Why Form a Captive?

1. www.bermudacaptive.bm JUN 2 - 4, 2014 Why Form a Captive?

2. Why Form a Captive? Moderator: • Dennis Silvia, President, Cedar Consulting LLC Speakers: • Carol Frey, Business Development, Great American Ins. Co. • Robert Walling, Principal and Consulting Actuary, Pinnacle Actuarial Resources • Oliver Shestopal, Head of Claims, HSBC Insurance (Bermuda) Limited

3. Why Form a Captive? • Risk Financing Mechanism • Risk Retention Cheaper than Risk Transfer • Access to Reinsurance Capacity • Entrepreneurial Programs • Specialized Coverages, forms or endorsements

4. Case Study 1: HSBC

5. HSBC Group: Facts & Figures • One of the world's largest banking and financial services organisations, with assets of US$2,758bn at 31 March 2014. • HSBC Holdings plc, the parent company of the HSBC Group, is headquartered in London, UK. • The Group serves customers worldwide from over 6,300 offices in over 75 countries and territories in Europe, Asia, North and Latin America, and the Middle East and North Africa. • The Group serves around 54 million customers through four global businesses: Retail Banking and Wealth Management, Commercial Banking, Global Banking and Markets, and Global Private Banking. • Listed on the London, Hong Kong, New York, Paris and Bermuda stock exchanges.

6. HSBC Insurable Risk Function • Based centrally in London, consists of around 40 dedicated staff located in 7 countries - United Kingdom, Bermuda, China, Hong Kong, France, United States & Mexico. • Part of the Group’s Global Risk function and is responsible globally for how the Group manages its insurable risks. • Engages with a number of other Group functions (e.g. Operational Risk, Corporate Real Estate, Human Resources etc) in order to align insurable risk retention and transfer to the Group’s risk profile and appetite. • Consists of three inter-connected parts: Insurable Risk Management, Insurable Risk Financing and Insurable Risk Transfer. • Utilises a captive to provide an Insurable Risk Financing solution to the Group.

7. The HSBC Captive: HSBC Insurance (Bermuda) Limited • Established as a single parent captive in Guernsey in 1987. • Re-domiciled to Bermuda in 2005 following HSBC’s acquisition of The Bank of Bermuda. • Since 2010, the HSBC Captive has been self-managed, currently employing 13 dedicated staff covering: Finance, Underwriting, Claims, Legal, Risk/Actuarial. • Acts as the risk financing “arm” of the wider Insurable Risk Function of the HSBC Group, predominantly via reinsurance of global programmes placed with fronting insurers. • Retains insurable risks that are outside local business/entity risk appetite but within Group risk appetite and/or outside of external insurer risk appetite. • Underwrote gross premium of approximately $150m in 2013, made up as follows: • Professional Indemnity: 42% (approx.) of GWP • Bankers Blanket Bond (Crime & Physical Damage): 20% • Property & Business Interruption: 2% • Employee Benefits (Life / Disability / Medical): 33% • Other: 3%

8. Why does HSBC have a Captive? • NOT viewed as a profit centre. • Allows local entities/businesses to transfer to another part of the Group risks that are outside of local risk appetite but which remain within the Group’s risk appetite (P&L Protection). • Provides an alternative insurance solution where coverage is unavailable externally. • Enables Group to manage its insurable risks in a single risk retention vehicle. • Demonstrates strong risk management to regulators. • Potential capital efficiencies through having insurance programmes aligned to risk profile and appetite. • Provides Group with granular and centralised claims/loss data upon which risk management decisions can be based. • Provides additional layer of control to the Group in terms of product design, claims handling and the security of sensitive information.

9. Deciding which Risks to Finance and which to Transfer – The “Risk Alignment” Process • The Goal: • The Group should manage its insurable risks by reference to a clearly stated appetite for such risks. • Insurance programmes should be aligned to local and Group risk appetites. • The Process: • Identify the Operational Risks of the Group • Assess which of the identified risks are insurable risks • Model the risks at entity and Group level to assess scope and size of loss at different levels of severity (this informs the limits that should be purchased) • Assess whether there is any appetite within the Group to retain part or all of those insurable risks: • If there is no appetite, seek to transfer the entire risk into the external insurance market • If there is appetite, assess whether that appetite exists at local business or Group level and: • If entirely within local risk appetite, no insurance required • If any part of the risk falls outside of local risk appetite but remains within Group risk appetite, and absent other relevant factors (e.g. pricing or capital considerations), seek to transfer the relevant part into the Captive (in which case, the local appetite will be the deductible, and the Group appetite will be the limit, of the Captive (re)insurance)

10. Key Challenges • Risk appetites are often qualitative are not quantitative, making their conversion into limits and deductibles a challenge. • Fronting insurers required to ensure global compliance of programmes and full alignment is subject always to those insurers’ agreement to front on that basis. • Insurance often viewed by local entities as a cost rather than as loss protection. There is often pressure to reduce insurance costs when there are budgetary restraints. • Although the Group will consider the captive to be a Group risk financing vehicle, often local entities will see it just as another insurer. A strong global mandate is required to operate effectively in a multinational setting. • “A Captive is for life, not just for Christmas” – Adopting a risk management and financing strategy takes time and will inevitably involve some “pain” in the short term. This ought to be outweighed, however, by the long term gain.

