Underwriting Participation Structures for Property Owners & Managing Agents

Underwriting Participation Structures for Property Owners & Managing Agents An alternative to revenue generation through insurance commissions

Contents Introduction 2 The Captive Concept: A brief but necessary Introduction 3 The Alternative approach to Commission 5 A Worked Example a. The Starting Position: 6 b. Moving to a Captive Structure: 6 c. Pictorial Illustration 8 d. The Comparative Position using a Captive: 9 e. Capital Considerations: 10 f. Security 11 g. PORC Disclosure 11 Route Map to Implementation 12 Information Requirements 14 Next Steps 15 Heritage Contacts 15 Appendix A: Heritage Insurance Management 16 Appendix B: Captives and Protected Cell Companies 19 1

This briefing paper focuses on the issue of Property Owners Insurance and a potential, but tried and tested, alternative to revenue generation through insurance commissions. This concept will be of interest to property owners (and property investors) and managing (or ground rent) agents who are responsible for the placement of insurance for a property portfolio, and typically where the annual combined premium spend is in excess of 500,000 and generates good underwriting profits. Insurance companies have tended and still tend to pay higher than average insurance commissions for blocks of Property Owners insurance and it is usual for some of this commission to be paid to the property owner or managing agent. Historically this was reflective of the fact that many large property owners had direct relationships with insurers, and therefore as there was no insurance broker involved the insurer could pay the property owner or managing owner the commission. The levels of commission also tended to be higher as an incentive for the business to remain with the insurer, but also due to the recognition by the insurer that this line of business tended to perform exceptionally profitably. Therefore property owners and managing agents have become used to earning part of their revenue from insurance commissions, although over time, and in line with the general move in the insurance industry towards commission disclosure, insurers have taken action to reduce the level of commissions payable. There was a time when commissions of 70% or 80% were common, however nowadays insurers tend to apply maximum levels of around 40%, and we are aware that even this level is being questioned. Many property owners and managing agents have, over time, become increasingly uncomfortable (for a number of reasons but including the issue of commission disclosure) with the concept of commissions and as a result have sought alternative means by which they could earn revenue. This briefing paper describes and explains one such approach whereby revenue can be earned by risk sharing or underwriting a proportion of the insurance portfolio. Heritage Insurance Management Ltd ( HIM ) is an independent insurance management company operating out of offices in Guernsey (Headquarters), Malta and Gibraltar. HIM specialises in the creation and operation of insurance companies for our clients. For more information about HIM please refer to Appendix A. 2

The Captive Concept: A brief but necessary Introduction This briefing paper and the alternative approach proposed within refer to Captive insurance companies and therefore the first section of this paper is a brief introduction to these types of company. Please also note for the purpose of this report the term Captive or Captive insurance company is used to generically to describe a wholly owned subsidiary or a Cell within a Protected Cell Company. For a more detailed explanation of Captives, including Cells within Protected Cell Companies ( PCC ) please refer to Appendix B or, alternatively contact HIM (contact details at the end of the paper). A captive insurance company ( Captive ) is a legal entity licensed as an insurer or reinsurer formed primarily to insure a proportion of the risks of a corporate parent or a number of similar corporations (e.g. trade associations) thereby contributing to a reduction in its parent s total cost of risk. Captives are usually domiciled in a specialised location, often offshore, and sometimes underwrite insurance business unrelated to their parent. Captives are formed for many reasons, including: The unpredictability of commercial insurers and the corresponding market cycle whereby price, capacity and cover can quickly change; The desire to capture underwriting profits and investment income that would otherwise be earned by the commercial underwriter; As a means to access the reinsurance market or, in certain circumstances, as a means of diversifying into insurance services. Captives are used extensively throughout the world by a wide range and size of corporations and private individuals to cover risks situated both at home and abroad. The use of captives has in recent times expanded and developed greatly from the traditional mechanism of risk financing self-insurance to structures where third party insurance is being underwritten, often to customers, whereby additional revenue is being generated. Most, but not all, captives are established in an offshore location. The main reason for this is not, as is often the perception, the desire to establish in a benevolent tax environment but because of regulatory issues and other business considerations. The recognised offshore domiciles all have statutory regulation drafted with captives in mind and the regulatory authorities are used to dealing with captives. This reduces both the time taken to licence a captive and the regulatory costs incurred by the captive in comparison with most onshore locations. In addition, all of the established offshore domiciles have developed an infrastructure of support organisations tailored to the needs of captives thereby aiding a captive s ability to trade effectively and economically. There are many advantages to the operation of a Captive but in the context of this report it is the mechanism whereby property owners and/or managing agents can earn revenue from sharing in the profitable underwriting of their insurance portfolio. Other benefits include: Offering more stable premium rates in comparison to the unpredictable swings typical of the conventional market. This can be achieved by moving the conventional insurance/reinsurance market to a position where they are only covering infrequent large or catastrophe losses. Promoting awareness & control of risk management strategy: central control and greater awareness of the overall cost of risk Providing the potential for bespoke cover/wordings and provision of cover for risks unavailable or inappropriately priced in the conventional market Providing market leverage. Captives are a proven tool to place pressure on the conventional insurance markets to ensure the most competitive total cost of risk is achieved 3

