Captive Pricing: How and When

1. Captive Pricing: How and When Cayman Islands Singapore British Columbia Vanatu Hawaii Luxembourg Dublin Delaware Illinois Bermuda Turks & Caicos Islands Switzerland Guam New York US Virgin Islands Barbados British Virgin islands Curacao Barbados Colorado Florida South Carolina Georgia Guernsey Bahamas Vermont Illinois

2. Fundamental Risk Management Questions • Why do we transfer some risks and retain others? • For risks we choose to transfer, how do we determine the appropriate limit? • How much risk are we retaining? • What are the firm’s key risks? • How do these risks align to our risk management programs? • Is our risk management process as efficient as it could be?

3. Corporate-Wide RM Solution Implementation Risk Mitigation then Transfer Economical to transfer after mitigation Risk Transfer Economical to transfer risk immediately Risk Avoidance Risk relative to reward is too high Risk Mitigation Not economical to transfer Financing Solutions Organizational Solutions – enhance management processes to better manage risk: Exit Risk Area Risk Management/Mitigation Financial (Capital Mkts) Insurance Hybrid Structure Strategy Improvmnt People Improvmnt Process Improvmnt Systems Improvmnt The Risk Management Decision Model

4. Spectrum of Risk Finance Risk Transfer Risk Funding To Unrelated Third Party First Dollar / Guaranteed Cost Group Captives / Pools Single Parent Captives Rent-a-Captive / Cell Facilities Self-insurance

5. The Captive • A Special Purpose Insurance Company • Typically owned by non-insurance parent(s) • Located in “enabling” domiciles / regulatory jurisdictions • Incorporated (C-Corp) • Capitalized and Operated as an Insurance Company (Commitment) • Managed by Professionals (Turn-key Industry) • Individual Reporting Concern and a Consolidated Entity • Captives may (re)insure third-parties • Risk Retention Levels and Captive Utilization are two different considerations. • The Emphasizes the "Insurance Transaction and Insurance Operations”

6. Where Captives Fit into the Risk Finance Evolution

7. The Reasons • Concerns are still forming captives for all the right reasons • Program Cost Savings • Risk Management / Program Facilitation & Allocation • Business Enhancement

8. The Real Value Proposition • A “seasoned” insurance company / corporate-wide risk management vehicle to allow non-insurance concerns to opportunistically navigate the insurance arena and nurture long-term relationships. • An insurance company for tax planning efficiencies • A Risk Warehouse of containing and comprehensively executing enterprise-wide risk strategies. A manifestation of corporate commitment to new risk management thinking and disciplines. • A profit center for diversifying and / or differentiating its operating affiliates by offer value-added services / insurance products to customers.

9. A Reasonable Approach to Business Case • NPV of Cash Flows • Accelerated Tax Benefits • Captive Operating Costs • Capital Commitment: Opportunity Cost of Capital • State (& International) Tax Benefits / Arbitrage • Other, Non-quantified Costs Issues • Qualitative

10. Tax Reality • The underlying issues which define whether an insurance transaction has occurred or whether a transaction is self-funding are: • “Insurance Risk” • Notions of Risk - Form • Risk Transfer / Risk Distribution

11. Accelerated Tax Benefits: Premium Deductibility • Taxes represent a concern’s single largest sunk cost. • What's it worth? - Recognition of "self-funded" losses on incurred instead of paid basis. - Accelerated benefit • The captive must be an insurance company for tax purposes (qualified). • Demonstration of Risk Transfer • Evidence of Risk Distribution • IRS' "Economic Family" position • Harper Group, AMERCO, Sears, ODECO (Unrelated Risk) • The Humana / Balance Sheet Fact Pattern - HCA, Kidde

14. 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 • Other - TPA / Risk Control / Minimization.

15. Risk Transfer Savings Current Program Risk Risk Finance Efficiency Frontier The Efficient Frontier 1 Risk Financing Alternatives 1The efficient frontier is the point at which there is no greater expected reward for a given level of risk, and vice versa

16. Actuarial Issues • Retention Level • Attachment Point • Per Occurrence Limit • Aggregate Limit • Pricing • Pure Premium • Expenses • Profit & Contingency • Dynamic Financial Analysis

17. Factors Influencing Retention Level • Financial Wherewithal of the Insured • Financial Wherewithal of Insurers • Risk Philosophies • Insurance Market Conditions • Cost / Benefit Analysis

18. $500,000Retention $1,000,000Retention UnlimitedRetention Retention Level Decisions: Appetite meets Opportunity

19. Auto Liability Workers Comp Products Liab. Property Multi-Risk Comparison

20. Retained Risk @ 85th Percentile - Risks Treated In Combination Retained Risk @ 85th Percentile - Risks Treated In Isolation “Portfolio Effect”

21. Pricing Issues • Similar to Pricing • “High Deductible” • “Excess Reinsurance” • Methodology • Traditional methods • Aggregate • Frequency / Severity • Monte Carlo simulation models

22. Pricing Issues - Cont’d • Data • Use insured own experience • Supplement using “industry” data • Similar company/industry • Bureau • Correlation of Risks • Risk Loads • Captives, which insure the risks of the parent and affiliates / subsidiaries, is only self-insurance in its most sophisticated form (i.e., no real risk transfer)

23. Dynamic Financial Analysis • DFA’s goal is to provide management with: • solid information about the interaction of decisions from all areas of company operations; • a quantitative look at the risk-and-return trade-offs inherent in emerging strategic opportunities; and • a structured process for evaluating alternative operating plans. • Captive insurance companies are well-suited for DFA application