11. Case Study 2: Agency Captive

12. How does it all work? Is my agency the right candidate? Why Now? AGENCY CAPTIVE MODEL

13. Motivation for Pursuing an Agency Captive • Profitability Outpaces Profit Sharing or Contingencies • Current Commissions are not Compromised • Unique Access to a Specialty Carrier • Portfolio Protection from Large Market Swings • Franchise Value with Great American • Wide Range of Loss Prevention Services – Nationwide that will benefit your client and compliment your agency’s services • Long Term Strategic Approach to Improved Revenue • Retention Tool for Key Contributors/Producers

14. Indicators that suggest an Agency Captive is NOT the right approach • To replace a lost market • Inability to collect historical performance • Lack of adequate capital for 3 year stack • Portfolios with low retention • Unwilling to secure more rate when the industry or risk warrants it • Focus is production and not profit

15. Well Established & Strong Financials P&C Book of $20M or more (per agency) Min Portfolio Performance < 90% Combined Risk Management/Value Added Approach Loss Prevention & Safety are a Priority Strong Account Retention; 85% or better Ability to shift renewal business Willingness to take risk and post capital Key Qualifiers for a Successful Agency Captive

16. Agency Captive: What can I put in an agency captive and how would I share risk? • Homogeneous or Heterogeneous • Program Specific and/or Generalist • Combination of WC, GL, Auto, Package and/or Business Owners (BOP), Property • 50/50 QS – Pure Alignment of Interests • Aggregate Attachment for Protection • Rollover commitment required

17. GAP (Collateral) at 50% Quota Share, 85% Aggregate Great American(50% QS) 50% QS GAP 8.40% of Original Gross Premium (Risk) Great American Loss Fund 25.6% of Original Gross Premium (Potential Underwriting Profit) GAP expressed as a % of Original Gross Premium Using Presentation Reinsurance and Expense Components

18. Due Diligence Process Front End Process Launch & Transition Finalize Portfolio Targeted for Risk Sharing Agency Appointments Reinsurance Agreement Collect Collateral Select Book Rollover Date Quarterly Monitoring of Premium Targets • Complete Agency Profile • Collect Agency Financials • Collect Data ( 5 yr P&L) • Actuarial Analysis • Agency Site Meeting • Test Rating • Underwriting Analysis • Claims Due Diligence • Loss Prevention • Present Terms

19. Keys to Success and Sharing Lessons Learned • Focus on quality…not quantity • Each agency has to “own” it and drive it throughout the organization • Each agency needs a “champion” • Each agency has to set achievable goals • Consider building the success of the agency captive into individual, team and agency performance (submission/quote/bind/premium) • Maximize your agency captive to retain key employees • Continually examine your portfolio for business that is worthy of risk sharing

20. Case Study 3- Group Captive

21. Why Group Captives? • Example – Trucking Captive • 12 Trucking Companies • 75 to 200 powered units per risk • Currently Insured with Bobtail Insurance Company • Currently use Deadhead Insurance Agency • Auto Liability and Workers Compensation • Concerns about Bobtail’s Service

22. Why Group Captives? • Proposed Solution • Group Captive • Fronted program with leading trucking insurer • Leading trucking claims administrator as TPA • Trucking specific loss control and loss prevention services contracted for by the captive • Each insured retains $100K per occurrence (A Fund) • Policies are assessable in excess of loss pick in retained layer • Captive pools and retains $250K excess of $100K (B Fund) • Amounts in excess of $350K are reinsured by front

23. Why Group Captives? • Benefits • Emphasis on loss control due to A Fund • Risk distribution satisfied via B Fund • Access to superior risk management tools • Collaborate on best practices/Safety Workshops • Lower capital requirements than pure captive • Opens the captive doors to risks too small to own a pure captive…yet • More negotiating leverage with fronts and TPAs • Risk pooling reduces volatility • Rate stability • Deductibility of premiums (vs. self-insurance)

24. Why Group Captives • Risk Distribution/Pooling on Your Terms • A Fund – B Fund ($250K x $100K) • Straight Quota Share (50%) • Pool Primary Layer (Pool first $50K) • Pool above Nuisance ($210K x $15K) • Related-unrelated (Owner-operators, subcontractors) • Unrelated risk (Lloyds, ILWs, etc.)