Deconstructing the Value Proposition of Captives

1. 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

2. Economics of Insurance: The Stage Profits & Losses 55 -75% • Fixed (25%-35%) • Insurance CompanyOverhead, Taxes,Reinsurance Cost, Commissions • Profits & Investment Income • Underwriting Profit and Investment Income Accrued by Insurance Company • 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

3. 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 Program Sophistication • 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 HIGH LOW Assumption of Risk

4. 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

5. 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.

6. 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

7. 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.

8. 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

9. 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

10. 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

11. 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

12. Group Captives Unbundling the Insurance Transaction

13. 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

14. 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

15. Construction Solutions Case Study

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17. 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

18. 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 Dallas • May, 2015 Pittsburgh • Bi-Annual Board & Shareholder Meetings: • October 19-21, 2014 Toronto • May 17-19, 2015 Cayman

19. 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

20. 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

21. 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

22. 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 Workers Compensation General Liability Auto

23. Construction Solutions Premium Distribution Example: Captive Expenses $ 345,900 Loss Funding $ 654,100 Total Premium $1,000,000

24. Construction Solutions Premium Distribution Example: A Fund $ 490,575 B Fund $ 163,525 Loss Funding Allocation $ 654,100

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28. Construction Solutions Maximum Cost: $ 1,482,510 Premium + Assessment Minimum: $ 356,654 Captive “Fixed” Expenses Less - Investment Income Plus - Shared Losses

29. 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

30. Construction Solutions Service Providers • 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

31. Captive Flow Underwriting Profits! Insured CS Retail Broker Arch Insurance Company CS INSURANCE LTD. Willis, SRS, KR&W, Milliman, KPMG, GB

32. 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

33. 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

34. 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

35. Construction Solutions Questions?