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

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.

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

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

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”

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

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

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.

Tax Facts & Circumstances

Tax Facts & Circumstances

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

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.

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

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

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