A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT

 
A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
A Captive Primer:
What they are and how they work

            Educate – Evaluate – Elevate

                                    2018
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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
Do It Right, Or Don’t Do It At All

At Elevate, we passionately believe in what we do. We are conservative and
focus on insurance, risk financing, and risk management strategies to mitigate
your risk over the long term.

It’s imperative you understand the captive strategy and how it works for your
organization – we do not believe in a “one size fits all” captive approach.

This presentation is a summary only and not a replacement for a full captive
feasibility study. Nothing contained in this presentation should be deemed an
offer to sell insurance or offer legal or tax advice.

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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
Elevate Captives
Jerry has over 34 years experience in the insurance and alternative risk transfer
industry and serves as CEO for Elevate Captives. In his position with Elevate, he
is an approved captive manager in multiple jurisdictions, both onshore and off.

Jerry is the Founding President of the Oklahoma Captive Insurance Association,
member of the Captive Insurance Committee of the Self Insurance Institute of
America (SIIA) and is an active speaker with industry trade groups. Jerry is an
accredited Associate in Captive Insurance with ICCIE and an Adjunct Professor
with Clear Law and Lawline.

Ryan serves as Managing Director of Risk Management for Elevate Captives.
Ryan performs the Elevate “CORE™ Review” for clients and his experience
includes being the Director of Risk and creating captives for Boing, Whirlpool,
and Koch Industries.

Ryan has participated on many insurance and reinsurance company advisory
boards and is a frequent speaker at RIMS (Risk & Insurance Management
Society) and CICA (Captive Insurance Company Association), where he currently
serves on the Board

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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
What Are We Talking About Today?

      A Little About Elevate
 ü Create/manage captives to provide
   long-term solutions for enterprise
   risk management                           A Lot About Captives
 ü Domiciles: Arizona, Delaware,
   Hawaii, New York, Oklahoma,          ü History
   Texas                                ü Types
 ü Our goal is to provide the best      ü Structures
   captive administrative service in    ü What they’re used for (and what
   the industry and to do so with the     they shouldn’t be used for)
   highest integrity                    ü Who makes a good captive
                                          candidate
                                        ü The captive formation process
            Captive Examples
      ü Single Parent with Mixed P/C
        and Employee Benefits
      ü Expense Profile
                                                                            4
A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
Onshore/Offshore Captives
                as of 12.31.16 (Business Insurance)

   7,006
 CAPTIVES
WORLDWIDE

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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
Captive’s Ranked by State
   as of 12.31.16 (Business Insurance)

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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
Definition/History of Captives

Definition by Captive.com: A captive insurer is generally defined as an insurance
company that is owned and controlled by its insureds.

Captives first used in 1700’s in Europe
   Ø   Lloyd’s Café (the ship-owners meeting…thereby creating Lloyd’s of London)
   Ø   Apple ($99 AppleCare)
   Ø   Federal Express (”check the box”)
   Ø   Allstate (Sears)

Three main markets that host captives:
   Ø   Europe (Isle of Man, Guernsey, Luxembourg, etc.)
   Ø   Offshore Financial Centers (OFC’s – Bermuda, Cayman, Nevis, etc.)
   Ø   USA (Vermont, Delaware, North Carolina, etc.)
   Ø   Over 7,000 captives worldwide and growing rapidly

30+ states currently have captive legislation:
   Ø   In US, first captive formed for “captive” coal mines named/owned by Fred Reiss, an
       insurance agent in Ohio in 1951
   Ø   Delaware/Vermont have over 1,000+ each
   Ø   Most have specialties like series captives, medical stop-loss, XXX and AXXX

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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
Mix and Match Types of Captives
“Small, fronted, protected cell, US-based, homogenous group captive”

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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
2 Most Common Captive Types

• Single Parent Captive: A single owner for whom the captive provides
  insurance protection. Also known as a “Pure Captive” representing over
  60% of all captives. Can also be a protected cell or series captive
  insurance company.

• Group Captive: Formed by a group of individual companies that
  typically own the captive. A group captive can also be started/owned by
  an association (aka “Sponsor”) and come in the form of a risk retention
  group (RRG), reciprocal group captive, or group reinsurance captive
  where a fronting company is involved.

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A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
The Large Captive
                        Over $2.3m in Premium
              (The limit is indexed to inflation or $50,000, whichever is less)

Historically, a “large captive” has been defined as anything over the limit within the
831b election (currently $2.3m). You typically see these as single parent (pure)
captives owned by medium-to-large companies or some smaller-to-medium sized
businesses. For example, a $150m company writing a large workers compensation
deductible reimbursement policy or large healthcare systems writing medical
malpractice and general liability.

