Captives Create Income and Growth for Agencies

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Captive insurance companies provide an excellent format from which an insurance agency, MGA or other insurance intermediary, can achieve income and enhanced revenue opportunities in both a soft and hard market.

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  • Captives Create Income and Growth for Agencies

    1. 1. Captive Fuel Growth for Agency Owners
    2. 2. | | | | | | | | | | | | | | | | | | | | | | | | | | | . | |
    3. 3. The time to repair the roof is when the sun is shining. John F. Kennedy
    4. 4. Captives Fuel Growth and Income for Agency Owners
    5. 6. <ul><li>3rd largest independent </li></ul><ul><li>captive manager w/ 150 </li></ul><ul><li>captives* </li></ul><ul><li>$.250 billion in premiums </li></ul><ul><li>Fee-based only </li></ul><ul><li>US, Cayman, BVI, Anguilla, </li></ul><ul><li>Nevis, Bahamas </li></ul><ul><li>3 rental captives for client use. </li></ul><ul><li>Enterprise solution w/ vast </li></ul><ul><li>resources for fronting, </li></ul><ul><li>reinsurance, 3 rd party providers </li></ul><ul><li>Senior management owns firm. </li></ul><ul><li>. </li></ul>Independent Captive Manager Survey, 2009 , Captive Review Chris Kramer, MBA SVP, Atlas Insurance, Ohio, with offices in Washington, DC Former insurance agency owner. XL Insurance (now X L Capital) FM Global Neace Lukens, Captive Insurance MBA, Case Western Reserve University BS/BA, Ins. & Risk Management, BGSU
    6. 7. First, some history… <ul><li>How “old” are today’s modern captives? </li></ul><ul><li>Youngstown Sheet & Tube’s captive formed in Ohio in mid-1950s and </li></ul><ul><li>then Bermuda in 1961. </li></ul><ul><li>Who came up with the term “captive”? </li></ul><ul><li>Fred Reiss, an insurance agent from Ohio. </li></ul><ul><li>Why did Reiss form a captive? </li></ul><ul><li>To reinsure a Lloyd’s property Insurance program. He was going to lose his </li></ul><ul><li>account and a captive would also use his expertise in risk management. </li></ul><ul><li>Why Bermuda? </li></ul><ul><li>Met a couple of lawyers from Bermuda at a meeting in </li></ul><ul><li>Sussex, England. </li></ul><ul><li>What’s changed since then? </li></ul><ul><li>Most everybody has heard of a “captive”. Originally used as expense/risk </li></ul><ul><li>management entities, today’s captives are increasingly used as profit </li></ul><ul><li>centers & by privately held businesses to help protect assets and transfer </li></ul><ul><li>wealth </li></ul>
    7. 8. Captives are making the news… <ul><li>Captives to escape haven crackdown ( BI 5/11/09) </li></ul><ul><li>&quot;There's nothing specific in the concepts that would seem to impact offshore captives in any particular manner…&quot; </li></ul><ul><li>Kentucky captive licenses increase by a third in Q1 ( Captive Rev . 5/09) </li></ul><ul><li>“ Kentucky has reported an excellent start to 2009, licensing 23 new captive insurance companies since 31 December 2008.” </li></ul><ul><li>Self-insurance cell captives a viable option for small firms (Bus. Day. 4/09) </li></ul><ul><li>“… used by medium and even some small companies - they are not there just for the major corporations.” </li></ul>
    8. 9. What is a Captive? <ul><li>Definition 1960’s </li></ul><ul><li>An insurance company formed by its parent for the </li></ul><ul><li>sole purpose of insuring the risks of the non-insurance </li></ul><ul><li>parent. </li></ul><ul><li>Currently </li></ul><ul><li>A limited purpose, licensed re/insurance company to </li></ul><ul><li>mainly insure the risks of the captive’s owners, </li></ul><ul><li>participants, or affiliates. </li></ul>
