SRMC Fall Conference 2012
Captives,
Microcaptives and More…..
Presentation by:
Kathryn Marsh
Somers Risk Consulting
[email protected]
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Somers Risk Consulting
• Captive Overview
• Micro-captives
• Risk Pooling Arrangements
• Case Studies
• Steps for Looking at the Captive Option
• Q&A
• Info on Somers Risk and Bio
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Agenda
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What is a Captive?
A captive is an insurance company that insures the
risks of its owners, affiliates, or a group of companies.
It issues policies, collects premiums, and pays claims.
Characteristics of Captives
• Licensed Insurance Company
• Formed to insure or reinsure the risk of its owners or
unrelated parties of their choosing
• Regulated under special legislation regulating captives
(regulated less stringently than state insurance laws which
govern fully admitted insurance companies)
• Located offshore or onshore – many domiciles available
• Admitted only in its domicile and non-admitted in all other
jurisdictions.
Somers Risk Consulting
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Reasons to Form a Captive
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 Micro-Captive/831(b) Captive – is a single parent captive
writing smaller premiums that has special tax benefits. These
are focused on small to mid-size businesses.
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 Single Parent Captive – insures the risk of the
owner and it subsidiaries, traditionally used by large
companies
 Group /Association Captives – owned & operated
by a group of members; 100% of risk and assets
pooled
 Sponsored/Rent-a-Cell /Segregated Cell/Series
Captive – owned & operated by a sponsoring entity; liabilities
and assets legally segregated
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Types of Captives
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Micro-Captive option
• Heightened awareness of ability to control risk management costs
• Potential to insure and pre-fund enterprise risks
• Potential to share risk and decrease exposure to catastrophic or
large losses
• Asset protection
• Favorable tax treatment
• Estate planning/wealth transfer
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• Increased awareness of this option amongst attorneys,
financial planners, accounting firms, consultants, etc.
• Increased sophistication of small and medium sized
companies
• Recognition of the following benefits:
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• In recent years, increased focus on Micro-Captives as a
result of:
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Somers Risk Consulting
• Section 831(b) of the IRS Code
allows Property/Casualty insurance
companies writing under $1.2
million in premium to be taxed on
investment income only. They are
not taxed on underwriting income.
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What is a Micro-Captive?
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Somers Risk Consulting
• Premium payments from company to insurance
company are a tax-deductible expense
• Premium less losses/expenses = underwriting profits grow in captive untaxed
• Annual – therefore, ability to have significant tax-free
growth
• Typically, tax will be paid on dividends when paid currently at 15% dividend/capital gains rates
• Potential for no-tax exit strategy
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How does it work?
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An Example
Financials Assuming No Losses – Single Year
Insured Company’s financials:
Premium payment
Tax Deduction
After tax cost
$1,000,000
400,000
$600,000
Net Cost = $600,000
$1,000,000
70,000
-0930,000
-0$930,000
Net Value = $930,000
Annual Benefit = $330,000*
Assumptions:
Captive qualifies as a bona fide insurance company
Tax rate is 40% (combined federal and state)
Investment income is ignored (will be subject to taxation – typically federal only, not state)
Assumes no losses. Loss activity will reduce benefit.
There will be a capital requirement in the first year of captive formation - $120K minimum
*Although tax savings are significant, the primary reason for forming a captive should not be tax motivation but to meet
risk management needs.
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Premium income
Captive Admin Expenses
Losses
Underwriting Income
Tax due
After tax Retained Earnings
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Captive Insurance Company financials:
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An Example
Financials Assuming No Losses – After 5 Years
Insured Company’s financials:
Premium payment
Tax Deduction
After tax cost
$5,000,000
2,000,000
$3,000,000
Net Cost = $3,000,000
$5,000,000
350,000
-0$4,650,000
-0$4,650,000
Net Value = $4,650,000
Five Year Benefit = $1,650,000
Assumptions:
Captive qualifies as a bona fide insurance company
Tax rate is 40% (combined federal and state)
Investment income is ignored (but will be subject to taxation – typically federal only/not state)
Assumes no losses. Loss activity will reduce benefit.
There will be a capital requirement in the first year of captive formation - $120K minimum
*Although tax savings are significant, the primary reason for forming a captive should not be tax motivation but to meet
risk management needs.
