SOA 2013 Life & Annuity Symposium May 6-7, 2013 Session 31 PD, Captive Reinsurers for the Small and Medium Insurance Companies Moderator: Graham W. G. Mackay, FSA, FCIA, MAAA Presenters: Jeffrey N. Altman, FSA, MAAA Dhiren Jhaveri Graham W. G. Mackay, FSA, FCIA, MAAA Primary Competency Results-Oriented Solutions
Session 31: Captive Reinsurers for Small and Medium Insurance Companies Moderator: Graham Mackay, FSA Presenter: Dhiren Jhaveri Jeff Altman, FSA Agenda Polling An insurer s perspective An advisor s perspective Regulatory update Q&A 2 1
Captive Reinsurers for Small and Medium Insurance Companies - Polling questions Moderator: Presenter: Audience Demographics. 1. Please tell us about your affiliation: A. Insurance company B. Advisor C. Capital provider D. Regulator E. Not sure 58% 32% 3% 0% 6% 4 A. B. C. D. E. 2
Audience Demographics. 2. Please tell us about your previous experience with the use of captives: A. Have already executed transactions B. Not yet, but want to execute a transaction C. Not sure,. I need more information 41% 10% 48% 5 A. B. C. For Insurance Companies... 3. Please tell us about your previous experience with the use of captives: A. Have already executed transactions B. Not yet, but want to execute a transaction C. Not sure,. I need more information 39% 14% 46% 6 A. B. C. 3
For Insurance Companies... 4. How would you use any captive in the future? A. Finance redundant reserves B. RBC relief C. Change accounting basis D. All of the above E. Other 63% 4% 0% 22% 11% 7 A. B. C. D. E. For Insurance Companies... 5. Do you have access to the full range of options described in industry literature? A. Yes B. No 50% 50% 8 A. B. 4
For Insurance Companies with limited options... 6. What reasons have been given for limitations for this option? A. Transaction size too small B. Credit rating of insurer C. Limited access to a guarantor D. Other 73% 27% 0% 0% 9 A. B. C. D. Captive Reinsurers for Small and Medium Insurance Companies - An Insurer s Perspective Moderator: Presenter: Dhiren Jhaveri Presenter: Sammons Financial Group 5
Forms of Capital Solutions Numerous tools available to raise/generate capital Self Funding (e.g. surplus, earnings) Capital Markets Co-insurance Financial i Reinsurance Captives 11 Forms of Capital Solutions (cont.) Captives can be an efficient risk transfer mechanism if structured appropriately Strong counterparty Ability to target specific risks Potentially lower cost vs. other capital generating tools Regulatory considerations 12 6
Considerations Important to consider these major aspects of a deal Counterparty strength/reputation Recourse Cost and fees Length of transactionti Transaction constructs Regulatory process 13 Considerations (cont.) Equally need to consider often overlooked tradeoffs Upfront capital required and recourse Dividends and experience refunds Investment guidelines Funding mechanisms and events of default Accounting, Administration and Reporting Taxes 14 7
Challenges Key challenges to overcome Learning curve Team resources Time to executive Regulatory approvals Rating agencies Legal document review and negotiation Benefits can outweigh the challenges Potentially low cost financing Diversify counterparty risk Capital efficiency Operating Leverage 15 Captive Reinsurers for Small and Medium Insurance Companies - An Advisor s Perspective Moderator: Presenter: Jeff Altman, FSA Presenter: Deloitte, LLP 8
BUSINESS REASONS FOR ESTABLISHING CAPTIVE INSURANCE COMPANY GAAP profits earned by the captive reinsurance transaction remains within the affiliated group of companies. Captive provides surplus relief to the ceding company through reinsurance expense allowances or statutory reserve credits. Federal income tax losses of the captive arising from XXX term life reserves remain within the life consolidated group. Regulation by business plan provides flexibility in establishing a captive that operates on a financial sound basis. Access to capital markets provides financing and risk management solutions to meet specific corporate objectives. 17 OBSTALCES TO CAPTIVE FORMATION SMALL LIFE INSURANCE COMPANIES Estimate of formation expenses ranges from $50,000-$75,000 which includes captive manager, local attorney and application fees. Expenses paid to external service providers for actuarial and legal support required by the investment bank can be expensive. Internal resources (accounting, legal & actuarial) is needed to prepare feasibility study, meet with regulators and bankers. Securitization transaction (letter of credit or surplus note financing) can be expensive to obtain and may not be available. Lack of mortality, lapse & profitability studies will make it difficult for investment banks to feel comfortable with the transaction. 18 9
