Cayman Captive Forum Presentation 2013

1. Cayman Captive ForumPresentation 2013 Captive / Actuarial 101

2. Julie E. Robertson Partner Joseph A. Herbers Managing Principal Fiona J. Moseley President & Director

3. " Everything you wanted to know and were afraid to ask… An introductory session to cover practical guidelines on legal, actuarial and regulatory matters during the formation and operational stages of a new captive."

4. What is a Captive? • The most simple definition: a licensed insurance company formed to insure the risks of its owners But the world is more complicated • RRGs; cell companies (SPCs), agency captives, rent-a-captives, micro captives, branch captives, reciprocals, series LLCs, portfolio insurance companies (PICs) • If you’ve seen one captive . . . you’ve only seen one captive! • Array of models provides flexibility, but creates the need for expertise and evaluation of the options in formation

5. What is a Captive? • A licensed insurance company • Regulated in a state or country (domicile) that has unique laws for captives • They typically vest a great deal of authority in the regulator and are less stringent than laws regulating commercial carriers • Owners/insureds involved in governance • Often have no employees but are managed by contracted service providers

6. Why form a Captive?

8. Captive Feasibility Studies - Outline • What is a Captive Feasibility Study • What are Actuaries? • Actuarial Involvement in Captive Feasibility Study • Dealing with Uncertainty • Predicting the Future

9. Captive Feasibility Studies • Data Analysis • Loss Estimates • Capitalization Requirements • Domicile • Tax Issues • Coverages, Retentions, Limits • Expenses • Reinsurance Costs • Regulatory Issues • Pro forma Financials

10. Actuaries & Captive Feasibility Studies • Projecting the future as regards: • Premiums • Losses • Loss Adjustment Expenses • Captive expenses • Acquisition, general, taxes • Reinsurance costs • Capitalization Requirements • Investment Returns

11. What is an Actuary? • Insurance professional skilled in measuring and quantifying risk • Typically a math or statistics major in college • Schooled in all aspects of insurance operations - Claims - Accounting - Underwriting - Ratemaking - Marketing - Reinsurance - Legal - Systems/IT

12. What does an Actuary do? • Quite simply – Predict the Future • Ratemaking – Figure out what premiums to charge for variety of coverages, limits and deductibles • Loss Funding Studies – Projecting future costs so insurer or self-insured entity can budget costs • Loss and loss adjustment expense reserve accruals for financial reporting purposes • Retention Level Analysis • Exposure Modeling (CAT) • Risk Transfer in Reinsurance

13. Essential Background Information • Business Plan • Historical premium, losses, claim counts & exposures for entity being considered • Domicile, Service Providers being considered

14. Captive Business Plan • Key management of enterprise • Owner(s), officers, roles • Nature of underlying business being insured • Coverages • Retentions - both per occurrence and aggregate • Limits • Service Providers

15. Data Analysis • Projecting Ultimate Losses • Start with current reported incurred losses • Adjust for retentions • Adjust for expected future loss development • Adjust for future trend • Adjust for changes in statutory benefit levels (WC) • Use multiple methods to project ultimate losses • Rely on a point estimate or reasonable range of ultimate losses • Project Ultimate Loss Ratio

16. Lags • Projecting Ultimate Losses • Start with current reported incurred losses • Adjust for retentions • Adjust for expected future loss development • Adjust for future trend • Adjust for changes in statutory benefit levels (WC) • Use multiple methods to project ultimate losses • Rely on a point estimate or reasonable range of ultimate losses • Project Ultimate Loss Ratio • Property/Casualty insurance business is characterized by lags (which give rise to need for IBNR)

17. Uncertainty in Projecting Ultimate Losses • Changes in rate of claim payments • Changes in case reserving practices • Changes in mix of exposure • Changes in retention limits • Changes in claim reporting procedures

18. Data Analysis • Projecting Expenses • Commissions/Brokerage • Fronting • Taxes, Licenses & Fees • General (audit, actuarial, legal) • Claims Handling • Reinsurance • Loss Control • Federal Excise Tax Usually stated as % of either WP or EP

19. Data Analysis • Underwriting Profit • Investment Returns • Investment Income • Mix of investments by type (stocks, bonds, cash, other) • Expected returns by type • Realized Capital Gains/Losses • FIT • Dividends

20. Pro Forma FinancialsRun Pessimistic, Base and Optimistic scenarios • Underwriting Exhibit • Projected premiums (direct / ceded / net) • Projected losses (premium x loss ratio) • Projected expenses • Dividends • Underwriting profit (by subtraction) • Balance Sheet • Assets, Liabilities & Surplus

21. Pro Forma FinancialsRun Pessimistic, Base and Optimistic scenarios • Income Statement • Underwriting Income, Investment Income, Other Income • Change in Surplus • Beginning Surplus • Capital Paid In • Net Income • Change in unrealized gains • Stockholder dividends • Cash Flow Statement • Beginning Cash • Inflows (premiums, investment income, paid-in capital) • Outflows (losses, expenses, taxes, dividends)

22. Consideration of Uncertainty • Reliance on actual data versus benchmarks and/or external data – less uncertainty if we have reliable data for entity being studied • Nature of historical data (# of years, consistency between years) • Examine reasonable range versus point estimate

23. Predicting the Future • We know our projections will not be absolutely correct • Objective is to have projections “in the right neighborhood” close to reality • Systematic pessimism or optimism is not good • With feasibility studies, we provide a range from pessimistic to optimistic

