Captive 101 by 4Fw8addN

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									                 CAPTIVES 101
                Charles Collis – Conyers Dill & Pearman
Shelby Weldon – Bermuda Monetary Authority, Deputy Director, Insurance
                        Scott Bradley – Quanta
                   Lorraine Mewett – Ernst & Young
                      Jennifer Murkison – Marsh
The views expressed by the participants in this
session are their own and not necessarily the
views of their employers or any other
organization with which they may be affiliated.
If you decide to establish an insurance
company in Bermuda you should seek legal
and other necessary advice.
SHOULD I HAVE A CAPTIVE?
                                       Advantages

• Enhance Risk Management Program
   – incentive for loss control and safety programs
• Flexibility in program design and structure
• Reduce insurance cost
• Capture underwriting profit
• Earn investment income
• Fronting opportunities in certain circumstances
• Access to the reinsurance market
• Potential tax benefits
• Provide evidence of insurance if required
                     Potential Disadvantages

• Risk of adverse loss
• Capital commitment
• Unable to write admitted cover in most cases
• Restricted in some countries
• Operating costs
• Lack of risk pooling
• Requires long-term management commitment to
  see results
      Captive Utilization – Risk Funding

• Uninsured Exposures
• Deductible Buy-down – Hazard, Financial &
  Business Risk
• Investment Income Identified – Accrues to Risk
  Management Department
• Portfolio Transfers
• Visibility
      Captive Utilization – Profit Center

• Customer Coverages
• Joint Ventures
• Suppliers/Distributors
• Employee Benefits
• Employee Personal Lines – Homeowners,
  Automobile, Umbrella
                                                            Captive Structures
Fronted Reinsurance Captive                              Direct Issue Captive
 Owner / Insured                                           Owner / Insured


              Fronting insurer issues policies and
              arranges claims handling service                          Captive insurer issues policies and
                                                                        arranges claims handling service and
                                                                        retains risk at agreed level
 Admitted
 Fronting
 Insurer
              Reinsurance cessions to captive. Captive                       Captive
              retains risk at agreed level



                   Captive                                              Captive reinsures in excess of its
                                                                        desired retention

              Captive retrocedes risk in excess of
              its desired retention



Reinsurer                                                Reinsurer
                                                        Topic

BAD REASONS FOR ESTABLISHING A CAPTIVE
• I want a free trip to Bermuda each year
• Everyone else has one
• My experience is so much better than anyone else‟s…
• Tax with no other business reasons
• Off balance sheet financing
• Best available terms
         REASONS
OFF BALANCE SHEET FINANCING

            Owner



           “Parent”



           Captive
           REASONS
 OFF BALANCE SHEET FINANCING



            Owner




“Parent”               Captive
            BEST AVAILABLE TERMS


                              Reinsurer
                                10%


Insurer 1     Insurer 2    Captive
  50%           40%         10%



              Insured
THE FEASIBILITY STUDY
                               Feasibility Study

What is it?
Provides you with relevant and objective analytics
and discussion needed to asses the reasonable
merits and anticipated cost / benefits of a captive.
                          Feasibility Study

The Process             The Result


• Data collection       • Specific
                          recommendations
• Retained loss
  projections           • Captive implementation
                          plan
• Economic analyses
                        • Written report with
• Domicile comparison     quantitative exhibits and
                          schedules
THE SERVICE PROVIDERS
• INSURANCE MANAGER/PRINCIPAL
  REPRESENTATIVE
• AUDITOR
• ACTUARY
• ATTORNEY/CORPORATE ADMINISTRATOR
          Role of Principal Representative

•   Principal Representative: statutorily required to report
    certain „events‟ to include:
    – Failure of the captive insurer
    – Insurer ceases to carry on insurance business
    – Monitor compliance to Section 56 directives
    – Advise of insurer is involved in any criminal
        proceedings
    – Significant changes in the business plan


    Basically the eyes and ears of the regulators
               Role of Insurance Manager

• Accounting
• Insurance
• Treasury
• Investment
• Claims
                             Role of the Auditor

• The role of the Approved Auditor is to express an
  opinion as to whether the statutory financial
  statements are free of material misstatement and
  whether the statutory financial returns comply with
  criteria established in the Act. Such opinion should be
  independent and objective.
• Every registered insurer must appoint an independent
  auditor based in Bermuda who reports annually to the
  Authority.
• The audit is conducted in accordance with generally
  accepted auditing standards and generally US,
  Canadian, UK or International standards would be
  followed.
                             Role of the Auditor

• The auditor issues a report which is filed with the
  statutory financial return which is addressed
  specifically to the Authority.
• Auditor is required to qualify the report if:
       - Deficiencies in the audit
       - Disagreements re valuations
       - Statutory financial statements or certificate
  of solvency or declaration of statutory ratios do
  not comply with the Act and Regulations
      - Opinions in the solvency certificate are
  unreasonable
       - Going concern
                              Role of the Actuary


Original feasibility study:
• Actual cost of proposed coverage(s)
• Correct value for current self-insured reserves
• Cash flow analyses
• Required funding levels (nominal or discounted)
Ongoing:
• Pricing
• Reserving
• “Special Projects”
       ROLE OF THE
BERMUDA MONETARY AUTHORITY
THE APPLICATION
Application to Incorporate & Licence
• Bermuda Monetary Authority
      • Authorization and Compliance Division
      • Ownership
      • Insurers Admission Committee
      • Insurance Program
      • Knowledge and Insurance Expertise
Insurance Application

• Pre-Incorporation Form

• Business Plan

• 5 Year Pro Forma Financial Statements
  (Balance Sheet and Income Statement)

• Other Supporting Documentation (if necessary)
Business Plan

•   Description of Shareholder

•   Description of Insurance Business

    –   Lines of business to be written
    –   Layers to be written
    –   Fronting arrangements
    –   Retention Levels

•   Reinsurance Program

•   Section 56 Directions

•   Service Providers
INSURERS ADMISSION COMMITTEE
           (“IAC”)
IAC: What is it?


