A CAPTIVE PRIMER: WHAT THEY ARE AND HOW THEY WORK - EDUCATE - EVALUATE - ELEVATE - INLIGHT RISK MANAGEMENT
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A Captive Primer:
What they are and how they work
Educate – Evaluate – Elevate
2018
1
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.
2
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
3
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
Onshore/Offshore Captives
as of 12.31.16 (Business Insurance)
7,006
CAPTIVES
WORLDWIDE
5
Captive’s Ranked by State
as of 12.31.16 (Business Insurance)
6
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
7
Mix and Match Types of Captives
“Small, fronted, protected cell, US-based, homogenous group captive”
8
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.
9
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
10The 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.
11Small 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!!
12The 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.
13Benefits, Uses, and
Coverage
Educate – Evaluate – Elevate
14What 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…
15Who 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
16How 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)
17Risk 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
18The Captive Wrap Program™
Stand-alone and Difference-in-Conditions Policies
19Coverage 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
20Stop 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
21What Do the Structures
Look Like?
Educate – Evaluate – Elevate
22International 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
23Single 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
24Group 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)
25Captive Examples and
Expense Examples
Educate – Evaluate – Elevate
26Single 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 27Reinsurance - 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
285-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 29Actual 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.
30Risk and Insurance Review
Process & Foundations
Educate – Evaluate – Elevate
31Elevate CORE™ Review
Coordinated Overview
of Risk and Exposure
32The 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
33Questions 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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