SM RISK WELL REWARDED CAPTIVE INSURANCE AND ALTERNATIVE RISK SOLUTIONS FOR THE MIDDLE MARKET ARTEX RISK SOLUTIONS, INC
For many years large corporations have used alternative risk transfer strategies to reduce insurance costs, improve risk management, and save taxes. With the growth of the captive insurance industry, these benefits are now available to middle market companies, as well as groups and associations. For sophisticated companies, managing and financing risk are important aspects of overall business strategy. A captive insurance company is the premier risk management and risk SM financing tool...this is Risk Well Rewarded. We invite you to review this brochure and contact us to discuss how your organization can obtain the benefits of a captive insurance company or other alternative risk transfer vehicle. ARTEX RISK SOLUTIONS, INC www.captiveadvisors.com
CAPTIVE INSURANCE THE MIDDLE MARKET SOLUTION A captive is an insurance company that insures the risks of its owner, affiliated businesses, or a group of companies. It issues policies, collects premiums, and pays claims. Basic Captive Diagram Shareholders Business Insurance Premiums Insurance Coverage Captive
MOTIVATING FACTORS The purposes of forming a captive include: Reduce Insurance Costs Capture Underwriting Profit Pricing Stability Purchase Based on Need Minimize Insurance Cost Greater Control over Claims Increase Coverage Increase Capacity Underwriting Flexibility Access Reinsurance Market Incentives for Loss Control Retain Premium Dollars Tax Benefits Investment Income Additional Profit Center Improve Cash Flow Control Risk Wealth Accumulation Estate Planning Asset Growth Asset Protection
GROWTH OF T HE C APTIVE M ARKET If you don t have an alternative risk transfer program in place, you may soon be in the minority. Insurance industry trends indicate that many middle market businesses will implement a captive or alternative risk transfer strategy over the next few years. Modern captives began in Bermuda in the early 1960s, and captive insurance was formalized in the late 1970s, with a medical malpractice captive for Harvard University. The number of captives increased over 100% from 1989-2010 In recent years, the growth of captive insurance and related risk transfer mechanisms has boomed, driven by businesses seeking to better manage insurance needs, including cost, coverage, service and capacity. When segregated cells, risk retention groups and rent-a-captives are included, the number of captive and alternative risk arrangements today is in the thousands, and is rapidly growing. The market for alternative risks exceeds $100 billion of annual insurance premiums. 6000 The Rapid Growth of the Captive Industry 1 5617 5000 (1989-2010) 2535 2896 3199 3418 4095 4936 4000 3000 2000 1000 Number of Captives 89 92 95 98 02 06 10 0 1 Source: III based on Business Insurance and Conning Research data.
EXPANSION TO T HE M IDDLE M ARKET Beginning in the 1980s, captives were commonly used by Fortune 500 companies to capture insurance premiums. With a captive, these large organizations could insure general liability, workers compensation, auto and property insurance. These captives soon became a profit center for the entire organization. The trend in captive regulations and rulings has been positive and should continue now that most states in the U.S. have passed captive legislation. Until 2001, IRS regulations restricted many businesses from using captives. However, the IRS has now issued guidelines that provide safe harbors for captives. These new rulings have opened the door to middle market businesses. Today, captives have become the primary risk management and planning tool for many successful businesses.
BUSINESSES SUITABLE FOR CAPTIVES Captive insurance companies are appropriate for all types of businesses, including: Construction Finance Hospitality Restaurants Distribution Franchising Manufacturing Retail Energy General Contracting Professional Services Transportation Engineering Healthcare Real Estate Development Wholesale
CAPTIVES CAN LOWER THE COST OF INSURANCE... A this retention layer with insurance premiums, and realizes both the insurance cost and tax benefit associated with financing risk through the captive. A captive may reduce the cost of workers compensation, general liability, medical malpractice, auto liability, property, or other conventional insurance. There are several methods available. One method, shown below, is to use the captive to retain the low severity risks, and purchase insurance from a large carrier only for catastrophic risks. Under this arrangement, the insured business takes a large deductible. The captive then issues a policy directly to the business for the deductible (or retention ) layer. The business then funds Result More dollars retained within the business enterprise, less premium paid to unrelated insurance carriers, and a business deduction for additional insurance expense. This approach has been used by large corporations for years to substantially reduce their insurance expense and retain underwriting profit. With the growth of the captive market, this strategy is now available to middle market companies. Shareholders Business Premium related to catastrophic risks Premium related to retention layer (low severity) Large Insurance Carrier Captive