    9. 10. Is it an Insurance Company? <ul><li>For tax purposes the captive must qualify </li></ul><ul><li>as an insurance company </li></ul><ul><li>Business purpose not solely a tax planning; </li></ul><ul><li>Require capital; </li></ul><ul><li>Arms length calculation of premiums </li></ul><ul><li>Risk shifting – risk must be transferred </li></ul><ul><li>Risk distribution – there must be spread, pooling. </li></ul><ul><li>Real risks with real possibility of loss; </li></ul><ul><li>Pay claims; </li></ul><ul><li>Must be run and regulated as an insurance company. </li></ul>
    10. 11. Why are Captives so popular? Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute 1975-78 1984-87 2001-04 Captive Strategy 5,500+ Captive Strategy $50-60 Billion in premiums $150-60 Billion in Assets
    11. 12. Why are Captives so popular? <ul><li>Reasons are not always insurance cycles : </li></ul><ul><li>Provide Profits from UW and Investments </li></ul><ul><li>Competitive advantage – Financial efficiency. </li></ul><ul><li>Access to reinsurance </li></ul><ul><li>Control or reduce claims costs </li></ul><ul><li>Create asset protection strategies </li></ul><ul><li>Facilitates flexible risk financing </li></ul><ul><li>Tailor protection to unique risks </li></ul><ul><li>Owners are getting access to education </li></ul><ul><li>Transfer of wealth </li></ul>
    12. 13. Cell Captives –fastest growing <ul><li>Earliest version “rent-a-captives” - 1970’s </li></ul><ul><li>Can write virtually all lines </li></ul><ul><li>Cells can write directly or with a front </li></ul><ul><li>Biggest growth in owners taking 831(b) tax election </li></ul>
    13. 14. Captive Coverages <ul><li>Traditional </li></ul><ul><li>General Liability </li></ul><ul><li>Workers’ Comp. </li></ul><ul><li>Automobile </li></ul><ul><li>Professional Liability </li></ul><ul><li>Property </li></ul><ul><li>Medical Stop Loss </li></ul><ul><li>Directors & Officers </li></ul><ul><li>Employee Benefits </li></ul><ul><li>Retained & Asset Protection </li></ul><ul><li>Deductible & SIRs </li></ul><ul><li>Legal Expense Reimbursement. </li></ul><ul><li>Loss of Key Client/Account </li></ul><ul><li>Administrative Action </li></ul><ul><li>Business Interruption </li></ul><ul><li>Intellectual Property </li></ul><ul><li>Machinery Breakdown </li></ul><ul><li>Political Risk </li></ul><ul><li>Patent Infringement </li></ul><ul><li>Employment Practices </li></ul>
    14. 15. Captives by Industry Source: Marsh Survey Group <ul><li>Fastest growing business segment using captives are the “Small and Medium Sized Business” (SMB) </li></ul><ul><li>99% percent of all independent businesses employ fewer than 500 people. Small (up to 100 employees) and Medium-sized (up to 500) </li></ul><ul><li>Businesses are increasingly using a captive to manage risk, control insurance costs, create wealth and use pre-tax premium dollars to fund future liabilities. </li></ul>Manufacturing 10% Financial Institutions 20% Construction 6% Chemicals 3% Aviation and Aerospace 2% Other 7% Automotive 2% Health Care 11% Life Sciences 3% Mining, Metals and Minerals 3% Power & Utilities 8% Real Estate 3% Retails and Consumer Products 10% Technology & Telecom 6% Transportation 6%
    15. 16. Types of Captives <ul><li>Single Parent Captives - single owner, for whom they provide insurance coverage (70% of all captives are pure). </li></ul><ul><li>Association/Group Captives - formed by an association or group to provide insurance coverage for members and/or policyholders. </li></ul><ul><li>Agency Captives – business is produced by agency. Owned by an agent, MGA or group of agents. These are formed by brokers or intermediaries for their clients or book of business. </li></ul>
    16. 17. Why an Agency Captive? <ul><li>Increase revenues in soft markets </li></ul><ul><li>Share in underwriting profits </li></ul><ul><li>Recover contingency income </li></ul><ul><li>Generate investment Income </li></ul><ul><li>Stabilize/establish insurer partnership </li></ul><ul><li>Keep key employees via equity in captive </li></ul><ul><li>Consolidate small books </li></ul><ul><li>Create new products/ancillary lines </li></ul><ul><li>Best Investment is your book </li></ul>Why not? Agencies are businesses, too!)
