Deconstructing the Value Proposition of Captives

Report
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
20th Annual Willis Construction Risk Management Conference
Marriott Legacy Town Center – San Jacinto Room
Tuesday, September 16, 2014
Economics of Insurance: The Stage
Profits & Losses
55 -75%
• 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 & Investment Income

Underwriting Profit and Investment
Income Accrued by Insurance
Company
1
The Continuum of Risk Finance
HIGH
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
LOW
Assumption of Risk
HIGH
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.
4
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
5
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.
6
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
7
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
8
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 1st 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 
Frequency Fund A
First Dollar to $ 125,000
General Liability
Workers
Compensation
Auto
Construction Solutions
Premium Distribution Example:
Captive Expenses
$ 345,900
Loss Funding
$ 654,100
Total Premium
$1,000,000
Construction Solutions
Premium Distribution Example:
A Fund
$ 490,575
B Fund
$ 163,525
Loss Funding Allocation
$ 654,100
Construction Solutions
Conceptual Annual Program Pricing
ABC Construction
WC
49.06%
16.35%
65.41%
18.98%
5.72%
3.50%
1.30%
2.09%
3.00%
34.59%
A Fund - $0 - $125,000 $
B Fund - $125,000 - $500,000 $
Total Loss Funds $
Excess & Aggregate Charge
Front Administrative Charge
Taxes/Boards & Bureaus Charge
Loss Control Funding
Claims Admin Funding
Captive Expense Funding
Subtotal
Total Estimated Subject Premium
Estimated Composite Rate
Auto
Total
269,816 $
147,173 $
73,586 $
490,575
89,939 $
49,058 $
24,529 $
163,525
359,755 $
196,230 $
98,115 $
654,100
$
104,390 $
56,940 $
28,470 $
189,800
$
31,460 $
17,160 $
8,580 $
57,200
$
19,250 $
10,500 $
5,250 $
35,000
$
7,150 $
3,900 $
1,950 $
13,000
$
11,495 $
6,270 $
3,135 $
20,900
$
16,500 $
9,000 $
4,500 $
30,000
$
190,245 $
103,770 $
51,885 $
345,900
$
Estimated Exposure
GL
$
550,000
$
15,000,000 $
3.67
300,000 $
15,000,000
$
1,000,000
140
2.00 $
Share Purchase
Retail Brokerage Fee
Assessment Exposure
Collateral Required
150,000
1,071
$
(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 $
100,000 $
- $
325,000 $
300,000 $
- $
325,000 $
375,000 $
500,000 $
125,000 $
375,000 $
1,500,000 $
1,950,000 $
1,150,000 $
2,000,000 $
Total Incurred
200,000
650,000
425,000
625,000
1,200,000
2,000,000
5,100,000
Construction Solutions
ABC Construction
Gross Subject Premium
Losses Incurred (Paid+Reserved)
Losses Excess of $500,000 Reinsured:
$
$
$
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 $
B FUND
Net Premium
Losses Incurred (Paid+Reserved)
$
$
Profit/(Loss) $
Transfer from A
$
Deficit Reallocation (Risk Share)
$
Final B Fund Balance $
Loss Equity Balance*: $
2013
2012
1,000,000 $
200,000 $
$
1,000,000 $
650,000 $
$
2011
2010
1,000,000 $
425,000 $
$
2009
1,000,000 $
625,000 $
$
2008
1,000,000 $
700,000 $
500,000 $
Total
1,000,000 $
500,000 $
1,500,000 $
6,000,000
3,100,000
2,000,000
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
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
154,100 $
15.4%
1,029,925
17.2%
454,100 $
45.4%
163,525 $
16.4%
229,100 $
22.9%
29,100 $
2.9%
$
0.0%
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)

1st Year 2/3 of A Fund = $321,673

2nd Year 2/3 of A Fund = $321,673
$643,346 combined

3rd Year 2/3 of A Fund = $ 321,673
$965,019 combined
No Additional Collateral required at 4th renewal!!

4th Year Caps at 2/3 of 3 Year Total = $965,019
Construction Solutions
Service Providers

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




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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
Construction Solutions
Questions?

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