Captive Presentation Texas Department of Insurance

Presented by:

Ross Elliott, Captive Insurance Director, Utah Department of Insurance Jeff Kehler, Program Manager, ARTS, SC Department of Insurance David Dimit, Executive Director, MO Captive Insurance Association Rod Morris, Sr. VP, R&Q Quest Management Services Austin, TX November 18, 2013

Rules of the Meeting

Be interactive Ask questions as they occur to you, dont wait for the end of the presentation ilence your cell phone S Learn, share, have some fun

Texas Department of Insurance Captive Presentation

David Dimit, Executive Director, MO Captive Insurance Association

INTRODUCTION TO CAPTIVE INSURANCE

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What Is a Captive?
Much depends upon whom you ask, and when A form of self-insurance in which the structure enables deductions for premiums and loss reserves Theoretically insuring the owner; not the public o, the owners balance sheet rules S

Texas Department of Insurance Captive Presentation

What Is a Captive?
A funding strategy for providing adequate assets to pay for potential claims Owned by an entity associated with an operating company and its affiliates Write policies for specific risks chosen by the operating company and the captive owners Important: Captives are not writing policies for the general public. As an insurer, they have a close relationship with, and operate in conjunction with, the insured
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Why do you want one?

Control of your risk dollars Generally, if you understand risk, you can do it more efficiently than an insurer Get coverage and limits not available ettle claims faster S

Texas Department of Insurance Captive Presentation

Why regulate one here?

There are 20,000+/ -, growing rapidly. Everybody wants one, including your residents Know that it is done well Brings in jobs, money

Texas Department of Insurance Captive Presentation

Types
S ingle parent (pure) Group/ association RRGs S egregated, protected cells

Texas Department of Insurance Captive Presentation

Traditional Market Reaction

Now they love them
Fronting, reinsurance, fees, investments, no piddly claims

ome own their own cells S ome do them badly S

Texas Department of Insurance Captive Presentation

Regulatory Challenges
Do they have the money? Do they know what they are doing? Who are the players? Where (else) are they going to operate? NAIC challenges? ub rosa declinations S

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What do they write?

70% do work comp
HUGE advantage over self insurance

Almost everything else whatever they can afford

Med mal EPLI D & O/ E & O OM KIDNAP/ RANS
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S ize
$200,000 to $1 billion Multiple states, foreign countries 46 of the Fortune 50 Most hospitals

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Taxes
There are tax advantages Must have a qualified tax adviser Taxes cant be the primary or only reason

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Regulation
Important in terms of flexibility The REGULATOR is the most important element in the transaction it is a people business

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Rod Morris, S r. VP, R&Q Quest Management S ervices

LICENSING & SERVICE PROVIDERS

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Licensing Pre-Application Phase

Licensing follows a rigorous and responsible pre-application and application processes to determine a captives feasibility and long-term viability. Phase one: research and analysis-the Consulting phase
Captive Managers help hire & coordinate with other S ervice Providers to determine a captives feasibility, costs, type of captive, best domicile, etc.
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Licensing Pre-Application Phase

Require potential captive owners to put their thoughts into a Business Plan/ Plan of Operation.
forces clarity and discipline formulation of clear objectives Drives a common understanding by all parties.

tudy: Actuarial Feasibility S

loss projections, rate/ premium, the capital & surplus required, etc.

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Licensing Pre-Application Phase

Lawyer--determines the best legal structure
legal liability, tax &, perhaps, wealth preservation draws up the legal documents like Articles, Bylaws .

Many Pures will need Fronts or Reinsurers

Reinsurancefor control of losses Reinsurance Poolsif unable to achieve IRS Insurer status without more risk distribution/ sharing. Frontslaw or clients wont accept unrated captive paper, e.g. WC, AL, or other state exposure.
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Licensing Application Phase

Applications should not be submitted or reviewed piecemeal. Do NOT accept an incomplete app or immature process:
the data must be collected & analyzed, the formal legal documents and status has been achieved, all the service providers are in place, and all of the application required material put together

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Licensing Regulatory Review: Plan of Operation

The Plan of Operation is the Core document which has to be supported by everything else. Require the Plan of Operation to be a concise but comprehensive overview with data and exhibits
purpose of the captive, Org charts its structure, ownership, financing, limits, retained risk, lines of business, atypical results/ expectations for the industry/ class with reasons
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Licensing Regulatory Review: The Numbers

Actuarial ReviewCore document of the numbers
Describes all material reviewed, methodology, credibility Worst, expected, and best case scenarios Rate/ Premium for each coverage Necessary capital and surplus Based on 3-5 years of loss history of captive if possible and of industry if not.
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Licensing Regulatory Review: Legal/ Organizational

THE PARENTSARE THE FOCUS
Annual Report & financial statements from parents

Organizational chart of parents, subs and any other party along with their relationship to the captive Narrative & chart of all beneficial owners with percent of ownership and explanation of relationships

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Licensing Regulatory Review: Legal/ Organizational

If individuals formed a Holding Co. as the captives parent,
get dated and CPA certified 10k or personal financial statements of the individuals forming the Holding Co.