    17. 18. The Good <ul><li>Captive shares in the UW profit with carrier </li></ul><ul><li>Gains investment income </li></ul><ul><li>Captives access reinsurance/specialty cover </li></ul><ul><li>Control expenses </li></ul><ul><li>Gain leverage on claims/administration/mitigation </li></ul><ul><li>Can transfer wealth from business </li></ul><ul><li>Can be used for funding buyouts </li></ul>
    18. 19. The Not So Good <ul><li>Captive may require more capital for growth </li></ul><ul><li>May require additional collateral </li></ul><ul><li>Stress on scarce human resources (governance) </li></ul><ul><li>Underutilize possibilities/strategies </li></ul><ul><li>Long (er) term commitment </li></ul><ul><li>Accounting oversight </li></ul>
    19. 20. Agency Agency-Carrier Organizational Chart Policy Issuing Carrier Captive Policyholder Captive Manager Collects Premium Underwrites Issues Policy Pay Claim Captive Owner Agency-Carrier-Captive Organizational Chart Pay Commission Reinsures to Captive CaptiveProfits FRONT Carrier Investment Income } Negotiable
    20. 21. <ul><li>50/50 </li></ul><ul><li>Quota Share </li></ul>Typical Agency Captive Structure (1) Specific XS Reinsurance Layer (2)Agg XS (3)GAP Collateral <ul><li>The specific XS attaches above the captive’s retention per occurrence </li></ul><ul><li>Aggregate XS (aka “stop loss”) provides accumulation protection </li></ul><ul><li>“ GAP” represents difference between Loss Fund and Agg attachment </li></ul>1,000,000 $250,000 $125,000 $125,000 50/50 Quota Share $250,000 of Risk Agency Captive Skin In the game Skin In the game Capital
    21. 22. Product Development … last hard cycle <ul><li>2004 - Agency Captive for nursing homes. </li></ul><ul><li>10,000 beds, occ. form. </li></ul><ul><li>Capital by agency, clients, investors. </li></ul><ul><li>MGA Commission 28% </li></ul><ul><ul><li>Producers 15% </li></ul></ul><ul><li>Payback – 3 years </li></ul>MGA Captive Board of Directors TPA Risk Mgmnt Admin UW Risk Purchasing Group Financial Summary* 12/31/2008 Assets - $45,878,948 Surplus - $8,268,536 Premium - $18,527,828 Captive Insurer Agency
    22. 23. Captive Expenses Losses estimated at 40% Manage “fixed” expenses 23% est. profit margin 63% Loss Fund 37% Total Expenses 100% Total 15% MGA management fee 3% Taxes 1% Loss Control (to MGA) 3% Claims Administration (to MGA) nil Reinsurance (100% net to captive) 15% Commission
    23. 24. Agency Captive Illustration <ul><li>Program Pro forma (number rounded to highest 000s): </li></ul><ul><li>(A) Premium expected (1st year) - $10,000,000 @15% comm. or $1,500,000 </li></ul><ul><li>(B) Reinsurance costs (reinsurance provided by the carrier) – 20% of GWP or $2,000,000 </li></ul><ul><li>(C) Premium ceded to the captive (after reinsurance) – 2,000,000 (25%QS of $8,000,000) </li></ul><ul><li>(D) Captive expenses: </li></ul><ul><li>Commission paid to agency (was 15%) 18.0 % $ 360,000 </li></ul><ul><li>Claims, Loss Services 4.0 % 80,000 </li></ul><ul><li>Premium Audit, Taxes 3.5 % 70,000 </li></ul><ul><li>Fronting, Cell Mgmt 9.0 % 180,000 </li></ul><ul><li>Total 36.5 % 690,000 </li></ul><ul><li>(E) Premium allocated to Loss Fund (C minus D) 1,310,000 </li></ul><ul><li>(F) Losses incurred/IBNR(A times 35%) x (25% QS) ( 875,000) </li></ul><ul><li>(G) Underwriting Profit (E minus F) 435,000 less 152,000 Tax </li></ul><ul><li>(H) Investment Income (3% times E) 40,000 less 6,000 Tax </li></ul><ul><li>(I) Total Income (G plus H) 475,000 Tot. 158,000 </li></ul><ul><li>(J) Net Income after taxes 317,000 </li></ul>Summary: (1) Commission Increase - $300,000, (2) underwriting profit - $435,000 (3) investment income - $40,000. Total ADDITIONAL income is over $775,000
    24. 25. BONUS - Business Owner IRC § 831(b) <ul><li>Uncle Sam offers one of the best tax benefits </li></ul><ul><li>for owners of small non-life insurance </li></ul><ul><li>companies - created onshore or offshore! </li></ul><ul><li>Federal Tax exemption on underwriting profits </li></ul><ul><li>subject to: </li></ul><ul><li>$1.2 million in premium or less </li></ul><ul><li> Taxed only on investment income </li></ul>
