The Broker s Role in Developing Captive Management Best Practices

1. The Broker’s Role in Developing Captive Management Best Practices

2. 2 AGENDA Challenging the Broker/Consultant: Key Issues Managing a Captive in Today’s Environment Keeping the Captive relevant The Broker/Consultant’s Role on the “Team” Traditional Governance Developing the Mission Operations/Financial Management Developing the Captive Board’s Agenda and Organizing the Effective Board Meeting Strategic Planning

3. 3 BERMUDA CAPTIVE ‘07 Challenging the Broker/Consultant: Key Issues for Managing a Captive

4. 4 CHARACTERISCS OF A HIGHLY RATED SINGLE PARENT CAPTIVE Quantitative factors Strong balance sheet—capital and surplus = solvency Optimal reinsurance program Conservative reserving Captive is meeting stakeholders expectations see Mission Appropriate investment Liquidity Consistent operating performance

5. 5 CHARACTERISCS OF A HIGHLY RATED SINGLE PARENT CAPTIVE Qualitative Factors Committed financial parent Prudent risk management program Demonstrated interest by parent in captive’s activities and performance Good geographic spread of risk Hidden ROI

6. 6 TEN BEST PRACTICES OF SUCCESSFUL CAPTIVES Devise a living mission statement Establish underwriting discipline Build a responsive management team Develop board member expertise Assume ownership of financial modeling Invest in strategic planning Provide comparative information in shareholder reports Ensure capital adequacy Devote time and attention to managed investments Orient and indoctrinate Insureds See Katherine Westover—”Ten Best Practices of Insurance Companies”—The Risk Report Vol. XXVI No. 8 April 2004

7. 7 CHALLENGES Need for capital-must be managed over time Most fund expected losses + margin. Can’t decrease premium based on book of business. Funding must truly reflect the risk. Managing the discount rate Overhead costs > pure self-insurance Insurance Market Cycles Travel Complex Organizations Underwriting Investment Management Claims Management Loss Prevention

8. 8 KEEPING THE CAPTIVE RELAVANT Cost Stability/Reduction Cushion from commercial market cycles-the Long View Stable funding over time –taming variation Risk Variability (Funding at what confidence level?) Reduce operating/frictional costs (Transparency) Broker: withstanding market cycles

9. 9 KEEPING THE CAPTIVE RELEVANT Maintaining control over what is important Underwriting - Does the Captive have to “beat” the commercial market? Cost allocation Experience rating “FAS 113” “Is it Insurance” ? Claims Management Who is the CMO? Doing business on shore? Indemnification Form Reporting to the Board? Capacity ART—need to create market capacity (capital to support premium) that is not commercially available (until now?) Access to reinsurance not otherwise available Excess/Reinsurance (underwriter’s view)

10. 10 KEEPING THE CAPTIVE RELEVANT Coverage Add cover either restricted or not available in the commercial market Draft policies to meet your firm’s needs Modifying or eliminating exclusions Consent to settle Definition of a claim/trigger Claims-made v. Occurrence coverage Prefunding the tail?

11. 11 KEEPING THE CAPTIVE RELEVANT Creativity Direct issue Excess Programs Reinsurance/Retrocede (horizontal and vertical exposure) Quota share Specific excess of loss Clash cover Batch cover Influencing Institutional Risk Management behavior New uses for the Captive What makes sense?

12. 12 BERMUDA CAPTIVE ‘07 The Broker/Consultant’s Role on the Captive Team

13. 13 CAPTIVE TEAM Board of Directors Risk Manager/CFO of the Parent Captive Management Expertise Broker/Consultant Reinsurance Broker Actuary Underwriting (rating) Claims Management (reduce $) Loss Prevention (reduce #) Legal Counsel Onshore v. Offshore Auditor Banking Investment Management

14. 14 THE BROKER/CONSULTANT’S ROLE ART Feasibility Studies Reinsurance/Insurance Placement Program Design Reviewing Actuarial Analysis Placement Policy Drafting and Issuance Negotiating Front Policy and Collateral Developing Best Practices for Captive Management Governance The Board Meeting Developing Board Reports Strategic Planning

15. 15 GOVERNANCE STRATEGY Risk Management Informed Shareholder Meaningful Board Meetings Qualified service providers Qualify for Best rating Use to effect change Financial Captive is a low priority Meeting avoidance Rubber Stamping Factions Delegation

16. 16 DEVELOP THE CAPTIVE’S MISSION To provide: Stable rates Customized coverage Value-added services By improving the insured's access to: Affordable excess coverage Effective loss control services Proactive claims management

17. 17 DEVELOP THE CAPTIVE’S MISSION Promote a focus on managing risk at the highest level Support the effort to enhance quality of shareholder’s performance Provide flexibility to manage and finance risk Achieve cost effective risk financing programs Assure continued access to insurance and reinsurance for the shareholder Enhance recruitment of quality personnel

18. 18 MANAGE CAPITAL Capital – what is it for? Underwriting risk = 56% Credit risk = 8% Investment risk = 36% CFO – “minimize capital in the captive” Restricted v. Unrestricted funds Balance: Captive’s “needs” to serve its shareholder/insureds’ against shareholder on-shore operations needs

19. 19 CAPITAL MANAGEMENT POLICY STATEMENT Capital should be adequate to support premium growth Possible impact on shareholders’ bond rating Loss reserves should be maintained at high confidence levels Function of volatility/variation Dividends should be regulated by an on going policy Avoid political pressures