tatements should be signed under Financial S oath by the president & secretary Determine the captives funding source & that it is unencumbered.
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Licensing Regulatory Review: Legal/ Organizational

Determine how the captive will get additional funding if in deficit.
crutinize parental contracts for fairness, arms S length

Funding is in proper form: cash or irrevocable LOC or TX bonds or bonds/ evidence of debt guaranteed by US G

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Licensing Regulatory Review: Legal/ Organizational

Proposed Coverages must be legitimate forms of insurance & risk transfer with clear potential for loss.
Review the actual contracts

crutinize the Bio Affidavits for Directors, S Officers, & S ervice Providers for relevant expertise, standing, experience, potential conflicts, & inconsistencies.
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Licensing Regulatory Review: Legal/ Organizational

uggestion: Application S
Has any domicile declined, suspended, revoked, or taken administrative action on or against an application for ANY kid of insurance entity, ANY company or ANY individual associated with or involved in formation?

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Licensing Regulatory Review: S ervice Providers

Captive Manager Attorney CPA Actuary Financial Institution or Bank

Claims Administrator Reinsurance Broker Fronting Carrier Reinsurers

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Licensing Regulatory Review: S ervice Providers

Trust No One but give deference to those who have earned it in other domiciles BUT
Just because someone is approved in another domicile does not mean they are competent or responsible Contact other regulators for their experience

Review contracts for fairness in terms and pricing.

It may be the captives money but they sometimes need help in not being taken advantage of.
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Licensing Regulatory Review: S ervice Providers

Impose minimum acceptable standards for service providers with no prior captive or insurance experience. Question the captive or captive manager about the weak or inexperienced providers. Refuse any that are suspect. ervice Providers, especially Captive S and/ or Program Managers & Lawyers can do much harm through greed and incompetence.
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Licensing Regulatory Review: S ervice Providers

Poorly constructed Reinsurance Pools can destroy programs and ruin the reputations of everyone involvedespecially the domicile & captive manager. Publish lists of approved service providers
I preferred to approve them for each captive submission. They are only as good as last at bat. If someone turns out to be a crook, the domicile looks foolish and may become liable.
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Ross Elliott, Captive Insurance Director, Utah Department of Insurance Jeff Kehler, Program Manager, ARTS ,S C Department of Insurance

SERVICING, MONITORING, & TRANSACTIONS

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The Utah Paradigm

Business-friendly reputation Educated, responsive work culture S ingle parent, pure captives Rapid growth rate

Some Utah history

2003
Captive Act passed First captive licensed

2006
Captive Insurance Director hired

2007
63 captives licensed

2009
New Captive Insurance Director

Captive Landscape (circa 2009)

UID Captive Employees (circa 2009)

Dedicated staff
One division director Two analysts

Qualifications
FLMI MBA, MAcc, CFE (x2)

Captive Tools (circa 2009)

Binders Folders Microsoft Word Microsoft Excel

Our Responses
Adopt a technology focus
Embrace rocket science

Monitor work flows and deliverables

Maximize blue light time

Accumulate insurance designations

OFE: AFE, CFE S ICCIE: ACI NAIC: APIR, PIR

The Annual Statement Project

Captives dont file the NAIC annual blank No data warehouse for captive financials How to create a custom annual statement?
Adobe Acrobat? Microsoft Excel? FormDocs?

Is the data exportable / extractable? Does the form meet reporting standards?

The Filing Project

Each captive application to be filed in duplicate binders Applications are protected (confidential) documents Where to store 800 binders? Move to electronic filing and archiving (WebTop)

The CRM Project

Captive insurer information tracked in Excel With growth in staff, account reassignments diluted familiarity with each captive insurer Existing UID database system did not provide adequate functionality Minimal budget for application development Internally created Microsoft Access database for tracking captive data - Nexus

The Checklist Project

New regulations could be interpreted differently by different analysts Regulate conservatively and consistently Internal checklists and templates have been created for each different type of event

The Examination Project

Acquire licenses for examination / audit management software (TeamMate) Coordinate with Examinations Division for some consistencies Build distinct captive-oriented exam shells Use experienced examiners as mentors

Monitoring
tep The First S
Ensure the correct arrangement before the certificate of authority is granted Owner, manager, providers, plan of operation, financials, business goals

econd S tep The S

Know your business partners Trust, but verify Dont be afraid to say no

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Monitoring: Financial Analysis

Analyst Duties
Follow up on licensing stipulations & requirements Coordinate with post licensing review ervice request monitoring (as needed) S

Analyst Tools
Annual Report Annual Assessment Actuarys Report & Opinion Auditors Report Company Profile Report
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Monitoring: Financial Analysis

Analyst Focus
Reliance on the work of experts Look for trends Compliance with plan of operation Compliance with statutes and regulations Company familiarity improves understanding Work with captive manager to build relationship and resolve issues or concerns

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Monitoring: Analyst Tool Kit

Plan of operation & revisions
Comport with statute & regulation Look for trends in repetitive, unusual changes
High director or officer turnover Excessive loans to parent Change in manager, auditor, or actuary Reducing levels of retention Dropping lines of coverage Request to reduce capital & surplus requirements