Somers Risk Consulting
Premium income
Captive Admin Expenses
Losses
Underwriting Income
Tax due
After tax Retained Earnings
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Captive Insurance Company financials:
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An Example –
Estate Planning Vehicle
With Captives owned by Three Heirs – After 5 years
Insured Company’s financials:
Net Cost = $9,000,000
$15,000,000
Unknown but tax rates have been as high as 55-60% in past
$ 5,250,000
Total of Financials of Captive Insurance Companies owned by 3 Heirs :
Premium income
Captive Admin Expenses
Losses
Underwriting Income
Tax due
After tax Retained Earnings
$15,000,000
1,050,000
-0$13,950,000
-0$13,950,000
Net Value = $13,950,000
Five Year Benefit =
$5,250,000 + $4,950,000= $10,200,000
Assumptions:
Captive qualifies as a bona fide insurance company
Tax rate is 40% (combined federal and state)
Investment income is ignored (will be subject to taxation - typically federal only/not state)
Assumes no losses. Loss activity will reduce benefit.
There will be a capital requirement in the first year of captive formation - $120K minimum
*Although tax savings are significant, the primary reason for forming a captive should not be tax motivation but to meet risk
management needs.
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Reduction in Value of Estate
Reduction in Estate Taxes
Assume 2012 35% Rate
$15,000,000
6,000,000
$9,000,000
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Premium payment
Tax Deduction
After tax cost
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Good Candidates are …
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• Typically $10 million + in gross revenue
• Pre-tax profits of at least $1MM
• Stable cash flow
• Substantial self-insured / uninsured business risk
• Larger companies who intend to grow a captive
over time but like the opportunity to start with a low
capital base and an immediate quantifiable economic
benefit
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• Small to mid-size private companies
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Industries include:
Construction
Real Estate
Transportation
Agriculture & Livestock
Manufacturers
Professional/Financial Services Firms
Franchisees
Hospitality
Medical Services
Most!
Somers Risk Consulting
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Types of Risk
Somers Risk Consulting
• Enterprise risks that are currently not
insured
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• Work best for risks that have possibility but
low probability of loss
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Examples of Coverages
Professional Liability Gap Coverage  Loss of Key Customer
 Loss of Key Supplier
 HIPAA/Billing Audit Liability
 Loss of Key Contract
 Contractual Liability

 General Liability DIC
 Professional Misconduct
 Cyber Liability
 Product Recall
 Intellectual Property
 FDA Administrative Actions Liability
 Environmental Liability
 Product Liability DIC
 Regulatory Changes
 Directors and Officers Liability
 Collections
 Punitive Damages
 Product/Service Rework
 Labor Shortage/Strike Loss
Reimbursement
 Employment Practices
 Employee Dishonesty
 Loss of Key Employee
 Deductible Reimbursement (Property,
Workers Comp, General Liability, Product
Liability)
 Patent Infringement/Intellectual
Property
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• Captive must be considered a bona fide insurance company.
Therefore, there must be risk spread and distribution from
either:
• Several legal entities
• Source of 3rd party business
• Captive must operate in a manner consistent with
traditional insurance companies
• Insured must be a current taxpayer in order to benefit from
831(b) status
• Must be able to justify premium level
• Must consider capitalization requirements (high policy limits
typically mean higher capitalization especially with low
frequency)
• Captive will typically incur costs of approximately $40-70K per
year for captive management fees, audit and actuarial fees,
domicile fees and travel.
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Further Considerations
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Somers Risk Consulting
• Many companies don’t have the appropriate risk
spread to qualify as an insurance company
• Participation in a risk pool provides third party risk
• Various pools available but most are similar to those
that follow
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Risk Pools – What and Why?
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Enterprise Risk Pool
Premium
Risk Pool
Quota
Share %
X Premium
Quota
Shared
Premium
Unrelated
Premium
$0.89
$4 x $18 =
$18
$4
$1.33
$4
A’s
Captive
$6
B’s
Captive
$8
C’s
Captive
$1.78
$6
Total
Pooled
Premium
=
$18
$1.00
$6 x $18 =
$18
$2.00
$3.00
$1.78
$8
$8 x $18 =
$18
$2.67
$3.55
Enterprise Risk Pool
• 115+ Pool Participants
• $50MM + in total pool premium
• No policy limits in excess of $1,000,000
• Participant share of pool varies from 0.034% to 1.294%
• Example: Assume the max loss for single claim covered by pool ($750,000)
• Loss paid by lowest percentage captive participant = $255 (0.034% x
$750,000)
• Loss paid by highest percentage captive participant = $9,705 (1.294% x
$750,000)
• All policies in the pool must meet strict UW guidelines established by the pool.