            What are some of the benefits? The same as a Small
            Captive, plus:
                ü You tend to have greater flexibility in writing on a direct basis
                ü You can take advantage of a net-operating-loss carryforward
                ü All expenses, including administration, risk management, and any
                  claims themselves, are deductible within the captive, thereby
                  allowing for the potential of the premiums paid and all operating
                  expense to be deductible
                                                                                         10
The Small Captive
                      Under $2.3m in Premium

A captive is a real insurance company the insured ultimately owns and controls. The
small captive model can be used for low-frequency/ high severity risk.

 The captive also exists to cover gaps in commercial policies while protecting against
 risk where no coverage exists at all. It doesn’t replace the commercial insurance
                              program, it ENHANCES it.

            What are some of the benefits?
               ü It creates significant SAVINGS on commercial premiums

               ü Allows for GREATER protection using difference-in-conditions polices

               ü The underwriting profit is not taxed, thereby allowing an accelerated
                 build-up of surplus. This allows you to take even more risk down the
                 road.

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Small or Large - Key Ingredients
                                        Legitimate
                                         Business
                                          Reason
                                        (Real Risk)
       Pay Claims (Formal                              Legitimate Asset Investment
         TPA Process)
                                                                   Domicile Credibility

Adequate Capital                      What is a
                     Must Have
                                       Captive          Must Have
                      Transfer        Insurance         Distribution

                                      Company?
                                                                       Quality Reinsurance
Legitimate Governance

      Credible Service Providers –
                                        CANNOT           Conservative Parental
                                        be just for
        actuary, tax, audit, legal,        Tax        Guarantees or Loan Backs(?)
            captive manager              Benefit!!
                                                                                          12
The 831b Tax Election

     The IRS provides a special election for insurance companies
    collecting less than $2.3m in premium…it’s known as the 831b
                               election.

Ø    Any underwriting profit is not taxed (only taxed on investment income)
Ø    Designed for low frequency/ high severity risk models
Ø    Captive assets may be invested per regulatory guidelines
Ø    It does have limitations: No NOL carry forward, no claim or operating expense
     deductions (except expenses related to investments)
Ø    Effective May 1, 2017, certain captives and their owners that elect 831b tax treatment
     must disclose this interest as a Transaction of Interest and file Form 8886
Ø    This election is only considered after all aspects of the risk have been reviewed, not
     before

In our opinion, the 831b election has been abused by certain promoters that
exclusively push the tax benefits of the captive. They are not focused on the
insurance and risk management aspects of the captive and they will not stand up
to audit.
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Benefits, Uses, and
          Coverage

   Educate – Evaluate – Elevate

           14
What We Hear…
I keep paying premiums year-after-year and NEVER
                                have any claims…

      I know if I turn these small claims in, I’ll be cancelled or
       they’ll raise my premiums, so I just pay them out of my
                                                         pocket…

On the one claim I did turn in, they denied it, so why
                                  pay for insurance…

              The quote seemed really expensive and I don’t
                         typically have claims anyway, so…

                                     15
Who can benefit from a Captive?

Those who have strong financial statements and wish to have ultimate control
over their insurance and risk management programs – “Seller of Risk”
Those who have a clear understanding of their own risk & loss history:
   Ø    Sufficient operational exposures (employee benefits, fleets, property, business interruption,
        supply chain, etc.)
   Ø    Quality exposure and loss data (or ”shadow price”) demonstrating profit over time
   Ø    Strong financial statements showing sufficient net income
   Ø    Committed to risk management and cost containment programs

Owners committed to paying appropriate premiums for multiple years:
   Ø    Captives are seldom short-term solutions
   Ø    How much is the minimum? About $400,000 captive premium due to the fixed expense ratio.

Those wanting ultimate control over:
       - Consistent Premium          - Underwriting Profit
       - Claims Management            - Investment Return
       - Risk Management             - Cost Containment Programs
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How is a Captive Used?

Deductible Reimbursement & Difference in Conditions (DIC):
     Ø   Raise deductibles and retentions to retain more profit & cut commercial insurance
         premiums
     Ø   DIC - covers exclusions, deductibles & excess protection with your commercial
         policies

Risk that is too expensive, not available in the commercial market, or is currently
uninsured (whether you know it or not):
     Ø   Medical Stop-loss
     Ø   Property, Hurricane (Named storm), Wind, Flood, DIC
     Ø   Key Contract/Key Employee (expense reimbursement)
     Ø   Business Litigation, Business Income (Interruption)
     Ø   Product Recall, Reputation, Crisis Management
     Ø   Employee Related Practice Liability/Directors & Officers
     Ø   Supply Chain Risk

Enhance business planning (Enterprise Risk Management)
                                                                                     17
Risk Financing Continuum
HIGH

