Transcript Deconstructing the Value Proposition of Captives
Deconstructing the Value Proposition of Captives
Charlie Woodman, CPA, CGMA Risk Finance & Analytics Willis Construction Practice Craig A. Ream Program Administrator - CS Insurance Ltd. Willis Captive Practice
20 th Annual Willis Construction Risk Management Conference Marriott Legacy Town Center – San Jacinto Room Tuesday, September 16, 2014
Economics of Insurance: The Stage
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Components of Traditional Insurance:
Expected loss and ALAE Taxes and regulatory fees Overhead and administration Insurer selling and distribution expense Reinsurance and Intermediary charges Risk Margins Surplus charges Risk Based Capital offsets Fixed (25%-35%)
Insurance Company Overhead, Taxes, Reinsurance Cost, Commissions Profits & Losses 55 -75% Profits & Investment Income
Underwriting Profit and Investment Income Accrued by Insurance Company
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The Continuum of Risk Finance HIGH LOW
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Integrated Risk
Traditional Hazard lines (property, Casualty, EPL) Integrated layers at specified layers
Qualified Self Insurance w/ Risk Funding
• State Qualified Self Insured • Insured is legal insurer
Group Captives
• Formed to insure member owners (shared risks/assets) • Replication of insurance and group purchase of excess
Large Deductible Policy
• Significant/complete risk assumption in exchange for deductible credit
Loss Sensitive or Retro Policy
• Assumption of limited risk in exchange for potential return premium • Deferred “pay-in” premium
Guaranteed Cost
• Complete transfer of risk • Commercial insurance with no deductible
HIGH Assumption of Risk
Program Selection Drivers are
Risk Appetite
Financial Protection
Asset and Revenue Protection
Performance Certainty
Liquidity and Cash Certainty / Cost of Short-term Finance
Statutory or Counter-party Requirements
Revenue / Expense Matching
Safety & Loss Containment Services and Acquired Disciplines
Control
Negotiation & Leverage
Catastrophic Protection
Taxation
Market Opportunity
Captive Insurance Company - Defined
An Insurance Company, typically owned by non-insurance parent(s), insuring the risks or interests of its owner(s)
Incorporated, Regulated, Capitalized and Individually Accountable
May be fairly transparent
May or May not be a replacement for insurance. Depends on Form (ownership and insured relationship)
Emphasizes the ‘Insurance Transaction’
Insurance Company Operations:
Insurance Accounting and Financial Metrics Must Always Maintain Positive Capital and Surplus (Unrestricted Net Worth I.e., Marketable Assets > Liabilities)
Typically administered by professional third-parties
Captive Mgt / Legal / Audit / Actuarial / etc.
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Forms of Captives
Single-owner or Pure
Group – Homogeneous or Heterogeneous
Association
Insurer Controlled
Agency / Sponsored
Rent-a-captive
Segregated account (cell) captives
Captive pools
Risk retention groups
Trusts
Special Purpose (Re)insurer
Etc… Feasibility Prerecorded Lecture/ 5
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Boil It Down – Two Real Types Single Parent
Wholly-owned (and can include Rent-A Captive “Cells” & Trusts)
Emphasis on Risk Funding and Cost / Funding Efficiencies
Underwrites ‘related’ risks to single economic interest as insureds are commonly parental operations
Will consolidate operating and financial position with publicly-held parent; may deconsolidate under certain circumstances in closely-held.
Group Owned
No common ownership among insured participants
Group, Association Captive, Risk Retention Group
Emphasis on Risk Transfer as an insurance market alternative
Will pool certain retention layers among participant insureds
Common services and emphasis on the health of the group as a whole.
