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Captives: 101 and Beyond

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Introduction to Captive Insurance Companies.

Published in: Economy & Finance, Business
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Captives: 101 and Beyond

  1. 1. Captives: 101 and Beyond Phillip J. Gajewski, CPCU, ARM AVP, Business Development Meadowbrook Insurance Group
  2. 2. What is a Captive? <ul><li>Captive insurance organizations are insurance companies that are owned and controlled by their insureds. </li></ul><ul><li>A captive insurance company can be defined as a special purpose insurer whose sources of business are (1) its shareholders and their affiliates which put their own capital at risk, or (2) other participants such as association or group members. </li></ul>
  3. 3. What are the Reasons for Forming a Captive? <ul><li>Stabilize insurance costs by getting off the pricing “roller coaster”. </li></ul><ul><li>Separate your own premium and loss experience from those of other groups or insureds. </li></ul><ul><li>Assure availability of tailored coverage. </li></ul><ul><li>If experience is good, insurance costs can be trimmed through premium reductions or dividends. </li></ul><ul><li>If loss experience is adverse, the situation should still be better because of realized investment income. </li></ul>
  4. 4. How a Captive Can Save Costs. <ul><li>Eliminates normal insurance company overhead. </li></ul><ul><li>Realize investment income on premium and capital. </li></ul><ul><li>Realize investment income on loss reserves. </li></ul><ul><li>Specialized claims handling and administration. </li></ul><ul><li>Specialized loss control activities. </li></ul><ul><li>Potential tax advantages? </li></ul>
  5. 5. Advantages <ul><li>Reduced operating costs </li></ul><ul><li>Investment income and underwriting profit </li></ul><ul><li>Broader coverage </li></ul><ul><li>Pricing and coverage stability </li></ul><ul><li>Direct reinsurer access </li></ul><ul><li>Improved service </li></ul><ul><li>Increased control </li></ul><ul><li>Immediate reward for reducing losses </li></ul><ul><li>Enhanced risk management status </li></ul><ul><li>Fewer regulatory restrictions </li></ul>
  6. 6. Types of Captives <ul><li>Single-Parent Captive (Pure) </li></ul><ul><li>Group (or Association) Captive </li></ul><ul><li>Agency Captive </li></ul><ul><li>Hybrid… </li></ul><ul><li>also, </li></ul><ul><li>Rent-a-Captives </li></ul>
  7. 7. Method of Writing Business <ul><li>Direct Write Captives </li></ul><ul><li>vs. </li></ul><ul><li>Use of / Need for Fronting Companies </li></ul><ul><li>Risk-Sharing Opportunities? </li></ul>
  8. 8. Risk Sharing Partnerships Excess Commercial Reinsurers Front Co. Quota Share Premium Quota Share Losses Underwriting Profit + Investment Income Agency Policyholder Captive Shareholders
  9. 9. Excess Commercial Reinsurers 100% $750,000 (Excess Layer) $250,000 (Working Layer) QUOTA-SHARE (Captive decides their share) Limitation of Risk $1 Million Exposure Front Co. 50% CAPTIVE 50%
  10. 10. Collateral Requirements for Fronting / Risk-Sharing <ul><li>Letter of Credit (LOC) </li></ul><ul><li>Trust Agreement </li></ul><ul><li>Funds Withheld </li></ul>
  11. 11. Domicile Selection <ul><li>On-Shore </li></ul><ul><ul><li>AL, AR, AZ, CO, DE, DC, GA, HA, IL, KY, ME, MO, MT, NV, NY, RI, SC, SD, UT, VT </li></ul></ul><ul><li>vs. </li></ul><ul><li>Off-Shore </li></ul><ul><ul><li>Bermuda, Barbados, British Virgin Islands, Caymans, Dublin, Guernsey </li></ul></ul>