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• Example: On a $1,000,000 claim in the pool (the max. policy limit), the first
$250,000 will be paid by the insured business, or that business’ captive
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• The frequency layer of risk (the first 25% of all claims) is retained by either the
captive or the insured
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Terrorism Risk Pool
•Operating
Business A
•Operating
Business B
•Operating
Business A’s
Captive
•Operating
Business B’s
Captive
•Terrorism
Insurance
Provider (“Pool”)
•Operating
Business C
•Operating
Business D
•Operating
Business C’s
Captive
•Operating
Business D’s
Captive
 Each Operating Business will pay 30%-50% of its captive premium to the Pool in return for terrorism coverage.
 The Pool then reinsures its risk with each Operating Business Captive in the same percentage that the Operating
business’s premium represents.
Example: Assume Operating Business A pays $200k to the Pool and that $200k premium represents 2% of
•all premiums received by the Pool. The Pool will then pay Operating Business A’s Captive $200k to reinsure 2%
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of the Pool’s total risk (i.e. 2% of all of the other participating Operating Business’s risk).
Ownership Options
Shareholders
Key Employees
Captive
Captive
Family
Estate Plan Trust
Estate Planning With a Captive
Child Trust
Mom / Dad
Mom / Dad
1%
LLC
Business
1.2 M P&C Premiums
Captive
Investments
99%
99%
Case Studies
Case Study 1
Client – Large Trucking Company
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Facts:
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Poor but improving loss experience, considerable resources committed to improvement
•
High premiums, no credit for improving loss experience
•
High AL deductibles, expensive premiums, limited cash available to establish captive
•
Private Company, several subsidiaries, owned by Parents with 2 sons involved in business
Solution:
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Established captive and wrote $150K xs $100K first year to keep premium and capital at
affordable level. Qualified for 831(b) status and aided by favorable tax treatment.
•
As funds in captive grew, company felt comfortable increasing retentions and decreasing
commercial premium charge. Over time, increased deductibles to $500K, $750K and
eventually became a qualified self-insured. Still use captive to write the self-insured risk.
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Write bob-tail liability exposure of independent drivers to provide a source of third party
risk to strengthen tax position.
•
Recently established an additional captive owned by the sons. As well as having a risk
management purpose, this allows for transfer of wealth and serves as an estate planning
tool.
Case Study 2
Client – Time Share Company
• Facts:
• Wanted to establish captive as a risk management tool to ultimately have more control
and less cost.
• Did not have enough subsidiaries to be qualify for favorable insurance accounting
treatment.
• Solution:
• Identified source of third party business - sell credit life and unemployment insurance
on loans they finance.
• Developed fronted program using an A-rated carrier
• Obtained appropriate licensing (limited lines licenses – full agent’s license is typically
not required)
• Now have a substantial additional source of revenue and a tax-efficient captive !
Case Study 3
Client – Time Share Company
• Facts (similar to prior case)
• Wanted to establish captive as a risk management tool to ultimately have more control
and less cost.
• Also was motivated by estate planning need and desire for tax efficiencies of 831(b) IRS
code.
• Did not have enough subsidiaries to be qualify for favorable insurance accounting
treatment.
• Solution:
• We suggested credit life program but client did not want to go through training and
licensing requirements.
• Established a captive owned by combination of parents and majority aged daughter.
• Used the enterprise risk pool arrangement . Sharing of exposures above primary layer
for coverages including: regulatory risk, mold, general liability gap, cyber liability, etc.
• Accomplishing reduced exposure to large, previously retained losses and very tax
efficiently transferring wealth to daughter and providing parent’s with a retirement
vehicle.
