Why investing money for captive insurance companies is different and the role of an Investment Advisor

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1 Why investing money for captive insurance companies is different and the role of an Investment Advisor Ronnie Dennis Merrill Lynch

2 Why investing money for captive insurance companies is different Regulatory constraints SC SC Collateral requirements Restricted assets Financial Statement analysis Cash Flow Analysis (float) Liability profile (tail) Asset / Liability Management Financial reporting GAAP (FAS 115 & FAS 157) Statutory filings (Schedule D, DA, & E) Insurance company taxation 2

3 Regulatory constraints Title 38, Chapter 90, Section 100 Applicability of Investment Requirements (a) an association captive insurance company and an industrial insured captive insurance company insuring the risks of an industrial insured shall comply with the investment requirements contained in this Title. (b) A pure captive insurance company, an industrial insured captive insurance company, and a sponsored captive insurance company are not subject to any restrictions on allowable investments contained in this Title; however, the director may prohibit or limit an investment that threatens the solvency or liquidity of the company (c )Only a pure captive insurance company may make a loan to its parent company and only upon the prior written approval of the Director and must be evidenced by a note in a form approved by the Director. 3

(b) A pure captive insurance company, an industrial insured captive insurance company, and a sponsored captive insurance company are not subject to any restrictions on allowable investments contained

4 Regulatory constraints Title 38, Chapter 12, Sections (P&C Section) Investments of Insurers Act Purpose: To protect the interests of insuredsby promoting insurer solvency and financial strength through application of investment standards which facilitate a reasonable balance of the following objectives: 1) Preserving principal 2) Assuring reasonable diversification as to type of investments; issuer and credit quality 3) Allowing insurers to allocate investments consistent with principles of prudent investment management to achieve a return adequateto meeting obligations to insured's and financial strength sufficient to cover reasonably foreseeable contingencies 4

Assuring reasonable diversification as to type of investments; issuer and credit quality 3) Allowing insurers to allocate investments consistent with principles of

5 Regulatory constraints General diversification limitations:unless specifically allowed in SC 38-12, investments in single issuers must be limited to 5% of *admitted assets. Cash-no limit. Money market instruments -If issued by a government money market mutual fund or an SVO approved money market mutual fund (Class 1 fund) -Aggregate limit up to 10% of admitted assets or 75% of total capital and surplus (if approved by SC DOI). Fixed Income If issued, assumed, guaranteed, insured by, or otherwise backed by the full faith and credit of U.S. Government. No aggregate limit, also not limited by single issuer restriction (normally 5%). * Admitted Asset means an asset that is identified specifically as an admitted asset within the NAIC manual. Specifically, an asset the RRG is allowed to get credit for on its financial filing with the SC DOI. 5

capital and surplus (if approved by SC DOI). Fixed Income If issued, assumed, guaranteed, insured by, or otherwise backed by the full faith and credit of U.S. Government.

6 Regulatory constraints Credit Limitations: No aggregate limit for investment grade assets (SVO 1-2) No more than 20% of admitted assets in non-investment grade (SVO 3-6) No more that 10% of admitted assets in non-investment grade (SVO 4-6) No more than 3% in SVO 5-6 and no more than 1% in SVO 6. SVO ratings are as follows: Category 1 corresponds to AAA,AA, and A; Category 2 to BBB; Category 3 to BB; Category 4 to B; and Category 5 or 6 to CCC,C, or D ratings. 6

(SVO 4-6) No more than 3% in SVO 5-6 and no more than 1% in SVO 6.

7 Regulatory constraints Municipal Bonds credit limits apply. General Obligation Bonds - limited to 10% of admitted assets per issuer. Revenue Bonds -limited to 5% of admitted assets per issuer. Corporate Bonds credit limits apply. Limited to 5% general diversification, meaning that no more than 5% of admitted assets may b invested with any one issuer. Mortgage related securities that are backed by any single pool of mortgages - credit limits ap Limited to 5% general diversification per issuer pool. 7

Revenue Bonds -limited to 5% of admitted assets per issuer. Corporate Bonds credit limits apply.

8 Regulatory constraints Asset-backed securities secured by a single pool of assets credit limits apply. Limited to 5% general diversification per issuer pool. Preferred Stock -20% of admitted assets, but only 10% if no sinking fund or rated lower than SVO 2. Limited to 5% general diversification and credit limits apply. Equities-25% of admitted assets or 100% of surplus (shareholder equity). Limited to 5% general diversification per issuer. 8

Preferred Stock -20% of admitted assets, but only 10% if no sinking fund or rated lower than SVO 2.