Gaining access to the reinsurance market, which can open new avenues Retaining investment income and cash flow benefits Whilst there are many potential benefits in forming a captive, there are some potential disadvantages which should be considered before a decision to establish a captive is taken. These are, mainly: Capital: The parent must contribute the requisite capital to support the captive s underwriting; Risk of Adverse Results: The captive s capital could be eroded by adverse underwriting results, although most captives tend to adopt a fairly cautious approach and limit the underwriting downside by the use of aggregate limits and reinsurance. Operating Costs. 4

The Alternative Approach to Commission An alternative approach to generating revenue from the insurance portfolio exclusively by the earning of commission, as previously mentioned, involves the property owner or managing agent taking some risk and effectively sharing in the underwriting performance of the portfolio. This risk sharing is facilitated by the establishment of a captive which is owned by the property owner or managing agent and which enters into a reinsurance relationship (contract) with the insurer that is underwriting the portfolio. The structure we suggest positions the captive as a reinsurer rather than an insurer. This is due to the fact that in our experience it is preferable for property owners insurance to be underwritten by a wellknown insurer brand as often there are tenants who receive insurance certificates along with invoices for premium payment, and using a captive to issue the insurance documentation creates difficulty as this is an unfamiliar name. Also, tenancy agreements and banking covenants (where the portfolio has some financing in place) often specify that the property owner will insure with an FCA authorised and well rated insurance company. Clearly captives do not satisfy that criteria and therefore a reinsurance structure is preferable. The proposal does not mean that there cannot be any commission payable by the insurer, and it is appreciated that removing the commission element entirely could create cash flow issues for the property owner. The concept is that the level of commission is reduced and that corresponding loss of revenue is compensated and usually increased by the underwriting profits and future flow of dividends from the captive insurance company. The proposal therefore involves working with an insurance company and there are many well-known companies in the insurance market that are willing to consider these types of captive structure. Heritage first started constructing captive structures for the property owner s market some 15 years ago, and since then the concept has become more and more popular with many of the UK s largest property owning companies adopting this strategy. The advantage of working with either the existing insurer for the property portfolio, or another well-known insurer that specialises in this class of business, is that the existing processes for premium collection, claims management and all other administration processes can usually be kept in place. The addition of a captive acting as a reinsurer to the insurer is merely a back end structure which does not affect the original insurance arrangements. This keeps any disruption to a minimum in changing from a traditional to a captive arrangement. It is our experience that the property owners liability ( POL ) element of the cover that is underwritten as part of the original contract of insurance is best retained 100% by the insurer and does not form part of the risk sharing that passes through to the captive. This is due to the fact that POL is a long tail class of insurance and some claims can take many years to settle. The inclusion of long tail classes such as POL within the captive can result in a situation whereby dividends arising from underwriting profits can be delayed due to the uncertainty of the claims position for the POL. It is therefore easier and more efficient for the captive owner that this class of business is retained by the insurer. The same approach is often adopted for terrorism insurance, which again is normally underwritten as part of the original contract of insurance. Most insurance companies use Pool Re as their capacity provider for UK Terrorism cover and there is often little benefit in a captive taking a participation in this cover. The establishment of a captive requires the owner to subscribe share capital to the company or cell (within a PCC). This is necessary in order for there to be risk transfer in the reinsurance contract between the insurer and the captive. The level of capital required depends on the contract of the reinsurance and how much risk is being underwritten by the captive, as well as the solvency requirements under the insurance law the domicile of the captive. It is probably easiest to illustrate how this can work by the use of an example and this is covered in the next section. 5

