365 Days of Captivity A Survivors Guide to Operating a Captive

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365 Days of CaptivityA Survivors Guide to
Operating a Captive

• Presented by
• Peter Joy, ARM Executive VP - Aon Insurance
  Managers
• Michael Sheehan Director and President Tenn
  Re, Inc.
• Pam Cote, CPA - Audit Partner - Saslow Lufkin
  Buggy, LLP

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Agenda the Life Cycle of the Captive

• The captive formation stages
• Pre-renewal planning
• Captive renewal pricing
• Financial Reporting - Actual vs Budget
• Daily Operations
• Business Plan Changes
• Year-end reporting
• Commencement of Audit
• Regulatory statement filing
• Completion of Audit
• Audit Adjustments, Weakness and Deficiency
• Board meeting
• Compliance
• Captive Review

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Captive Feasibility

• Sell to senior management/ownership the business
  reasons for the captive
• Get approval to do feasibility study
• Partner with a good consultant
• Demonstrate the advantages
• Optimal ownership structure
• Form of entity - C-Corp vs LLC?
• Select your insurance or reinsurance markets
• Domicile
• Service providers
• Capitalization and form cash vs LOC vs assets
• Obtain approval to implement the captive

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Captive Implementation

• Select name not as easy as it sounds!
• Identify directors and officers
• Obtain latest actuarial study
• Get market quotations to derive pricing
• Prepare proformas
• Complete the narrative Business Plan
• Select law firm to incorporate the entity
• Complete the captive application
• Attend pre-application meeting
• Always be honest and forthright with the
  regulators
• Submit Application
• Obtain license
• Finalize arrangement with insurer or reinsurers
• Commence business

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Pre-renewal planning

• When should the captive enter the renewal
  discussions? As early as possible!
• Who should be involved? Broker and insured with
  skin in the game
• Program structure deductible/SIR/reinsurance?
• Primary in captive and excess as insurance?
• Full limits in captive and excess as reinsurance?
• What is the best form of collateral?
• Policy writing and issuance. Standard or
  customized?
• Do not be afraid to forego use of the captive
  when capacity is cheap and security is good !

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Captive renewal pricing

• Three usual methods of calculating premium
• Market Rates
• Experience Rating
• Other techniques

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Market Rates
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Experience Rating based on actuarial study
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Other Premium Pricing Techniques

• Exposure based
• Loss experience based
• Mixture of both percentage weighting to each
  factor can be judgmental
• Higher confidence levels
• Discounted vs non-discounted
• Last year /- inflation/growth percentage

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Financial Reporting Actual vs Budget

• Having established premium, compare it closely to
  actual received
• If exposure changes then issue addendum to policy
  and associated invoice
• Are expense deductions taken by the front company
  the same as appears in the contract? Check
  carefully !
• As premium is recorded and earned, adjust IBNR so
  budgeted loss ratio is achieved
• As claims and reserves are recorded, adjust IBNR
• Compare claims with expected and take action !
• Is cash being received in a timely manner?
• Interest income in-line with expectations?

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Financial Ratios

• Which ratios are appropriate?
• Premium to Surplus Ratio (31)
• Reserves to Surplus Ratio (51)
• Combined Ratio (lt100)
• Risk Retention Ratio (max per occurrence loss
  exposure retained by captive to surplus) 10 to
  200
• RBC Tests Does not work well with GAAP
• IRIS Tests Focus is on changes and trends

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Daily operations - Captive Manager

• Act as Principal Representative in Domicile
• Co-ordinate activities of Domicile legal
  representatives, brokers, actuaries and other
  service providers Provision of Financial Services
• Preparation of Financial Statements and Forecasts
  
• Year end audits (Independent auditor, assisted by
  Captive Manager)
• Statutory filings
• Treasury Service Activities
• Financial transactions (Captive Manager and
  Investment Manager)
• Monitoring and processing cash and investment
  activities
• Assisting implementing of with collateral
  requirements LOCs and trusts (Captive Manager,
  Fiduciary, Owner)
• Insurance Services
• Policy documentation
• Mid-term endorsements
• Claims handling (TPA with reports to captive
  manager)
• Business Development
• Periodic reviews of captive utilization and
  development possibilities (Captive
  Manager/Consultant/Broker)
• Implementing new programs

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Daily operations - Captive Owner

• Provide leadership
• Determine the strategic use of the captive
• Set and Manage operational expectations
• Be the ultimate decision maker
• Approve filings
• Approve financials
• Provide necessary data

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Roles and Responsibilities Document in
Procedures Manual
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Business Plan Changes

• Material changes to business written, limits,
  reinsurance, requires prior approval from
  regulators
• Dividends, change in certain investments (loan
  backs) require prior approval from regulators
• Such actions are best recorded as Board decisions
• Rationale for changes should be documented
• Material impact on the captives financials
  require revised projections
• Some changes not to make !
• Canceling reinsurance
• Pledging assets
• Inappropriate investments (e.g. hedge funds)
• Allowing capital and surplus to fall below
  statutory minimums
• Theft of assets

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Year-end reporting

• Very important for consolidation with parents
  year-end results
• Must reflect latest actuarial findings
• Consider actuarial study based on Oct or Nov data
  and then roll forward to Dec
• Forms basis for audit and regulatory filings so
  accuracy is paramount

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Commencement of Audit

• Audit planning meeting several months in advance
• Agree upon timeline and how this will be achieved
• Ensure other service providers agree with the
  timeline
• Prepared by Client (PBC) customized request list
  issued well in advance
• Inform auditors of any major changes in the
  program or in the process
• Photo copying or electronic filing is cheaper
  done by captive manager than by auditor
• Have documentation supporting the main processes
• Avoid Material Weaknesses or Control Deficiency

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Regulatory Statement Filing

• Specialized reporting format required by domicile
• Can be the NAIC Statutory report for certain
  types of captives and domiciles
• Required 90 days after fiscal year-end
• Required 3 months in advance of audit and
  actuarial filings
• Should agree with audit
• Development of losses by line of business
• etc

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Completion of Audit

• Be ready for the start of the audit and ensure
  items requested are available to the auditors
• Inform the auditors of any changes between
  planning and field work
• Early completion means less subsequent events
• Recommend frequent communication with auditors to
  ensure the audit is progressing smoothly

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Audit Adjustments, Weakness and Deficiency

• Audit must be compared with statutory report and
  differences noted within the footnote of the
  report
• Audit Adjustments must be discussed with
  management and provided to the Board
• Material Weaknesses/Significant Deficiencies
  will need to disclose within the letters to the
  Insurance Department
• Management letter recommendations for
  improvements that are not considered material
  weaknesses or significant deficiencies

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Board Meeting

• Get it on everyones calendar early
• Consider special invitees such as
• regulator, investment managers, claims, auditor,
  actuary, reinsurance broker, etc
• Present the important topics such as premium,
  claims, investments, dividends, etc
• Encourage meaningful debate
• Review compliance check-list and ensure adherence
• This may be a once a year opportunity to make an
  impression dont waste it !
• Afterwards.. Have fun !

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Captive Review

• What measures are available to review
  performance?
• Should there be internal/external review how
  often?
• Review of service providers how have they
  performed?
• Things learned for next year

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Types of Review
Full Analytical Review Integrated With Parent Fina
ncial Impact
Financial Performance Ratios
Governance Review
Utilization
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