...AND INSURE HIDDEN RISK Most business owners unknowingly self insure a large amount of risk. Many of these are hidden or below the surface risks inherent in the operation of a business. With a captive, self-insured risks can be converted into tax-deductible premiums that are paid to a captive. Any materialized risks can now be paid with pre-tax assets. If insurance claims are as projected, the captive may retain substantial profits that can be distributed to its owners. Insured Risk Auto General Liability Medical Malpractice Property Workers Compensation Self-Insured Risk Administrative Actions Business Interruption Construction Defect Credit Default D & O / E & O Deductibles Difference in Conditions Earthquake/Hurricane Employment Practices Exclusions Legal Defense Reimbursement Loss of Key Customer Pollution Product Recall Warranty
CAPTIVE BENEFITS Cost Reductions / Capture Underwriting Profit Typically 30% 50% of the premium paid to a commercial insurer goes to overhead and profit. Instead, pay insurance premiums to a captive and retain the underwriting profit. With a captive, insurance premiums can be controlled within the same economic family. Cash Flow Benefits / Investment Income Apart from pure underwriting profit, captives earn investment income on the premiums received. Premiums are typically paid in advance while claims are paid out over time. The captive retains control over the investment portfolio consisting of premiums and retained profit. Unavailability of Coverage Where the commercial market is unable to provide coverage for certain risks (including warranty, pollution, or product liability), or where the price quoted is unreasonable (such as medical malpractice or construction defect), a business can insure such risks through a captive. If desired, the captive can obtain reinsurance for any large potential claims. Risk Management A captive can act as the focal point for the risk management and risk financing activities of its affiliated businesses, and be viewed as a profitable part of the business enterprise. Conventional insurance typically provides little incentive to improve risk management, as there is no participation in the profitability of the insurance program. However, with a captive, the business will benefit from good claims experience. A captive provides strong incentives to improve risk management throughout an organization.
Access to the Reinsurance Market Reinsurance is available only to insurance companies and can provide coverage at advantageous rates. A captive can access the reinsurance market, determine risk retention levels, and structure the overall insurance program with greater flexibility. Reinsurance allows the captive to precisely determine the amount of risk to be held by the captive, and the amount to be reinsured. Asset Protection As with other insurance company structures, properly-formed captives have many asset protection benefits. Captives can shield assets from creditors of the business. Estate Planning Business owners with estate planning objectives will find that captives provide many beneficial solutions. It is important to consult with a qualified advisor to ensure that your captive meets necessary requirements. Underwriting Stability A captive insurance company is less vulnerable to the cyclical nature of hard and soft markets that affect the conventional insurance market. Thus, a captive can aid a business that requires accurate financial projections. Taxation Insurance companies follow special rules with respect to taxes. Tax benefits may be available by utilizing a captive. Tax benefits alone, however, should not be the reason behind establishing a captive insurance company. Writing Unrelated Risks for Profit Apart from writing insurance to affiliates, a captive may operate as a separate profit center by insuring the risks of third parties. For example, a captive could provide insurance to existing customers of its core business (such as extended warranty coverage), or even provide coverage to suppliers or distributors, for additional revenue and profit.
CHOICE OF DOMICILE With the strong growth of the captive market, many domestic and foreign jurisdictions have approved captive insurance legislation. In the early years, foreign jurisdictions such as Bermuda and the Cayman Islands were industry leaders. A few years later, some states in the U.S. passed captive insurance legislation. Today, over half of the states have captive laws in place. There are now many domiciles from which to choose, both domestically and internationally. In deciding on the best location for your captive, the major issue is whether to locate onshore or offshore. Other domicile differences should also be considered. As part of your captive feasibility study, Artex will analyze and help determine the appropriate domicile for your captive. Key Domicile Considerations Capital and Surplus Requirements Investment Limitations Regulatory Restrictions Government Fees and Taxes Infrastructure
TYPES OF CAPTIVES Single-Parent Captive Insures the risks of related companies. The most common form of captive. Group / Association Captive Insures the risks of companies in an industry group, franchise, or association. A group captive can share the risk among several participants and spread the fixed cost of the captive among its members. Agency Captive Formed by insurance brokers to allow them to participate in high-quality risks which they control. Protected Cell Captive A protected cell captive (PCC) enables users to legally segregate assets and liabilities within a separate vehicle, or cell. This allows many cells to be created within the same captive. Risk Retention Group A group self-insurance plan or group captive operating under the Liability Risk Retention Act of 1986. A Risk Retention Group (RRG) can cover the liability exposures, other than workers compensation, of its owners. Once licensed in a state it can operate in any other state. RRGs are often used to insure medical malpractice risks, and avoid the need of a fronting insurance company.