    25. 26. Agency Captive Illustration – 831(b) <ul><li>Program Pro forma (number rounded to highest 000s): </li></ul><ul><li>(A) Premium expected (1st year) - $5,000,000@15% commission or $750,000 </li></ul><ul><li>(B) Reinsurance costs (reinsurance provided by the carrier) – 20% of GWP or $ 1,000,000 </li></ul><ul><li>(C) Premium ceded to the captive (after reinsurance) – 1,200,000 (25% QS of $4,000,000) </li></ul><ul><li>(D) Captive expenses: </li></ul><ul><li>Commission paid to agency (was 15%) 18.0 % $ 180,000 </li></ul><ul><li>Claims, Loss Services 4.0 % 40,000 </li></ul><ul><li>Premium Audit, Taxes 3.5 % 35,000 </li></ul><ul><li>Fronting, Cell Mgmt 9.0 % 90,000 </li></ul><ul><li>Total 36.5 % 345,000 </li></ul><ul><li>(E) Premium allocated to Loss Fund (C minus D) 655,000 </li></ul><ul><li>(F) Losses expected (A times 35%) x (25% quota share) ( 438,000) </li></ul><ul><li>(G) Underwriting Profit (E minus F) 217,000 Zero Tax </li></ul><ul><li>(H) Investment Income (3% times E) 19,000 less 2,850 Tax </li></ul><ul><li>Total Income (G plus H) 236,000 Total 2,850 </li></ul><ul><li> 233,150 </li></ul>Summary: (1) Commission Increase - $150,000, (2) underwriting profit - $217,000 (3) investment income - $19,000. Total ADDITIONAL income is over $386,000
    26. 27. Reinsurance Strategy <ul><li>Taxed as US Tax Payer </li></ul><ul><li>$10M GWP w/ 25% QS </li></ul><ul><li>Premium Ceded to Captive: $2,000,000 </li></ul><ul><li>(E) Loss Fund 1,310,000 </li></ul><ul><li>(F) Losses incurred ( 875,000) </li></ul><ul><li>(G) UW Profit x .35% 283,000 </li></ul><ul><li>(H) Investments less tax 36,000 </li></ul><ul><li>(I) Total Income 319,000 </li></ul><ul><li>Taxed as US Tax Pater w/ 831(b) election </li></ul><ul><li>$5M GWP w/ 25% QS </li></ul><ul><li>Premium Ceded to Captive” $1,000,000 </li></ul><ul><li>(E) Loss Fund 655,000 </li></ul><ul><li>(F) Losses Incurred ( 438,000) </li></ul><ul><li>(G) UW Profit x ZERO 217,000 </li></ul><ul><li>(H) Investments less tax 16,000 </li></ul><ul><li>(I) Total Income 233,000 </li></ul>Difference of $86,000 Questions to Ponder: How much capital will the captive needed to support each strategy? What are the collateral requirements of the fronting carrier – hint: Stop loss aggregate attachment point or the “gap”
    27. 29. Reinsurance Strategy <ul><li>Taxed as US Tax Payer </li></ul><ul><li>$10M GWP w/ 25% QS </li></ul><ul><li>Premium Ceded to Captive: $2,000,000 </li></ul><ul><li>(E) Loss Fund 1,310,000 </li></ul><ul><li>(F) Losses incurred ( 875,000) </li></ul><ul><li>(G) UW Profit x .35% 283,000 </li></ul><ul><li>(H) Investments less tax 36,000 </li></ul><ul><li>(I) Total Income 319,000 </li></ul><ul><li>Taxed as US Tax Pater w/ 831(b) election </li></ul><ul><li>$5M GWP w/ 25% QS </li></ul><ul><li>Premium Ceded to Captive” $1,000,000 </li></ul><ul><li>(E) Loss Fund 655,000 </li></ul><ul><li>(F) Losses Incurred ( 438,000) </li></ul><ul><li>(G) UW Profit x ZERO 217,000 </li></ul><ul><li>(H) Investments less tax 16,000 </li></ul><ul><li>(I) Total Income 233,000 </li></ul>Difference of $86,000 Questions to Ponder: How much capital will the captive needed to support each strategy? What are the collateral requirements of the fronting carrier – hint: Stop loss aggregate attachment point or the “gap” $435,000 $471,000 Difference of $238,000
    28. 30. Case Example Fronting Carrier CAPTIVE Retained Risk Asset Protection Provides insurance Pays claims Produces profit Build surplus <ul><li>Owner Benefits </li></ul><ul><li>Estate Planning </li></ul><ul><li>Retirement </li></ul><ul><li>Tax Planning </li></ul><ul><li>Asset Protection </li></ul><ul><li>Buy-Sell </li></ul>Case Example - IRC § 831(b) captive captive captive Owner Employee Partner Business Partner Key Employee Clients $1.2 million $1.2 million $1.2 million Agency Premiums from controlled group are aggregated.
