1 Alternative Risk Transfer/ (fronting) Process by which a primary insurer cedes a portion of the risk it has underwritten to a reinsurer, such as a captive insurance company Ceding company (front) securitizes for projected losses less paid losses while working with the captive to obtain maximum risk finance leverage Front retains primary responsibility for regulatory and statutory compliance Front usually retains some amount of underwriting risk

2 What is Alternative Risk? Alternative risk in an insurance-based product where a substantial portion of the insurance risk is assumed by an entity other than a traditional insurance company.

3 A closely held insurance company whose insurance business is primarily supplied by and controlled by its owners and in which the original insureds are the principal beneficiaries. A captive insurance company’s insureds have direct involvement and influence over the company’s major operations, including underwriting, claims and management policy and investments. Definition of a Captive

4 Pure captive Single-parent captive writing only the risks of its owners and/or affiliates. Captive writing connected business Type 1 insurer writing the risks related to or arising out of the business or operations of its owners and/or affiliates. Captive writing third-party business Captive writing a portion of its net premiums for risks which are unrelated to the business of its owners and/or affiliates. Captive of insurer Single-parent captive owned by a professional insurer and/or reinsurer. Types of Captives

5 Association captive Owned by members of a common industry or trade association in order to share the risks of that industry among its members. Health care captive Owned by a hospital or health maintenance organization and writing the risks of its owners and/or affiliates. Multi-owner captive Owned by two or more unrelated persons and writing the risks of its owners and/or affiliates. Long-term (or life) insurer and/or reinsurer Insurance company writing mainly life insurance as a direct writer and/or reinsurer. Types of Captives

6 Composite Insurance company writing a combination of long-term (or life) business and general business. Rent-a-captive Owned by unrelated persons and providing captive facilities to others for a fee. Agency captive Owned by one or more independent insurance agents to write business that they control. Types of Captives

7 Finite insurer and/or reinsurer Insurance company writing unrelated risks reflecting (i) clearly defined aggregate limits and (ii) anticipated investment income. Professional insurer and/or reinsurer Insurance company writing unrelated risks as a direct writer and/or reinsurer. Types of Captives

8 RANKDOMICILE2000 TOTAL CAPTIVES 1Bermuda1,564 2Cayman517 3Vermont361 4Guernsey375 5Luxembourg264 6Barbados119 7Isle of Man168 8Ireland163 9British Virgin Islands181 10All Other492 WORLDWIDE TOTALS4,204 *Totals increase when take into consideration the numerous segregated cells within various captive companies Captives by Domicile

9 Is The Market Shifting? The alternative market has grown from 21% of commercial premium to 33% of the last 20 years Throughout the last decade traditional commercial line premiums have grown 3% annually, while alternative markets have experienced a 8% annual growth rate The alternative risk market has expanded beyond individual employer programs to group/agency captives

10 All rate, form, reporting rules apply as the standard insurance market. Regulatory Impact

11 May not know they are in a captive May receive captive profits Customer Impact

12 Defends against direct writing, retail, banks selling insurance Increased revenue on profitable business Ability to function as your own insurance company Control of agents own destiny Impact on Independent Agency System

13 PROS Underwriting Profits to Agent/Insured Investment Income to Agent/Insured Direct access to reinsurance market Ability to separate all insurance service components CONS Underwriting risk born by Agent/Insured Possible tax implications Collateral may be required Pros/Cons of a Captive Structure

14 Captive Cycle CAPTIVE TPA Claimant Insured Agent POLICY ISSUING COMPANY PROFITS Reinsurer

15 Underwriting Control

16 Underwriting

17 Alternative Risk – Financial Impact to Client Gross Premium$2,000,000 Loss Fund$1,300,000 Aggregate Stop$1,625,000 Risk Assumption$ 325,000 Expense Components Front7.0% Reinsurance8.0% Rent a Captive1.5% Claims5.0% Taxes4.0% Loss Control1.0% Commission7.5% FET1.0% Total35% Risk Assumption $325,000 Aggregate Reinsurance Captive $1,300,000 Stat/1M $250,000 Aggregate Attachment: $1,625,000 Specific Reinsurance Statutory XS 250,000 W/C 750 XS 250 AL/GL/Prop

18 Captive Structure $148,000 $150,000 $220,000 $592,000 $838,000 $1,085,000 $370,000 $742,000 $988,000 $1,235,000 Current Income65% Loss 50% Loss 40% Loss 30% Loss LevelRatio Ratio Ratio Ratio $150,000 80% Loss Ratio $ 2, % Loss Ratio $300,000 $150,000 $ -150,000