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Primary Focuses of Single Parent Captive Programs
Cost Savings
Long Term “Seasoning” of a Property & Casualty Insurance Company: Platform and enhance the placement of insurance coverage, terms and conditions Access or contract with alternative markets or reinsurers Effect optimal balance of risk retention and transfer, glean greater control over risk process Projected performance is difficult to quantify Short Term “Business Case” / Cash Flow Efficiencies: Highly Quantitative / Heavy Tax
Risk Management / Program Facilitation
Provide rapid liquidity Buy Down Deductibles of Subsidiaries or Operating units Stabilize or enable allocations and budgeting / contracting processes
Business Enhancement: “Profit Center”
Controlled Insurance Programs Sub Contractor Default Insurance Extended Warranty / Service Contracts
Asset Facilitation / Wealth Strategies – Closely-helds
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Business Case: Assessment and Short-term Viability NPV - Short Term Business Case cost Savings
Accelerated Tax Benefits
State Tax Arbitrage
Operating Costs
WACC / Opportunity Cost of Capital Other Quantitative & Qualitative
Capital Commitment / Operating Cost
Internal Costs & Resource Commitment
Recognitions and Materiality
Corporate Culture
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Group Captive Value Proposition
Control over insurance “destiny” Unbundled service providers Retain underwriting profits and earn investment income Disciplined loss funding in a tax favorable structure Access to capacity and economies of scale
Group Captive Value Proposition
Reduce and stabilize costs Improve risk management through accountability Customized and focused loss control services Improved long term premium stability Best in class coverage Captive benefits on shared platform – reduced expense
Group Captives
Unbundling the Insurance Transaction
How do they do it?
Assumption of a high level of risk Cost of risk transfer significantly reduced Insurance market volatility minimized Proven risk sharing structure Reduces volatility in claims experience for participants Provides needed risk shifting and distribution Volume purchase #61 on ENR top 400 - $900M in combined revenues Shock claims are diluted
How do they do it?
Investment income Enhanced loss prevention and claims management Avoid exposure to cat risks Member selection - “Best in Class” controlled growth Assures health of program over time Reduces cost of risk transfer Enhances peer group best practices exchange
Construction Solutions
Case Study
Construction Solutions
Construction Solutions
Contractors Group Captive Established in 2001 100% Member Owned and Controlled Domiciled - Cayman Islands Prospective Members: Moderate/High hazard contractors generating between $500,000 and $3,000,000 in combined WC, GL and Auto Standard Premium Contractors with a strong senior management commitment to safety Contractors with loss and incident rates superior to average for class Contractors with a formal loss control and safety program Contractors with solid financials
Construction Solutions
Common January 1 st renewal date $136,000,000 of payroll insured 1,700 power units insured $10,000,000 in annualized captive premium Renewals presented in October and bound in November Strict loss control covenants and annual CORR analysis Bi-Annual Loss Control Meetings: September 15, 2014 May, 2015 Dallas Pittsburgh Bi-Annual Board & Shareholder Meetings: October 19-21, 2014 May 17-19, 2015 Toronto Cayman
Construction Solutions
Insured Coverage
Workers’ Compensation Statutory Coverage & 1M Employers Liability General Liability 1M per occurrence 2M aggregate per project/per location aggregate Automobile 1M Liability Physical Damage
Construction Solutions
Current Membership
2 Masonry Construction 2 Commercial Roofing & Sheet Metal Fabrication 1 Machinery Installation, Rigging, and Transportation 1 Road/Street Construction and Paving 1 Road/Street & Bridge Construction 2 Asphalt Distribution and Paving 1 Aggregates and Precast Concrete Products 1 Pipeline Construction
Construction Solutions
Current Members
Peckham Industries – White Plains, NY The Hamlin Companies – Garner, NC Franco Associates – Pittsburgh, PA Cost Company – Pittsburgh, PA Energy Services of America (ESA) – Huntington, WV Valley Group – Fishersville, VA Suit-Kote – Cortland, NY Economy Paving – Cortland, NY Diamond Materials – Wilmington, DE Greenwood Industries – Millbury, MA LC Whitford – Waterville, NY
Construction Solutions
Internal Structure
One Time Capitalization: $ 30,000 Share Purchase Experience Adjustment Assessment equal to one times A Fund In a multi coverage occurrence the total clash retention is $ 500,000.
