Dr. James Kallman, ARM 8-1 Advanced PowerPoint Presentation ©2009 The National Underwriter Company

Dr. James Kallman, ARM 8-1

AdvancedPowerPointPresentation

©2009 The National Underwriter Company

Dr. James Kallman, ARM 8-2

This Advanced PowerPoint Presentation accompanies the “Tools & Techniques of Risk Management & Insurance” textbook. Each of the 28 chapters in the textbook are presented here in the following sections:

OutlineKey conceptsMajor sectionsChapter summary

©2009 The National Underwriter Company

©2009 The National Underwriter Company Dr. James Kallman, ARM 8-3

Contents

Techniques of Risk Management & InsuranceCh 1 Introduction to Traditional Risk Management……………1-5

Ch 2 Enterprise Risk Management…………………………….2-1

Ch 3 Risk Assessment: Identification…………………………..3-1

Ch 4 Risk Assessment: Quantification…………………………4-1

Ch 5 Overview of Risk Treatment Alternatives………………. 5-1

Ch 6 Non-insurance Transfer of Risk…………………………. 6-1

Ch 7 Insurance as a Risk Transfer Mechanism……………….7-1

Ch 8 Overview of Alternative Risk Transfer Techniques……..8-1

Ch 9 Global Risk Management…………………………………9-1

Ch 10 Loss Control Techniques………………………………..10-1

Ch 11 Emergency Response Planning………………………..11-1

Ch 12 Business Continuity Planning…………………………..12-1

Ch 13 Claims Management……………………………………..13-1

Ch 14 Monitoring Claims for Financial Accuracy……………..14-1

Ch 15 Insurance Companies and Risk Management………..15-1

Ch 16 Working with an Agent or Broker……………………….16-1


Contents

Tools of Risk Management & Insurance

Ch 17 Commercial General Liability Insurance……………….17-1Ch 18 The Workers’ Compensation System………………….18-1Ch 19 Commercial Property Insurance………………………..19-1Ch 20 Directors and Officers’ Liability Insurance……………..20-1Ch 21 Employment-Related Practices Liability Insurance…..21-1Ch 22 Business Automobile Insurance………………………..22-1Ch 23 Crime Insurance………………………………………….23-1Ch 24 Capital Markets Risk Transfer Tools…………………..24-1Ch 25 Loss Control Tools……………………………………….25-1Ch 26 The Certificate of Insurance…………………………….26-1Ch 27 Surety Bonds……………………………………………..27-1Ch 28 Claim Reviews……………………………………………28-1


Chapter 8Overview of Alternative Risk Transfer Techniques

Outline• What is Alternative Risk Transfer (ART)?

• Step One: The Options

• Step Two: Funding Loss Retentions

• Step Three: Understanding Types of Captives

• Step Four: Choosing a Captive Domicile

• Step Five: Reviewing the Differences

• Advantages of a Group Captive

• Potential Disadvantages of a Captive

• Step Six: The Captive Feasibility Study

• Step Seven: Understanding Captive Tax Issues

• Other Alternative Risk Financing Techniques

• Chapter Summary



What is Alternative Risk Transfer (ART)?• Defined: a collection of risk financing techniques

• The ART market is the set of products and services

• All ART techniques contain significant risk retention

• ART topics:

• ART retention types

• Funding loss retentions

• Captives

• Finite Risk contracts



Step One: The Options• Risk retention connotes

• retention of risk, and

• the responsibility for managing risk

( loss control, claims mgmt, and reinsurance)

• Retention requires three characteristics:

• losses predictable in amount and frequency

• non-catastrophic losses

• insurance premiums are not a good value

• Non-insurance (being uninsured) is not a deliberate act



Step One: The Options• Types of retention

• Per-loss (straight dollar) deductible – per occurrence

• Annual aggregate deductible – per year

• Percentage deductible – proportion of each loss

• Franchise deductible – per-loss that disappears at max

• Waiting period deductible – time deductible

• SIR – Insured pays first dollar losses up to retained limit

(may be subject to deductible stacking)

• Qualified self-insurance – retention plan complying with state regulations



Step Two: Funding Loss Retentions• Two main categories: Informal & Formal

• Informal loss funding techniques

• Current expensing

• Unfunded reserves

• Formal loss funding techniques

• Post-loss funding

• Borrowing, letters of credit, equity issues

• Pre-loss funding

• Funded reserves, trusts, captives



Step Three: Understanding Types of Captives• Captives and Risk Retention Groups (RRG)

• Captive defined: a closely held and controlled company that accepts risk financing transfers from its principals rather than independently for the general public

• Characteristics

• Control over claims and reserving practices

• Control over investments

• Recapture of investment income and underwriting profits

• Potential tax advantages



Step Three: Understanding Types of Captives• Captives goals

• reduce/stabilize costs

• provide risk management services

• provide tax opportunities

• assure risk financing markets

• Captive classifications

• Owned

• Rented

• Captive types

• Pure (single parent)

• Group (multiple parents)



Step Three: Understanding Types of Captives• Captive classifications

• Owned: (policyholders own the capital)

• Pure: Single parent, single customer

• Group: Multiple parents, many customers

• Association: similar companies

• Agency: owned by a broker or agency

• RRG: permitted by the Risk Retention Act for specified exposures; with regulatory exemptions

Supplement

• Single parent captives

• pure – captive’s only client is the parent

• broad – captive also sells to independent third parties

• third parties may deduct premiums paid to broad form



Step Three: Understanding Types of Captives

• Captive classifications

• Rented captives: (principals provide the capital)

• Rent-a-captive: Owners rent captive to others; contracts are separated to avoid risk sharing

