Best Strategies for Choosing a Domicile

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ACI’s Captive Insurance

Benjamin Gould

Attorney

Paul Frank + Collins P.C.

Best Strategies for Choosing a Domicile

Arthur Koritzinsky

Managing Director

Marsh

Chris Mandel

Senior Vice President

Sedgwick

April 24-25, 2014

Gregg Sgambati

President

New Jersey Captive Insurance Association

Daniel Towle

Director of Financial Services Vermont Agency Commerce & Community Development

Tweeting about this conference?

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Number of Captives Worldwide

Source: BI Survey, “Total Captives Worldwide,” Business Insurance, March 17, 2014: 24

*Numbers restated by BI.

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Active Captives by Domicile –2013 Total Active Captives – 6,342

Source: BI Survey, “Counting Captives,” Business Insurance, March 17, 2014: 19

Source: BI Survey, “Captive Options Pile Up,” Business Insurance, March 17, 2014: 19

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Onshore Domiciles – Year End 2013

Source: BI Survey, “Counting Captives,” Business Insurance, March 17, 2014: 19

Source: BI Survey, “Captive Options Pile Up,” Business Insurance, March 17, 2014: 19

Source: New York State Department of Financial Services

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US Domestic Captive Domiciles

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EU Domiciles – Year End 2013

Source: BI Survey, “Counting Captives,” Business Insurance, March 17, 2014: 19 and Malta Governmental Website

Source: BI Survey, “Captive Options Pile Up,” Business Insurance, March 17, 2014: 19

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Offshore Emergence - 2014

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•Anguilla •Bermuda •Bahamas •Barbados •British Virgin Islands •Cayman Islands •Curacao •Puerto Rico •Netherland Antilles •Nevis •Turks and Caicos •US Virgin Islands

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Domicile Considerations

• Domicile Criteria • How do the various domiciles differ from one another?

• Domicile Selection • What attributes of your captive should you consider in selecting a domicile?

• Domicile Growth • Too much, too soon?

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Domicile Criteria

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• Captive statute and regulations • Business organization statute • Logistics for formation • Number of captives • History as a captive domicile • Regulatory strength • Location • Infrastructure

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Domicile Criteria – Captive Statute

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• Big picture – does the captive statute allow you to form the type of captive you want to form?

• Details: • Capitalization (minimum amounts, form) • Taxes and fees • Third-Party Business allowed? • Audit requirements • Regulatory examinations (how often, costs) • Travel (meeting requirement, costs/time) • Confidentiality

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Domicile Criteria – Formation Logistics

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• Ease, speed, costs of formation

• Expertise of regulators in evaluating application

• Formation of new captive vs. redomestication of existing captive

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Domicile Criteria – Experience

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• Number of captive licenses

• Number of active captives

• History as a captive domicile

• Regulatory strength and stability

• Responsiveness of legislature

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Domicile Criteria - Location

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• Ease and costs of travel

• Ease of communications (time zone, working hours, holiday calendar)

• Perception – onshore vs. offshore

• Home state of parent company

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Domicile Criteria - Infrastructure

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• Service Providers • Sufficient service providers in-state? • Do they even need to be in-state?

• Regulators

• Trade Association

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Domicile Selection

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• Parent Industry Type • Parent Location • Parent Form • Coverage Written • Captive Form • Captive Structure • Tax Considerations

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Domicile Selection – Parent Attributes

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• Industry • e.g. healthcare, manufacturing, construction, education, finance and banking, insurance

• Location – consider home state vs. travel

• Parent Form • e.g. public company, private company, nonprofit, group or association, sponsor

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Domicile Selection – Coverage Written

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• Lines of coverage • Direct or fronted? • Reinsured? • Amount of premiums to be written

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Domicile Selection – Form of Captive

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• Pure • Association • Group/Industrial Insured • Branch • Sponsored (i.e. cell)

• Segregated cell • Incorporated cell

• Risk Retention Group

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Domicile Selection – Structure of Captive

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• Stock corporation • Mutual corporation • Non-profit corporation • Limited Liability Company (LLC) • Series LLC • Reciprocal

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Domicile Selection - Tax Considerations

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• Premium Taxes

• Self-Procurement Taxes

• Tax Position as “Insurance Company” • Foreign insurance excise taxes

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Domicile Growth - Positives

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• Free market competition

• Innovation is encouraged

• Domiciles likely available in your backyard

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Domicile Growth - Negatives

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• Regulatory strength being spread too thin

• Race to the bottom

• One bad apple spoils the bunch

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Considering ERM in Domicile Selection

Chris Mandel

SVP, Strategic Solutions

Sedgwick, LLC

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What is ERM and How Does it Relate to Captives?

