Alternative%20Risk%20Transfer/%20(fronting)

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
Definition of a Captive
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 companys insureds have direct
involvement and influence over the companys
major operations, including underwriting, claims
and management policy and investments.
4
Types of Captives

• 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.

5
Types of Captives
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.
6
Types of Captives
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.
7
Types of Captives
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.
8
2000 Captives by Domicile
RANK DOMICILE 2000 TOTAL CAPTIVES 1 Bermuda 1,5
64 2 Cayman 517 3 Vermont 361 4 Guern
sey 375 5 Luxembourg 264 6 Barbados 119
7 Isle of Man 168 8 Ireland 163 9 Br
itish Virgin Islands 181 10 All
Other 492 WORLDWIDE
TOTALS 4,204 Totals increase when take into
consideration the numerous segregated cells
within various captive companies.
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
Regulatory Impact
All rate, form, reporting rules apply as the
standard insurance market.
11
Customer Impact

• May not know they are in a captive
• May receive captive profits

12
Impact on Independent Agency System

• 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

13
Pros/Cons of a Captive Structure

• 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

14
Captive Cycle
Insured
Agent
POLICY ISSUING COMPANY
PROFITS
Reinsurer
CAPTIVE
TPA
Claimant
15
Underwriting Control
16
Underwriting
17
Alternative Risk Financial Impact to Client
Expense Components Front 7.0 Reinsurance 8.0 R
ent a Captive 1.5 Claims 5.0 Taxes 4.0 Loss
Control 1.0 Commission 7.5 FET 1.0 Total
35

• Gross Premium 2,000,000
• Loss Fund 1,300,000
• Aggregate Stop 1,625,000
• Risk Assumption 325,000

Stat/1M
Specific Reinsurance Statutory XS 250,000 W/C 750
XS 250 AL/GL/Prop
250,000
Risk Assumption 325,000
Aggregate Reinsurance
Captive 1,300,000
Aggregate Attachment 1,625,000
18
Captive Structure
1,235,000
1,085,000
988,000
742,000
838,000
592,000
370,000
220,000
80 Loss Ratio
100 Loss Ratio
150,000
150,000
150,000
150,000
150,000
150,000
150,000
148,000
300,000
Current Income 65 Loss 50 Loss
40 Loss 30 Loss Level Ratio
Ratio Ratio Ratio
2,000
-150,000