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Deconstructing the Value Proposition of Captives Charlie Woodman, CPA, CGMA Risk Finance & Analytics Willis Construction Practice Craig A. Ream Program.

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Presentation on theme: "Deconstructing the Value Proposition of Captives Charlie Woodman, CPA, CGMA Risk Finance & Analytics Willis Construction Practice Craig A. Ream Program."— Presentation transcript:

1 Deconstructing the Value Proposition of Captives Charlie Woodman, CPA, CGMA Risk Finance & Analytics Willis Construction Practice Craig A. Ream Program Administrator - CS Insurance Ltd. Willis Captive Practice 20 th Annual Willis Construction Risk Management Conference Marriott Legacy Town Center – San Jacinto Room Tuesday, September 16, 2014

2 Economics of Insurance: The Stage 1 Fixed (25%-35%)  Insurance Company Overhead, Taxes, Reinsurance Cost, Commissions Profits & Investment Income  Underwriting Profit and Investment Income Accrued by Insurance Company Profits & Losses % Components of Traditional Insurance:  Expected loss and ALAE  Taxes and regulatory fees  Overhead and administration  Insurer selling and distribution expense  Reinsurance and Intermediary charges  Risk Margins  Surplus charges  Risk Based Capital offsets

3 The Continuum of Risk Finance HIGH LOW Program Sophistication HIGH Assumption of Risk Guaranteed Cost Loss Sensitive or Retro Policy Large Deductible Policy Complete transfer of risk Commercial insurance with no deductible Assumption of limited risk in exchange for potential return premium Deferred “pay-in” premium Significant/complete risk assumption in exchange for deductible credit Integrated Risk Qualified Self Insurance w/ Risk Funding State Qualified Self Insured Insured is legal insurer Traditional Hazard lines (property, Casualty, EPL) Integrated layers at specified layers Group Captives Formed to insure member owners (shared risks/assets) Replication of insurance and group purchase of excess

4 Program Selection Drivers are Risk Appetite Financial Protection Asset and Revenue Protection Performance Certainty Liquidity and Cash Certainty / Cost of Short-term Finance Statutory or Counter-party Requirements Revenue / Expense Matching Safety & Loss Containment Services and Acquired Disciplines Control Negotiation & Leverage Catastrophic Protection Taxation Market Opportunity

5 Captive Insurance Company - Defined An Insurance Company, typically owned by non-insurance parent(s), insuring the risks or interests of its owner(s) Incorporated, Regulated, Capitalized and Individually Accountable  May be fairly transparent May or May not be a replacement for insurance. Depends on Form (ownership and insured relationship) Emphasizes the ‘Insurance Transaction’ Insurance Company Operations:  Insurance Accounting and Financial Metrics  Must Always Maintain Positive Capital and Surplus (Unrestricted Net Worth I.e., Marketable Assets > Liabilities) Typically administered by professional third-parties  Captive Mgt / Legal / Audit / Actuarial / etc. 4

6 Forms of Captives Single-owner or Pure Group – Homogeneous or Heterogeneous Association Insurer Controlled Agency / Sponsored Rent-a-captive Segregated account (cell) captives Captive pools Risk retention groups Trusts Special Purpose (Re)insurer Etc… 5 Feasibility Prerecorded Lecture/ 5

7 6 Boil It Down – Two Real Types Single Parent Wholly-owned (and can include Rent-A-Captive “Cells” & Trusts) Emphasis on Risk Funding and Cost / Funding Efficiencies Underwrites ‘related’ risks to single economic interest as insureds are commonly parental operations Will consolidate operating and financial position with publicly-held parent; may deconsolidate under certain circumstances in closely-held. Group Owned No common ownership among insured participants Group, Association Captive, Risk Retention Group Emphasis on Risk Transfer as an insurance market alternative Will pool certain retention layers among participant insureds Common services and emphasis on the health of the group as a whole.

8 Primary Focuses of Single Parent Captive Programs Cost Savings  Long Term - “Seasoning” of a Property & Casualty Insurance Company:  Platform and enhance the placement of insurance coverage, terms and conditions  Access or contract with alternative markets or reinsurers  Effect optimal balance of risk retention and transfer, glean greater control over risk process  Projected performance is difficult to quantify  Short Term - “Business Case” / Cash Flow Efficiencies: Highly Quantitative / Heavy Tax Risk Management / Program Facilitation  Provide rapid liquidity  Buy Down Deductibles of Subsidiaries or Operating units  Stabilize or enable allocations and budgeting / contracting processes Business Enhancement: “Profit Center”  Controlled Insurance Programs  Sub Contractor Default Insurance  Extended Warranty / Service Contracts Asset Facilitation / Wealth Strategies – Closely-helds 7

9 Business Case: Assessment and Short-term Viability NPV - Short Term Business Case cost Savings Accelerated Tax Benefits State Tax Arbitrage Operating Costs WACC / Opportunity Cost of Capital Other Quantitative & Qualitative Capital Commitment / Operating Cost Internal Costs & Resource Commitment Recognitions and Materiality Corporate Culture 8

10 Group Captive Value Proposition  Control over insurance “destiny”  Unbundled service providers  Retain underwriting profits and earn investment income  Disciplined loss funding in a tax favorable structure  Access to capacity and economies of scale

11  Reduce and stabilize costs  Improve risk management through accountability  Customized and focused loss control services  Improved long term premium stability  Best in class coverage  Captive benefits on shared platform – reduced expense Group Captive Value Proposition

12 Unbundling the Insurance Transaction Group Captives

13 How do they do it?  Assumption of a high level of risk  Cost of risk transfer significantly reduced  Insurance market volatility minimized  Proven risk sharing structure  Reduces volatility in claims experience for participants  Provides needed risk shifting and distribution  Volume purchase  #61 on ENR top $900M in combined revenues  Shock claims are diluted

14  Investment income  Enhanced loss prevention and claims management  Avoid exposure to cat risks  Member selection - “Best in Class” controlled growth  Assures health of program over time  Reduces cost of risk transfer  Enhances peer group best practices exchange How do they do it?