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Monitoring: Analyst Checklist

High-Level Review
The Big Picture: what jumps out at you? Risk-focused like approach Determine need for more granular review

Management Letter
Focus on changes or trends Compare to service requests & plan changes

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Monitoring: Analyst Checklist

Compliance with Licensing Letter
tipulations, Requirements, Conditions S

Loans to Parent & Affiliates

Arms-length transaction Governing document submitted and approved

urplus Capital & S

till in place? Bank okay?) Cash or LC (S Fluctuations statutory or stipulated
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Monitoring: Analyst Checklist

Review of Plan of Operation
Material changes impacting solvency or liquidity Revised financial proformas (expected)

Corporate Governance
Biographical affidavits and background checks ignificant changes to key personnel S Turnover in parent causing turnover in captive

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Monitoring: Analyst Checklist

Company Investments
Filed plan (6 months post licensure) Reasonableness given economic environment Ratio of cash, stocks, bonds, other Liquidity, risk, expectations of returns olvency highly dependent on investment income S elf-managed or investment advisor S Detailed disclosure, avoid broad or ambiguous categories

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Monitoring: Analyst Checklist

Actual to Expected Performance
Explanation of variance Reasonableness of business plan and projections Wide variance, consistently = unsustainable plan Look for trends that may indicate solvency issues

Consistent Hyperbole of Optimism?

Re-evaluate business plan, financial proformas, viability of captive

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Monitoring: Analyst Checklist

Actuarial Report and Opinion
Clean opinion or reason for concern? Actuarial report agrees with Annual Report? Concerns/ issues for follow-up

CPA Report
Clean opinion or reason for concern? CPA report agrees with Annual Report? Concerns/ issues for follow-up
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Monitoring: Analyst Checklist

Reinsurance
Regular review of reinsurer rating Risk transfer V. amount of credit for reinsurance wing rated S
olvency issues? Reflected in proformas? S

Contingent commissions Profit sharing Reinstatement provisions

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Monitoring: Analyst Checklist

Insurer Profile Report
Great tool for summarizing changes and visualizing trends Overview of parent company and captive summary Officers & Directors ummary Table Financial S LCs and Loans Business summary, changes, owners, dividends, providers, compliance issues or concerns tatement of strengths and weaknesses S

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Monitoring: Financial Examinations

Compliance V. Financial
Reliance on CPA report to ascertain financial condition (GAAP reporting, not S AP) Facilitates desk exam instead of in-person Anticipated field work Three year exam, then five year exam Risk-Focused: factors impacting solvency Compliance with laws and regulations

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Monitoring: Examination Focus

Background
Ownership Lines of coverage, limits, and reinsurance Key service providers
Manager Actuary Auditor TPA, or other

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Monitoring: Examination Focus

Department Activities
Financial analyst input Review of analyst work papers, issues, concerns

Management Environment
Captive manager Involvement of owner

upplements to CPA Report S

Fraud risk Inherent risk Control risk

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Monitoring: Examination Focus

Risk of Material Misstatement
Liability for losses and ALAE Reinsurance recoverables Investments Related party transactions Deferred tax assets

ensitivities Planning S
Budget taffing S Time and timing
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All Panel Participants

RED FLAGS AND LESSONS LEARNED

AKA: BEEN THERE, DONE THAT, DIDNT LIKE IT

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Red Flags & Lessons Learned

You are public servants meant to be helpful as well as diligent. The domiciles reputation can be protected only by demanding integrity, quality, and professionalism. Dont let captive parents be absentee or passive. Proper levels of officers and directors must be involved and diligent.
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Red Flags & Lessons Learned

Dont over estimate how informed and capable captive owners and risk managers are. Require that Captive Managers be your allies. Publish your expectations of them. Dont underestimate human nature/ weakness.
Guard against internal politics/ turf battles Where money is involved, integrity of everyone inside and outside, including owners, involved in justifying or approving or monitoring must be closely controlled.
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Red Flags & Lessons Learned

Achievement of IRSstatus is technically not your job BUT IT IS . Be sure that there is at least a plausible rationale. There are very few reputable, responsible, viable & affordable reinsurance pools.
IRSis on the warpath and will embarrass the domicile, the manager, and the owners.

Available & Affordable Fronts are a huge problem also.

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Red Flags & Lessons Learned

Most Pures screw things up out of ignorance rather than malice. Give them a chance to correct non-material violations without too heavy a hand but put controls in place to assure no further violations. Avoid getting the domicile specialized or pigeon-holed.

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Red Flags & Lessons Learned

You will be dealing with na ve owners and thats true even of major corporations with Risk Managers. S ome are too smart by half and think they have the universe all figured out while others just think regulators are a speed bump. Push for independent directors with competence and experience.
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Red Flags & Lessons Learned

Professionalism is defined not by how demanding, unreasonable, or strict you are. Be flexible and rational. Very few things are pristine & unquestionable.

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Final Thoughts, Last Questions Big Thank You!

Ross Elliott, rcelliott@utah.gov Jeff Kehler, jkehler@doi.sc.gov Michael Mead, mmead@mrmeadandco.com Rod Morris, rod.morris@rqih.com

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