• A quasi governmental committee that reviews all
  applications to establish insurance and reinsurance
  companies, brokerage firms, and other insurance related
  entities.


• The deliberations of the IAC are subject to the Official
  Secrets Act.
IAC: Who are the members?
Industry representatives from a variety of Companies


•   Actuaries (non-life and life)
•   Accountants
•   Capital Markets Specialists
•   “Traditional” Underwriters
•   Others


Representatives of the BMA attend all meetings
WHAT DOES THE IAC LOOK FOR?
Business Plan:
   Who are the players?
   What do you want to do?
   Does the plan make sense?
Is the plan adequately supported:
   Justification for the premium
   Pro-forma financial statements
   Do the various documents agree (cover letter, business plan,
   pro-forma‟s, actuarial report, forms…)
Section 56 directions
• Incorporation
• Organization
   – Directors and Shareholders Meetings to:
      • Issue shares
      • Approve bye-laws
      • Appoint insurance managers
      • Other formalities
• Capitalization
• Registration
   – File Formal Application
     (substantially identical to preincorporation application)
Timing
• Submit application on a Monday
• Application consideration by Committee on the following
  Friday (4 days later)
• Incorporation early the following week
• Organization, capitalization and registration may all occur
  on the day of incorporation or at the shareholders
  convenience
• Commence business
INSURANCE REGULATION
Categories of Insurers


• Long Term Business Insurers
      • Life and annuity
      • Some accident and health

• General Business Insurers
      • All insurance business other than Long
        Term Business
Classes of General Business Insurers
• Class 1   Pure Captives

• Class 2   - Group / Association Captives
            - Captives writing less than 20%
            unrelated business

• Class 3   General commercial companies

• Class 4   Property catastrophe/ excess liability
            companies
  Minimum Capital and Surplus


            Class 1    Class 2    Class 3      Class 4        Long-Term

Minimum
Capital
            $120,000   $120,000   $120,000     $1,000,000     $250,000


Minimum
Capital &
Surplus     $120,000   $250,000   $1,000,000   $100,000,000   $250,000
• Margin of Solvency

• The amount by which the Assets must exceed the
  Liabilities


• Liquidity Ratio

• General Business Insurers Only
    Solvency Margins – General Business
                      Class 1       Class 2          Class 3         Class 4
                      Single-   Group/Association     General    Liability/Property
                      parent        Captive         Commercial     Catestrophe
                      captive                        Insurance

Margin of Solvency
The greatest of:
Figure A             $120,000       $250,000        $1,000,000    $100,000,000

Figure B
% of Net Written       20%            20%              20%             50%
Premium to $6
million plus …
% of Net Written       10%            10%              15%             50%
Premium in excess
of $6 million
Figure C               10%            10%              15%             15%
% of Loss Reserves
Liquidity Ratio


• The “Relevant Assets” of an insurer carrying on general
  business must not be less than 75% of “Relevant
  Liabilities”


• THERE ARE NO OTHER RESTRICTIONS ON THE
  INVESTMENTS OR BUSINESS OF A BERMUDA
  INSURANCE COMPANY
Relevant Assets

Include
• Cash and Time Deposits
• Quoted Investments (including Equities, Bonds & Debentures)
• Unquoted Bonds & Debentures
• Investments in first lien mortgage loans on real estate
• Accounts and premiums receivable
• Funds held by ceding reinsurers
Plus any other assets approved by the Bermuda Monetary
   Authority

NB: Investments in and advances to affiliates are not “Relevant
  Assets”
              Margin of Solvency


• Long-term Insurers
                   $250,000
Annual Filings


Every insurance company must prepare annually:


• Statutory Financial Statements
• Statutory Financial Returns


Section 56 Exemption
NEW BMA GUIDELINES
REVISED SUPERVISORY
      MODEL
RISK BASE FRAMEWORK
OPERATIONAL ISSUES
         What to Expect – Calendar of events


• Monthly/Quarterly
  – Production of financial statements
  – Monitor solvency/liquidity ratios
  – Working meetings
• Annually (required)
   – Audit completed 6 months after year end
   – File Statutory Return
   – Annual General Meeting (AGM)
   – Payment of government fee and business fee
                             Things to Consider

• Careful not to underfund captive
• Tax implications for the parent
• How will accounting for the captive be handled at
  the parent end?
• Is there a plan to infuse capital if it is needed?
• Management of service providers (attorney,
  auditor, manager, actuary). Whose responsibility
  will this be?
                                   Audit Concerns

• GAAP vs Statutory financial statements only
• Risk Transfer
• Actuarial
• Tax
• SOX 404
• Investment strategy
• Reinsurance structure
• Claims Handling
• Capitalization & distributions
CORPORATE GOVERNANCE

								
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