THE RATIONALE FOR CAPTIVES 2017 Fall Education Forum October 2, 2017 Baltimore Maryland

SPEAKERS Megan Ogden, Director Captive Management JLT Insurance Management Tim Averill, Executive Director SET SEG Property/Casualty Pool Michael Rebeleati, Finance/Operations Nevada Public Agency Insurance Pool Michael Rhyner, Executive Director Michigan Municipal Risk Management Authority

Overview of Captive Basics PART ONE Overview of Captive Basics

WHAT IS A CAPTIVE INSURANCE COMPANY? A captive insurer is generally defined as an insurance company that is wholly owned and controlled by its insureds; its primary purpose is to insure the risks of its owners, and its insureds benefit from the captive insurer’s underwriting profits. Captive insurance is utilized by insureds that choose to put their own capital at risk by creating their own insurance company, working outside of the commercial insurance marketplace, to achieve their risk financing objectives. Captives are essentially a form of self-insurance whereby the insurer is owned wholly by the insured. They are typically established to meet the risk-management needs of the owners or members. Captive insurance companies have been in existence for over 100 years

Worldwide Number of Captives CAPTIVE STATISTICS Worldwide Number of Captives

2016 NEW CAPTIVE STATISTICS Number of Captives by Location All numbers include new cells/SBU’s

TYPES OF CAPTIVES Type Ownership Pure/Single Parent Wholly owned by one parent company Insures the risks of its parent, subsidiaries and affiliates Group Owned by multiple non-related organizations Insurers or reinsurers the risks of the group/owners Association Owned by members of a common industry or trade association Insurers or reinsurers the risks of the group or association Branch Division of an existing off-shore captive formed in the US Allows companies to access to TRIA and US employee benefit coverages that are required to be in a US domicile

TYPES OF CAPTIVES Type Ownership Risk Retention Group Owned by policy holders and members Regulated under US federal legislation, licensed in domicile, and allowed to register to operate in all 50 states Sponsored/Cell Captives Owned by 3rd party sponsor Insurers participants in the various cells Agency Captive Owned by insurance agents Allows agency to share in underwriting profits and investment income of its book of business Special Purpose Financial Captive Created for a limited purpose of entering into a SPFC contract Allows securitization transactions by a captive insurance company, transferring insurance risk to the capital markets

CAPTIVE ADVANTAGES & OPPORTUNITIES Reduce Insurance Costs: Retention of underwriting profits Claims settlements Premium advantages Risk Management Customize Coverage Claims Management Loss control and monitoring Balance Sheet Preservation Asset Protection Owner control of captive Flexible ownership structure Investment Opportunities

COMMON CAPTIVE COVERAGES Workers’ Compensation General Liability Products Liability Auto Liability Property, including wind and quake Professional Liability Product or Service Warranty Environmental D&O Liability Employment Practices Liability Construction Exposures Trade Risk Excess Liability Intellectual Property Medical Stop Loss Punitive Damages Terrorism

Increased Accessibility WHY SHOULD A POOL USE A CAPTIVE? Premium Commercial rates not competitive Combined premium is advantageous Operational Commercial coverage not available Provided coverage that the pool is statutorily unable to provide Proof of insurance needed Seeking formalized risk funding and loss control monitoring Good loss ratios and risk management protocols Investment income Desire for a potential profit center Desire for a regulated environment Protection from political risk Access to Capacity Federal Programs (TRIA) Reinsurance otherwise not accessible in commercial market Secure Profitable Regulated Increased Accessibility

CAPTIVE DEVELOPMENT PROCESS Review Current Insurance Program & Risk Appetite Formal Feasibility Study Decision to Proceed Business Plan Development Captive Application, License, Incorporation & Capitalization Commence Operations

CAPTIVE FEASIBILITY STUDY Identify core objectives 2. Data collection Exposure Loss history Financial statements Policies 3. Actuarial loss analysis Project losses under various scenarios Decide how much risk to retain Determine amount of capital Groups: consider underwriting structure 4. Program design & organizational structure 5. Domicile selection 6. Regulatory, tax and legal analysis Identify Objectives Collect Data Analyze Actuarial Loss Design Program & Structure Select Domicile Analyze Regulations, Taxes & Legal Implications

DOMICILE SELECTION CRITERIA Statutory Capitalization and surplus requirements and solvency ratios Receptiveness of regulatory environment Quality of local infrastructure Availability of expertise Stability of regulatory environment CRITERIA Flexibility as respects investment portfolio Ease of doing business – in a suitably regulated environment Experience in business under consideration Efficient financial outcomes: tax, wealth, investment etc.