A Worked Example a. The Starting Position: Pembroke Property Investments Ltd ( Pembroke ) is a UK registered company that specialises in the raising of capital to invest into UK property that can be leased to tenants. Pembroke also manages the property administration and their property portfolio is a mixture of residential and commercial property including some houses, blocks of flats, industrial units, office blocks and a number of shopping centres. Pembroke was established in 2003 and spent the first 5 years building up a large portfolio which is all tenanted. Pembroke purchases comprehensive property owners insurance cover, using the services of an insurance broker - Vazon Insurance Brokers Ltd ( Vazon ), and recharges the cost of this cover to the tenants (as per the terms of the tenancy agreement). The existing coverage has in place nominal (market standard for this type of policy) excess levels, for instance a water damage or malicious damage loss would have an excess of 100 applied, which would be payable by the tenant. Vazon places the insurance coverage for Pembroke s property portfolio with Cobo Insurance Company Ltd ( Cobo ). Cobo allows a total of 40% commission payable from this policy for which the arrangement is that Vazon earn 10% for their services and Pembroke earn 30%. The historic premium and claims information is shown in the table below. Period Gross Premium Commission Net Premium Total Claims Largest Claim* Cobo U writing Position Pembroke Position (30%) 01.04.07-31.03.08 01.04.08-31.03.09 01.04.09-31.03.10 01.04.10-31.03.11 01.04.11-31.03.12 1,756,800 702,720 1,054,080 123,100 35,000 930,980 527,040 1,652,210 660,884 991,326 230,200 28,000 761,126 495,663 1,700,850 680,340 1,020,510 400,250 238,500 620,260 510,255 1,800,540 720,216 1,080,324 350,760 125,000 729,564 540,162 1,820,680 728,272 1,092,408 280,350 87,600 812,058 546,204 Total 8,731,080 3,492,432 5,238,648 1,384,660 3,853,988 2,619,324 * No other claims in excess of 100,000 From the information above it can be seen that this has been a very profitable book of insurance business. There have been some medium sized losses but overall both Pembroke and Cobo have made good profits over the 5 year period. b. Moving to a Captive Structure: Pembroke, taking advice from their insurance broker Vazon, decide to investigate the possibility of moving their insurance arrangements to a captive structure. Their drivers for considering this are: the high levels of underwriting profit that have been made historically by the insurer, Cobo; and a desire to earn some of their revenue from the property portfolio by means of risk-taking rather than solely commission. 6

Given the existing good relationship that Pembroke (and Vazon) enjoy with Cobo, it is decided that a good starting position would be to discuss this possibility with Cobo, rather than conduct a full marketing exercise whereby many insurers would be asked to quote. Whilst Pembroke are keen to retain their long-term relationship with Cobo and also to keep in place all administration processes that have been developed over time, they are also keen to derive more revenue from their insurance program. The discussions and negotiations between all parties progress well, and Cobo (being familiar with this type of structure) are happy to facilitate a captive structure for Pembroke. It is agreed that the existing policy coverage, premium, claims management, and all other documentation/administration will remain as existing and that Cobo will enter into a reinsurance relationship with Pembroke s captive. In terms of the reinsurance contract and the parameters by which Pembroke s captive will participate in the underwriting of the portfolio, there needs to be consideration given to the level of risk that the captive will underwrite and the corresponding share of the premium that Cobo will allow the captive to take. For any insurance policy, including those underwritten by a captive, there needs to be risk transfer i.e. a position whereby an underwriting profit or loss may arise from the contract, and therefore there must be an appropriate differential between the policy limit and the premium for the captive share. Having given some consideration to the historic claims experience it is agreed that Pembroke s captive will reinsure Cobo for the first 100,000 of each and every loss subject to an annual aggregate loss limit of 125% of the captive premium. This means that in the event that a series of losses exceeds 125% of the captive premium then all further losses would be payable by Cobo. This is an important aspect as it gives Pembroke s captive a definite position in terms of maximum amount payable during the period. This also plays an important role on the level of capital required to support the underwriting by the captive. In terms of this commission arrangements going forward, it is agreed that there will be a total of 20% commission payable on the insurance policy, of which Vazon will continue to earn 10% and Pembroke will earn the remaining 10%. The net premium, after payment of commission, is agreed to be split equally between Cobo and Pembroke s captive. Cobo will also require some security over Pembroke s captive, to ensure that there is the requisite ability to pay losses recoverable under the reinsurance contract, in the form of a letter of credit or similar. 7

c. Pictorial Illustration Tenanted Properties Nominated Loss Adjuster Pembroke Property Investments Ltd Pembroke Property Management Ltd Appointed as required Vazon Insurance Brokers Ltd 10% UNDERWRITING PROFITS (Dividend Payments) CAPITAL paid into Pembroke Captive 10% Cobo Insurance Company Ltd Reinsurance Contract Pembroke Captive Reinsurance Co. Ltd Retention 100,000 each and every loss & aggregate limit equal to 125% of Captive premium Ownership Premium Claims Commission 8

