1. STATE OF TENNESSEE CAPTIVE INSURANCE SECTION
DEPARTMENT OF COMMERCE & INSURANCE
CAPTIVE INSURANCE SECTION
Association for Financial Professionals – Nashville
Captive Insurance – A Risk Management Tool
Thursday February 8, 2018
Michael Corbett, Director

2. First a Primer Definitions:
Financial Professional – An individual managing large amounts of money, especially for governments or large corporations.
Insurance - The practice by which a company or government agency provides a guarantee of compensation for a specified loss in return for payment of a premium.

3. Primer (continued)
The management of large amounts of money includes two basic fundamentals:
Improving the investment return on the assets being managed.
Establishing safeguards protecting investments from loss.

4. Primer (continued)
This second fundamental is our focus today. Safeguards almost always involve the concept of “insurance”. Whether hedging a financial investment or buying an insurance policy, it’s all about protection from loss. One method being used by large and small companies is owning a Captive Insurance Company.

5. History of Captive Insurance
19th Century and earlier
Marine Voyages - Early captives shared risks among shippers on the same voyage and among different owners of different voyages.

6. 1920s
European Single-Owner - Captives were formed to respond to the absence or unwillingness of commercial insurers to cover important risks. Some examples are British Petroleum's captive called “Tanker” which was used to insure for shipping risks.

7. 1953
First "Captive“ - Frederic M. Reiss (1924–1993), often called the father of the captive movement, founded Steel Insurance Company of America, a captive developed for an Ohio steel company, from which the term "captive" was borrowed from "captive" mines sending ore to company's mills.

8. 1958
First Bermuda Captive - Fred Reiss set up American Risk Management in Bermuda, where the first captives were domiciled. The three keys to his unique success were as follows:
Captive management in Bermuda offered fronting, administration, governance, reinsurance, and brokerage.
Property loss-control engineering was in-house, with Factory Mutual.
The reinsurance capacity included captives as reinsurers, funneled through a pooling facility.

9. 1976
This was the start of Cayman as a healthcare captive center. The Harvard medical centers' captive met with "resistance" to licensing in Bermuda because of its need to cover individual physicians, so they switched to Cayman. Today, Cayman is the largest offshore domicile for healthcare organizations based in the United States.

10. 1978 – Colorado Tennessee
1980 – Vermont
Nevada
2000 – South Carolina
Utah
Delaware

11. 2011 – Tennessee Governor Bill Haslam and Insurance Commissioner Julie Mix McPeak update captive insurance statute.

13. How Captive Insurance Operates within Traditional Insurance Marketplace

28. Financial Impact of Forming a Captive

29. Who Should Establish a Captive?
Captives should only be formed for non-tax business purposes and should only retain a comfortable level of risk and volatility.
The owners must want to be in the insurance business (willing to assume and share insurance risk).
The captive must be operated as an insurance company (observing formalities and operating at arms length with the insureds).

30. Reasons to Investigate a Captive
Inability to obtain needed coverage.
Coverage is available only at an excessive price.
Widely fluctuating premiums.
Dissatisfaction with claims handling.
Inability to access the reinsurance market.
Desire to capture the commercial insurance company’s profits.
Bring formality to the risk management and financial aspects of retained risk.

31. Tax Consequences - Background
Non-Captive Insurance Taxation
Premiums paid to an unrelated insurance company are deductible.
If a company transfers an equal amount of money to a sequestered account exclusively to pay its claims, that is self-insurance which is not deductible.
The general tax question is whether premium payments to a wholly-owned insurance company are more like deductible third-party insurance or more like nondeductible self-insurance?

32. Balance Sheet & Income Statement Impact
Case Study: Tractors R Us, Inc.

33. Case Study: Tractors R Us, Inc.
Assumptions
Tractors R Us, Inc. is a wholly owned subsidiary of Tractor Holding Company.
Tractor Holding Company (the Parent) will form a captive insurance company called Tractor Insurance, Inc. (the Captive)
Tractors R Us will take 1/4 of their risk from their traditional carrier and put it in the Captive
Tractors R US will also insure some previously uninsured risks in the Captive (theft, deductible reimbursement, etc.)
Let’s look at the Income Statement and Balance Sheet of Tractors R Us.

34. Tractor Holding Company – The Parent
Tractors R Us, Inc.
Tractor Insurance, Inc.
Affiliate

35. Tractors R Us, Inc.

36. Tractor Insurance, Inc. – The Captive
Now let’s look at the Captive. Why would Tractors R Us reduce their cash/net income by $325,000?
$1,000,000 in premiums paid to the captive is wholly owned by the Parent holding company
The Parent holding company becomes more involved in their risk management now that they own their own insurance company
Insurance companies are profitable businesses – Warren Buffet!
The Captive builds surplus over time
Dividends from the Captive to the Parent holding company are tax-free – Cash Flow when Parent needs additional funds

37. Tractor Insurance, Inc. – The Captive

38. Forming a Captive Insurance Company

39. The Captive Formation Process
Select the captive team
Manager
Attorney
Actuary
Accountant
Banker
Choose a domicile
Where is parent or insured located?
Where is risk?
Meet with regulators

40. The Captive Formation Process
Prepare and file the Captive Application
What is risk to be insured?
Biographical affidavits
Business plan
Pro forma financials

41. The Captive Formation Process
Legal Issues and Documents
Charter
Principal place of business and resident agent
Resident director
Bylaws
Organizational consent
Statutory minimum capital
Depository/custodial agreement with Bank
Investment policy
Investment adviser
Ethics policy
Shareholder agreement?

42. Tennessee Statistics Risk Bearing Entities (RBEs) 2011 – 2 RBEs
Total Premiums
$116.5M
$1.0B
Economic Impact (Direct and Indirect Investment in TN)
$32M
$692M

43. STATE OF TENNESSEE CAPTIVE INSURANCE SECTION
DEPARTMENT OF COMMERCE & INSURANCE
CAPTIVE INSURANCE SECTION
Association for Financial Professionals – Nashville
Captive Insurance – A Risk Management Tool
Thursday February 8, 2018
Michael Corbett, Director