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Captives 301 1 Peter A. Joy, ARM Aon Captive & Insurance Managers Executive Vice President Jim Kasprzyk McDonald’s Corporation Senior Director Corporate.

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Presentation on theme: "Captives 301 1 Peter A. Joy, ARM Aon Captive & Insurance Managers Executive Vice President Jim Kasprzyk McDonald’s Corporation Senior Director Corporate."— Presentation transcript:

1 Captives Peter A. Joy, ARM Aon Captive & Insurance Managers Executive Vice President Jim Kasprzyk McDonald’s Corporation Senior Director Corporate Insurance

2 Purpose of this Session Give an appreciation of the advanced uses of captives  Cell captive  Branch  RRGs  Special Purpose Financial Captives  Domicile Selection  Tax  Pooling Arrangements  831(b) Small Insurance Companies Case Study – McDonald’s Corp 2

3 What is a Captive? A captive is an Alternative Risk Transfer vehicle It transfers premium from the insurance marketplace to an alternative vehicle It is a special form of insurance company that insures or reinsures the risks of related entities and closely managed business partners. 3

4 Types of Captives Pure  Multiple captives  Domicile importance Cell Captives Branch Risk Retention Groups Special Purpose Financial Captives 4

5 Cell Captives Various names, eg segregated cell, protected cell, etc Core is owned by one entity, and ‘cells’ are rented to others Activity in cell is governed by contractual agreement or preferred share arrangement ‘Capital’ (in the form of cash, LOC, parental guarantee, reinsurance) must cover the maximum risk written by cell Usually formed for a specific purpose and can be a short-term reaction to the marketplace Easy exit if the market softens or a pure captive is pursued Can be incorporated or non-incorporated 5

6 Typical Cell Structure Cell 1 Cell 2 Cell etc... Management Shares Cell 3 Cell 4 Cell 5 Cell 6 Cell 7 Cell 8 Cell 9 Cell 10 Insurance Shares (clients) Cell 10 Cell 1 1. Each cell has legal segregation and protection of assets and liabilities 2. Legal segregation and contractual segregation 3. Management shares MAY be at risk Bust 6 PROTECTED 6

7 Cell to Access Reinsurance Cell 1 Cell 2 Cell etc... Management Shares Cell 3 Cell 4 Cell 5 Cell 6 Cell 7 Cell 8 Cell 9 Cell 10 Insurance Shares (clients) Cell 10 INSURED REINSURER 7

8 Cells to Segregate Liabilities Cell 1 Cell 2 Cell etc... Management Shares Cell 3 Cell 4 Cell 5 Cell 6 Cell 7 Cell 8 Cell 9 Cell 10 Separate Insurable Risks Cell 10 Cell 1 Each cell holds a separate liability, eg a physician practice, a property subject to legal challenges, etc Cell 6 8 Captive 1 Captive 6 Captive 10 New owners

9 Branch Formed by a pure-captive for a specific purpose in another domicile It is not an incorporated entity and so the D&O’s are the same as the parent 9

10 Typical Branch Structure Parent Captive Majority of lines of insurance Specific line of insurance Branch Captive Branch results are reflected in captive since the branch is not an incorporated entity 10

11 Branch to Write Employee Benefits Parent Captive Majority of lines of insurance Employee Benefits Insurance Branch Captive Branch results are reflected in captive since the branch is not an incorporated entity 11 Life or LTD Insurer Reinsurance

12 Branch to Write Surety Parent Captive Majority of lines of insurance Surety insurance HI or NV Branch Captive Branch results are reflected in captive since the branch is not an incorporated entity 12 Certificates of Insurance 3 rd -party

13 Risk Retention Group Operates similar to a group captive yet is regulated under federal legislation Can write direct – no front company needed Can operate in a state after it ‘registers’ Can only write liability lines of risk – no WC or property It is regulated very similar to a regular insurance company Subject to a great deal of scrutiny Insureds must be owners and owners must be insureds 13

14 Risk Retention Group Typical Risk Retention Group Surplus Assessments Capital Premiums If necessary One Time Annually Owner A Owner B Owner C Members Reinsurance (if any) A B C Reinsurers 14

15 Risk Retention Group Physician RRG Surplus Assessments Capital Premiums If necessary One Time Annually Doc A Doc B Doc C Members Reinsurance (if any) A B C Reinsurers 15 Profit/Dividends

16 Risk Retention Group Closed Trucking RRG Surplus Assessments Capital Premiums If necessary One Time Annually Sub A Sub B Sub C Members Evidence Insurance FMCSA State DMV Customers 16

17 Special Purpose Financial Captive Primary example is the XXX Securitization Captive Highly valued by Life Insurers Efficient way to remove redundant statutory reserves from balance sheet Many states have specific laws to attract such transactions Some states have simpler, similar laws that allow the captive to reinsure unrelated business Used to capture another source of income! 17

18 Domicile Selection Domicile decision criteria:  Capitalization requirements  Costs – premium taxes vs license fees  Receptiveness & stability of regulatory environment  Quality of local infrastructure & expertise – or can I use outside vendors?  Flexibility as respects investment portfolio, loan backs, etc  Ease of doing business  Convenience of travel if an annual domicile Board meeting is mandated  Acceptance of non-admitted reinsurance Geographic Convenience Dodd Frank Act – Self Procurement Tax 18