d. The Comparative Position using a Captive: In the next section we will consider the route map to implementation of a captive structure, however in order to conclude this part of the paper it would be helpful to consider how the captive structure would have performed historically for Pembroke versus the traditional insurance arrangements. The table below shows the as is position for blocks Pembroke s insurance placement but using a captive. Period Gross Premium Commission* Net Premium Captive Premium Cobo Premium 01.04.07-31.03.08 01.04.08-31.03.09 01.04.09-31.03.10 01.04.10-31.03.11 01.04.11-31.03.12 1,756,800 351,360 1,405,440 702,720 702,720 1,652,210 330,442 1,321,768 660,884 660,884 1,700,850 340,170 1,360,680 680,340 680,340 1,800,540 360,108 1,440,432 720,216 720,216 1,820,680 364,136 1,456,544 728,272 728,272 Total 8,731,080 1,746,216 6,984,864 3,492,432 3,492,432 Period Captive Claims Cobo Claims Captive Underwriting Position Cobo Underwriting Position Pembroke Overall Position 01.04.07-31.03.08 01.04.08-31.03.09 01.04.09-31.03.10 01.04.10-31.03.11 01.04.11-31.03.12 123,100 0 579,620 702,720 755,300 230,200 0 430,684 660,884 595,905 261,750 138,500 418,590 541,840 588,675 325,760 25,000 394,456 695,216 574,510 280,350 0 447,922 728,272 629,990 Total 1,221,160 163,500 2,271,272 3,328,932 3,144,380 In this example the effect of the 100,000 retention by Pembroke s captive puts Cobo into a position whereby they only pay out any losses on two of the five underwriting years for the larger losses. Overall Pembroke now enjoy 10% commission plus the underwriting profits from the captive which over the five-year period illustrated above shows a 20% increase, or over 500,000 in total. Additionally Pembroke are also less reliant on commission. For this example, as already mentioned, the captive premium was equal to 50% of the net premium. Depending on Pembroke s appetite for risk it may have been possible to have negotiated a greater share of the premium for an increased retention, say 60% of the net premium for 200,000 of each and every loss and again subject to an annual aggregate loss limit of 125% of the captive premium. Alternatively for a profitable insurance policy such as Pembroke s it may also have been possible to have simply priced the insurer s retention more aggressively, perhaps if there had been a full market exercise to create competition, whilst retaining the same 100,000 captive retention. This would have created an even more profitable position for Pembroke. See the table on the following page which assumes an insurer/captive net premium split of 40%/60%: 9

Period Gross Premium Commission* Net Premium Captive Premium Cobo Premium 01.04.07-31.03.08 01.04.08-31.03.09 01.04.09-31.03.10 01.04.10-31.03.11 01.04.11-31.03.12 1,756,800 351,360 1,405,440 843,264 562,176 1,652,210 330,442 1,321,768 793,061 528,707 1,700,850 340,170 1,360,680 816,408 544,272 1,800,540 360,108 1,440,432 864,259 576,173 1,820,680 364,136 1,456,544 873,926 582,618 Total 8,731,080 1,746,216 6,984,864 4,190,918 2,793,946 Period Captive Claims Cobo Claims Captive Underwriting Position Cobo Underwriting Position Pembroke Position 01.04.07-31.03.08 01.04.08-31.03.09 01.04.09-31.03.10 01.04.10-31.03.11 01.04.11-31.03.12 123,100 0 720,164 562,176 895,844 230,200 0 562,861 528,707 728,082 261,750 138,500 554,658 405,772 724,743 325,760 25,000 538,499 551,173 718,553 280,350 0 593,576 582,618 775,644 Total 1,221,160 163,500 2,969,758 2,630,446 3,842,866 This change in the split of the net premium drives a 47% or 1.2mn increase for Pembroke over the 5 year period compared to the traditional arrangement and demonstrates how the captive structure can be used to create additional revenue and value. Please note that these figures take no account of investment income (on premium reserves held by the Captive) or the operational costs of the Captive. e. Capital Considerations: Using this example we can identify the capital requirements for Pembroke s captive to underwrite this business. Working on the basis of Guernsey as a domicile the capital requirement for a captive is the required margin of solvency which is related to the net premium volume transacted. In Guernsey this is 18% of net premium up to 5mn and 16% thereafter. In addition it is also necessary as part of capital adequacy to cover the Risk Gap: the difference between the maximum limit underwritten by the Captive (after reinsurance if applicable, although not in this example) and the net premium retained for the risk i.e. after payment of reinsurance premium (if applicable) and other deductions. Capital can be provided in the form of cash deposits, acceptable letters of credit (unconditional, irrevocable, evergreen and issued by a bank in a recognised territory). There must be sufficient paid up share capital to meet solvency, however in respect of covering the risk gap there is, with the consent of the regulator (and the PCC board of directors if the captive is a Cell within a PCC), the opportunity for capital to be partly paid. Using the 2011-12 underwriting period (and the 50%/50% net premium split), for Pembroke s captive minimum capital of 131,089 is required to meet solvency (Net captive premium of 728,272 x 18%). 10