Case Study 4
Client – Agricultural and Canning
•
Facts:
•
Wanted to build a fund to insure retained risk from high deductibles, environmental (holding
ponds with potential substantial exposure), commodity risk and key customer/contract exposure
•
Business owned primarily by 2 retiring brothers and several adult children involved in business –
estate planning motive
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Cash rich company
Solution:
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Program is still under development but initially will establish 3 Micro-captives owned by
combination of children.
•
Will use the enterprise risk pool initially for first 3 captives. Will likely establish a forth Micro-
captive using the terrorism pool.
•
Accomplishes risk management goals and, at the same time, is transferring over $4 million out of
the parent’s estate each year in a very tax-efficient manner.
Case Study 5
Client – MGA
• Facts
• MGA specialized in coastal homeowners policies – mainly vacation homes. State
flood pool covers this exposure and their program covers ex-wind.
• Have a large book of very profitable business with years of historical experience.
• Want to receive more of the profits than they are receiving under current
commission structure
• Solution:
• Established an offshore captive (onshore domiciles typically do not like unrelated,
third party risks).
• Established a fronted arrangement with an A-rated insurer.
• Write the business on a quota share basis with excess reinsurance, with captive
taking most of the risk.
•
Over time, intent is to write 100% of risk. In meantime, considerable profits that
were previously transferred to insurance company, are being retained.
Why a Captive? Benefits to Client and
Consultant
Why Captives are Formed – Benefits to Client
• To reduce total cost of risk
• To provide increased control over risk management program
• To provide coverage where there is a lack of available coverage in
marketplace
• To provide premium stability
• To create a new profit center
• To provide increased control over claims process
• To improve consolidated tax position
Additional Benefits to Consultant or Broker
• Proactively discussing the captive option wards off competitors who may
use a captive presentation as a door opener.
• Promotes a sense of goodwill – client recognition of the potential valueadd and recognition that you are seeking options in client’s best interest.
• Having a captive in place tends to tie a client more closely to the parties
involved with that captive.
• Captive provides more options when marketing program in marketplace
• Good prospecting tool
The Feasibility Process
Captive Feasibility
Feasibility study = Does a captive make sense for us?
Study should:
• identify potential risks of the captive and structure the program, ownership,
select domicile, etc.
• analyze the business andfinancial effects of the captive on its owners
• discuss the cash flow/ tax benefits
• Provide all necessary information for owners to make an informed decision!
Captive Formation Process
Captive makes business and financial sense.
- Now What?
• Draft operations plan and financial projections
• Meet with regulators in chosen domicile
• Submit captive application & all required documentation to regulator.
• Educate, inform and respond to regulators. Amend business plan if
necessary.
• Obtain approval. Incorporate & capitalize company.
[email protected]
770-645-2242 (o)
770-286-7551 (c)
Somers Risk Consulting
Contact: Kathryn Marsh
Somers Risk Consulting
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For more information….
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Kathryn Marsh, Managing Director
Somers Risk Consulting
Kathryn has a Bachelor of Business Administration degree majoring in Insurance from St. John’s
University in New York and an MBA with a double major in Finance and Multinational Management
from the Wharton School of the University of Pennsylvania. She holds the Chartered Property and
Casualty Underwriter (CPCU) and Associate in Risk Management (ARM) designations.
Somers Risk Consulting
Prior to establishing Somers Risk Consulting, Kathryn held high level consulting positions with
boutique captive consulting firms as well as large firms such as KPMG and AON. At AON she headed
the company’s regional quantitative and alternative risk groups, and was Chair of the company’s
Captive Council, a network of the key captive personnel worldwide. Her employment at KPMG was
within the Structured Risk Financing Group of KPMG’s Tax Practice where she was fully immersed in
captive tax strategy. Kathryn also spent a number of years managing captive insurance companies in
Bermuda with Marsh and was the Director of Risk Management for NCR Corporation. Most recently
she was the insurance expert within the management team of a cell phone insurance company where
she structured and implemented the risk program which helped grow the entrepreneurial company
into one that was recently acquired by Brightstar, a $5 billion global distributor of mobile
communication equipment.
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Kathryn Marsh is a seasoned consultant within the alternative risk industry with over 30 years of
experience in various facets of the industry. After many years of working for various large and small
companies, she has formed Somers Risk Consulting which specializes in captive and alternative risk
consulting and captive management.
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