Captives – Alternative or Obstacle Business Case

1. Captives – Alternative or ObstacleBusiness Case Charlie Woodman, CPA SVP, Risk Finance Marsh CAS Annual Meeting November, 2004

2. Captive Insurance Company - Forms • Single Parent - Non Risk Pooling • Wholly-owned / Rent-A-Captive / Trusts / etc. • Emphasis on Risk Funding and Cost / Funding Efficiencies • Group Owned- Risk Sharing / Risk Pooling • Group, Association Captive, Risk Retention Group • Emphasis on Risk Transfer replacement / Alternative “insurance” • This distinction is critical in assessing the merits of a program.

3. Current Captive Insurance Program Emphases • Cost Savings • Risk Management Facilitation • Business Enhancement • Insurance / Risk Transfer Replication (Group Emphasis)

4. Cost Savings • Long-term: “Seasoning” / Risk Management Point Facility • Short-term: “Business Case”

5. Seasoning • “Seasoning” / Risk Management Point Facility • Extends the Corporate Risk Management “Commitment” to It’s Own Risks • Engages in Insurance under the Insurance Industry’s Mechanisms and Measurements • Regulated and “Grounded” • Reinforces Relationships with (Re)insurance Markets • Hard to quantify / “Theoretical in Many Instances”

6. Business Case • NPV of Cash Flows - Short Term Business Case cost Savings • Accelerated Tax Benefits - Qualified Insurer • State (& International) Tax Arbitrage • Operating Costs • Opportunity Cost of Capital • Other Quantitative & Qualitative

7. Accelerated Tax Benefits - Qualified Insurer • Insurance Premiums are Deductible over the policy term • “Casualty” losses are subject to “Economic Performance” for tax • Accounts and “set-asides” are not economic performance • Incurred Basis (incl. IBNR) vs. Paid Basis • SubChapter L of the IRC • Accelerated Recognition, not an accelerated realization • i.e. Already recognized for financial reporting • No “above the line” accounting benefit • Consolidated Cash Flow Benefit • Note: Basis of tax benefit is actual premium deduction from insured to Group Captive

8. Tax Reality • The underlying issues which define whether an insurance transaction has occurred or whether a transaction is self-funding are: • “Insurance Risk” - Insurer must assume a reasonable possibility of incurring significant loss. • Notions of Risk - Form • Risk Transfer / Risk Distribution - Risk of loss must be legally transferred from one legal entity to another, which pools the risk among other risks so as to increase predictability, and reduce adverse loss uncertainty.

9. Tax Facts & Circumstances

10. Tax Facts & Circumstances

11. Other Business Case Components • State (& International) Tax Arbitrage • Operating Costs • WACC / Opportunity Cost of Capital • Capitalization • Losses as Premiums • Discount rate on enhanced cash flows • Other Quantitative & Qualitative • (Re)insurance • Internal Costs & Resource Commitment • Recognitions and Materiality

12. Captive Operating Costs • Start-up • Fronting, if applicable. • Management • Measurement: Audit & Actuarial • Legal & Regulatory • (Re)insurance • Pools and Participations • Premium-based Taxes • Direct / Reinsurance • Federal Excise Taxes • Self-procurement / Direct placement.

13. Design Components and Issues • Coverages • Structure • Direct Writer • Reinsurer • Capitalization & Collateral • Domicile • Cost • Regulatory • Other • Premiums & Operating Expenses • Premium Taxation

14. Underwriting • Traditional risk • Professional Liability/Medical Malpractice • Workers compensation, auto and general liability • Products/completed operations, errors & omissions, environmental • D&O, Surety, Property? • Employee Benefits • TRIA

15. Program Evaluation or “Feasibility” • Risk Assessment / Self-Assessment • Insurance Marketplace • Risk Quantification • Qualitative Issues • Pro Forma • Structure & Design • Time - Urgency versus Commitment • Capital • Cultural