Payment of the Captive s operating expenses also need to be taken into account in this calculation, and therefore additional capital would be required to ensure that the Captive could cover these costs and remain solvent. A figure of 200,000 would be appropriate for this example. In terms of the risk gap, capital of 235,000 is required to cover the annual risk gap which is calculated as the Captive s maximum limit of 837,513 (captive premium of 728,272 x 125% aggregate limit) less the Captive s net premium of 728,272 and making an allowance for year 1 costs ( 50,000 estimate). In this example as the risk gap requirement is a greater figure than the solvency calculation the capital requirement will be dictated by this value for Pembroke s Captive. Depending on the spread of insurance renewal dates for Pembroke s property portfolio (many property owners insurances have various properties renewing at different times during the year), there can be a need for additional capital to take into account the run-off for the policy issued in the first period during the second underwriting period. This is due to the fact that the underwriting result of the first period can be unknown for some time after the period has ended and therefore there also needs to be sufficient capital to cover both annual periods. This aspect needs consideration on an each case basis. f. Security Many insurers, having agreed to this type of captive structure, will ask that the captive (being an unrated entity) provide them with security in relation to the reinsurance premiums paid. This can be achieved by the captive using the reinsurance premium received to provide financial security to a bank (or other financial institution) in order to procure either a letter of credit ( LOC ) or a security trust agreement ( STA ) in favour of the insurer. Over time, as premiums build, claims are settled and underwriting years close the value of the LOC or STA will vary and this is usually determined by a clause in the reinsurance contract between the insurer and the captive. g. PORC Disclosure Where a captive owner is using their captive to participate in an insurance programme which is covering third party business for which they are the producer (broker or intermediary) i.e. where the benefit of the indemnity under the insurance accrues not to the producer/captive owner but a third party there are some requirements which must be satisfied. This type of captive is called a Producer Owned Reinsurance Companies (PORCs) and these defined as captives that are beneficially owned by the producers of insurance business where such insurance business is ultimately reinsured into the PORC through an independent fronting insurer. In relation to the example of Pembroke this would not be a PORC as, despite the premium being rechargeable to the tenants under the terms of the lease, the property portfolio is owned by Pembroke and therefore the captive is merely participating in their own insurance programme i.e. self-insurance. However, if in this example Pembroke were to be using the services of a Managing Agent, not beneficially owned by them (a separate company), and the Managing Agent (as part of their responsibility for the placement of the insurance programme) were to create a captive structure where they owned the captive, then this would be a PORC. Most insurance regulators require that Producer Owned Reinsurance Captives (PORCs) must disclose to the third party insured s that the producer has a financial interest in the insurance programme. Most PORCs achieve this by an appropriate disclosure on their website or contractual documentation. 11

Route Map to Implementation Item/Action Responsibility Timescale Using the methodology detailed in this paper and the Working example, determine whether the property portfolio insurance programme is suitable for a captive structure. Heritage is able to assist with this aspect if required. The basic criteria are: Sufficient Premium spend: generally 500,000 is the minimum entry point; Profitability of the insurance programme: if the insurance programme is consistently unprofitable for the insurer under the traditional arrangement then a captive structure is unlikely to work; Consider whether it is desirable for the existing commission payments under the traditional arrangement to be modified, usually reduced, for the captive structure, or whether these are to remain unchanged if there is sufficient underwriting profitability to justify this approach; Basic feasibility study to be carried out to determine the most suitable captive structure for the client and the property portfolio in question, taking into account the client s requirements in relation to: Levels of upfront commission vs. underwriting risk to be accepted by the captive; Risk appetite: level of risk the client is prepared to accept into the captive; Client/HIM HIM W1/2 Starting Point Also considering: Levels of capital necessary for the structure; Whether additional capital is required for underwriting year 2 whilst underwriting year 1 is running-off; Which type of captive entity is most suitable: wholly owned subsidiary or cell within a host protected cell company; How the captive is to be owned; Any necessary tax, accounting and other professional advice; The required timescales for implementation. Heritage to carry out Business Risk & AML assessment HIM W1/2 Formally engage with Heritage & project team appointed HIM/Client W1/2 Prospective client due diligence request pack sent HIM/Client W1/2 Appoint Advocate to provide company incorporation services and any other required legal work (unecessary if the captive is a cell) Appoint captive auditors and other professional advisors as required (not required if the captive is a cell) Investigate availability/acceptability of proposed name for the captive (not required if the captive is a cell) HIM/Client W2/3 HIM/Client W2/3 HIM/Client W3/4 Client due diligence completed satisfactorily including GFSCPQ forms Client W5/6 Either work with the existing Insurer to negotiate the captive structure and fronting/ceding services to the captive or use a broker to administer a market exercise whereby several insurers can quote for the structure Select the insurer and complete the final negotiation in relation to the reinsurance structure and the captive s participation/pricing, and all other terms and conditions Arrange any necessary additional reinsurance usually unnecessary for this type of captive structure Agree all contracts, policy wordings and other necessary paperwork between Client, captive, Insurer and any other service providers included Consider any security requirements on the captive by the Insurer and how these will be met e.g. Letter of credit HIM/Client/ Brokers W5/6 Brokers/HIM W6/7 Brokers/HIM W6-8 Brokers/HIM W6-8 HIM W6-8 Finalise the captive s capital requirements and form of capital to be provided HIM/Client W6-8 Agree PORC ownership/interest wordings (transparency to the insured) if applicable Consider and agree captive ownership (tax/accounting issues) & consider whether any additional due diligence is required as a result of ownership structure HIM/Client W7/8 Client/Advisors W2-8 12

