Creative Uses of Captives

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2 Creative Uses of Captives Moderator Daniel W. Houston EPIC Insurance Brokers & Consultants Ethan Harrington H&R Block Steve Kinion Delaware Insurance Dept. Karin Landry Spring Consulting Group L.L.C.

3 Creative Uses of Captives: Introduction Dan Houston Senior Vice President of Enterprise Risk Management, Principal EPIC Insurance Brokers & Consultants Web: Phone:

4 Creative Uses of Captives- To Secure Financing Background: Section 8 Program was authorized by Congress in 1974 and developed by HUD to provide rental subsidies for eligible tenant families (including single persons) residing in newly constructed, rehabilitated and existing rental and cooperative apartment projects. Problem: Securing HUD Financing in a crowded marketplace Situation: Borrower must differentiate itself

5 Creative Uses of Captives- To Secure Financing Solution: Develop Captive on a per unit basis to provide $10,000 contents insurance at no charge. Option to Renter: Increase Value for Premium charge.

6 Creative Uses of Captives- To Consolidate Insurance Background: Company in 130 countries with 10 s of thousands of facilities shipping product around the world. Problem: Property/ Ocean/ Inland Insurance became prohibitively expensive Situation: Develop Captive for transits and property

7 Creative Uses of Captives- To Consolidate Insurance Solution: Develop Captive for transits and property New Scenario: As an example, a Country previously paid $100, for insurance. Under the new program the Country paid $60,000 with a $20, retention excess of small deductibles.

8 Captive Evolution- 1 st Party/3 rd Party The previous way of thinking has been challenged and as a result, the whole captive strategy has shifted For many years, captives have followed 1 st Party/3 rd Party analysis. That is, there must be a relatively high amount (30-50% safe harbor) of 3 rd Party (unrelated risk) for federal tax purposes. There were several ways to accomplish 3 rd Party risk: Employee Benefits Franchisees Reinsurance The difficulty became that captives cannot sell insurance as a traditional carrier, but to select companies or reinsurers. As you can see, the test is difficult to satisfy Before any decisions are made regarding your captive, please consult with legal counsel and captive strategic partners

9 Captive Evolution- Brother/Sister However, based on several cases (Rent-A-Center, Inc. v. Commissioner and Securitas Holdings, Inc. v. Commissioner), the landscape has shifted to: Brother / Sister wholly owned subsidiaries of captives parent can be issued policies and risk distribution is met if a diverse spread of risk is associated o Risk must shift from subsidiaries to the captive, not the parent to captive o The captive must have enough spread of risk to remain viable in the event of loss beyond premium In doing so, the entire captive strategy has been altered and other risks associated with a business may be more applicable It should be noted, that before any decisions are made regarding types of business or risks to insure in your captive, an open dialogue with your Department of Insurance and a thorough review with captive strategic analysts and legal counsel is recommended Before any decisions are made regarding your captive, please consult with legal counsel and captive strategic partners

10 Creative Uses of Captives Steve Kinion Director, Bureau of Captive and Financial Insurance Products Delaware Department of Insurance Web: DELAWARE DEPARTMENT OF INSURANCE INSURANCE COMMISSIONER KAREN WELDIN STEWART Bureau of Captive and Financial Insurance Products Delaware is the 3 rd Largest U.S. Captive Domicile and the World s 5th Largest Captive Domicile

11 What you Should Learn What types of Captive Insurance Companies are Insuring Cyber Risk Why are Captive Insurance Companies Insuring Cyber Risks What does a Captive Insurer s Cyber Risk Policy Cover How are Cyber Risk Policies Priced by Captive Insurance Companies

12 What Types of Captive Insurers are Insuring Cyber The easy answer is most types of captives are insuring cyber risks. Pure or single parent captives is the most common type. Industrial insured and agency being second. But... not seeing association captives insuring cyber.

13 Why are Captive Insurers Insuring Cyber Risks Answer: Uncertainty. Insurance Services Office, Ltd. (ISO) policy forms issued in May 2014 exclude cyber under Coverage B. Litigation. Zurich successfully defended against an obligation to cover Sony for the hacking of the PlayStation Network. Travelers and P.F. Chang s lawsuit stayed pending outcome of class actions against P.F. Chang s.

