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Captives 301. Peter A. Joy, ARM Aon Captive & Insurance Managers Executive Vice President Jim Kasprzyk McDonald’s Corporation Senior Director Corporate Insurance. Purpose of this Session. Give an appreciation of the advanced uses of captives Cell captive Branch RRGs

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slide1

Captives 301

Peter A. Joy, ARMAon Captive & Insurance ManagersExecutive Vice President

  • Jim Kasprzyk
  • McDonald’s Corporation
  • Senior Director Corporate Insurance
purpose of this session
Purpose of this Session

Give an appreciation of the advanced uses of captives

Cell captive

Branch

RRGs

Special Purpose Financial Captives

Domicile Selection

Tax

Pooling Arrangements

831(b) Small Insurance Companies

Case Study – McDonald’s Corp

what is a captive
What is a Captive?

A captive is an Alternative Risk Transfer vehicle

It transfers premium from the insurance marketplace to an alternative vehicle

It is a special form of insurance company that insures or reinsures the risks of related entities and closely managed business partners.

types of captives
Types of Captives

Pure

Multiple captives

Domicile importance

Cell Captives

Branch

Risk Retention Groups

Special Purpose Financial Captives

cell captives
Cell Captives

Various names, eg segregated cell, protected cell, etc

Core is owned by one entity, and ‘cells’ are rented to others

Activity in cell is governed by contractual agreement or preferred share arrangement

‘Capital’ (in the form of cash, LOC, parental guarantee, reinsurance) must cover the maximum risk written by cell

Usually formed for a specific purpose and can be a short-term reaction to the marketplace

Easy exit if the market softens or a pure captive is pursued

Can be incorporated or non-incorporated

slide6

Typical Cell Structure

Insurance Shares (clients)

Management

Shares

Bust

6

Cell

10

Cell

1

Cell

1

Cell

2

Cell

3

Cell

4

Cell

5

Cell

6

Cell

7

Cell

8

Cell

9

Cell

10

Cell

etc...

PROTECTED

PROTECTED

1. Each cell has legal segregation and protection of assets and liabilities

2. Legal segregation and contractual segregation

3. Management shares MAY be at risk

slide7

Cell to Access Reinsurance

INSURED

Management

Shares

Insurance Shares (clients)

Cell

10

Cell

1

Cell

2

Cell

3

Cell

4

Cell

5

Cell

6

Cell

7

Cell

8

Cell

9

Cell

10

Cell

etc...

REINSURER

slide8

Cells to Segregate Liabilities

Separate Insurable Risks

Management

Shares

Cell

6

Cell

10

Cell

1

Cell

1

Cell

2

Cell

3

Cell

4

Cell

5

Cell

6

Cell

7

Cell

8

Cell

9

Cell

10

Cell

etc...

Captive

1

Captive

10

Captive

6

New owners

Each cell holds a separate liability, eg a physician practice, a property subject to legal challenges, etc

branch
Branch

Formed by a pure-captive for a specific purpose in another domicile

It is not an incorporated entity and so the D&O’s are the same as the parent

typical branch structure
Typical Branch Structure

Parent

Specific line of insurance

Branch Captive

Majority of lines of insurance

Branch results are reflected in captive since the branch is not an incorporated entity

Captive

branch to write employee benefits
Branch to Write Employee Benefits

Life or LTD

Insurer

Parent

Employee Benefits Insurance

Reinsurance

Branch Captive

Majority of lines of insurance

Captive

Branch results are reflected in captive since the branch is not an incorporated entity

branch to write surety
Branch to Write Surety

Surety insurance

Parent

HI or NV

Branch Captive

Certificates

of

Insurance

Majority of lines of insurance

3rd-party

Branch results are reflected in captive since the branch is not an incorporated entity

Captive

risk retention group
Risk Retention Group

Operates similar to a group captive yet is regulated under federal legislation

Can write direct – no front company needed

Can operate in a state after it ‘registers’

Can only write liability lines of risk – no WC or property

It is regulated very similar to a regular insurance company

Subject to a great deal of scrutiny

Insureds must be owners and owners must be insureds

typical risk retention group
Risk

Retention

Group

Typical Risk Retention Group

Members

One Time

Capital

OwnerA

Annually

Premiums

OwnerB

If necessary

Surplus

Assessments

OwnerC

Reinsurers

A

Reinsurance(if any)

B

C

physician rrg
Risk

Retention

Group

Physician RRG

Members

One Time

Capital

DocA

Annually

Premiums

DocB

If necessary

Surplus

Assessments

DocC

Reinsurers

A

Reinsurance(if any)

B

C

Profit/Dividends

closed trucking rrg
Risk

Retention

Group

Closed Trucking RRG

Members

One Time

Capital

SubA

Annually

Premiums

SubB

If necessary

Surplus

Assessments

SubC

FMCSA

Evidence

Insurance

State DMV

Customers

special purpose financial captive
Special Purpose Financial Captive

Primary example is the XXX Securitization Captive

Highly valued by Life Insurers

Efficient way to remove redundant statutory reserves from balance sheet

Many states have specific laws to attract such transactions

Some states have simpler, similar laws that allow the captive to reinsure unrelated business

Used to capture another source of income!

domicile selection
Domicile Selection

Domicile decision criteria:

Capitalization requirements

Costs – premium taxes vs license fees

Receptiveness & stability of regulatory environment

Quality of local infrastructure & expertise – or can I use outside vendors?