Consider captive s Board composition (not applicable if a cell) and obtain GFSCPQ (and due diligence) for proposed independent director Complete GFSC Application form HIM W8/9 Obtain auditors willingness to act letter (not required if the captive is a cell) Complete Business Plan and attachments HIM W8/9 Complete financial projections HIM W8/9 Calculate capital adequacy/solvency & OSCA calculation Preliminary meeting held with GFSC to discuss the application at the same time as the application is delivered to the GFSC with the fee HIM W10 Application acknowledged by the GFSC HIM W10 GFSC application review comments addressed fully HIM W14 Application approved by GFSC HIM W14/15 Obtain signed share application form HIM/Client W15 Incorporate captive and subscribe for Memorandum & Articles of Incorporation (not required if the captive is a cell) Open bank accounts HIM W15 Pay share capital into captive s bank account HIM W15/16 GFSC issue captive s insurance licence (or if a cell the consent letter) HIM W15/16 Issue shares as per business plan HIM W15/16 Prepare (and agree with the client) the captive s Management agreement HIM W15/16 Obtain independent director s & other directors consent to act letters (not required if the captive is a cell) Hold inaugural board meeting including: 1. Management agreement to be adopted and signed 2. HIM appointed as Company Secretary 3. HIM appointed as MLRO 4. HIM appointed as Compliance Officer (this item is not required if the captive is a cell) HIM/Client W16 Captive commences underwriting All W16 13

Information Requirements The following is a list of the ideal information requirements: 5 year insurance information a. Insurer; b. Broker; c. Gross Premium including, if known, the amounts included which relate to property owners liability and terrorism; d. Commissions and other deductions including work transfer allowances and profit shares/ commissions; e. Claims experience, ideally a complete listing also showing property owners liability losses; f. Details of any large (> 50,000) losses; g. A note of changes in the property portfolio exposure over the 5 year period, including significant acquisitions and disposals and, ideally, the effect on the claims history; Details of any long term arrangement or undertaking; Split in the workload administration of the portfolio insurance programme by the broker, Managing agent, Loss adjuster and the insurer and any information on remuneration for these services not included in the 5 year insurance information; A description of the composition of the property portfolio, or a listing including occupation details e.g. PDH, commercial, office etc.. 14

Appendix A Next Steps We hope you have found this briefing paper useful and if you would like to progress this concept we would be delighted to arrange a meeting, at a mutually convenient time and place, to discuss the detail of the captive approach and respond to any questions raised by this document. Name Job title / role Contact Details Paul Eaton New Business Director T: +44 1481 737405 M: +44 7781 131970 E: paul.eaton@heritage.co.gg Nick Heys Managing Director T: +44 1481 704639 M: +44 7781 134173 E: nick.heys@heritage.co.gg Martin Le Pelley Compliance Officer T: +44 1481 750325 M: +44 7781 131962 E: martin.lepelley@heritage.co.gg 15

Heritage Insurance Management Background Heritage Insurance Management ( HIM ) is part of the Heritage Group ( Heritage ), a multi-faceted financial services group comprising seven Guernsey based trading companies. The Heritage Group was formed in 2001 as a leveraged buy-out of the business which the management team had been running for the previous 25 years. Since that date, it has grown its turnover to a forecast position for 2013 of 24mn. In addition to Guernsey the group has representation in London, Malta, Gibraltar and Belfast and provides a broad range of offshore financial services including insurance management, underwriting agency management, fiduciary & wealth expertise, fund administration and insurance broking. The total value of assets under the administration of the Heritage Group is more than 50bn. HIM is the largest independent insurance management company in Europe. We manage a diverse client portfolio numbering over 160 clients with facilities ranging from PCC cells to large and mature insurance companies undertaking substantial risk transfer on behalf of their owners. Our Successful Business Model HIM believes that having an insurance manager which is not owned by an insurer or insurance broker is a major advantage. Not only does this allow us to offer totally objective advice but also to work effectively with the client s chosen service providers, as HIM operates as an extension of the client rather than a competitor. We are proud to offer an impartial service being an independent insurance manager and administrator in Guernsey which is owned entirely by the senior management. We pride ourselves on offering a first class service by providing a strong technical, customer focussed team for each of our clients. We partner with clients who, like us, have a strong brand and reputation, and for whom a quality service is critical to their business success. HIM People The Heritage Group has in excess of 240 staff in total. The majority of employees are located in Guernsey, of which some 85 are involved in insurance company management. We have a large number of insurance qualified (ACII/FCII/Chartered Status) members of staff within our insurance team and others are at various stages towards qualification. Our accounting team has 10 qualified accountants, with many of the remainder studying towards CAT/ACCA. Our Experience HIM manages insurance vehicles, including commercial insurance and reinsurance companies, captive insurance companies, protected cell companies, protected cells and special purpose vehicles. Our varied client base includes tour operators (including Tui), financial service providers (including Capita Group Plc), insurance companies (including Hiscox and Aviva), retailers (including the Lewis Trust Group), property investment/owner & management companies, a number of international airlines (including KLM and Monarch), law firms (including DLA Piper), diversified resources groups and other renowned groups such as McDonalds Franchisees, and Diageo Plc. We do not have a typical client profile as all of our clients are unique. Accordingly we seek to proactively provide a bespoke service to deal with the specific needs of each client individually. 16

