The Captive Concept Presented by Beverley Todd JLT Insurance Management (Bermuda) Ltd.

1. AIPAGIA Mid-Winter Conference March 2009 The Captive ConceptPresented by Beverley ToddJLT Insurance Management (Bermuda) Ltd.

2. Presentation contents • Introduction – Beverley Todd • The captive concept • Why form a captive? • Types of captives – applicability for AIPAGIA Members? • Agency Captives – an example • Next Steps?

3. Introduction Beverley Todd Executive Vice President JLT Insurance Management (Bermuda) Ltd. • Born and bred Londoner! • Accountant by trade – Chartered Institute of Management Accountants • 15 years Bermuda captive management experience

4. A captive is …… • A special purpose insurance company established to insure or reinsure the risks of its shareholder(s) and their subsidiaries or affiliated companies • A useful risk management and risk financing tool to help a company better handle the financial impact of risk exposures • Usually formed in a specialized environment or “domicile” – “onshore” or “offshore” A captive is not a magical solution to every insurance problem.

5. Historical development of captives • 1970’s – Property hard market • 1980’s – Liability crisis • 2001 – Market crisis – WTC aftermath • 2008 – Insurer security problems – captive opportunities • Today there are over 4,458 captives worldwide • 1,405 Bermuda • 1,069 Europe • 1,984 Others (includes 24 USA States)

6. Why form a captive? • To Reduce Costs • To Generate Underwriting Profit & Investment Income • To Optimize Risk Management • To Obtain more Information and Control • To Obtain Additional Capacity • To Obtain Direct Market Access • To Achieve Financial Stability • To Achieve Tax Efficiency

7. Cost Reduction • Lower overhead costs than a commercial insurer’s, allowing a larger percentage of premium to be used for claims payments • Accessing the reinsurance market, which operates on a lower cost structure than direct insurers • Premiums based upon your own company’s loss experience, not on industry-wide standards • Tax advantages

8. Underwriting Profit & Investment Income • Retention of underwriting profits and investment income that would otherwise go to the commercial market • Earned investment income on unpaid reserves

9. Optimize Risk Management • As a separate subsidiary of the business, focuses senior management attention on risk • Ability to design a program to meet specific needs i.e. can include risks which may be currently uninsurable or cost prohibitive • Use captive surplus to fund risk improvements • Ring-fence risk funding • Use contributions to fund loss control projects

10. Information and Control • Influence program design and cost through progressive retentions • Reliable data for reinsurance purposes • Access to loss data/reserving practice • Claims handling control • Image preservation, • Avoidance of legal precedents, • Out-of-court settlement, • Negative publicity management, • Damage limitation

11. Additional Capacity • Can act as a direct insurer (where permitted) • Can act as a reinsurer behind a fronting company • Provides insurance coverage throughout fluctuating insurance cycles = price stabilization • As captive matures and realizes increased capital and surplus, it reduces the dependency for obtaining risk transfer through commercial markets • Strategic layer completions e.g. • Left with a gap – unable to complete property layer at lead underwriter premium

12. Direct Market Access • Allows direct access to reinsurance markets & ART markets • Reinsurance markets are less heavily regulated, wider range of solutions – better program design • Can obtain more competitive wholesale premium quotes than primary insurers • May reduce/eliminate brokerage fees • Collection of reinsurance commissions

13. Financial Stability • Cost of insurance is cyclical and volatile – a captive insulates owner from withdrawal of capacity by conventional markets: pollution, asbestos, flood, windstorm, terrorism…. • Uses its capacity and reservoir of earnings to stabilize premiums during harder markets – ensures that premiums are determined by company’s own loss experience, not industry-wide standard • Allows access to multi-year ART programs to spread losses across time • Dividend release can be harmonized with parent’s capital needs to reduced debt/equity ratios, tax offset….

14. Tax Efficiency • Captive premium and loss reserves may be tax deductible expenses • Offshore captives can avoid costly and burdensome regulation by the US insurance and tax authorities in each state. • Small (i.e. under $1.2m of premium written p.a.) non-life insurance companies can elect to be taxed under IRS section 831 (b) – taxed on investment income only

15. Captive disadvantages • Capital requirement – opportunity cost • Costs – compared to self insurance • High premiums during soft market • Risk of adverse results.