                                                                                Cell or Single Parent Captive
                                                                                 • Complete assumption of risk on
                                                                                   primary layer
                     What happens to the premium
                                                                                 • Subject to Regulatory Oversight
                       as the retentions go up?
                                                                 Group Captive
  Program Control

                                                                  • Pooling of Risk with Participants subject
                                                                    to Corporate Governance

                                                   Deductible Policy
                                                    • Significant/complete risk assumption in exchange
                                                      for deductible credit

                                      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 little-to-no deductible
 LOW                                                                                                   HIGH

                                          Financial Control

                                                                                                                     18
The Captive Wrap Program™
Stand-alone and Difference-in-Conditions Policies

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Coverage Examples

Medical Stop-loss                           Political Risk
Professional Liability DIC* Coverage        HIPAA/Billing Audit Liability
Contractual Liability                       Cyber Liability
Business Litigation DIC                     Business Interruption/DIC
Environmental Liability/Excess              Employment Practices/DIC
Labor Strike Reimbursement                  Employee Dishonesty
Patent Infringement/Intellectual Property   General Liability DIC
Property Management Professional            Professional Misconduct
Errors & Omissions Liability DIC            Administrative Actions
Product Liability/Recall DIC                Directors & Officers Liability
Loss of Key Employee                        Wind Deductibles on Property
Wage & Hour Liability                       Inland Marine DIC
Credit Default                              Trade Credit
Medical Malpractice/DIC                     Regulatory Change
Subcontractor Performance                   “Fat Finger” Insurance
Reputational Risk                           Adverse Party Legal Risk

*Difference in Conditions

                                                                             20
Stop Loss
      Insurance
                         Funding Medical Stop Loss
    Captive Layer

     Self-Insured
                                                                                       5315%(
      Retention
                                                                                      Savings
                                                                        Medical(
                                                                      Stop(Loss(in(
How it Works                                                            Captive

Ø   Medical stop loss may be funded in a captive as a direct reimbursement policy, or as
    reinsurance behind a regular carrier (“fronted”)
Ø   The captive layer typically sits above a self-insured retention of $25 - $100K
Ø   Specific and aggregate stop loss may be purchased above the captive layer to cap losses
Ø   Captive layers are often funded at 125% of expected losses, based on an actuarial calculation
Ø   Employer may fund the captive layer with their own funds and avoid complicated ERISA issues
    (by using employee funds, but not applicable in Hawaii)
Ø   Purchasing stop loss from a captive insurer is functionally the same as from a commercial
    insurer and can be structured to have no impact on plan participants
Ø   Employers with smaller populations can participate in a group medical stop loss captive
Ø   Subject to regulatory approval, medical stop loss policies may be funded in existing P&C
    captives

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What Do the Structures
           Look Like?

      Educate – Evaluate – Elevate

              22
International Risk Insurance Company (IRIC)
         Delaware-domiciled Series Captive Insurance Company (SCIC)

                                            IRIC
Contractual Relationship             “Administrative Core”

                Series Captive “A”    Series Captive “B”     Series Captive “C”
                 Min $100k Capital     Min $100k Capital      Min $100k Capital

                                      Own FEIN
                                      Own Board
                                      Own Assets
                                                                                  23
Single Parent (Pure) Structure

                                     Why a holding company?
                                     1. Not regulated, so no
                                        NAIC bio or D&O issues
                          Holding    2. Flexible ownership
                         Company        changes
   Ownership of                      3. Used in ”Golden
Holding Company                         Handcuff” structure
will typically mirror                4. Some cash flow benefits
                         Insurance
  that of Insured
                         Company

                         Insured

                                                           24
Group Captive with Fronting Company
          Funding Model
                                                           Three Funding
              Capital Loan Repayments                         Phases:
                                                        1. Feasibility
                    or Dividends                        2. Statutory Capital
                                                        3. Growth Capital
  Insured A

                  Capital              Holding
  Insured B      Loans or             Company
               Investments

  Insured C
                         100% Capitalization     Surplus Note

                Fronting                    Group Captive
 Premium        Company                 (Insurance Company)

                                                                               25
Captive Examples and
  Expense Examples

     Educate – Evaluate – Elevate

             26
Single Parent Captive Example
                            (Mixed P&C – Stop Loss)

    Commercial renewal in 2013
         (without a captive):
•   $840,000 premium
                                     Holding Company
•   $250k SIR on commercial policy                                 Coverage Examples
•   Fully-insured on health plan
•   Multiple gaps/exclusions
                                                         Loss of Key Contract   Reputational Risk