Delivery of Core Services Each HIM managed client has a dedicated service team, which comprises a minimum of three senior people: a Client Service Director (CSD), Client Insurance Executive (CIE) and Client Accounting Executive (CAE). The Client Service Director has overall responsibility for the quality of service delivered to the client and the Client Insurance Executive and Client Accounting Executive take charge of the insurance and accounting/company secretarial functions respectively. In addition, insurance and accounting assistants may also be allocated to a client account depending on the nature and volume of work involved. Treasury, operations and compliance are non-client specific functions which overlay the client teams, but each with specific individuals appointed to the roles. The delivery of our services in the respective insurance and accounting areas is tailored to each client dependant on the framework in which we need to operate and the interaction with other services providers and the client. In many instances the CIE takes the lead operational role in terms of the daily activity on the account, as this often tends to be insurance orientated. The CIE would likely have significant interaction with the clients insurance broking/placement team and those responsible for insurance. The CAE is responsible for production of the company accounts which would normally involve close liaison with the finance department of the client. Again this aspect tends to be bespoke as different clients require different reporting styles and timescales. The CSD is responsible for ensuring that the team delivers a high quality and responsive level of service and would, as part of this role, have a regular dialogue with the client. We have standardised processes and procedures that run across all of our operations, providing a bedrock of competence upon which we can build service packages specific to each individual client s needs. This standardised base means that it is comparatively easy to move staff across client portfolios as needs be, though we also recognise that a stable service team can be essential to the maintenance of a good client relationship. HIM s structure, divided into insurance and accounting teams creates a culture where technical development is encouraged through day-to-day interaction as well as structured training and the pursuit of formal qualifications. This means that there are always staff with the technical knowledge to support or replace any member of any service team. All of our staff are set structured goals to attain levels of competence and experience that will enable them to take on an ever widening scope of operation as their careers progress. Every member of the senior management team is required to ensure that successors to their positions are identified and educated to grow into their role in the future. 17

Core Services 1. Accounting & Company Administration HIM routinely provides management information to clients in a variety of formats and subject to various timescales. We welcome the opportunity to work with our clients to produce a standard format for presentation of management accounts that will facilitate an efficient consolidation of the captives results into the Group s figures. We believe that it is important to discuss the format and content of these reports with the captive directors and the client on a regular basis to ensure that they continue to provide the information required in a format that is easily assimilated. Additionally we have the capability to work with clients, to develop a system that would minimise the data entry points to ensure the integrity of the base data. Standard HIM practice is to produce and dispatch board packs a minimum of 5 working days prior to all board meetings. The board packs routinely consist of a detailed company business plan and key compliance and commercial information, such as: the manager s report on insurance activities, management accounts, details of the latest solvency position, investment performance and corporate governance/compliance reports. Further information can be included as requested by the board. Delivery of board packs is performed by recognised international couriers, to ensure delivery sufficiently in advance of board meetings. Copies are also delivered electronically by email, attaching the relevant Word, Excel or PDF documents. The client service team would normally attend all board meetings. Additional specialist staff will attend meetings as and when required. The statutorily required Company Secretarial functions are performed by our qualified accounting team via a corporate appointment of HIM as Company Secretary. Part of this role is to ensure compliance with the Guernsey Company legislation. 2. Legal & Regulatory Heritage Group employs several individuals charged solely with compliance functions. HIM has a dedicated Compliance Officer, Martin Le Pelley, who also acts as the Heritage Group Insurance Division s Money Laundering Reporting Officer. Martin was previously employed as Assistant Director at the Guernsey Financial Services Commission ( GFSC ). Martin reports to Andrew Weatherburn, HIM Operations Director who also plays a major role in ensuring that adherence to our standard practices and procedures maintains compliance with all local regulatory standards. As a licensed insurance manager of licensed insurers, HIM applies a quality assurance style of approach and performance, whereby a procedures manual is supported by detailed activity processing checklists. The checklists are required to be cross-checked by senior levels of authority and cover all of HIM s routine management activities including movement of funds, board meeting preparation and administration, policy renewal and the introduction of new policies, compliance reporting and management accounts preparation. The area of Guernsey law that most visibly impacts on the board of an insurance company is the Licensed Insurer s Corporate Governance Code ( the Code ), originally introduced in 2002, and amended in 2008. The Code requires licensed insurers to establish and maintain effective internal controls including risk assessment and management systems addressing various specified business risks. The adoption of our quality assurance approach ensures that all requirements of the Code, as well as all legislative requirements (insurance and otherwise), are considered and achieved. It also assists in recognising any issues which may require prior discussion with the GFSC and as such supports the excellent relationship HIM has with the regulator. 18