$ 1,000,000/Unlimited (WC)
Reinsurance – Arch
Excess of $ 500,000 $ 500,000
Severity Fund B
$ 375,000 XS $ 125,000 $ 125,000 General Liability
Frequency Fund A
First Dollar to $ 125,000 Workers Compensation Auto
Construction Solutions
Premium Distribution Example: Captive Expenses $ 345,900 Loss Funding
Total Premium
$ 654,100
$1,000,000
Construction Solutions
Premium Distribution Example: A Fund B Fund
Loss Funding Allocation
$ 490,575 $ 163,525
$ 654,100
Construction Solutions
Conceptual Annual Program Pricing ABC Construction 49.06% 16.35% 65.41% WC A Fund - $0 - $125,000 B Fund - $125,000 - $500,000 $ 269,816 $ 89,939 Total Loss Funds $ 359,755 GL $ 147,173 $ 49,058 Auto $ 73,586 $ 24,529 $ 196,230 $ 98,115 Total $ 490,575 $ 163,525 $ 654,100 18.98% 5.72% 3.50% 1.30% 2.09% 3.00% 34.59% Total Estimated Subject Premium Excess & Aggregate Charge Front Administrative Charge Taxes/Boards & Bureaus Charge Loss Control Funding Claims Admin Funding Captive Expense Funding $ 104,390 $ 31,460 $ 19,250 $ 7,150 $ 11,495 $ 16,500 Subtotal $ 190,245 $ 56,940 $ 17,160 $ 10,500 $ 3,900 $ 6,270 $ 9,000 $ 103,770 $ 28,470 $ 8,580 $ 5,250 $ 1,950 $ 3,135 $ 4,500 $ 51,885 $ 189,800 $ 57,200 $ 35,000 $ 13,000 $ 20,900 $ 30,000 $ 345,900
Estimated Exposure Estimated Composite Rate
$ 550,000 $ 300,000 $ 150,000 $ 1,000,000
$ 15,000,000 3.67
$ 15,000,000 140 2.00
$ 1,071 Share Purchase Retail Brokerage Fee Assessment Exposure Collateral Required (A Fund) (2/3 A Fund)
$ 30,000 TBD $ 490,575 $ 326,723
Construction Solutions
ABC Construction Policy Term 2013 2012 2011 2010 2009 2008 TOTALS All Lines to include General Liability, Auto Liability and Workers Compensation $0 - $125,000 $125,001 - $500,000 $500,001+
$ $ $ $ $ $ 200,000 650,000 325,000 325,000 325,000 125,000 $ $ $ $ $ $ 100,000 300,000 375,000 375,000 $ $ $ $ $ $ 500,000 1,500,000 -
Total Incurred
$ 200,000 $ 650,000 $ 425,000 $ 625,000 $ 1,200,000 $ 2,000,000
$ 1,950,000 $ 1,150,000 $ 2,000,000 $ 5,100,000
Construction Solutions
ABC Construction
2013 2012 2011 2010 2009 2008 Total
Gross Subject Premium
Losses Incurred (Paid+Reserved) Losses Excess of $500,000 Reinsured:
$ 1,000,000
$ 200,000 $ -
$ 1,000,000
$ 650,000 $ -
$ 1,000,000
$ 425,000 $ -
$ 1,000,000
$ 625,000 $ -
$ 1,000,000
$ $ 700,000 500,000
$ 1,000,000
$ $ 500,000 1,500,000
$
$ $
6,000,000
3,100,000 2,000,000
A FUND
Net Premium Losses Incurred (Paid+Reserved) Profit/(Loss) Transfer to B
A Fund Assessment
Sub-Total: Deficit Reallocation (Risk Share)
Final A Fund Balance
$ 490,575 $ 200,000 $ 290,575 $ -
$ -
$ 290,575 $ -
$ 290,575
$ 490,575 $ 650,000 $ (159,425) $ -
$ 159,425
$ $ -
$ -
$ 490,575 $ 325,000 $ 165,575 $ -
$ -
$ 165,575 $ -
$ 165,575
$ 490,575 $ 325,000 $ 165,575