    Commercial renewal in 2017         Captive with
           (with a captive):                              Hedge Fund E&O           Loss of Key
                                       $250,000 in
•   $515,000 premium                                           DIC                  Employee
                                     Statutory Capital
•   $500,000 SIR on commercial
                                                             “Fat Finger”        Network/Cyber
    policy                                                  Endorsement             Liability
•   $30,000 Spec Ded ($10,000
    excess $20,000 in captive)
                                                              EPLI/D&O          Crisis Management
•   $1m DIC limit with Zero SIR in
    captive
•   $5.3m in captive assets                                                         Business
                                                          Business Litigation
                                                                                   Interruption
•   $4.3m in premium deductions
•   $325,000 in annual premium
    savings, $1.6m total so far                                                                   27
Reinsurance - Why you might need or want it
                                 Ground-up Quota-share

Purpose                                                                                1M Limit –
  Ø   Protect captive against                                                         Quota-share
      significant loss
  Ø   Preserve capital                                                   49%       51%
                                                       Your Captive        of        of
  Ø   Risk transfer
                                                                         prem.     prem.
  Ø   Risk distribution                                                 kept in     for
                                              51% of                      the     51% of
Structure                                  Premium/Risk                 Captive    Limit
  Ø   Quota-share
  Ø   49/51% Ratio
  Ø   2.5% Cost                                           Reinsurance

                        Captive
                       Participants

                                 Captive
                                Participants        Captive
                                                   Participants
                                                                                              28
5-year Financial Overview
                           Pure Captive with Reinsurance

                                                                                                                 Available
                                                                               Loss Ratio    Paid Claims
                                                                                                           Captive Assets
                                                                                     5%         486,500       10,028,386
   •   Expense ratio should be much lower than commercial at 35%+
                                                                                    25%       2,342,500        7,917,147
   •   Reduction in commercial premium due to retentions (10-20%+)
   •   Claims are paid to owner (they do not come out of your cash flow)            50%       4,685,000        5,278,098
   •   Highly efficient regardless of tax election                                  80%       7,496,000        2,111,239

       This table reflects a 35% loss ratio, 2% ROI, WITH reinsurance:

                                 Year 1       Year 2        Year 3         Year 4           Year 5           Total
Premium                          2,000,000    2,000,000     2,000,000      2,000,000        2,000,000       10,000,000
Admin/Operational (est.)            75,000       75,000        75,000        75,000           75,000           375,000
Reinsurance                         51,000       51,000        51,000        51,000           51,000           255,000
Paid Claims                        655,900      655,900       655,900       655,900          655,900         3,279,500
EBITDA                           1,218,100    1,218,100     1,218,100      1,218,100        1,218,100        6,090,500
Investment Inc (net of tax)         48,724       99,397       152,097       206,905          263,905           771,027
Net Profit                       1,266,824    1,317,497     1,370,197      1,425,005        1,482,005        6,861,527
Available Captive Assets         1,266,824    2,584,321     3,954,518      5,379,523        6,861,527                29
Actual Claim Examples

Ø Wage & Hour: $480,000 due to allegations the insured didn’t follow strict
  guidelines on breaks, lunchtimes, and overtime rules. Excluded from
  commercial EPLI/D&O policy.

Ø Trade Credit: $260,000 due to large client (of the insured) filing bankruptcy and
  continuing to use security services. Insured’s IT system failed to flag
  nonpayment’s. Commercial policy declined claim due to “prior acts” date on
  policy.

Ø Reputational Risk (Headline): $63,000 due to homicide investigation of elder
  death. Nurse falsified medical records. Hiring of PR firm not covered under
  General Liability policy and claim denied due to ”actual or alleged” wording in
  commercial policy.

Ø Sexual Abuse Allegation: $140,000 due to defense of Owner by previous
  employee alleging sexual abuse. Commercial carrier declined due to retro-date.
  Defense verdict and insured fully reimbursed.

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Risk and Insurance Review
    Process & Foundations

          Educate – Evaluate – Elevate

                  31
Elevate CORE™ Review

Coordinated Overview
of Risk and Exposure

                                              32
The Captive Creation Process

   Step I:               Step II:          Step III:
  CORE™                 Regulatory        Funding &
  Process                 Filing            COA

Insurance              Regulator         Receipt of Cert
review                 discussion        of Authority

Actuarial rates        Corporate         Capitalize
                       structure
Captive lines of       creation          Fund Premium
insurance
                       Bank accounts     Policy Issuance
Loss projections
                       Investment plan   Implement
Domicile and                             investment plan
Service provider       Business plan
                                         Governance
Go/no go               File              plan

 30 Days                  15 Days            30 Days
                                                           33
Questions and Answers

Our family is blessed to do what we do, and we love doing it.
        Thank you for allowing us to visit with you today.

                      Jerry D. Messick, ACI
                               CEO
                        Elevate Captives
                        M: 405.550.2651
                    jm@elevatecaptives.com

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