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Captives 301
1
Peter A. Joy, ARMAon Captive & Insurance Managers
Executive Vice President
Jim KasprzykMcDonald’s Corporation
Senior Director Corporate Insurance
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
2
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.
3
Types of Captives
Pure Multiple captives Domicile importance
Cell CaptivesBranchRisk Retention GroupsSpecial Purpose Financial Captives
4
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
5
Typical Cell Structure
Cell1
Cell2
Celletc...
Management
SharesCell3
Cell4
Cell5
Cell6
Cell7
Cell8
Cell9
Cell10
Insurance Shares (clients)
Cell10
Cell1
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
Bust6
PROTECTED PROTECTED
6
Cell to Access Reinsurance
Cell1
Cell2
Celletc...
Management
Shares
Cell3
Cell4
Cell5
Cell6
Cell7
Cell8
Cell9
Cell10
Insurance Shares (clients)
Cell10
INSURED
REINSURER
7
Cells to Segregate Liabilities
Cell1
Cell2
Celletc...
Management
SharesCell3
Cell4
Cell5
Cell6
Cell7
Cell8
Cell9
Cell10
Separate Insurable Risks
Cell10
Cell1
Each cell holds a separate liability, eg a physician practice, a property subject to legal challenges, etc
Cell6
8
Captive 1
Captive 6
Captive 10New
owners
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
9
Typical Branch Structure
Parent
Captive
Majority of lines of insurance
Specific line of insurance
Branch Captive
Branch results are reflected in captive since the branch is not
an incorporated entity
10
Branch to Write Employee Benefits
Parent
Captive
Majority of lines of insurance
Employee Benefits Insurance
Branch Captive
Branch results are reflected in captive since the branch is not
an incorporated entity
11
Life or LTD Insurer
Reinsurance
Branch to Write Surety
Parent
Captive
Majority of lines of insurance
Surety insurance HI or NVBranch Captive
Branch results are reflected in captive since the branch is not
an incorporated entity
12
Certificatesof
Insurance
3rd-party
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
13
Risk
Retention
Group
Typical Risk Retention Group
SurplusAssessments
Capital
Premiums
If necessary
One Time
Annually
Owner
A
Owner
B
Owner
C
Members
Reinsurance(if any)
A
B
C
Reinsurers
14
Risk
Retention
Group
Physician RRG
SurplusAssessments
Capital
Premiums
If necessary
One Time
Annually
Doc
A
Doc
B
Doc
C
Members
Reinsurance(if any)
A
B
C
Reinsurers
15
Profit/Dividends
Risk
Retention
Group
Closed Trucking RRG
SurplusAssessments
Capital
Premiums
If necessary
One Time
Annually
Sub
A
Sub
B
Sub
C
Members
Evidence Insurance
FMCSA
State DMV
Customers
16
Special Purpose Financial Captive
Primary example is the XXX Securitization Captive
Highly valued by Life InsurersEfficient way to remove redundant statutory
reserves from balance sheetMany states have specific laws to attract
such transactionsSome states have simpler, similar laws
that allow the captive to reinsure unrelated business
Used to capture another source of income!
17
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 ConvenienceDodd Frank Act – Self Procurement Tax
18
WA
CA
IO
NV
MT
OR
WYSD
UTCO
ND
HI
NMAZ
TX
AR
KS
NE
OK
MS
LA
OH
NC
MO
IA
MN
ME
FL
TN
NY
PA
KY
IN
MI
IL
WI
GA
MA
NH
WVVA
AL
SC
DE
RI
CTNJ
VT
MD
DC
No Captive Legislation
Captive Legislation
Alaska is not shown, but does not have legislation
19
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
20
Third Party Business
IRSSafe HarborRR2002-89
Case LawHumana/
Kidde
30%
50%
21
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 ProgramsEmployee Programs
Pooling
22
Brother/Sister Model
CAPTIVE
Proportion of parent risk insured is not deductible
Subsidiary premiumsare deductible
Safe Harbor – 12 entitiesRR2005-40(5% - 15% premium range)
Case Law – 8 entities Malone & Hyde
SUB
All must have separate balance sheetsNo single member LLCs
SUB SUB SUBSUBSUBSUBSUBSUBSUBSUBSUB
Parent
23
Pooling
Sharing in risks of others Controlled Reduces volatility Source of third party business
24
Pooling
$10m $5m $5m $8m $30m $25m$2m$15m
10% 5% 5% 8% 30% 25%2%15%
Pool$100m
Pay in first partypremiums
Captives
Own proportion of pool:PremiumTotal Pool
25
Pooling$10m $5m $5m $8m $30m $25m$2m$15m
$10m 5% 5% 8% 30% 25%2%$15m
Pool Value$100m
Pay in first partypremiums
Captives
Receive reinsurance premiums
First Party & Third Party
$1m$9m $0.04m
$1.96m $0.25m$4.75m
$0.64m$7.36m
$9m$21m
$6.25m$18.75m
$2.25m$12.75m $0.25m
$4.75m
3rd Party % 90% 85% 95% 92% 70% 75%98% 95%
26
Federal Tax Accounting
Insured Captive Consolidated
Premium Deduction ($10) ($10)
Premium Income $10
Loss Reserve Deduction ($ 8)
Net Captive Income $ 2 $ 2
Net Consolidated Deduct ($ 8)
Tax Benefit @ 40% $3.2
27
831(b) Election - Example
Insurance Company Without Election
Insurance Company With Election
Premium $1,200,000 $1,200,000
Claims $200,000 $200,000
Underwriting Profit/Loss
$1,000,000 $1,000,000
Investment Income $10,000 $10,000
Total Income $1,010,000 $1,010,000
Taxable Income $1,010,000 $10,000
Tax @ 35% $353,500 $3,500
Net Income $656,500 $1,007,500
Difference = $351,000
28
Wealth Transfer
Trust 1
Grandson
Trust 2
Granddaughter
Auntie Mabel
InheritanceInsurance
Pops Co. 1
Pops Co. 2
Pops Co. 3
Pops Co. 4
Pops Co. 5
Pops Co. 6
Pops Co. 7
Pops Co. 8
Insured deductspremium as expense(Tax Saving $350k)
No Claims$1m
Dividend
$1m
CaptiveTakes831(b)
election
Shareholders paytax at their applicable
rate
29
Putting all the Pieces TogetherMcDonald’s Corp - a Case study
The size of the insurance needsDiffering stakeholder needsMultiple CaptivesMultiple DomicilesNothing stays the same…..
30
McDonald’s Corporation Inc.
$75 Billion in System-wide Sales32,500 StoresOperations in almost 120 Countries81% of locations franchised% of Profits by Area of the World
47% US 37% Europe 16% APMEA
31
Scope of RM OperationsProperty & 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
Golden Arches Insurance Limited ( GAIL )
Golden Arches Re-Insurance Limited ( GARL )
McDonald’s Owner Operator Insurance Company ( MOOIC )
BRS Insurance Company
33
Creativity Needed for Health Insurance
MIP offers a ‘ limited benefit ‘ plan with three medical options: Basic, Mid 5 and Mid 10
Mini Med PlanBasic Plan
Maximum Annual Benefit $2,000 per person $150 Annual Outpatient Deductible
Mid 5 Plan has $5,000 per person benefitMid 10 Plan a $10,000 per person benefit
34
The Latest: BRS Insurance Company
Arizona captiveA 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”
35
Nothing stays the same…..
Solvency II impacting Dublin captivesNew capital requirements, new costsNew Treasurer asking “Why?”Justify purpose and domicile all over againStay ahead of the curve
36
ANY QUESTIONSANY QUESTIONS?37
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