This document provides an overview of captive insurance structures and discusses why brokers may set up their own captive insurance companies. It begins with definitions of captive insurance and describes common structures like pure captives and protected cell companies. Specific case studies are presented on how a pure captive could benefit an accounting practice client and how a broker captive could generate additional revenue from profitable business lines. Key benefits for brokers are maximizing control and flexibility while earning profit commissions. Guernsey is highlighted as a leading domicile for captives due to its infrastructure, reputation, and less stringent capital requirements compared to Solvency II.

1. What brokers need to know about Captives BIBA 2011, fringe session, Wednesday 11th May Mike Johns Alternative Risk Management Limited mjohns@arm.co.gg Paul Eaton Heritage Paul.Eaton@heritage.co.gg

2. Guernsey

3. Guernsey’s finance industry • Insurance, Banking, Funds and Trust • No.1 European Captive Domicile • 675 insurance entities • £3.4bn of GWP • 40% of the FTSE100 captives • Pioneer of Protected Cell legislation

4. Presentation agenda • What is a Captive? • The different types • How and why are Captives used? • Pure Captives: Case Study • Broker Captives: Case Study • Why Guernsey?

5. What is a Captive? • An insurance company • Usually formed for a specific purpose, primarily self insurance • Called ‘Captives’ as often only provides insurance to its owner • Often formed in a offshore domicile • Captures both premium and risk

6. Captive Insurance Structures Reinsurance Captive Direct-writing captive Ownership Parent Subsidiary Sweden Subsidiary Belgium Subsidiary UK Parent Cover Premiums Ownership Premiums Ownership Fronting Company (conventional / locally based insurer) Premiums Captive Insurer Cover Captive Reinsurer Premiums Cover Reinsurer Illustration of how Captives are used

7. Illustration of how Captives are used ownership REINSURANCE CAPTIVE DIRECT-WRITING CAPTIVE ownership Parent Parent Subsidiary Sweden Subsidiary Belgium Subsidiary UK premiums premiums cover Fronting Company Conventional / locally based insurer Captive Insurer ownership ownership premiums premiums cover cover Captive Reinsurer Reinsurer

8. Types of Captive facility • Wholly owned company (subsidiary) • PCC Cell • ICC Cell

9. Protected Cell Company Structure CELL A THE CORE CELL D CELL B CELL C

10. How and why are Captives used? PURE Captives • Used by your clients as a mechanism to manage self insurance • Can underwrite various risks of the owner • Control over the unpredictable market cycle • Optimise the insurance purchase • Cost of risk based upon actual performance • Leverage with the insurance market • Focal point for awareness of risk management • Flexibility in cover and innovative approach possible

11. How and why are Captives used? THIRD PARTY Captives • Can be used by brokers, MGAs or clients • A way of creating more value from existing profitable business • Earn additional revenue • Maximise control • Flexibility and Bespoke coverage

12. PURE Captive: a case study • Accountancy Practice purchases PI cover • £10mn limit purchased from the traditional insurance market • Layered programme with total premium spend £675,000 split: Primary £1mn: Annual Premium £350,000 £4mn excess £1mn: Annual Premium £200,000 £5mn excess £5mn: Annual Premium £125,000 • 5 year claims history good other than 1 large loss of £750,000 • Insurance market seeking to increase rates • Client believes he has excellent risk management in place • Interest in taking some of the risk exposure • Creates a captive

13. PURE Captive: a case study Advantages: • Potential for underwriting profit • No fronting insurer required – first party insurance only • Over time premium can be geared to actual loss experience • Positive cash flow/investment income on premiums and reserves • Possible greater control over claims • Influence over policy coverage • Potential leverage on overlying insurers at subsequent renewals Disadvantages: • Capital requirements • Exposure to losses

14. PURE Captive: a case study ACCOUNTANCY PRACTICE £10mn PI insurance £675,000 Premium Spend Share Capital £650,000 Broker CAPTIVE INSURANCE COMPANY Insurer 1 Insurer 2 £4mn xs £1mn £200,000 £5mn xs £5mn £125,000 Primary £1mn £350,000

15. PURE Captives for your clients Reasons why you might suggest this to your clients and the benefits for you? • Offering best ‘risk financing’ advice • Better client retention • A less adversarial insurance purchase • Stability of insurance placement • Remuneration?

16. THIRD PARTY Captives, Why are Brokers setting up Captives? • Good quality business – low claims ratio • Underwriting profit – maximise revenue stream from Portfolio • Possibility of Insurers reducing commissions • Hedge against a hardening market • Pricing and cover flexibility • Access to reinsurance markets

17. An example of a Broker Captive Customers Underwriting Risk Commissions Underwriting Input Insurance Broker/ MGA Profit Commission Claims Input Insurer 1 Insurer 2 Insurer 3

18. Commissions Underwriting Input Profit Commission Claims Services An example of a Broker Captive Customers Insurance Broker/ MGA Insurer 1 Insurer 2 Insurer 3 Agreed reinsurance arrangement Broker Captive Underwriting Profit Optional reinsurance protection, if required Reinsurance Programme

19. An example of a Broker Captive: simple number illustration Assumptions on Portfolio: • Portfolio Size: GWP £5mn • Current commission: 35% • Historic claims experience: 30% (based on net premium) • No losses > £50k Assumptions on Captive Solution: • No change in upfront commission • Captive reinsurers the insurer for £50k eel with an aggregate limit equal to 115% of net captive premium • Split in net premium: Insurer 40% and Captive 60%

20. An example of a Broker Captive: simple number illustration • Capital required for structure: £292,500 • Return on Capital: 300%+ • Capital can be subscribed as cash or letter of credit

21. Why Guernsey? • Europe’s No.1 captive domicile • Mature financial infrastucture • Excellent reputation • Highly skilled workforce • Convenient location and good travel links • Capitalisation requirements: No solvency II equivalence