24. Captive Models Single Parent Captive Wholly owned insurance company established to insure/reinsure the risks of the single parent and/or its affiliates. SINGLE PARENT NO AFFILIATES: COMPANY X Insurance CAPTIVE

25. Captive Models SINGLE PARENT CAPTIVE SERVING AFFILIATES: COMPANY X CAPTIVE COMPANY X Subsidiary 1 COMPANY X Subsidiary 2 COMPANY X Subsidiary 3

26. Captive Models Group Captive Two or more owners form an insurance company to insure/reinsure risks of its owners (or their affiliates) GROUP CAPTIVE: COMPANY X COMPANY Y COMPANY Z CAPTIVE

27. Captive Models Cell Captive (aka Segregated Cell Captive, Sponsored Captive, Segregated Portfolio Company) One insurance company with separate “cells,” each cell with a separate insurance program and possibly a shareholder. Ownership of Voting Stock of the Captive, Appoints Board Preferred X Shares CAPTIVE Cell X Cell Y Cell Z Preferred Y Shares Preferred Z Shares

28. Captive Models Risk Retention Group Similar in structure to a group captive, but formed in a U.S. state under authority of Liability Risk Retention Act. All insureds must be owners, and all owners must be insureds – only authorized to write liability risk. COMPANY X COMPANY Y COMPANY Z RISK RETENTION GROUP

29. Domicile Selection Other factors Capital/surplus requirements Operating costs Political stability Infrastructure Domicile meeting requirements Local director requirements Operating costs Ease of travel Perception, particularly for nonprofits Availability of home state as a domicile Unique characteristics of the domicile • Driving factors • Structure/Coverage Needs • Regulatory environment; history • Tax considerations • Onshore and offshore • Premium taxes

30. Tax • From the insured’s perspective • Is the premium deductible? • What are the premium taxes? • Domicile, US federal excise tax, state premium taxes • From the owners’ perspective • If offshore, are the owners subject to tax annually or only when distributions are made? • If offshore, is there “unrelated business taxable income” for the tax-exempt owners

31. Tax • From the captive’s perspective • Is it an insurance company for US tax purposes (ie, can deduct its loss reserves)? • If offshore, is it eligible to elect to be a US corporation for tax purposes (a 953(d) election)? • Is it eligible for a small company election (an 831(b) election)? • If offshore, are there withholding taxes on its income? • If offshore, controlled foreign corporation or not? • If offshore, does it intend to “conduct a U.S. trade or business”? • Are there opportunities for the captive to be a tax-exempt entity?

32. Tax What’s most important: • Understand that taxable and tax-exempt organizations may have different tax motivations • Recognize that there is not certainty in this area and determine owners/insureds’ risk tolerance • Determine tax positions up front, not when returns are prepared • Make sure all stakeholders’ tax advisors are involved at the beginning • Document the business reasons for captive formation as support in case of future audit • Include tax calculations in pro formas and projections

33. Direct Write or Fronted Program? • A captive typically is not licensed/approved/admitted in the jurisdiction in which the insureds are located and is treated as an “unauthorized insurer” • Can the captive write coverage directly or does it need a “front”? • State legal and regulatory requirements • Contractual requirements of insureds • Patient compensation funds • Does the captive intend to attract new insureds/have a desire to market the program?

34. Formation • Legal documents for formation: • US: Articles of Incorporation/Bylaws • Cayman: Memorandum of Association/Articles of Association • Other legal documents: • Shareholders agreement for group captives • Information circular/offering documents for group captives • Subscription agreement • License Application: • Pro formas • Actuarial projections • Business plan • Identification of service providers • Applications of directors and officers

35. Initial Operations • Approval in principle sparks a flurry of activity • Put in place operational guidelines • Board of Directors guidance • Front Company and Reinsurance • Insurance Manager • Committees • Regulatory

36. Approval in Principle Sparks a Flurry of Activity • Incorporation • Subscribers Meeting • First Directors Meeting • Open Bank Account • License issued

37. Put in Place Operational Guidelines • Board of Directors • Front company • Reinsurers • Insurance Manager • Committees • Claims Management, Audit and actuarial, investment etc.

38. Getting Up and Running • Approve insurance arrangements • Engage service providers • Actuary, auditor, lawyer, investment manager, banker, insurance manager • Adopt operating budget • Approve investment policy • Other policies: claims payment, expense reimbursement Congratulations: You’re running an insurance company!

39. Board of Directors Guidance • Frequency of meetings, circulation of contact details and agreement of approval mechanism • Understand business plan and laws of operation • Mind and Management discussion – who is driving the bus and from where? • Discuss and declare any conflicts and process around future conflicts • Appointment of Secretary and define role • Mandates for Committees • Signing Authority

40. Corporate Governance • Role of the Shareholders • Role of the Directors • Role of the Officers • Directors Duties • Fiduciary • Duty of care and skill • Minutes • Meetings • Engagement and oversight of service providers

41. Front Company and Reinsurance • Review and sign agreements • Confirm logistics and reporting

42. Insurance Manager • Confirm responsibilities and expectations • Reporting deadlines • Information exchange • Financial Statement prep, Actuarial and Audit • Who is driving the bus?

43. Committees • Define make-up • Adopt the mandate • Review the business plan

44. Regulatory • 6 month check up • Financial Statement submission • Conformity to Business Plan • What if something go wrong?

45. Success Factors • Taking the long view • Management commitment • Adequate funding and capitalization • Group captives: documentation and fairness • Focus on risk management and mitigation • Conservatism in the early years

46. Q & A

47. Thank you for your attention