14 What does a Captive s Cyber Risks Policy Cover This cyber and electronic privacy policy covers the business liability for a data breach in which their customers personal information, such as Social Security, account information, credit applications, or personal credit records, is exposed or stolen by a hacker, employee or other criminal who has gained access to the firm's electronic network. The policy covers a variety of expenses associated with data breaches, including: notification costs, credit monitoring, costs to defend claims by state regulators, fines and penalties, and loss resulting from identity theft. The policy covers liability arising from website media content, as well as property exposures from: (a) business interruption, (b) data loss/destruction, (c) computer fraud, (d) funds transfer loss, (e) cyber extortion, (f) costs to defend claims by government regulators, (g) penalties and loss resulting from identity theft, and (h) costs of indemnification.

15 Pricing Cyber Risk: Actuarial Pricing Actuarial pricing approaches: Market pricing based on quotes from admitted insurers. Benchmark pricing based on filed rates from rating bureaus like the ISO. Frequency and severity models based on assumed claim frequency and claim sizes. Rate on line based on the number of years worth of premium required to pay one full coverage limit loss which is a common reinsurance pricing approach.

16 Creative Uses of Captives: Employee Benefits Karin Landry Managing Partner Spring Consulting Group LLC Web: Phone: LinkedIn: spring-consulting-group-llc

17 How Do Employee Benefits Fit? Faced with escalating costs, many organizations are now considering funding employee benefits through a captive The process is simpler Obtaining DOL approval for ERISA based benefits is moving back to Fast-Track (EXPRO) programs because of Coca-Cola and Intel o Intel used as the new template o The DOL regulatory assistance is more systemized o Initial EXPROs Sealed Air, Hormel and others

18 Benefit Captives Have Come a Long Way Ten Years Ago Now Captives were not common for benefits financing: Companies often perceived obstacles (e.g., reinsurance restrictions) Territorial restrictions (i.e., U.S. only) Relatively few employee benefits reinsured by captives Limited HR familiarity with captives Insurer reluctance Alleged marginal economics More people involved: HR, Finance and Risk agendas Everyone knows about it Enterprise risk financing Network restructuring and changes not aligned with growing market Companies looking at captive solutions as the next step in cost savings and control What does this mean? Companies need a clearly defined strategy around the risk financing of its benefits programs

19 Growth in Employee Benefits Captives 2014 (March). CICA International Conference "Captives Global Opportunities & Solutions."

20 Growth in Employee Benefits Captives Group / Cell / Association Captives

21 U.S. Employee Benefit Offerings Health & Welfare Voluntary Fringe Retirement Health Security Time Off Pension Defined Contribution Medical Drugs Life Ins. STD 1 Vacation Holiday Auto / homeowners Insurance Financial Products Mortgages Training, Education Assistance Transportation FSA 3 Post-Ret Life Post-Ret Medical Dental Prevention, Disease Mgmt LTD 2 Workers' Compensation Sick Leave Other Leave Investment Funds Life Critical Illness EAP 4, Work/Life Long Term Care Legal, Financial Planning 1 Short Term Disability 2 Long Term Disability 3 Flexible Spending Accounts 4 Employee Assistance Programs (mental health, legal assistance, etc.) Executive Benefits Multinational Pooling, Expatriate Global Assistance Stop Loss Typical Non-ERISA = Typical Captive Programs Typical ERISA Plans

22 Benefits Captive Advantages Manage Costs Accelerate cash flow through premiums, claims and reserves Reduce frictional costs (commissions, taxes, risk charges, administration) Captive underwriting savings and investment returns Improve cash flow and centralize investment of reserves Support P&C in a Captive Enhance coverage spread of risk Create unrelated business potential efficiency Increase reserves and reduce dependence on external markets Increase Control Enhance coverage spread of risk Improve data management and claim cost management Remove insurer s profit loading Improve management reporting and understanding of risk

23 Employee Benefit Cost Savings Using Captives Program Estimated Savings* Potential Savings * These are typical savings that our clients have experienced in the past; actual performance may vary

24 Risk Hierarchy Captive 301 Strategic Business Risk Reputational Performance guarantees Product development International strategy People & culture Captive Funding Captive 201 Captive 101 Market/Business Environment Risk Trade Credit/ Financial Risk Benefits New Technology Disruption of supply chain Capital structure Change in reporting requirements Life Disability Auto/General Liability/ Workers Comp/ Property & Casualty