• Protected cell: legislation provides firewalls between policyholders to avoid risk sharing



Step Three: Understanding Types of Captives• History of captives

• late 1800’s: Factory Mutual System for fire insurance

• early 1900’s: Church Insurance Company,

Ocean Marine P&I Clubs

• late 1900’s: market failures led to off-shore markets



Step Four: Choosing a Captive Domicile• Captives subject to the domicile’s laws and regulations

• Minimum capital & surplus requirements

• Regulation’s purpose is to protect the consumer

• US domiciled captives are onshore captives

• Captives domiciled outside US are offshore captives



Step Four: Choosing a Captive Domicile• Domicile Selection Criteria

• Friendly regulatory environment: applications & reporting

• Required capitalization: minimum assets & premium to surplus

• Local service infrastructure

• Low fees and taxes

• Permitted business: few restrictions on classes or

third-party business

• Permissive Investment regulations: low relevant asset ratios

• Geographic convenience

• Onshore/offshore social perceptions and tax issues

• Political climate: stability of local governments & laws



Step Five: Reviewing the Differences• Fronted versus Direct Captives

• State regulations & rating agency requirements may cause captives to not be

• Licensed and/or

• Admitted

• Captives use fronting companies - licensed, admitted insurers

• Insured pays premium to fronting insurer

• Insurer cedes % of risk and premium to insured’s captive

• Captive acts as a reinsurer for the fronting company

• The fronting company provides paper and claim service

• Direct-writing captives

• Insured pays premium to captive

• Captive may use other reinsurers

Captive Owners(insureds)

Fronting Carrier(Provides paper & services)

Reinsurance Captive(invests funds, accumulates surplus)

Captive Owners(insureds)

Direct Captive

Reinsurer



Advantages of a Group Captive• Reduced operating cost – compared to insurer overhead

• Lower/stable pricing – free from hard market increases

• Investment income & underwriting profit – retained by owners

• Broader coverage – due to fewer regulations

• Equitable premium rating - reflects actual losses

• Coverage availability/stability – free from market swings

• Direct reinsurer access – lowers commissions, better pricing,

access to reinsurer pools

• Improved service – better understanding of captive’s risks

• Reduction in long-term cost of risk

• Enhanced risk management perspective – increased visibility of risk management, optimal retention levels, better allocation of costs, investment income offsets cost of risk

• Fewer regulatory restrictions – allows self-funding and better rates



Potential Disadvantages of a Captive• Internal administrative costs – more time than insurance program

• Capitalization and commitment – substantial initial costs

• Dependent upon service providers – must outsource many services

• Inadequate loss reserves and potential losses – variation in losses may deplete reserves and necessitate additional capitalization

• Increased cost and reduced availability of other insurance – loss of account pricing discounts from packaging policies



Step Six: The Captive Feasibility StudyFeasibility study factors:

• Unbiased perspective – study by an independent party

• Cost – expensive to perform a good study

• Qualified professional – hire a competent analyst

Introduction: Goals, sources, executive summary

Candidate overview: current insurance, loss history, actuarial report

Captive basics: risk/reward, minimums, structure, rented/owned, domicile

Financial analysis: loss calculations, discounts, proformas

Tax issues: premium deductibility, captive taxes

Legal issues: SEC, domicile requirements

Incorporation: expenses, business plan, service providers

Timeline

Captive Feasibility Study Basic Elements



Step Seven: Understanding Captive Tax Issues

• Tax deductibility –

Is the premium paid to the captive deductible?

• Tax timing –

When must the captive pay taxes on earnings?

Supplement

Seek appropriate tax advice from a qualified tax consultant

• tax issues are complex

• tax rules are subject to change



Other Alternative Risk Financing Techniques• Finite risk reinsurance

• Not dependent on the spread of risk

• useful for high severity, high frequency risks:

•product recalls,

•warranty programs,

•environmental impairment programs,

•commodity price fluctuations,

•credit risk

• Fully funded programs – the risk is in the timing of payments

• Uses investment earnings and the time value of money

• Multi-period policy term with policy aggregates

Supplement

Additional risk-financing techniques include catastrophe bonds, insurance derivatives, securitization, and contingent capital arrangements



Other Alternative Risk Financing Techniques• How a finite risk program works

• Risks identified

• Reinsurer establishes premium and experience account

• Reinsurer sets preset interest rate (keeps excess)

• Losses paid from experience account

• Any surplus returned to insured

• Reinsurer charges fees for service

• Risk transfer in finite risk contracts

• Pure finite risk contracts have no risk transfer

• Blended programs contain a layer of risk transfer



Other Alternative Risk Financing Techniques• Types of finite risk contracts

• Loss portfolio transfers (LPT) – transfer unknown liabilities off balance sheet for known expense

• Prospective aggregate contracts –

funds unknown prospective losses

• Retrospective aggregate contracts –

funds known prior losses

• Calculating a finite risk reinsurance premium

• Net present value of future cash flows + fees

• The potential accounting effects of finite risk reinsurance

• Get the advice of a competent tax counsel



Chapter Summary• What is Alternative Risk Transfer (ART)?

• Step One: The Options - types of retention

• Step Two: Funding Loss Retentions

• Step Three: Understanding Types of Captives

• Step Four: Choosing a Captive Domicile

• Step Five: Reviewing the Differences

• Advantages of a Group Captive

• Potential Disadvantages of a Captive

• Step Six: The Captive Feasibility Study

• Step Seven: Understanding Captive Tax Issues

• Other Alternative Risk Financing Techniques – finite risk

Documents

Dr. James Kallman, ARM 8-1 Advanced PowerPoint Presentation ©2009 The National Underwriter Company