CAPTIVE OWNERSHIP Captive ownership is quite flexible. In many cases the captive has the same or similar ownership as the business. For group captives, some or all of the group members can own the captive. For business owners focused on estate planning, a captive can provide substantial opportunities to efficiently transfer assets to future generations without gift or estate taxes. A captive can be owned by multiple parties, including LLCs, partnerships, corporations, trusts, key employees and individuals. Shareholders Shareholders Family Key Employees Estate Plan Trust Business Insurance Premiums Insurance Coverage Captive
CAPTIVES FOR THE MIDDLE MARKET Middle market companies can greatly benefit from a captive or other alternative risk transfer structure. Businesses of all types can use a captive. Good candidates for a captive generally meet one or more of the following criteria: Profitable operations with taxable income of at least $1 million per year. Substantial self-insured/uninsured business risk. $10 million or more in annual gross revenue.
RISK MANAGEMENT SOLUTIONS Medical Malpractice Hospitals and physician groups can self insure all or part of medical malpractice risks, obtaining underwriting profit, and achieving better loss and claims control. Excess and Surplus Lines Specialized coverage, such as business interruption insurance or comprehensive directors and officers coverage, can be obtained at reasonable and consistent rates. Construction Agency Captive A retail insurance agency specializing in one industry can develop an agency captive to control the book of business and thereby participate in the risks and rewards of the insurance written through the agency. Property Coverage Large property holders can use a captive to write the first layer of property coverage, thereby reducing overall insurance costs. Captives can cover performance risks, construction defect, mold, and other construction related risks, thereby improving cash flow and profitability of the developer. Non-Traditional Lines Captives excel at writing non-traditional insurance coverages, including: business interruption, equipment maintenance warranty, credit life and disability, employment practices, credit risk, post-retirement medical benefits, private mortgage insurance, extended-service warranty, voluntary employee benefits such as supplemental life, pollution liability, and medical stop-loss.
Workers Compensation A business with large workers compensation or general liability deductible can use a captive to establish a self-insured retention (SIR) layer for that risk. The premiums paid to the large insurance carrier are reduced, because the deductible is collateralized. Association An industry, franchise, or association with general or specialized risk can form an association captive for underwriting profits, investment income, and claims control. Employee Benefits PCC A protected cell captive (PCC) can allow individual insureds to participate only on a select layer of the risks written by the entire captive. PCCs can also be used with group captives to segregate assets and liabilities. Warranty Captives can insure or reinsure the product or service warranty risks of the business or association. Captives can insure employee benefits such as health insurance, executive retirement programs, group term life and long-term disability, achieving substantial cost reductions to the business. Moreover, the business immediately deducts an insurance reserve for future expenses, providing current tax savings to the business. General Liability / Auto Liability Captives can replace (in whole or part) expensive general liability or auto liability insurance. In other cases, the captive can write the deductible layer of insurance. Captives can cover any type of traditional insurance.
ARTEX RISK SOLUTIONS, INC. Captive insurance and alternative risk transfer solutions for the middle market Artex Risk Solutions, Inc. is one of the leading captive managers in the country, delivering a collaborative expertise to assess, formulate and manage alternative risk solutions for our clients. We re experienced with the full spectrum of risk management options, from single parent and group captives, to rent-a-captives, pools and domicile solutions. Our services begin with the initial feasibility study and continue through formation and ongoing captive management. The Artex team includes captive managers, CPAs, risk managers, underwriters and other professional staff. Because of our turn-key approach, we are able to deliver efficient and affordable captive management services, and avoid the confusion resulting from multiple firms, each providing only a portion of the management service. We look forward to meeting with you to explore how alternative risk transfer strategies can benefit your business. Robust Innovative Turn Key
Captive insurance and alternative risk transfer planning involves sophisticated insurance and risk management issues, regulatory and corporate legal issues, federal, state and ofen international tax issues, and a wide range of accounting and financial issues. This planning is specific to each set of circumstances. It is not appropriate to apply general information described herein to any particular situation. The information herein is general in nature, and may not be relied on for any specific use. The content herein (including graphics) does not purport to show all details and complexity in establishing a compliant captive or alternative risk transfer program. Artex is not engaged in rendering legal services or advice. Disclosure under IRS Circular 230: The information and services offered are not intended to and do not comply with the U.S. Treasury Department s technical requirements for a formal legal opinion, and cannot be used by a taxpayer to avoid any penalty that might be imposed on a taxpayer. Nothing herein may be used in promoting, marketing or recommending an investment plan or arrangement. All materials are owned and copyrighted by Artex Risk Solutions, Inc. 2011. All rights reserved. Risk Well Rewarded SM is a service mark of Artex. No reproduction, distribution, or transmission of the copyrighted materials is permitted without prior written permission of Artex.
ARTEX RISK SOLUTIONS, INC Captive Insurance and Alternative Risk Solutions for the Middle Market 1635 N. Greenfield Road, Suite 127 Mesa, Arizona 85205 (480) 553-6221 www.captiveadvisors.com