Maximizing ART (Alternative Risk Transfer)

1. Maximizing ART(Alternative Risk Transfer) SCCIA Road Show Richard (Dick) C. Goff

2. What is a Captive? • Captives are truly “Special Purpose Insurance Companies.” • They are created primarily to serve a single corporation (or corporate family), members of an association, homogenous groups, an insurance agent’s/broker’s, TPA’s or MGU’s controlled book of business. • The captive’s owner(s) dictate its underwriting and investment policies.

3. What is a Sponsored Captive? • Sponsored captives may be owned by insurance companies, associations or a captive. • Sponsored captives have protected cells. • The term “protected cell” applies to separate insured risks or lines of coverage that are segregated (protected) from other insured risk exposures and liabilities. • Protected cell design structures are flexible in make-up. As examples, they may be made up of single insureds, controlled books of business, homogenous groups or by line of coverage.

4. What is an RRG? • A risk retention group (RRG) is a liability insurance company that is owned by its members. • Under the Liability Risk Retention Act (LRRA), RRGs must be domiciled in a state. • Once licensed by its state of domicile, an RRG can insure members in all states. • Because LRRA is a federal law, it pre-empts state regulation, making it much easier for RRGs to operate nationally. • As insurance companies, RRGs retain risk.

5. What is an RRG? • Avoidance of multiple state filings and licensing requirements. • Member control over risk and litigation management issues. • Establishment of stable market for coverage and rates. • Elimination of market residuals. • Exemption from countersignature laws for agents/brokers. • No expense for fronting fees. • Unbundling of services.

6. Why Form a Captive/RRG? • Provide alternative risk transfer/funding mechanism. • Smooth out insurance cost volatility. • Control coverage design, cost and administration. • Benefit from proactive risk management program. • Provide coverages not otherwise available.

7. Why Form a Captive/RRG? • Gain access to reinsurance market. • May enhance strategic relationships and opportunities. • Capture underwriting profit and investment income. • Creative financial tool. • Long-term fluid investment.

8. What Coverages?* • Medical Malpractice • General Liability • Auto Liability & Physical Damage • Workers’ Compensation • Environmental Liability • Professional Liability • Property • Medical Stop Loss • Short & Long Term Disability • Employee Benefits • Coverages not otherwise available

9. What Coverages?* • These coverages in “most cases” may be reinsured to a captive whether the front is a traditional insurance company or an RRG.

10. What is a Fronting Company? • A fronting company retains responsibility for the captive’s regulatory and statutory compliance, which includes the ultimate financial responsibility for all coverages reinsured within the captive. Reinsurance Captive Insurance Company Fronting Insurance Company

11. What is Involved? Step 1 • Gather underwriting information. • Incorporate received underwriting information into a financial model to determine proposed captive’s financial viability. • Agree whether proposed captive is a “go” or “no go” proposition.

12. What is Involved? Step 2 • An actuarial firm will provide financial models that will include suggested retention limits and capitalization requirements. • Identify and begin dialogue with qualified underwriting partners. • Team members will develop captive’s business plan, which will include marketing and financial sections. • Orchestrate a meeting with selected domicile’s regulators and Department of Labor if appropriate (employee benefits only).

13. What is Involved? Step 3 • Incorporate and capitalize captive and/or RRG. • Complete and file captive’s and/or RRGs applications with the insurance department for approval. • Contract with a captive management company for ongoing mind and management services.

14. What is Involved? Step 4 • “Roll out” program.

15. Small Captive Insurance Co.? • Internal Revenue Code 831 (b) provides a very powerful tax advantage through small insurance companies (captives) to provide them additional financial resources to pay claims. • This advantage assumes insurance tax treatment (as opposed to deposit accounting tax treatment) for the premiums paid to the company. • Legitimate risk is being transferred. • Available to onshore and offshore captives that choose to be taxed as a U.S. company through a 953(c) election.

16. Small Captive Insurance Co.? • IRC Section 831(b) allows for a property and casualty insurance company to elect to be taxed only on its investment income. • The company is able to accumulate surplus from underwriting profits free from tax. • Owners are taxed on dividends and other compensation received from the 831(b) and long-term capital gains rates on any gains from sale or liquidation of their stock.

17. Small Captive Insurance Co.? • Any properly structured and operated insurance captive writing less than $1.2 million of annual premium may elect to be taxed as an 831(b). • Other applications of these codes: • A captive that is in runoff with little or no premium. • A start-up captive in its year of inception, though higher premium levels may be anticipated in subsequent years. • This overview should not be considered tax advice.

18. Benefits of Forming? • Allows a corporate family to cover business risk on a tax-deductible basis with coverage that is not normally available within the traditional insurance marketplace (as examples, contingent sales tax liability and construction rework exposures). • Earned premium accumulates on a tax-free basis (only investment income is taxable as ordinary income). • Annual premium range allowed under Section 831(b): Minimum-0; Maximum $1.2 million. (this flexibility allows the captive insured(s) the ability to allocate premium levels to be paid in, or not, annually).

19. Benefits of Forming? • Coverages may be modified, rewritten, or non-renewed on an annual basis at the insured’s discretion. • Small captive insurance company structures may be used for estate planning, company perpetuation, key employee benefit/compensation package purposes, and to begin to pre-fund the necessary capital and surplus required for a traditional captive structure insuring traditional lines of coverage. • Dividends may be declared to owner(s) on an annual basis, which are taxed at the new capital gains rate of 15%.

20. Small Captive Insurance Co.? Small Captive Insurance Company Premium Premium Insured(s) Owner(s) Claim Pay Claim Pay Dividends Dividends Reinsurance (Optional)

21. Small Captive Insurance Co.? • Premium(s) deductible. • Premium income accumulated tax free. • Investment income taxed as ordinary income. • Dividends taxed at new capital gains rate (15%). • Claim payments are tax neutral.

22. Maximizing ART(Alternative Risk Transfer)

23. Med Mal RRG 10% of Risk Hospital Owned Captive 15% of Risk Sponsored Captive 25% of Risk Clinic 10% of Risk Doctors’ Practice I 25% of Risk Doctors’ Practice II 5% of Risk Doctors’ Practice III 35% of Risk Hospital $1 million per claim $3 million aggregate

24. Richard (Dick) C. Goff The Taft Companies Phone: (877) 587-1763 E-mail: Dick@taftcos.com