Appendix B During December 2009, HIM underwent an assessment by the GFSC as part of its inspection process of the compliance and operational performance of all licensed insurance managers. We are pleased to advise that the GFSC s subsequent report highlighted no issues of concern or otherwise requiring attention. 3. Insurance The HIM insurance team numbers over 20 staff. With large international insurance clients such as Hiscox and Aviva, we are experienced in every aspect of the insurance discipline, from high level theory to the minutiae of complex claims processing. We currently manage companies that provide most types of cover available and are aware of and have strategies for dealing with any and all insurance issues that might arise. The level of service provided to clients differs for their individual needs. At the more involved end of the scale, we act as a virtual risk manager, working with the client to design its risk financing programme and advising on the risk retention strategy. We also provide underwriting services and broke risks to the international insurance and reinsurance markets if required. Most importantly we offer all the core insurance processing services one might expect: producing documentation, handling claims, and providing reports in a format and at a time that the client needs. We recognise that many of our clients are supported by an insurance broking & placement team and a risk consultancy team and we would look to provide a service which brings together the different inputs supplied by these different teams in as efficient manner as possible, ensuring an open dynamic environment in which the captive can operate effectively. 4. Advisory Services With the breadth of client base that we manage we are often requested to provide advisory services for both existing insurance management clients and in a consultancy role for other parties. We believe that this is an area of distinction for HIM and an integral part of the relationship between the insurance manager and the captive parent to ensure the ongoing success of the captive. Common areas of advice fall into the following categories: Review of the risks currently insured into the captive and consideration of opportunities for additional risks Review of the level of risk retention including use of reinsurance protection where appropriate Review of the corporate structure including ownership, governance and overall efficiency Alternative risk financing mechanisms Review of the capital efficiency Review of coverage including limits, specification, wording and risks currently uninsured Updates on legislative and regulatory developments impacting our managed companies 19

Types of Captive Vehicle There are two main types of Captive vehicle: Captives Insurance Company a wholly owned subsidiary; or Cells within a PCC We shall now consider each in turn and evaluate the respective advantages and disadvantages of each. Captive Insurance Company Captives are wholly owned insurance subsidiaries, usually formed offshore, to underwrite and carry a portion of the risks of their parents or sponsors. Captives can be either insurers or reinsurers depending on the risks to be covered and the desired structure. Where the business to be insured falls into a compulsory class (in the UK: motor third party risks and employers liability) this can be handled either by way of reinsurance from an authorised insurer to a non EU based captive or, for an EU based captive in domiciles such as Malta or Gibraltar, can be written directly. Advantages Premiums paid to captives are a business deductible expense Strong control over the strategic direction and operation of the captive vehicle via participation at board level Flexibility over the retentions that can be written and exposure that can be retained Access to the reinsurance market Capital requirements can be lower than for a PCC cell depending on the dynamics of the insurance/ reinsurance being underwritten Control and speed of decision making Disadvantages Minimum capital of 100,000 for a Guernsey based captive and significantly more for an EU domiciled captive Operating and start-up expenses Call on management time to attend quarterly board meetings IPT is payable on premiums 20

Cells within a PCC The PCC concept originated in Guernsey and was introduced under specific legislation in 1997. Similar facilities are now available in a number of other offshore insurance domiciles. A PCC is a single legal entity made up of a core and any number of cells. The cells are separate and distinct from each other. The assets and liabilities of each cell are statutorily segregated from those of the other cells and the core and a creditor of any one cell can only access the assets of that particular cell. This means that a PCC can be used to support the insurance underwriting activities of many clients. PCCs are a popular low cost alternative to captives and can have a number of additional benefits. Heritage owns two host PCCs for use by clients: Mannequin and Harlequin. In addition Heritage has access to PCCs in Malta and Gibraltar which are useful for those clients who wish to write statutory insurance classes on a direct basis or where EU passporting is required. Cells within a PCC offer similar advantages to those of captive insurance companies because, with respect to its underwriting activities, a cell behaves in the same way as a wholly owned captive insurance company. Similarly, the owner of a cell remains exposed to potential losses for the risks retained. Advantages Premiums paid to captives are a business deductible expense There is no minimum capital requirement as the PCC has already been capitalised by its owner to the minimum statutory level An EU based PCC has the ability to underwrite statutory classes on a direct basis which can: a. eliminate expensive fronting fees charged by insurers and b. alleviate the requirement for collateral or security needing to be provided to insurers in return for self insurance Operating expenses and start-up costs tend to be lower There is less call on management time due to there being no requirement for a cell to hold board meetings Disadvantages The main disadvantage to using a cell as opposed to having your own captive is that you lose an element of control as decisions need to be approved by the directors of the PCC Capital requirements depending on the view of the PCC owner, cells may need to maintain sufficient funds to cover the risk gap (which is the difference between the cell s maximum liabilities and net premium income). Depending on the dynamics of the insurance underwritten this can translate to a figure greater than the solvency calculation of a captive Reduced bespoke elements. Some of the cost savings attributable to using a PCC cell are the result of a common service approach i.e. less bespoke elements are possible as the PCC is designed to operate in a generic manner IPT is payable on premiums 21