15 Case Study Construction Solutions

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17  Contractors Group Captive Established in 2001  100% Member Owned and Controlled  Domiciled - Cayman Islands  Prospective Members:  Moderate/High hazard contractors generating between $500,000 and $3,000,000 in combined WC, GL and Auto Standard Premium  Contractors with a strong senior management commitment to safety  Contractors with loss and incident rates superior to average for class  Contractors with a formal loss control and safety program  Contractors with solid financials Construction Solutions

18  Common January 1 st renewal date  $136,000,000 of payroll insured  1,700 power units insured  $10,000,000 in annualized captive premium  Renewals presented in October and bound in November  Strict loss control covenants and annual CORR analysis  Bi-Annual Loss Control Meetings:  September 15, 2014 Dallas  May, 2015 Pittsburgh  Bi-Annual Board & Shareholder Meetings:  October 19-21, 2014Toronto  May 17-19, 2015 Cayman Construction Solutions

19  Workers’ Compensation  Statutory Coverage &  1M Employers Liability  General Liability  1M per occurrence 2M aggregate  per project/per location aggregate  Automobile  1M Liability  Physical Damage Insured Coverage Construction Solutions

20 Current Membership  2 Masonry Construction  2 Commercial Roofing & Sheet Metal Fabrication  1 Machinery Installation, Rigging, and Transportation  1 Road/Street Construction and Paving  1 Road/Street & Bridge Construction  2 Asphalt Distribution and Paving  1 Aggregates and Precast Concrete Products  1 Pipeline Construction Construction Solutions

21 Current Members  Peckham Industries – White Plains, NY  The Hamlin Companies – Garner, NC  Franco Associates – Pittsburgh, PA  Cost Company – Pittsburgh, PA  Energy Services of America (ESA) – Huntington, WV  Valley Group – Fishersville, VA  Suit-Kote – Cortland, NY  Economy Paving – Cortland, NY  Diamond Materials – Wilmington, DE  Greenwood Industries – Millbury, MA  LC Whitford – Waterville, NY Construction Solutions

22 Internal Structure Severity Fund B $ 375,000 XS $ 125,000 One Time Capitalization: $ 30,000 Share Purchase Experience Adjustment Assessment equal to one times A Fund In a multi coverage occurrence the total clash retention is $ 500,000. $ 1,000,000/Unlimited (WC)  $ 500,000  $ 125,000  General Liability Workers Compensation Frequency Fund A First Dollar to $ 125,000 Reinsurance – Arch Excess of $ 500,000 Auto Construction Solutions

23 Premium Distribution Example: Captive Expenses$ 345,900 Loss Funding $ 654,100 Total Premium $1,000,000 Construction Solutions

24 Premium Distribution Example: A Fund$ 490,575 A Fund$ 490,575 B Fund$ 163,525 B Fund$ 163,525 Loss Funding Allocation $ 654,100 Construction Solutions

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28 Maximum Cost: $ 1,482,510 Premium + Assessment Minimum: $ 356,654 Captive “Fixed” Expenses Less - Investment Income Plus - Shared Losses Construction Solutions

29 (Assume A Fund $482,510 Each Year)  1 st Year 2/3 of A Fund = $321,673  2 nd Year 2/3 of A Fund = $321,673$643,346 combined  3 rd Year 2/3 of A Fund = $ 321,673 $965,019 combined No Additional Collateral required at 4th renewal!!  4 th Year Caps at 2/3 of 3 Year Total = $965,019 Hypothetical Collateral Requirements Construction Solutions

30 Service Providers  Front and Reinsurance - Arch Insurance  Program Administration – Willis  Onshore Legal Counsel – Kerr, Russell & Weber, LLP  Captive Manager – SRS (Cayman)  Investment Manager – PRP Performa Ltd.  Auditor – KPMG  Actuarial – Milliman  Claims Administration – Gallagher Bassett  Loss Control – Willis Construction Solutions

31 Insured CS INSURANCE LTD. Captive Flow CS Retail Broker Arch Insurance Company Willis, SRS, KR&W, Milliman, KPMG, GB Underwriting Profits !

32  Policy Issuance  Financial Protection  Specific and Aggregate Excess Coverage  Statutory Coverage  Meets Legal Regulatory and Customer Requirements  Underwriting Expertise  Loss Control Resources  Claims Administration – Gallagher Bassett Construction Solutions

33  Construction specific focus – coverage and services  Size of program  Enhanced input and control of captive operations  Active peer group - culture of constant improvement  High average member premium size - $885,000  Low average risk sharing – 3.5%  Minimal assessments Why Construction Solutions?

34  Enhanced and focused risk control  Exceptional historical results – loss ratio 33%  $81 MM Premium - $22 MM paid & $3.5 MM reserves  Program Structure – flexible retention, ALAE, clash, aggregate  No automatic close-out policy  Excellent distribution history  $10 MM in distributions to date  Policy years closed – net cost was 70% of original premium

35 Questions? Construction Solutions


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