SPECIAL CONSIDERATIONS SMALL & MID-SIZE LIFE INSURANCE COMPANIES Captive insurance companies are being used by Regional Life Companies, Small Companies with national distribution. Minimum amount of redundant reserves needed to achieve economies of scale is estimated to be $150 million. Acceptable transaction can include several years of inforce term life insurance production to reach the right size. Recourse transactions requiring parental guarantee for small to mid-size companies may not be a viable option. The captive can utilize external or affiliated reinsurance to limit the volatility of financial results. 19 ADDITIONAL CONSIDERATIONS IN CAPTIVE FORMATION Commons forms of reinsurance used in captive transaction include modified coinsurance and coinsurance. Terms of the letter of credit, surplus note financing i and transaction terms are negotiated with the investment bank. Method of accounting used by the captive insurance company include GAAP, Statutory or Modified Statutory Accounting. Business plan submitted to the captive regulators indicates capital requirements and payment of shareholder dividends. Regulatory approval is needed from regulators of captive jurisdiction and from state of domicile. Decide on the captive jurisdiction by considering tax, capital, and regulatory implications of offshore vs. onshore transactions. 20 10
OTHER POTENTIAL USES OF CAPTIVES Captives can be used in accessing financing, capital management and tax planning for multiple lines of insurance products. Provide reinsurance expense allowance to finance blocks of business acquired via reinsurance. Captive reinsurance company can be used to share underwriting profits with agency groups responsible for writing the business. Cell & rent a captives are used for small P&C transactions because of the low cost structure. 21 Captive Reinsurers for Small and Medium Insurance Companies - Regulatory Update Moderator: Presenter: Graham Mackay, FSA Presenter: Ernst & Young, LLP 11
NAIC Captive & SPV Task Force Highlights Concern Focus on XXX and AXXX financing programs Inconsistent application of statutory accounting rules Review of previously executed transactions Limitations of Principle Based Reserves Limitations of Task Force Scope of white paper limited to Captive Reinsurers Discussion Primary vehicle to facilitate financing of perceived redundancies in statutory reserves for term life and universal life contracts with secondary guarantees (Captive Reinsurer) Task Force (TF) acknowledged value in use of captives in general; example of acceptable uses include: Pure captives Special Purpose Vehicles used to access capital markets Captive Reinsurers follow the statutory accounting rules of their domicile Domestic: NAIC statutory rules may be modified by permitted practice Offshore: expected to vary by country Regulators of Captive Reinsurers argue that permitted practices are appropriate for the risks assumed by the reinsurer Question: are the risks assumed by the Captive Reinsurer substantially different from the risks written by commercial reinsurers? TF acknowledges that its review of previously executed captive reinsurance transactions did not identify any transactions where the funding for risks assumed was lower than GAAP reserves TF acknowledges that the current version of PBR has limitations that may still result in perceived redundancies in statutory reserves for term and UL policies with secondary guarantees Question: is there a way to eliminate the need for Captive Reinsurers by further modifying accounting rules? TF acknowledges that insurers still have the option of using offshore domiciles It expressed a concern that the NAIC may force companies to use offshore domiciles if it does not eliminate the need for alternate financing Source: NAIC white paper Captives and Special Purpose Vehicles March 14, 2013 NAIC Captive & SPV Task Force Key Recommendations Issue Accounting considerations Confidentiality Recommendation Captive Reinsurers should not be used to avoid statutory accounting rules NAIC to form new task force to develop possible solutions for perceived redundancies d Uniform framework needed to define confidential information Regulators of holding companies must have access to information relating to Captive Reinsurers Access to alternate markets NAIC to update The Special Purpose Reinsurance Vehicle Model Act (#789) State regulators to adopt #789 and use the model as an accreditation standard IAIS principles, standards, and guidance Credit for reinsurance model enhancements Disclosure and transparency Financial analysis guidance handbook NAIC to monitor developments in IAIS and consider enhancements to US captive and SPV regulatory framework in advance of future FSAP reviews NAIC to study impact, and potential limitations, of alternate assets not identified in the Credit for Reinsurance Model Law (#785) Parental guarantees and conditional LOCs specifically mentioned Enhance the disclosure in ceding company financial statements of non-trade secret captive information Amend Financial Analysis Handbook to include alternate risk transfer arrangements Materiality Exposure on holding company system to parental guarantees and reimbursement obligations Other unique exposures that are retained within the insurance holding company system Source: NAIC white paper Captives and Special Purpose Vehicles March 14, 2013 12