9 Collateral requirements Grantor (Captive) - The entity which has to establish a trust for the sole benefit of the beneficiary. Beneficiary (Fronting Company) The entity for whose sole benefit the trust has been established. Fronting Companies ACE ARCH Chartis CNA Discover RE Hartford Liberty Mutual Zurich 9

Beneficiary (Fronting Company) The entity for whose sole benefit the trust

10 Financial Statement analysis OrthoForum Insurance Company (A Risk Retention Group) Pro-Forma Income Statement For the Policy Periods Incepting 2012 through Adverse Case Underwriting Income: Premiums Written... $ 18,532,628 $ 18,995,944 $ 19,470,842 $ 19,957,613 $ 20,456,554 Reinsurance Ceded... (4,462,021) (4,573,571) (4,687,910) (4,805,108) (4,925,236) Net Premium Earned $ 14,070,607 $ 14,422,373 $ 14,782,932 $ 15,152,505 $ 15,531,318 Underwriting Expenses: Loss and LAE Paid... $ 151,574 $ 963,760 $ 3,259,575 $ 6,346,833 $ 8,953,143 Change in Loss, LAE, and IBNR Reserves... 12,479,619 11,983,213 13,011,072 6,923,814 4,649,271 Claims Handling Fees. 152, , , , ,859 Premium Tax Expense / Government Fees. 74,131 75,984 77,883 79,830 81,370 Total Underwriting Expenses $ 12,858,302 $ 13,179,760 $ 16,509,254 $ 13,515,219 $ 13,852,643 Net Underwriting Income $ 1,212,305 $ 1,242,613 $ (1,726,322) $ 1,637,286 $ 1,678,675 General & Administrative Expenses: Management Fees...554,783 $ $ 568,653 $ 582,869 $ 597,441 $ 612,377 Legal Costs 100, , , , ,381 Audit & Tax Fees... 50,000 51,250 52,531 53,845 55,191 Actuarial Fees... 70,000 71,750 73,544 75,382 77,267 Board & Miscellaneous 115, , , , ,938 Loss Control..92,663 94,980 97,354 99, ,283 ad hoc Loss Control budget.. 277, , , , ,848 Annual Registrations.. 26,000 26,650 27,316 27,999 28,699 Total General & Administrative Expenses $ 1,286,436 $ 1,318,597 $ 1,351,561 $ 1,385,350 $ 1,419,984 Net Operating Income/(Loss) $ (74,131) $ (75,984) $ (3,077,883) $ 251,936 $ 258,691 Other Income Interest Income , ,501 1,201,763 1,518,906 1,730,306 Net Other Income/(Loss) $ 471,139 $ 851,501 $ 1,201,763 $ 1,518,906 $ 1,730,306 Net Income (Loss) Before Taxes $ 397,008 $ 775,517 $ (1,876,120) $ 1,770,842 $ 1,988,997 Federal Income Tax Expense/(Benefit)... (4,228,914) (3,922,694) (5,210,517) (1,803,540) (931,096) Net Income/(Loss) $ 4,625,922 $ 4,698,211 $ 3,334,397 $ 3,574,382 $ 2,920,093 10

.. (4,462,021) (4,573,571) (4,687,910) (4,805,108) (4,925,236) Net Premium Earned $ 14,070,607 $ 14,422,373 $ 14,782,932 $ 15,152,505 $ 15,531,318 Underwriting Expenses: Loss and LAE Paid.

11 Financial Statement analysis 11

12 Role of the Investment Advisor Investment Process I. Asset / Liability study II. Asset Allocation policy III. Investment policy development / review IV. Investment policy implementation V. Tactical asset allocation VI. Investment review VII. Portfolio reporting 12

Investment policy development / review IV.

13 Role of the Board Section Board of Directors responsibilities; adoption of written investment policy and review of Portfolio. (A) (B) (C) The Board of Directors shall adopt a written plan for acquiring and holding investments and for engaging in investment practices that specifies guidelines as to the quality, maturity, and diversification of investments. Investment practices engaged pursuant to this Chapter must be held under the supervision and direction of the Board of Directors or committee of the board charged with the responsibility to direct its investments. On not less than a quarterly basis, the Board of Directors or committee of the Board of Directors shall: (1) receive and review a summary report on the insurer s investment Portfolio. (2) review and revise, as appropriate, the written plan. 13

14 About the Presenter F. Ronald Dennis First Vice President -Wealth Management International Financial Advisor Ronnie Dennis is a senior partner of the Dennis Johnson Folline King Group at Merrill Lynch and is a member of the firms Global Institutional Consulting group. Ronnie s practice is focused on serving the complex needs of wealthy families and captive insurance companies. He provides counsel in the areas of financial risk management, investment strategy and the implementation of tax efficient investment strategies. He joined Merrill Lynch in 1994 and has spent his entire career at the firm. Ronnie holds the Certified Investment Management Analyst (CIMA) designation and is an Accredited Investment Fiduciary through the Center for Fiduciary Studies. Ronnie is a graduate of the International Center for Captive Insurance Education (ICCIE) program. Ronnie has a BS in Finance and Real Estate from the University of South Carolina. His outside interests include reading, running, bird hunting and offshore fishing. 14

the firms Global Institutional Consulting group. Ronnie s practice is focused on serving the complex needs of wealthy families and captive insurance companies.

KENTUCKY EMPLOYERS' MUTUAL INSURANCE AUTHORITY dba KENTUCKY EMPLOYERS' MUTUAL INSURANCE

KENTUCKY EMPLOYERS' MUTUAL INSURANCE AUTHORITY dba KENTUCKY EMPLOYERS' MUTUAL INSURANCE Statutory Basis Financial Statements and Supplementary Information Years Ended December 31, 2010 and 2009 with Independent