Captives: 101 and Beyond

Phillip J. Gajewski, CPCU, ARMAVP, Business Development

Meadowbrook Insurance Group

What is a Captive?

Captive insurance organizations are insurance companies that are owned and controlled by their insureds.

A captive insurance company can be defined as a special purpose insurer whose sources of business are (1) its shareholders and their affiliates which put their own capital at risk, or (2) other participants such as association or group members.

What are the Reasons for Forming a Captive?

Stabilize insurance costs by getting off the pricing “roller coaster”.

Separate your own premium and loss experience from those of other groups or insureds.

Assure availability of tailored coverage. If experience is good, insurance costs

can be trimmed through premium reductions or dividends.

If loss experience is adverse, the situation should still be better because of realized investment income.

How a Captive Can Save Costs.

Eliminates normal insurance company overhead.

Realize investment income on premium and capital.

Realize investment income on loss reserves.

Specialized claims handling and administration.

Specialized loss control activities.Potential tax advantages?

Advantages

Reduced operating costs Investment income and underwriting

profit Broader coverage Pricing and coverage stability Direct reinsurer access Improved service Increased control Immediate reward for reducing losses Enhanced risk management status Fewer regulatory restrictions

Types of Captives

Single-Parent Captive (Pure)Group (or Association)

CaptiveAgency CaptiveHybrid…

also,Rent-a-Captives

Method of Writing Business

Direct Write Captivesvs.

Use of / Need for Fronting Companies

Risk-Sharing Opportunities?

Risk Sharing Partnerships

ExcessCommercialReinsurers

Front Co.

Quota SharePremium

Quota ShareLosses

UnderwritingProfit

+Investment

Income

Agency

Policyholder

Captive

Shareholders

ExcessCommercial Reinsurers

100%

$750,000(Excess Layer)

$250,000 (Working Layer)

QUOTA-SHARE (Captive decides their share)

Limitation of Risk

$1 Million Exposure

Front Co.50%

CAPTIVE50%

Collateral Requirementsfor Fronting / Risk-Sharing

Letter of Credit (LOC)Trust AgreementFunds Withheld

Domicile Selection

On-ShoreAL, AR, AZ, CO, DE, DC, GA, HA, IL,

KY, ME, MO, MT, NV, NY, RI, SC, SD, UT, VT

vs.Off-Shore

Bermuda, Barbados, British Virgin Islands, Caymans, Dublin, Guernsey

Domicile Selection Factors Capitalization Requirements Surplus Requirements Investment Restrictions Reporting and Auditing Requirements Loss Reserving Requirements Income and Local Taxes Government Fees Overall Regulatory Climate Formation Time Miscellaneous Underwriting Limitations Acceptance by Fronting Companies and Reinsurers Formation Costs Management and Legal Fees Availability of Banking, Accounting, & Other

Services Location-Specific Factors

Average Annual Operating Costs

Management Fees: $35,000 - 250,000Legal Fees: $15,000 – 40,000Auditing, Actuarial: $15,000 – 45,000Government Fees: $3,000 – 10,000Meeting Expenses: $10,000 – 50,000

III. CORPORATION DOCUMENTATION

A. CharterB. Offering MemorandumC. Subscription AgreementD. Escrow AgreementE. By-Laws

IV. MULTIPLE OWNERS RELATIONSHIPS

A. Voting RightsB. Capital ContributionC. Standards for Participation In A

Group CaptiveD. Profit Participation In A Group

CaptiveE. Departing Shareholders/InsuredsF. Settlement of Disputes

I. INTRODUCTION

A. Domiciles and Legal StructuresB. Corporation DocumentationC. Relationships Between Multiple

OwnersD. Insurance RegulationE. Securities RegulationF. Insurance DocumentationG. Management ServicesH. Contracts

II. DOMICILES AND STRUCTURE

A. Company DomicileB. Corporate FormC. CapitalizationD. Board of DirectorsE. OfficersF. CommitteesG. Name of Captive

Captive Formation Steps

V. INSURANCE REGULATION

A. U.S. Insurance RegulationB. Captive Domicile Regulation

VI. SECURITIES REGULATION

A. U.S. Securities RegulationB. Captive Domicile Regulation

VII. INSURANCE DOCUMENTATION

A. Policy FormsB. Fronting ArrangementsC. Underwriting GuidelinesD. Rating of PolicyholdersE. MiscellaneousF. Reinsurance Placement

VIII. MANAGEMENT SERVICES

A. Designate ManagerB. Designate Law FirmC. Designate BankD. Designate AuditorsE. Other Service Providers

IX. CONTRACTS

A. Management AgreementB. Reinsurance AgreementC. Trust Agreement

Captive Formation Steps

Disadvantages /Potential Pitfalls

Captive Costs Capitalization and commitment Dependent upon service providers Internal administrative costs

Poor Underwriting Results Inadequate loss reserves and potential losses

Competitive Insurance Environment Failure to Employ Loss Control Techniques Large, Single Insured/Stockholder Possible taxation problems Some insurer/broker resistance

Increased cost of other insurance

Captive Resources:

www.captive.comIRMI – International Risk

Management Institute.Captive Insurance Company ReportsCaptives & the Management of RiskCaptive Practices & Procedures

Thank You!Questions?