Flexibility as respects investment portfolio, loan backs, etc

Ease of doing business

Convenience of travel if an annual domicile Board meeting is mandated

Acceptance of non-admitted reinsurance

Geographic Convenience

Dodd Frank Act – Self Procurement Tax

slide19

WA

VT

NH

MT

ND

ME

OR

MN

IO

WI

MA

SD

NY

WY

MI

RI

IA

PA

NE

NJ

CT

NV

OH

UT

IL

IN

DE

CO

WV

MD

CA

VA

KS

MO

DC

KY

NC

TN

AZ

OK

NM

AR

SC

GA

MS

AL

TX

LA

HI

FL

Captive Legislation

Alaska is not shown, but does not have legislation

No Captive Legislation

tax to achieve insurance company status
Tax: to Achieve Insurance Company Status

There must be risk shifting and risk distribution

The risk is shifted from the balance sheet of one entity to the balance sheet of another

A loss passed from the parent to the captive is not shifted, because upon consolidation the loss is returned

A loss passed from one subsidiary to another is shifted, because the subsidiaries are not consolidated together - known as the Brother-Sister Structure

A loss passed from a 3rd-party entity to the captive is shifted because clearly the entities are not consolidated together

Risk distribution invokes the law of large numbers – the premium collected from many is used to pay the losses of the few

third party business
Third Party Business

50%

30%

Case Law

Humana/

Kidde

IRS

Safe Harbor

RR2002-89

sources of third party business
Sources of Third Party Business

Unaffiliated Sources (potentially high risk and may be discouraged by captive regulator)

Affiliated Business

Minority owned joint ventures

Suppliers

Customer Programs

Employee Programs

Pooling

brother sister model
Brother/Sister Model

SUB

SUB

SUB

SUB

SUB

SUB

SUB

SUB

SUB

SUB

SUB

SUB

Safe Harbor – 12 entities

RR2005-40

(5% - 15% premium range)

Case Law – 8 entities

Malone & Hyde

Parent

Proportion of parent risk

insured is not deductible

CAPTIVE

All must have separate balance sheets

No single member LLCs

Subsidiary premiums

are deductible

pooling
Pooling

Sharing in risks of others

Controlled

Reduces volatility

Source of third party business

pooling1
Pooling

Captives

$10m

$15m

$2m

$5m

$5m

$8m

$30m

$25m

Pay in first party

premiums

Pool

$100m

Own proportion of pool:

Premium

Total Pool

10%

15%

2%

5%

5%

8%

30%

25%

pooling2
Pooling

Captives

$10m

$15m

$2m

$5m

$5m

$8m

$30m

$25m

Pay in first party

premiums

Pool Value

$100m

Receive reinsurance

premiums

First Party & Third Party

$1m

$9m

$2.25m

$12.75m

$0.04m

$1.96m

$6.25m

$18.75m

$0.25m

$4.75m

$0.64m

$7.36m

$9m

$21m

$0.25m

$4.75m

$10m

$15m

2%

5%

5%

8%

30%

25%

85%

98%

95%

95%

92%

70%

75%

3rdParty %

90%

831 b election example
831(b) Election - Example

Difference = $351,000

wealth transfer
Wealth Transfer

Pops Co. 1

Insured deducts

premium as expense

(Tax Saving $350k)

Trust 1

Pops Co. 2

Grandson

Pops Co. 3

Inheritance

Insurance

Trust 2

Granddaughter

Pops Co. 4

$1m

No Claims

$1m

Dividend

Auntie Mabel

Captive

Takes

831(b)

election

Pops Co. 5

Shareholders pay

tax at their applicable

rate

Pops Co. 6

Pops Co. 7

Pops Co. 8

putting all the pieces together mcdonald s corp a case study
Putting all the Pieces TogetherMcDonald’s Corp - a Case study

The size of the insurance needs

Differing stakeholder needs

Multiple Captives

Multiple Domiciles

Nothing stays the same…..

mcdonald s corporation inc
McDonald’s Corporation Inc.

$75 Billion in System-wide Sales

32,500 Stores

Operations in almost 120 Countries

81% of locations franchised

% of Profits by Area of the World

47% US

37% Europe

16% APMEA

scope of rm operations
Scope of RM Operations

Property & Casualty Coverage for: US & International Company, Owner Operator and JV Stores

Corporate Insurance Programs such as excess liability, aviation, D & O, Fiduciary etc.

US Owner / Operator Health & Welfare Plan

Estimated Total Insurance Cost: $500 Million

multiple captives
Multiple Captives

Golden Arches Insurance Limited ( GAIL )

Golden Arches Re-Insurance Limited ( GARL )

McDonald’s Owner Operator Insurance Company ( MOOIC )

BRS Insurance Company

creativity needed for health insurance
Creativity Needed for Health Insurance

MIP offers a ‘ limited benefit ‘ plan with three medical options: Basic, Mid 5 and Mid 10

Mini Med Plan

Basic Plan

Maximum Annual Benefit $2,000 per person

$150 Annual Outpatient Deductible

Mid 5 Plan has $5,000 per person benefit

Mid 10 Plan a $10,000 per person benefit

the latest brs insurance company
The Latest: BRS Insurance Company

Arizona captive

A new ‘ Risk Management Tool ‘ for use on future employee benefit programs such as MIP

In the meantime, US Property Insurance Program and re-insurance for US Ronald McDonald House Charity: “package insurance policies”

nothing stays the same
Nothing stays the same…..

Solvency II impacting Dublin captives

New capital requirements, new costs

New Treasurer asking “Why?”

Justify purpose and domicile all over again

Stay ahead of the curve