16. Minimum Capital and Surplus Classification of Insurance Companies - Bermuda Class 1 Pure Captives Class 2 - Group / Association Captives/Agency - Captives writing less than 20% unrelated business Class 3/3A/3B General commercial companies – including SAC/RAC Class 4 Property catastrophe/ excess liability companies

17. Types of Captive – AIPAGIA Applicability? • The main types of captives are:- • “Pure” or single parent captives • Group Captives • Agency captives • Association captives • Rent-a-captives/Segregated Accounts Companies

18. “Pure”/Single Parent Captive Structures Insured Insured Insured Insured Captive Insures only the risks of the non-insurance owner or the owner’s subsidiary operations Reinsurer Insurer Insurer Captive Captive Captive Captive Reinsurer Reinsurer

19. “Pure”/Single Parent Captive Structures • Applicability for AIPAGIA Members? • Fairly limited applicability due to relatively small parental risks presumed within each member agency’s portfolio • Considerations for “pure” captives – Class 1 • Single owner – single insured typically – i.e. direct agency risks • Individual Member agency with 100% ownership – thus total parental control and corresponding total captive risk • Annual premium written typically in excess of $2m • Set-up costs – minimum of $25,000 • Annual running costs of at least $100,000 pa • Minimum capital requirement - $120,000

20. Group Captives Insured/ Agency 1 Insured/ Agency 2 Insured/ Agency 3 Insured/ Agency 4 Premium Premium Premium Premium Insurer Reinsurer Premium Jointly owned by multiple, non-related organizations to insure the risks of these different entities Insurer Reinsurer Captive Captive

21. Group Captives • Applicability for AIPAGIA Members? • Possible applicability – i.e. members join to form the Group Captive for their own parental risks • Considerations for Group captives - Class 2 • Established by a group of individual Members rather than AIPIGIA • Shared control amongst participating members • Members obtain shares within the Group captive • Risks are shared among Group owners • Set-up costs (shared) – minimum of $25,000 • Annual (shared) premium written typically in excess of $2m • Annual running costs of at least $120,000 pa • Minimum capital and surplus of $250,000

22. Agency Captives Owned by an insurance agency or brokerage firm so that they may reinsure a portion of their client risks Insured Insured Agent Agent Insured Captive Reinsurer Insurer Insured

23. Agency Captives • Applicability for AIPAGIA Members? • Ideal structure for large member agencies • Considerations for agency captives - Class 2 • Individual Member agency with 100% ownership – thus total parental control • Established relationship with Fronting Insurer – although risks can also be written directly (albeit highly unlikely) • Annual premium written typically in excess of $2m • Set-up costs – minimum of $25,000 • Annual running costs of at least $120,000 pa • Minimum capital and surplus of $250,000

24. Association Captives Owned by a trade, industry or service group for the benefit of its members Insured/ Agency 1 Insured/ Agency 2 Insured/ Agency 3 Insured/ Agency 4 Premium Premium Premium Premium Insurer Insurer Reinsurer Premium Reinsurer Captive

25. Association Captives • Applicability for AIPAGIA Members? • Ideal structure for allAIPAGIA member agencies • Considerations for association captives - Class 2 • The Captive is established and owned by AIPAGIA rather than individual member agencies • Initial capital and operating funds obtained either via existing Association funds or via Member ‘assessments’ • Participating Members would obtain shares within the Association captive • Risks are shared among AIPAGIA participating members – strict underwriting guidelines required • Annual premium written typically in excess of $2m for entire Association captive – thus individual members annual premium can be fairly small dependant upon the number of active participants • Set-up costs – minimum of $25,000 • Annual running costs of Association captive will be at least $120,000 pa

26. Rent-a-captives/SAC SAC owner Insured/ Agency 1/Cell 1 A company that provides' captive facilities to others for a fee Insured/ Agency 4/Cell 4 Control Insured/ Agency 3/Cell 3 Core Non-Voting Shares Cell Owner Insured/ Agency 2/Cell 2

27. Rent-a-captives/Segregated Accounts Co.’s • Applicability for AIPAGIA Members? • AIPAGIA can establish its own RAC/SAC for its Members or alternatively Members can participate in an existing RAC/SAC structure e.g. Isosceles • Considerations for RAC/SAC captives - Class 3 • Non-owned RAC/SAC:- • No start-up costs • Relatively easy entry/exit • Typically no risk sharing among members – accounts are ‘ring fenced’ • Lower annual running costs • Risk ceded must have an aggregate limit – ‘risk gap’ must be fully secured • Annual premium written typically in excess of $500,000 • RAC/SAC sponsor has a ‘voice’ in direction of the insurance program • Owned RAC/SAC:- • AIPAGIA start-up costs will be incurred • AIPAGIA RAC/SAC will be established and maintained purely for the benefit of its members • Other segregated accounts benefits/limitations as per the non-owned RAC/SAC

28. Agency Captives – an example • Agency Coverages • Group Disability • Group Business Overhead Insurance • Group Life • Parental Coverages • Workers compensation/GL/Auto • General Liability • Errors & Omissions • Captive Participation • Quota share of all Agency coverages – Agency business • Captive premium $2,000,000 p.a. • Errors & Omissions – Parental Business • Captive premium 250,000 p.a.

29. Agency Captives – an example

30. Next Steps? • Feasibility Study performed:- • Optimal captive structure – based upon current Membership • Review of members historical loss history • Cost/benefit analysis – financial projections • Taxation issues • Domicile choices • Insurance Manager Selection – coordinates - entire incorporation process – including assistance with business plan preparation, liaison with corporate lawyers and final submission to the relevant regulatory authority • Congratulations - commence captive operations!!!!

31. Questions? THANK-YOU! QUESTIONS?