1. Retroactive Insurance © Baker & McKenzie 2003 Energy Insurance Bermuda February 23, 2003 Innisbrook Tarpon Springs, Florida James Cameron, Partner Baker & McKenzie 805 Third Avenue New York, NY 10022 (212) 751-5700 james.r.cameron@bakernet.com Baker & M c Kenzie

2. Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL u Portfolio liftoffs of: – Workers’ compensation reserves from old large deductible plans – General liability risks – Professional liability risks – Environmental risks (certain instances) – Combination of different coverages – Conversion of claims made to occurrence Some Retroactive Coverages

3. Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL u Risk transfer rules apply u Insurer must assume “meaningful” amount of insurance risk - FAS 113 u Minimum and maximum premium adjustment u Best if it is a fixed premium u Commutation clause u Combine with other coverages u Excess layers and quota shares of higher layers u Retained amounts, limits on annual, multi-year and first payments; claims settlement procedures u Underwriting risk – MGM Grand (Rev. Rul. 89-96) Portfolio Liftoffs

4. u FAS 113 & NAIC Accounting Chapter 22 u Transfer of a significant insurance risk u Reasonable possibility of a loss u The loss needs to be significant u The insurance risk cannot be remote u Get a good actuarial report u Use present value of cash flows u 10-15% chance of a 10-15% loss u Ignore labels, consider all obligations - premiums, commissions, claims & adjustment features Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Financial Reinsurance GAAP & SAP Rules

5. Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Premium Deductibility Tax Issue u No precise tax definition of risk transfer u Risk transfer must be significant u Must pass the accounting test u Policy language very important and carriers do not take proper precautions – not their issue u Not cover any future events - occurrence coverage u May have issue here with insured u Sort of equivalent of nose and tail coverage u Suspicion of IRS that you are just financing the losses, but have hard time with IBNR u Want to have a good business purpose

6. Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Premium Deductibility Tax Issue u Must have paid premium – Section 461(h) u Risk of capitalization of premium u IRS argues that insured has a substantial future benefit that should be charged to future periods u In reality, the coverage is for events that have occurred u Regulations are unclear and have caused confusion u Example on occurrences versus payments u IRS is beginning to come around u Desirability of “substantial authority” opinion

7. Excise Taxes u Can be an important issue for a portfolio lift-off u Applies to placements of insurance and reinsurance with foreign insurers, who are not ETB u Rate is 4 % for P&C insurance and 1% for all reinsurance u Exception for those with treaty protection, but tax applies if subsequently reinsured with non-treaty carrier u No off-shore domicile without taxation has a treaty waiver u Ireland has a treaty waiver, but only if insurer is subject to 12.5% taxation u 25% US owned foreign insurers can elect under section 953(d) to be taxed in the US and avoid excise tax Baker & McKenzie February 25, 2003 - Tarpon Springs, FL

8. Excise Taxes u Can reduce excise tax with a fronting company u Fronting company fees may be more expensive u Can use a section 953(d) company on insurance and get 1% on reinsurance; need real risk taking u Can use a domestic captive and reinsure; same issues u Need to remove excise tax risk from insurer so you can get refund if policy proves not to be “insurance” u Other possible solutions – Can use a stop loss and keep short term risk in US – Can make transaction not one of insurance – Could reinsure London placed risks (perhaps not under proposed UK treaty) Baker & McKenzie February 25, 2003 - Tarpon Springs, FL Baker & McKenzie February 25, 2003 - Tarpon Springs, FL

9. Self Procurement Tax u States impose premium taxes on admitted insurers and surplus lines insurers writing business in the state u Provisions in most states for self procurement of insurance, usually by sophisticated insureds u Some allow this as part of the industrial insured exemption — Full time employee or risk manager — Annual premiums of $25,000 — 25 full time employees u Have tax that is a substitute for the state premium tax u Some condition exemption on payment of this tax (NY) u Is many times ignored by risk managers and their captives Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL

10. Self Procurement Tax u Some condition exemption based on lack of activities in the state with the typical activities: — negotiation and issuance of the policy — payment of the premium and delivery of the policy — absence of the broker or agent — no use of the telephones and the mail u Risks in states where no longer conduct any business u General right to contract as set forth in Todd Shipyards, although weakened by subsequent cases u See also recent Dow case in Texas Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL

11. Self Procurement Tax u Can be significant with a portfolio lift-off u Licensed carriers do not want to be involved u Obligation goes both to the insured and the insurer u Use of a captive as a front for these transactions u Allocation rules may allow you to reduce exposure or liability to tax u Is an issue of increasing important to the State Insurance Departments u They are seeking to recoup lost revenue due to self insurance and captives Baker & McKenzie February 23, 2003 - Tarpon Springs, FL Baker & McKenzie February 23, 2003 - Tarpon Springs, FL