25 Risk Prioritization Highest ERM Pension Degree of Effort Non-qualified executive benefits WC STD SIR Funding of Auto/General Liability/ Property P&C Excess Supplemental life LTD Retiree Medical Uninsurable lines Medical Stop Loss AD&D (Basic & Voluntary) Basic life Lowest Cost Savings Highest

26 Example Captive Funded Benefit: Medical Stop-Loss The company self-insures its medical coverage, purchasing a stop-loss policy from the captive The captive then purchases an excess reinsurance policy from an outside reinsurer, creating a layer of coverage e.g., the captive covers all claims between $200,000 - $500,000 Medical stop-loss typically has large underwriting profits, which the captive will retain Improves data management and claim cost management Improves management reporting and understanding of risks

27 Example Captive Funded Benefit: Pensions A Defined Benefit Pension Plan can purchase annuities from the captive covering all or a portion of the obligations Annuities can be purchased at cost, eliminating the traditional carrier profit loads The Pension Plan s funded status remains level as its assets and liabilities move in tandem, while the captive can continue to invest in return-seeking assets The asset from the Plan s perspective is an offsetting annuity If the captive earns excess returns and becomes overfunded, it can return its profits to the parent An overfunded Pension Plan must pay excise taxes, effectively eliminating any benefit to being overfunded

28 Creative Uses of Captives: Risk Specific Ethan Harrington Director, Insurance and Risk Management H&R Block Web: Phone:

29 Where Else Can Captives Be Utilized As you consider the use of the captive for non-traditional usage, consider the likely severity, frequency and duration of risk. Based on existing risks, will a new risk impair an already profitable risk? Is the new risk an unknown in the marketplace and may put the captive in a weak position in the future? There are many uses of captives aside from those in my colleagues discussion. These include: Employment practices liability Crime / Fidelity Professional Liability (Accountant s or Errors and Omissions) Warranty Products Casualty (Workers Compensation, General Liability, Auto Liability) Environmental Pollution/Others Before any decisions are made regarding your captive, please consult with legal counsel and captive strategic partners

30 Risk Specific Questions Employment Practices Liability Is the risk substantial enough to utilize the captive o Or alternatively, is the captive utilized to create a buffer before commercial lines placed Do you have a larger risk of Wage & Hour claims or traditional EPL claims Are there gaps in other policies that a captive can insure (e.g. EPL exclusion on casualty) Crime / Fidelity Is one subsidiary far outsized on the exposure for first party loss What risk management controls are in place Is commercially available retention too high for majority of exposure (i.e. average exposure is less than $25K, but commercial retention is $250K) Before any decisions are made regarding your captive, please consult with legal counsel and captive strategic partners

31 Risk Specific Questions Professional Liability What services are offered Are services via 1 st party only, or 1 st and 3 rd party Fronted policy o Or alternatively structure a high retention program (e.g. $5M) with the captive writing a $5M policy within the retention Warranty/Guarantee Is the warranty service or product based Insure warranty on back-end, not to consumer, through captive instead of self insure Seamless to consumer, but true risk transfer for product or service Before any decisions are made regarding your captive, please consult with legal counsel and captive strategic partners

32 Risk Specific Questions Casualty Workers Compensation deductible buyback or direct write General Liability traditional bodily injury and property damage, but revise for specific needs of organization ( Cut the waste! ) Auto Liability large fleet of owned autos or large number of rented vehicles. Utilize front, but maintain large deductible Environmental Pollution/Product Recall/Strikes Insuring the previously uninsurable While commercial products may be available, what exclusions apply Before any decisions are made regarding your captive, please consult with legal counsel and captive strategic partners

33 Risk Specific Questions All of these options have several commonalities: Policies can be customized to meet a specific need o Commercial policies may cover many things when an insured is only concerned about a few Insured controls the claims handling process Insurance premium cost reduction But one of the largest benefits of placing any of the discussed in your captive is: To concentrate on Risk Management! Utilizing a captive assists greatly in narrowing the focus to truly understand the risk for that of the captive, but ultimately for the entire organization Before any decisions are made regarding your captive, please consult with legal counsel and captive strategic partners

34 Moderator Daniel W. Houston Ethan Harrington Steve Kinion Karin Landry

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