  12. 12. Domicile Selection Factors <ul><li>Capitalization Requirements </li></ul><ul><li>Surplus Requirements </li></ul><ul><li>Investment Restrictions </li></ul><ul><li>Reporting and Auditing Requirements </li></ul><ul><li>Loss Reserving Requirements </li></ul><ul><li>Income and Local Taxes </li></ul><ul><li>Government Fees </li></ul><ul><li>Overall Regulatory Climate </li></ul><ul><li>Formation Time </li></ul><ul><li>Miscellaneous Underwriting Limitations </li></ul><ul><li>Acceptance by Fronting Companies and Reinsurers </li></ul><ul><li>Formation Costs </li></ul><ul><li>Management and Legal Fees </li></ul><ul><li>Availability of Banking, Accounting, & Other Services </li></ul><ul><li>Location-Specific Factors </li></ul>
  13. 13. Average Annual Operating Costs <ul><li>Management Fees: $35,000 - 250,000 </li></ul><ul><li>Legal Fees: $15,000 – 40,000 </li></ul><ul><li>Auditing, Actuarial: $15,000 – 45,000 </li></ul><ul><li>Government Fees: $3,000 – 10,000 </li></ul><ul><li>Meeting Expenses: $10,000 – 50,000 </li></ul>
  14. 14. III. CORPORATION DOCUMENTATION A. Charter B. Offering Memorandum C. Subscription Agreement D. Escrow Agreement E. By-Laws IV. MULTIPLE OWNERS RELATIONSHIPS A. Voting Rights B. Capital Contribution C. Standards for Participation In A Group Captive D. Profit Participation In A Group Captive E. Departing Shareholders/Insureds F. Settlement of Disputes I. INTRODUCTION A. Domiciles and Legal Structures B. Corporation Documentation C. Relationships Between Multiple Owners D. Insurance Regulation E. Securities Regulation F. Insurance Documentation G. Management Services H. Contracts II. DOMICILES AND STRUCTURE A. Company Domicile B. Corporate Form C. Capitalization D. Board of Directors E. Officers F. Committees G. Name of Captive Captive Formation Steps
  15. 15. V. INSURANCE REGULATION A. U.S. Insurance Regulation B. Captive Domicile Regulation VI. SECURITIES REGULATION A. U.S. Securities Regulation B. Captive Domicile Regulation VII. INSURANCE DOCUMENTATION A. Policy Forms B. Fronting Arrangements C. Underwriting Guidelines D. Rating of Policyholders E. Miscellaneous F. Reinsurance Placement VIII. MANAGEMENT SERVICES A. Designate Manager B. Designate Law Firm C. Designate Bank D. Designate Auditors E. Other Service Providers IX. CONTRACTS A. Management Agreement B. Reinsurance Agreement C. Trust Agreement Captive Formation Steps
  16. 16. Disadvantages / Potential Pitfalls <ul><li>Captive Costs </li></ul><ul><ul><li>Capitalization and commitment </li></ul></ul><ul><ul><li>Dependent upon service providers </li></ul></ul><ul><ul><li>Internal administrative costs </li></ul></ul><ul><li>Poor Underwriting Results </li></ul><ul><ul><li>Inadequate loss reserves and potential losses </li></ul></ul><ul><li>Competitive Insurance Environment </li></ul><ul><li>Failure to Employ Loss Control Techniques </li></ul><ul><li>Large, Single Insured/Stockholder </li></ul><ul><li>Possible taxation problems </li></ul><ul><li>Some insurer/broker resistance </li></ul><ul><ul><li>Increased cost of other insurance </li></ul></ul>
  17. 17. Captive Resources: <ul><li>www.captive.com </li></ul><ul><li>IRMI – International Risk Management Institute. </li></ul><ul><ul><li>Captive Insurance Company Reports </li></ul></ul><ul><ul><li>Captives & the Management of Risk </li></ul></ul><ul><ul><li>Captive Practices & Procedures </li></ul></ul>
  18. 18. Thank You! Questions?

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