DOMICILE SELECTION CRITERIA Quick and efficient procedures for organizing and activating a captive Taxation Operation cost relative to other domiciles Compatibility of language, currency and customs CRITERIA Time zone convenience Strategic location Where does the owner conduct significant portion of its business?

Regulatory Requirements REGULATORY, TAX & LEGAL CONCERNS CAPTIVE STRUCTURE Type of Captive Ownership Tax Implications Underwriting Class of Stock Voting Shares Regulatory Requirements

NEXT STEPS FOR CAPTIVE FORMATION Internal client meeting to review feasibility study results Approve captive formation Finalize structure/coverages/corporate governance Engage captive manager to manage the captive and prepare the application Engage attorney to form company Meet with the domicile insurance department Captive manager to file application to domicile insurance department Capitalize captive Commence business

CAPTIVE APPLICATION PROCESS Captive Owner Meeting with DOI Service providers Board of Directors Biographical affidavits Start up fees LICENSE Attorney Name reservation Article of Incorporation Bylaws FEIN Corporate Agreements Captive Manager Captive Application Business Plan Application assembly Task manager Domicile Insurance Department Actuary Loss/Funding Projections Financial Forecasts

OPERATING A CAPTIVE Board of Directors oversees the captive, typically parent company management and/or a mix of professionals Board of Directors appoints local service providers for banking, management, auditing, and captive management Captive management company performs the operational functions on behalf, including insurance and financial expertise

Department of Insurance OPERATING A CAPTIVE – SERVICE TEAM Client Actuary Banker Insurance Brokers Department of Insurance Captive Manager Auditor Claims Administrators Tax Advisors Legal Counsel InvestmentAdvisors 20

COST OF A CAPTIVE Costs: Formation & feasibility Ongoing operations Capitalization Costs depend on the complexity of the structure and insurance program Pure captives are often less expensive to form and operate than Group captives or Risk Retention Group Captives with several lines of coverage are often more expensive to operate than smaller programs Premium taxes are based on the amount of premium written Capitalization requirements vary by domicile and type of captive

ESTIMATED COST OF PURE OR ASSOCIATED CAPTIVES Formation & Feasibility - $35k to $55k Includes actuary study, legal fees for formation, fees for application preparation & domicile fees Ongoing Operations - $100k to $150k Includes captive management, actuary, audit, legal, travel & meetings, premium taxes & license fees Capitalization – $250k to $500k (minimum) In the form of cash, marketable securities or irrevocable letter of credit

PART TWO Captive Case Studies

Tim Averill, Executive Director MASB-SEG PROPERTY/CASUALTY POOL Tim Averill, Executive Director

MASB-SEG PROPERTY/CASUALTY POOL Created in 1985 514 Members Michigan Public Schools Intermediate School Districts Community Colleges Property and Liability Auto liability Auto physical Damage Cyber Liability Educators Legal Liability General Liability Property

MASB-SEG REINSURANCE LIMITED Association Captive Wholly owned and controlled by MASB-SEG Property/Casualty Pool Domiciled in Cayman Islands $5.0 million capitalization Interlocking boards Officially licensed – May 1981

PRIMARY REASONS TO FORM THE CAPTIVE Comply with statutory aggregate excess requirements Strengthen our negotiation position with reinsurance partners Offer protection from increasing regulation Ensure greater stability by providing an alternative to the commercial market Broaden our offerings outside the scope of the Pool’s primary coverage Potential to turn Pool reinsurance expense into future member surplus

