Current Issues in the Captive Marketplace and Trends for the Future Presented by Kate Westover Vice President, Innovative Captive Strategies Barbados International Business Representative

Continued use even in softening market Majority of captives insure U.S. source business Majority still formed offshore Majority writing casualty, liability risks Majority single owner but use of “cell” companies increasing Up-to-date statistics hard to find! The Captive Marketplace

Sources of Captive Information Captive Insurance Company Reports (CICR) AM Best web site Business Insurance annual survey Captive Review (magazine and directory) Risk Retention Reporter and RRG/PG Directory Captive.com and Captive Guru Domicile web sites e.g. VCIA Captive Insurance Company Association (CICA)

2003 Statistics* Released by AM Best in March 2005 – 561 new captives formed – Record # of liquidations (398) – No figures for segregated cell companies 201 formed onshore (US) Total # domiciles: 43** * Source CICR ** Source BI

Trends in Captive Formations 2003 Vermont 66 Cayman44 South Carolina36 BVI25 Barbados 24 Ireland 24 Hawaii21 Bermuda (7) World wide total active captives over 5,000 Bermuda remains the world leader with 1,150 captives Does not count cell activations

Why so many formations? 2003 Hard market – Insureds control costs by increasing retentions – Group captives access fronting, reinsurance – Coverage focus on traditionally insurable P&C risks – Some new coverages Terrorism Employee benefits – Some state tax planning motives What will happen in a soft market?

2004 Total Licensed Captives* Bermuda1,150- Net change of 0 since 2003 Caymans 694 – Net change of 50 Vermont Net change of 17 Guernsey 410 BVI 350 – Net change of 47 Barbados 257 – Net change of 9 Luxembourg 219 Dublin 214 Isle of Man 175 Turks & Caicos 164 Hawaii 147 South Carolina 114 – Net change of 47 Source: Business Insurance March 2005 – Excludes credit life insurers

Formation Trends 2004 Increased interest in onshore domiciles – Leading offshore domiciles suffer from operating cost inflation – New onshore domiciles actively marketing US captive access to federal reinsurance for terrorism US jurisdiction required for ERISA risks Lingering “Post – Enron” perception issues and desire to be “better” regulated for Sarbanes Oxley compliance Fin 46 - Publicly traded companies cautious about use of offshore Variable Interest Entities

The Spitzer Factor Offshore domiciles scrambling to improve their regulatory reputation Domestic regulators increase level of responsibility of ceding companies to certify transfer of risk – “Finite Risk” becomes suspect – Accountants looking at revising FAS 113 Investigation of “PORCs” as rebating mechanisms – The Title Insurance scandal

The Future of Captives Soft market has not historically slowed captive growth Casualties of soft market – Group captives formed solely for short term price reduction – Single owner captives with financially distressed shareholders Soft market survivors – Group captives with customized and effective loss prevention and claims management programs (and insureds with long memories) – Single owner and segregated cell captives with owners/participants looking to elevate their insurance and risk management strategy

“Elevating” insurance strategy Expanding horizons beyond traditionally insurable risks Focus on responsibilities of company directors Sarbanes-Oxley Act of 2002 NYSE Requirements Organizations need to identify and reduce or stabilize long term cost of risk in order to protect shareholder assets

ERM Focus Define current cost of risk Evaluate the efficiency of current risk strategies Identify opportunities for reducing cost of risk Measure potential impact Determine risk ownership Catalog current controls Develop recommendations This is what a good captive feasibility study does!

Enterprise Wide Risks Operational – Pure risks – natural and manmade perils – Human resources Business – Regulatory and tax – Consumer demand – Technology changes Treasury – Currency, interest rates

Who can/should do this? Organizations with No cash flow or capital constraints Incentive to accelerate tax deduction for incurred losses Desire to “eliminate surprises” around financial results Focus is risk management Complete transparency Not financial statement window dressing Pre-financing risk is in public interest

How/Where To Do It? Pick reputable domicile with appropriate regulatory requirements – Capital efficiency Use of small insurance companies (831(b)) or non controlled foreign corporation (NCFC) segregated cell captives – Allows for faster accumulation of risk taking capacity

What About the IRS? Focus on – Risk transfer – Risk distribution – Standard insurance industry practices Revenue Rulings in 2005 – Confirms a source of risk as corporate entity – Reviewing treatment of cell companies, finite risk programs