    29. 31. Captive Manager (that’s us!) We perform re/insurance, accounting, underwriting, and claims functions, including: <ul><ul><ul><li>Annual reports and filings for regulators </li></ul></ul></ul><ul><ul><ul><li>Bind coverage and issue insurance or reinsurance contracts </li></ul></ul></ul><ul><ul><ul><li>Perform banking functions </li></ul></ul></ul><ul><ul><ul><li>Rate and underwrite risk exposure </li></ul></ul></ul><ul><ul><ul><li>Issue Policies </li></ul></ul></ul>
    30. 32. Getting Started <ul><li>1. Pre-feasibility strategy session </li></ul><ul><li>Which book(s) of business should you consider? </li></ul><ul><li>Specialty, carrier, geography or premium size </li></ul><ul><li>Heterogeneous or homogeneous </li></ul><ul><li>Coverage lines – WC, GL, AL, Inland Marine, etc.. </li></ul><ul><li>Frequency is always favored over severity </li></ul><ul><li>DO NOT FORGET – Ownership </li></ul><ul><ul><li>wealth creation, preservation & transfer </li></ul></ul>
    31. 33. FAQ 1 - Feasibility Study <ul><li>Set expectations (internal hurdle rate? ROI?) </li></ul><ul><li>Look at your contingency agreements </li></ul><ul><li>Gather your data – min. of 3 – 5 years </li></ul><ul><li>Results should include: </li></ul><ul><li>Multi-year financial and loss pro forma </li></ul><ul><li>Tax and accounting analysis – 953(d), 831(b), others? </li></ul><ul><li>Domicile considerations </li></ul><ul><li>Coverage, limits and estimated premiums </li></ul><ul><li>Ownership & structure of the captive </li></ul><ul><li>Business Plan! </li></ul>
    32. 34. FAQ 2 - Domicile my captive? <ul><li>US or Non-US </li></ul><ul><ul><li>Many agency captives offshore because of low(er) capitalization. </li></ul></ul><ul><ul><li>Washington, DC good onshore. </li></ul></ul><ul><li>Premium Taxes </li></ul><ul><li>Regulatory oversight </li></ul><ul><li>Board meetings </li></ul><ul><li>Captive statutes </li></ul><ul><li>Investment strategies </li></ul>
    33. 35. FAQ 3 - Cost of Forming a Captive <ul><li>Pre-feasibility session – free for TMPAA Members √ </li></ul><ul><li>Feasibility Study $ 5,000 - 50,000+ </li></ul><ul><li>Actuarial Study/Loss Analysis $ 8,000 - 20,000+ </li></ul><ul><li>Tax Advisory always a good idea </li></ul><ul><li>Captive Advisor/ Manager $ 10,000 - 50,000+ </li></ul><ul><li>Gov’t fees/application $ 2,000 – 10,000 </li></ul><ul><li>Legal $ 2,000 – 8,000 </li></ul><ul><li> </li></ul><ul><li>Est. Totals $ 27,000 - 138,000+ </li></ul>
    34. 36. FAQ 4 – Managing a Captive <ul><li>Captive Manager $ 20,000 - $50,000+* </li></ul><ul><li>Audit $ 8,000 - $20,000+ </li></ul><ul><li>Tax Advisory still always a good idea </li></ul><ul><li>Legal $ 1,000 - $10,000+ </li></ul><ul><li>Premium Taxes** $ 2,000 -$25,000+ </li></ul><ul><li>Gov’t fees/application $ 2,000 – 10,000 </li></ul><ul><li>Est. Totals $ 35,000 - 115,000+ </li></ul>*Many agree to a min fee or 1.5% of premium ***Some domiciles offer a 1 st year credit of no taxes - max $7500 credit
    35. 37. Captive Formation & Timeline <ul><li>Captive strategy session with Atlas </li></ul><ul><li>Feasibility Study – 30 to 45 days </li></ul><ul><ul><li>Determine type of cover, limits </li></ul></ul><ul><ul><li>Financial pro forma </li></ul></ul><ul><ul><li>Capitalization </li></ul></ul><ul><ul><li>Domicile analysis </li></ul></ul><ul><ul><li>Business Plan </li></ul></ul><ul><li>Application - 30 to 60 days </li></ul><ul><li>Implementation – 30 days </li></ul><ul><li>Ongoing </li></ul>
    36. 38. Chris Kramer, SVP                                 1991 Crocker Road Suite 600 Westlake, Ohio 44145 Office:      +1 (440) 892-3314 Fax:         +1 (440) 892-3396 Toll Free:  +1 (877) 242-4358 Martin Eveleigh, Chairman Nick Leighton, Managing Director 3rd Floor, Sagicor House 198 North Church Street George Town, Grand Cayman Cayman Islands, KY1-1107 Tel:     +1 (345) 945-5556 Fax:    +1 (345) 945-5557   www.atlascaptives.com
    37. 39. Q&A
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