EVOLUTION OF RISK MASB-SEG REINSURANCE LIMITED 1985 Aggregate Excess 2007 Annual Aggregate Property Deductible 2010 Employee Dishonesty Bonds 2011 Auto Liability, General Liability, Educators Legal Liability, Property 2013 Property & Liability Quota Share Future Growth: Medical Stop Loss, Cyber Liability

MASB-SEG REINSURANCE LIMITED Current Programs and Coverages: Statutory Aggregate Excess Coverage Property and Liability Excess Coverage Employee Dishonesty Bonds Participation in the Pools Quota Share Property and Liability Reinsurance Programs Future Programs and Coverages: Cyber Liability Medical Stop Loss

Mike Rebeleati, Operations Manager NEVADA PUBLIC AGENCY INSURANCE POOL Mike Rebeleati, Operations Manager

WHY THE NEVADA POOL/PACT FORMED TWO PURE CAPTIVES Flexibility in coverage design, scope and retentions for underlying pools Flow of capital to captives supported access to reinsurance and higher retentions Investment income opportunities are not as restricted as for public agencies and helps reduce costs over time Nevada Premium tax savings 3.5% plus Surplus lines fees 0.4% vs. reinsurance tax 0.25% Open Meeting Law and Public Records Laws do not apply to captives, but do to pools

PUBLIC RISK MUTUAL Formed and Capitalized by Nevada Public Agency Insurance Pool (POOL) A non-profit pure captive mutual insurance company Granted Certificate of Authority from Insurance Division on July 25, 2004 Capitalized with $1,000,000

PUBLIC COMPENSATION MUTUAL Formed by Members of Public Agency Compensation Trust (PACT) A non-profit association captive mutual insurance company Granted Certificate of Authority from Insurance Division on July 1, 2007 Initial Capitalization $5,000,000

RELATIONSHIPS OF NPAIP/PACT Nevada Public Agency Insurance Pool (POOL) Public Agency Compensation Trust (PACT) Insurance Captive Public Compensation Mutual (PCM) Public Risk Mutual (PRM) Administration & Governance Public Agency Compensation Trust (PACT)

NPAIP – LLOYD’S 2017-2018 PROPERTY STRUCTURE

NPAIP 2017-2018 LIABILITY STRUCTURE GRAPH UE’s participation decreased to 75% and PRM’s participation increased to 25% GEM 35% Brit 40% PRM 25% $10M PRM 25% Schools PRM 25% Schools UE 75% Schools CRL 70% Municipalities PRM 30% Municipalities $3M $500K NPAIP $500,000 SIR

Michael Rhyner, Executive Director MICHIGAN MUNICIPAL RISK MANAGEMENT AUTHORITY Michael Rhyner, Executive Director

MICHIGAN MUNICIPAL RISK MANAGEMENT AUTHORITY Created in 1980 400 members Cities Counties Townships Special districts Community colleges Property and Liability Only Auto Liability Auto Physical Damage General Liability Law Enforcement Liability Public Officials Liability Property

PRIMARY REASONS TO FORM THE CAPTIVE Provided coverages where MMRMA lacks statutory authority Expand product offerings which are not part of MMRMA’s core coverage Provide an alternative to commercial reinsurance for long-term predictability and stability Provide a traditional vehicle for direct partnerships and alliances with other insurance companies Create a “profit center” to benefit members Manage regulations and potential interference

DEVELOPMENT PROCESS Feasibility Study 2013-2014 Decision to Proceed 2015 Selection of Domicile Business Plan & Application Preparation 2016 Application Approved, License Issued, Incorporation & Capitalization Commence Operations 2016

Association Captive Wholly Owned and Controlled by MMRMA Domiciled in Michigan $10 Million Capitalization Interlocking Boards Board of Managers Appointed August 2016 Officially Licensed – December 2016

Programs and Coverages: Tax Collection Bonds for Michigan Counties Statutory Aggregate Excess Coverage for Pools Participation in MMRMA’s Quota Share Casualty Reinsurance Program General Liability Coverage for Other Pools Workers’ Compensation Excess Coverage for Self-Insureds

THE RATIONALE FOR CAPTIVES 2017 Fall Education Forum October 2, 2017 Baltimore Maryland