20. 20 CAPITAL MANAGEMENT POLICY STATEMENT Additional Margin should be factored in to allow the captive to: Increase limits Change retention Increase exposure base Broaden coverage Cushion market cycles

21. 21 FINANCIAL PERFORMANCE MEASURES Profitability Combined ratio Losses + Expenses/Net Premium Operating ratio Losses + ALAE /Net Premium + Investment income Investment ratio Leverage ratios-Solvency Premium to surplus Risk retention to surplus (10% rule) Reserves to surplus Liquidity (instruments shorter than a year)—Money pay claims Relevant assets/liabilities > .75

22. 22 WHY GET AN A.M. BEST RATING? Satisfy Shareholder/Insured Regulatory Requirements State Bond Authority Enhance access to reinsurance and help reduce its cost Financial security—aids the reinsurance underwriting process Provider greater flexibility in fronting arrangement Manage collateral Help attract and maintain members in Group Captives A marketing tool Facilitate expansion into Third Party Business Marketing tool—adds to piece of mind when there is no State Guarantee Fund protection Brokers’ Role

23. 23 CAPTIVE RISK MANAGEMENT Management Professional Liability for Alternative Risk Transfer Structures and Non-rated Insurance Companies Directors’ and Officers’ Liability Is the Board protected? Impact from third party or unrelated business? Insurance Company Errors and Omissions Bad faith allegations Employment Practices Exposure

24. 24 BUDGET-GENERAL AND ADMINISTRATIVE EXPENSES Losses Captive Management Underwriting Loss prevention Claims management (ULAE) Consultant fees Director fees

25. THE BOARD MEETING WHAT DOES A SUCCESFUL BOARD MEETING LOOK LIKE?

26. 26 WHO BRINGS THE TEAM TOGETHER? Communicating Vision— Initiate and lead strategic planning process Expectations— Service providers agenda Service provider performance standards and review Establish best practices

27. 27 THE BOARD BOOK Who prepares? Contents: Meeting notices Agenda Prior Minutes Audited and Interim Financial Statements Statutory Financial Return Investment Report Managers Report Insurance Market Updates

28. 28 SHAREHOLDER(S) REGULATORY COMPLIANCE- ANNUAL MEETING Annual Directors’ and Shareholder Meeting “Mind and Management Offshore” Venue Who attends Other meetings Operations Committees The “Two Hat” Complex

29. 29 Outgoing Board Meeting Elect chair Approve prior minutes Approve Audited financial Statements Approve Statutory Financial Statements and presentations to shareholder Other Business ANNUAL MEETING

30. 30 ANNUAL MEETING Shareholder Elect chair Approve prior meeting minutes Receive Audited Financial Statements Elect new board Appoint auditor for new year Confirm Acts of outgoing board

31. 31 ANNUAL MEETING New Board Elect chair Elect officers Approve audit fee for new year Go to Operations Meeting

32. 32 PROGRAM STRUCTURE

33. 33 OTHER REPORTING ISSUES Historical Premium by Line of Cover Change in Exposure Data Change in Cost of Risk Change in Cost of Risk/Exposure Unit

34. 34 MARKET UPDATE Primary Local Excess Domestic Bermuda London/Europe ART Trends Tort Reform Change in Regulation Local ART Domicile

35. 35 HISTORICAL CAPTIVE COVERAGE By Policy Period Limits Offered Insureds Fronting Carrier Reinsurance

36. 36 COLLATERAL STACKING

37. 37 CLAIMS REPORTING Large Losses by Line of Coverage Incurred Loss Development for Large Losses At Annual Valuation Dates From Date of Report Incurred Loss History by Policy year by Line of Cover Claim Count History by Policy Year by Line of Cover Changes in Loss Development from Last Report to this year By Policy Year Paid Claim Count Reserves Total Incurred

38. 38 ANALYTICS AND PROJECTED LOSSES Reserve Certification Confidence Level Discount Rate Loss Forecast for New Policy Year (Funding) By Line of Cover Confidence Level Discount Rate Development Issues Changes in Payment Patterns Changes in Exposures Expense Load Cost Assumptions

39. 39 PROPOSED RENEWAL PROGRAM Changes in Retention Changes in Funding at Various Confidence Levels Changes in Limits Offered Changes in Excess/Reinsurance Terms New Programs

40. 40 DOMICILE UPATE Key Regulatory Issues/Proposed Changes Activity Growth in Captives Audit Issues FAS 113 Recognizing unrealized Investment Gains and Losses through the P&L Transparency and Form 990’s

41. 41 STRATEGIC PLANNING Expand Use of the Captive Renewal Strategy Using the Captive to meeting challenges posed by the marketplace Tax Issues Legal Issues Actuarial Issues Reinsurance

42. 42 SWOT ANALYSIS

43. 43 RISK MAPPING

44. 44 THE DIRECTORS’ OPERATING MEETING AGENDA Operational issues Service providers Renewals Approve policies Financial report Underwriting/cost allocation Exposure v experience Rate promulgation Renewal Financial Statements Investment report

45. 45 TEN BEST PRACTICES OF SUCCESSFUL CAPTIVES Devise a living mission statement Establish underwriting discipline Build a responsive management team Develop board member expertise Assume ownership of financial modeling Invest in strategic planning Provide comparative information in shareholder reports Ensure capital adequacy Devote time and attention to managed investments Orient and indoctrinate Insureds See Katherine Westover—”Ten Best Practices of Insurance Companies”—The Risk Report Vol. XXVI No. 8 April 2004

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