict the Future
• Ratemaking – Figure out what premiums to charge for a
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
Essential Background Information
• Business Plan
• Historical premium, losses, claim counts & exposures for
entity being considered
• Domicile, Service Providers being considered
Captive Business Plan
• Key management of enterprise
– Owner(s), officers, roles
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Nature of underlying business being insured
Coverages
Retentions – both per occurrence and aggregate
Limits
Services Providers
Data Analytsis
• Projecting Ultimate Losses
– Start with current reported incurred losses
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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
Lags
Property/Casualty insurance business is characterized by
lags (which give rise to need for IBNR)
Uncertainty in Projecting Ultimate Losses
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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
Data Analysis
• Projecting Expenses
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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
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
Pro Forma Financials
Run Pessimistic, Base and Optimistic scenarios
• Underwriting Exhibit
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Projected premiums (direct / ceded / net)
Projected losses (premium x loss ratio)
Projected expenses
Dividends
Underwriting profit (by subtraction)
• Balance Sheet
– Assets, Liabilities & Surplus
Pro Forma Financials
Run Pessimistic, Base and Optimistic scenarios
• Income Statement
– Underwriting Income, Investment Income, Other Income
– Changes in Surplus
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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)
Consideration of Uncertainty
• Reliance on actual data versus benchmarks and/or
external data – less uncertainty in we have reliable data
for entity being studied
• Nature of historical data (# of years, consistency
between years)
• Examine reasonable range versus point estimate
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 in not good
• With feasibility studies, we provide a range from
pessimistic to optimistic
TAX
• From the insured’s perspective
- Are the Premiums Deductible?
- Are there any Premium Taxes?
Domicile, U.S. Federal Excise Tax, State Premium Taxes etc.
• From the owners’ perspective
– If Non-U.S. domiciled, are the owners subject to tax
annually or only when distributions are made?
– Is there any “unrelated business taxable income” for
the tax-exempt owners
TAX
• From the captive’s perspective
– Is it considered an “insurance” company for U.S. tax
purposes (i.e. can it deduct loss reserves, are the
premiums paid by the insureds deductible)?
– If Non-U.S., is it a controlled foreign corporation (“CFC”)?
– If Non-U.S., is it eligible to make the Section 953(d)
election to be taxed as a U.S. Corporation?
– Is it eligible to make the Section 831(b) election?
– If Non-U.S., are there withholding taxes on its income?
– If Non-U.S., does it intend to “conduct a U.S. trade or
business”?
TAX
• Items to Consider
– Taxable and tax-exempt organizations may have different tax
motivations
– Some uncertainty in the area of U.S. Tax of Captives. Should be
part of Owners/insureds’ risk tolerance assessment
– Determine upfront, how the Captive will be treated for U.S. Tax
purposes.
– Make sure all stakeholders’ tax advisors are involved at
formation and all on same page
– Document the business reasons for captive formation as support
in case of future audit
– Include tax calculations in proformas and projections
Formation Process
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Creation of Business Plan
Identification of Services Providers
Insurance Manager forwards Business Plan to CIMA
Meeting with CIMA
License Application submitted to CIMA
– Pro forma Projections, Actuarial projections, Business Plan, Identification of
service providers along with director applications
• “Approval-In-Principle received – 6 Weeks
• Company incorporated and capital put in place
• License Issued
Get Started
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Board of Directors
Appointment of Officers
Appoint and Engage Service Providers
Insurance Arrangements
Creation and approve operating budget
Creation of Committees
You are up and running!
On Going
• Board Meetting
– Determine how often
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Shareholder/Member Involvement
Committees
Signing Authority
Financial Statement Review
Investment Policy
Review of Goals/Establish new ones
Long Term
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Retention of Membership
Long Term Approach
Adequate pricing and capitalization
Risk Management
Return of Premiums/Dividends
Monitor Service Providers
Review of Structure/Retentions
Questions & Answers