19 WA CA IO NV MT OR WY SD UT CO ND HI NM AZ TX AR KS NE OK MS LA OH NC MO IA MN ME FL TN NY PA KY IN MI IL WI GA MA NH WV VA AL SC DE RI CTNJ VT MD DC No Captive Legislation Captive Legislation Alaska is not shown, but does not have legislation 19

20 Tax: to Achieve Insurance Company Status There must be risk shifting and risk distribution The risk is shifted from the balance sheet of one entity to the balance sheet of another A loss passed from the parent to the captive is not shifted, because upon consolidation the loss is returned A loss passed from one subsidiary to another is shifted, because the subsidiaries are not consolidated together - known as the Brother-Sister Structure A loss passed from a 3 rd -party entity to the captive is shifted because clearly the entities are not consolidated together Risk distribution invokes the law of large numbers – the premium collected from many is used to pay the losses of the few 20

21 Third Party Business IRS Safe Harbor RR Case Law Humana/ Kidde 30% 50% 21

22 Sources of Third Party Business Unaffiliated Sources (potentially high risk and may be discouraged by captive regulator) Affiliated Business  Minority owned joint ventures  Suppliers Customer Programs Employee Programs Pooling 22

23 Brother/Sister Model CAPTIVE Proportion of parent risk insured is not deductible Subsidiary premiums are deductible Safe Harbor – 12 entities RR (5% - 15% premium range) Case Law – 8 entities Malone & Hyde SUB All must have separate balance sheets No single member LLCs SUB Parent 23

24 Pooling Sharing in risks of others  Controlled  Reduces volatility  Source of third party business 24

25 Pooling $10m$5m $8m$30m$25m$2m$15m 10%5% 8%30%25%2%15% Pool $100m Pay in first party premiums Captives Own proportion of pool: Premium Total Pool 25

26 Pooling $10m$5m $8m$30m$25m$2m$15m $10m5% 8%30%25%2%$15m Pool Value $100m Pay in first party premiums Captives Receive reinsurance premiums First Party & Third Party $1m $9m $0.04m $1.96m $0.25m $4.75m $0.64m $7.36m $9m $21m $6.25m $18.75m $2.25m $12.75m $0.25m $4.75m 3 rd Party % 90% 85%95%92%70%75%98%95% 26

27 Federal Tax Accounting InsuredCaptiveConsolidated Premium Deduction ($10) Premium Income $10 Loss Reserve Deduction ($ 8) Net Captive Income $ 2 Net Consolidated Deduct ($ 8) Tax 40% $3.2 27

28 831(b) Election - Example Insurance Company Without Election Insurance Company With Election Premium$1,200,000 Claims$200,000 Underwriting Profit/Loss$1,000,000 Investment Income$10,000 Total Income$1,010,000 Taxable Income$1,010,000$10,000 35%$353,500$3,500 Net Income$656,500$1,007,500 Difference = $351,000 28

29 Wealth Transfer Trust 1 Grandson Trust 2 Granddaughter Auntie Mabel Inheritance Insurance Pops Co. 1 Pops Co. 2 Pops Co. 3 Pops Co. 4 Pops Co. 5 Pops Co. 6 Pops Co. 7 Pops Co. 8 Insured deducts premium as expense (Tax Saving $350k) No Claims $1m Dividend $1m Captive Takes 831(b) election Shareholders pay tax at their applicable rate 29

30 Putting all the Pieces Together McDonald’s Corp - a Case study The size of the insurance needs Differing stakeholder needs Multiple Captives Multiple Domiciles Nothing stays the same….. 30

31 McDonald’s Corporation Inc. $75 Billion in System-wide Sales 32,500 Stores Operations in almost 120 Countries 81% of locations franchised % of Profits by Area of the World  47% US  37% Europe  16% APMEA 31

32 Scope of RM Operations Property & Casualty Coverage for: US & International Company, Owner Operator and JV Stores Corporate Insurance Programs such as excess liability, aviation, D & O, Fiduciary etc. US Owner / Operator Health & Welfare Plan Estimated Total Insurance Cost: $500 Million

33 Multiple Captives Golden Arches Insurance Limited ( GAIL ) Golden Arches Re-Insurance Limited ( GARL ) McDonald’s Owner Operator Insurance Company ( MOOIC ) BRS Insurance Company 33

34 Creativity Needed for Health Insurance MIP offers a ‘ limited benefit ‘ plan with three medical options: Basic, Mid 5 and Mid 10 Mini Med Plan Basic Plan  Maximum Annual Benefit $2,000 per person  $150 Annual Outpatient Deductible Mid 5 Plan has $5,000 per person benefit Mid 10 Plan a $10,000 per person benefit 34

35 The Latest: BRS Insurance Company Arizona captive A new ‘ Risk Management Tool ‘ for use on future employee benefit programs such as MIP In the meantime, US Property Insurance Program and re-insurance for US Ronald McDonald House Charity: “package insurance policies” 35

36 Nothing stays the same….. Solvency II impacting Dublin captives New capital requirements, new costs New Treasurer asking “Why?” Justify purpose and domicile all over again Stay ahead of the curve 36

37 ANY QUESTIONS ? 37


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