$ (136,475) $ -
$ 29,100 $ -
$ 29,100
$ 490,575 $ 325,000 $ 165,575
$ (165,575) $ -
$ $ -
$ -
$ 490,575 $ 125,000 $ 365,575
$ (211,475) $ -
$ 154,100 $ -
$ 154,100
$ 2,943,450 $ 1,950,000 $ 993,450 $ (513,525)
$ 159,425
$ 639,350 $ -
$ 639,350 B FUND
Net Premium Losses Incurred (Paid+Reserved) Profit/(Loss) Transfer from A
Deficit Reallocation (Risk Share) Final B Fund Balance
$ 163,525 $ $ 163,525 $ -
$ $ 163,525
$ 163,525 $ $ 163,525 $ -
$ $ 163,525
$ 163,525 $ 100,000 $ 63,525 $ -
$ $ 63,525
$ 163,525 $ 300,000 $ (136,475)
$ 136,475 $ $ -
$ 163,525 $ 375,000 $ (211,475)
$ 165,575 $ 45,900 $ -
$ 163,525 $ 375,000 $ (211,475)
$ 211,475 $ $ -
$ 981,150 $ 1,150,000 $ (168,850) $ 513,525
$ 45,900 $ 390,575 Loss Equity Balance*: $ 454,100 45.4% $ 163,525 16.4% $ 229,100 22.9% $ 29,100 2.9% $ 0.0% $ 154,100 15.4% $ 1,029,925 17.2%
Construction Solutions Maximum Cost: $ 1,482,510
Premium + Assessment
Minimum: $ 356,654 Captive “Fixed” Expenses
Less - Investment Income Plus - Shared Losses
Construction Solutions
Hypothetical Collateral Requirements
(Assume A Fund $482,510 Each Year) 1 st Year 2/3 of A Fund = $321,673 2 nd Year 2/3 of A Fund = $321,673 3 rd Year 2/3 of A Fund = $ 321,673 $643,346 combined $965,019 combined No Additional Collateral required at 4th renewal!!
4 th Year Caps at 2/3 of 3 Year Total = $965,019
Construction Solutions
Service Providers
Front and Reinsurance - Arch Insurance Program Administration – Willis Onshore Legal Counsel – Kerr, Russell & Weber, LLP Captive Manager – SRS (Cayman) Investment Manager – PRP Performa Ltd.
Auditor – KPMG Actuarial – Milliman Claims Administration – Gallagher Bassett Loss Control – Willis
Captive Flow
Underwriting Profits !
Insured CS Retail Broker
Arch Insurance Company
CS INSURANCE LTD.
Willis, SRS, KR&W, Milliman, KPMG, GB
Construction Solutions
Policy Issuance Financial Protection Specific and Aggregate Excess Coverage Statutory Coverage Meets Legal Regulatory and Customer Requirements Underwriting Expertise Loss Control Resources Claims Administration – Gallagher Bassett
Why Construction Solutions?
Construction specific focus – coverage and services Size of program Enhanced input and control of captive operations Active peer group - culture of constant improvement High average member premium size - $885,000 Low average risk sharing – 3.5% Minimal assessments
Why Construction Solutions?
Enhanced and focused risk control Exceptional historical results – loss ratio 33% $81 MM Premium - $22 MM paid & $3.5 MM reserves Program Structure – flexible retention, ALAE, clash, aggregate No automatic close-out policy Excellent distribution history $10 MM in distributions to date Policy years closed – net cost was 70% of original premium