1. Captives – Alternative or Obstacle Business Case
Charlie Woodman, CPA
SVP, Risk Finance
Marsh
CAS Annual Meeting
November, 2004

2. Captive Insurance Company - Forms
Single Parent - Non Risk Pooling
Wholly-owned / Rent-A-Captive / Trusts / etc.
Emphasis on Risk Funding and Cost / Funding Efficiencies
Group Owned- Risk Sharing / Risk Pooling
Group, Association Captive, Risk Retention Group
Emphasis on Risk Transfer replacement / Alternative “insurance”
This distinction is critical in assessing the merits of a program.

3. Current Captive Insurance Program Emphases
Cost Savings
Risk Management Facilitation
Business Enhancement
Insurance / Risk Transfer Replication (Group Emphasis)

4. Cost Savings Long-term: “Seasoning” / Risk Management Point Facility
Short-term: “Business Case”

5. Seasoning “Seasoning” / Risk Management Point Facility
Extends the Corporate Risk Management “Commitment” to It’s Own Risks
Engages in Insurance under the Insurance Industry’s Mechanisms and Measurements
Regulated and “Grounded”
Reinforces Relationships with (Re)insurance Markets
Hard to quantify / “Theoretical in Many Instances”

6. Business Case
NPV of Cash Flows - Short Term Business Case cost Savings
Accelerated Tax Benefits - Qualified Insurer
State (& International) Tax Arbitrage
Operating Costs
Opportunity Cost of Capital
Other Quantitative & Qualitative

7. Accelerated Tax Benefits - Qualified Insurer
Insurance Premiums are Deductible over the policy term
“Casualty” losses are subject to “Economic Performance” for tax
Accounts and “set-asides” are not economic performance
Incurred Basis (incl. IBNR) vs. Paid Basis
SubChapter L of the IRC
Accelerated Recognition, not an accelerated realization
i.e. Already recognized for financial reporting
No “above the line” accounting benefit
Consolidated Cash Flow Benefit
Note: Basis of tax benefit is actual premium deduction from insured to Group Captive

8. Tax Reality
The underlying issues which define whether an insurance transaction has occurred or whether a transaction is self-funding are:
“Insurance Risk” - Insurer must assume a reasonable possibility of incurring significant loss.
Notions of Risk - Form
Risk Transfer / Risk Distribution - Risk of loss must be legally transferred from one legal entity to another, which pools the risk among other risks so as to increase predictability, and reduce adverse loss uncertainty.

9. Tax Facts & Circumstances

10. Tax Facts & Circumstances

11. Other Business Case Components
State (& International) Tax Arbitrage
Operating Costs
WACC / Opportunity Cost of Capital
Capitalization
Losses as Premiums
Discount rate on enhanced cash flows
Other Quantitative & Qualitative
(Re)insurance
Internal Costs & Resource Commitment
Recognitions and Materiality

12. Captive Operating Costs
Start-up
Fronting, if applicable.
Management
Measurement: Audit & Actuarial
Legal & Regulatory
(Re)insurance
Pools and Participations
Premium-based Taxes
Direct / Reinsurance
Federal Excise Taxes
Self-procurement / Direct placement.

13. Design Components and Issues
Coverages
Structure
Direct Writer
Reinsurer
Capitalization & Collateral
Domicile
Cost
Regulatory
Other
Premiums & Operating Expenses
Premium Taxation

14. Underwriting Traditional risk
Professional Liability/Medical Malpractice
Workers compensation, auto and general liability
Products/completed operations, errors & omissions, environmental
D&O, Surety, Property?
Employee Benefits
TRIA

15. Program Evaluation or “Feasibility”
Risk Assessment / Self-Assessment
Insurance Marketplace
Risk Quantification
Qualitative Issues
Pro Forma
Structure & Design
Time - Urgency versus Commitment
Capital
Cultural