Alternative Risk Transfer/ (fronting)

1. Alternative Risk Transfer/ (fronting) Process by which a primary insurer cedes a portion of the risk it has underwritten to a reinsurer, such as a captive insurance company • Ceding company (front) securitizes for projected losses less paid losses while working with the captive to obtain maximum risk finance leverage • Front retains primary responsibility for regulatory and statutory compliance • Front usually retains some amount of underwriting risk

2. What is Alternative Risk? Alternative risk in an insurance-based product where a substantial portion of the insurance risk is assumed by an entity other than a traditional insurance company.

3. Definition of a Captive A closely held insurance company whose insurance business is primarily supplied by and controlled by its owners and in which the original insureds are the principal beneficiaries. A captive insurance company’s insureds have direct involvement and influence over the company’s major operations, including underwriting, claims and management policy and investments.

4. Types of Captives • Pure captive • Single-parent captive writing only the risks of its owners and/or affiliates. • Captive writing connected business • Type 1 insurer writing the risks related to or arising out of the business or operations of its owners and/or affiliates. • Captive writing third-party business • Captive writing a portion of its net premiums for risks which are unrelated to the business of its owners and/or affiliates. • Captive of insurer • Single-parent captive owned by a professional insurer and/or reinsurer.

5. Types of Captives • Association captive • Owned by members of a common industry or trade association in order to share the risks of that industry among its members. • Health care captive • Owned by a hospital or health maintenance organization and writing the risks of its owners and/or affiliates. • Multi-owner captive • Owned by two or more unrelated persons and writing the risks of its owners and/or affiliates. • Long-term (or life) insurer and/or reinsurer • Insurance company writing mainly life insurance as a direct writer and/or reinsurer.

6. Types of Captives • Composite • Insurance company writing a combination of long-term (or life) business and general business. • Rent-a-captive • Owned by unrelated persons and providing captive facilities to others for a fee. • Agency captive • Owned by one or more independent insurance agents to write business that they control.

7. Types of Captives • Finite insurer and/or reinsurer • Insurance company writing unrelated risks reflecting (i) clearly defined aggregate limits and (ii) anticipated investment income. • Professional insurer and/or reinsurer • Insurance company writing unrelated risks as a direct writer and/or reinsurer.

8. 2000 Captives by Domicile RANK DOMICILE 2000 TOTAL CAPTIVES 1 Bermuda 1,564 2 Cayman 517 3 Vermont 361 4 Guernsey 375 5 Luxembourg 264 6 Barbados 119 7 Isle of Man 168 8 Ireland 163 9 British Virgin Islands 181 10 All Other 492 WORLDWIDE TOTALS 4,204 *Totals increase when take into consideration the numerous segregated cells within various captive companies.

9. Is The Market Shifting? • The alternative market has grown from 21% of commercial premium to 33% of the last 20 years • Throughout the last decade traditional commercial line premiums have grown 3% annually, while alternative markets have experienced a 8% annual growth rate • The alternative risk market has expanded beyond individual employer programs to group/agency captives

10. Regulatory Impact All rate, form, reporting rules apply as the standard insurance market.

11. Customer Impact • May not know they are in a captive • May receive captive profits

12. Impact on Independent Agency System • Defends against direct writing, retail, banks selling insurance • Increased revenue on profitable business • Ability to function as your own insurance company • Control of agents own destiny

13. Pros/Cons of a Captive Structure • PROS • Underwriting Profits to Agent/Insured • Investment Income to Agent/Insured • Direct access to reinsurance market • Ability to separate all insurance service components • CONS • Underwriting risk born by Agent/Insured • Possible tax implications • Collateral may be required

14. Captive Cycle Insured Agent POLICY ISSUING COMPANY Reinsurer PROFITS CAPTIVE TPA Claimant

15. Underwriting Control

16. Underwriting

17. Gross Premium $2,000,000 Loss Fund $1,300,000 Aggregate Stop $1,625,000 Risk Assumption $ 325,000 Alternative Risk – Financial Impact to Client • Expense Components • Front 7.0% • Reinsurance 8.0% • Rent a Captive 1.5% • Claims 5.0% • Taxes 4.0% • Loss Control 1.0% • Commission 7.5% • FET 1.0% • Total 35% Stat/1M Specific Reinsurance Statutory XS 250,000 W/C 750 XS 250 AL/GL/Prop $250,000 Risk Assumption $325,000 Aggregate Reinsurance Captive $1,300,000 Aggregate Attachment: $1,625,000

18. Captive Structure $1,235,000 $1,085,000 $988,000 $742,000 $838,000 $592,000 $370,000 $220,000 80% Loss Ratio 100% Loss Ratio $150,000 $150,000 $150,000 $150,000 $150,000 $150,000 $150,000 $148,000 $300,000 Current Income 65% Loss 50% Loss 40% Loss 30% Loss Level Ratio Ratio Ratio Ratio $2,000 $-150,000