• Recognizes that individual risks across the organization are interrelated and can create a combined exposure that differs from the sum of the individual risks

• Provides a structured process for the management of all risks, whether those risks are primarily quantitative or qualitative in nature

• Views the effective management of risk as a competitive advantage

• Seeks to embed risk management as a component in all critical decisions throughout the organization

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Risk Management Capability Evolution

Key Business,

Financial &

Operational Risks

Ad

op

tio

n o

f E

RM

Pra

cti

ces

Ability to Align Strategies for Company Performance

Insurable Risks

All Risk Stakeholders

Fully Enabled to

Manage All

Significant Risks To

Mission

Accomplishment

ERM

Audit

Legal

Compliance

Planning

HR

Finance

Hazard Risk

Management

•Corporate Insurance

Program

•Contractual Risk Transfer

•Active Claims Management

•Robust Prevention

Culture

Basic ERM

Implementation

Formal enterprise wide:

• Risk Identification

• Risk Assessment

• Risk Response

• Risk Control Activities

• Risk Monitoring

• BU Compliance

Reporting

Full ERM

Implementation

• Common terminology/standards

• Fully integrated into strategic

planning

• Data quantified where possible

• Fully integrated across functions & BUs

• Fully understood accountabilities for risk

• Cost of all risk types tracked & managed

• Compliance & regulatory reqmts met

Advanced

Performance

•CEO has key risk info

to manage

performance

•Fully integrated &

“embedded” risk

discipline in operations

and corporate culture

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Is ERM Process Different for Captives?

•Enterprise Risk Management…

• The organization-wide, strategic process of assessing and responding to the collective risks that impact the ability of the firm to maximize stakeholder value.

•Examples of risks addressed by ERM:

• Product recall • Investor litigation • Regulatory sanctions • Supply Chain • Competitive challenges • Union unrest • Political instability • Financial fraud • Pandemic

Terminate Mitigate Transfer Exploit Tolerate

Risk Response

Strategies

Exit Risk

AreaPreventative

Corrective

Directive

Detective

Make a

conscience

decision to

tolerate the

risk

Explore the

upside of risk

by taking new

opportunities

Financing Solutions

Insurance

Capital

Markets

Contractual

Transfer

Hybrid

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Standards: A Guide for Captives?

Principles

Framework

Process

Reproduced from ISO Standard 31000:2009 with permission from ISO at www.iso.org. Copyright remains with ISO.

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Captives and ISO 31000

The 7 core components of ERM – Captive Relevancy

Internal Environment / Establishing the Context

Objective Setting & Risk Criteria

Risk Identification

Risk Evaluation

Risk Treatment

Communication & Consultation

Monitoring and Review

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NAIC OWN Risk and Solvency Assessment (ORSA)

Enterprise Risk Management. Ed. Michael W. Elliott. Malvern, PA: The Institutes, 1st Edition, p. 8.22

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ORSA: Is It Relevant to Captives?

ORSA Can Enhance Captive Risk Management by: • Promoting enterprise risk management insurance (ERM) principles,

advocates financial soundness, and challenges insurers to reach their goals and objectives by effectively managing their risks and prospectively determining capital adequacy.

• Asking insurers to identify and quantitatively assess its risks, both current and reasonably foreseeable ones, and explain the processes it employs to manage those risks.

• Asking for an assessment of the insurer's current and future solvency.

• Differs in several ways from the NAIC's regulatory reporting requirements.

ORSA Is more closely aligned with many insurer's present risk management program and supports the implementation of future ERM practices.

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@Insurance_ACI Copyright © 2014 by Risk and Insurance Management Society, Inc. All rights reserved.

Solvency II: Why Should You Care?

• Solvency II is a new regulatory standard for insurers in the European Union (EU) to establish principles for risk management and consistency in regulation.

• As a consistent European standard, Solvency II should reduce the likelihood of an insurer's insolvency, market disruption, and consumer loss.

• Solvency II aims to achieve consistency across Europe in these areas:

• Market-consistent balance sheets

• Risk-based capital

• Own risk and solvency assessment (ORSA)

• Senior management accountability

• Supervisory assessment

• Contains three supporting pillars:

• Pillar 1- covers all financial requirements and aims to ensure adequate capitalization with risk-based capital.

• Pillar 2- imposes higher standards of risk management and governance within an organization and gives supervisors greater powers to challenge their firms on risk management issues.

• Pillar 3- aims for greater transparency for supervisors and the public.

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What’s Important to Rating Agencies Now?

Risk Communications

Risk & Strategic Decisions

Compensation Structure

Risk Expertise

Risk Tolerance

Top Risks

Risk Readiness

@Insurance_ACI Sedgwick © 2013 Confidential – Do not disclose or distribute. 33

Elements of Insurance Company Failure

S&P’s View of Key Factors Involved when insurers fail:

Poor liquidity management

Under pricing and under reserving

A high tolerance for investment risk

Management and governance issues

Rapid growth

Expansion into non-core activities

Sovereign related risks

Insurers that performed best during times of systemic stress and avoided significant risk impacts shared these common traits:

Held a robust franchise

Solid liquidity mgmt

Good capitalization

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Risk Manager Priorities vs Domicile Priorities

Captives are a proven and long-term solution for handling specific exposures to risk

Does the domicile support the exposures?

Evolving solvency standards will impact domicile attractiveness

What solvency standard is your target domicile aligned with?

Captives enable focused risk mitigation

Does the targeted domicile give the appropriate credit for related efforts?

Captives enable focus efforts to fund for and reinsure risk exposures beyond traditional

Does the targeted domicile philosophy align with this strategy?

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Risk Manager Priorities vs Domicile Priorities

ERM opens the door to risks not traditionally insurable Is the targeted domicile receptive to allowing

coverage for new, less predictable risks? Rating agencies influence domicile selection Will you seeking a rating for your captive and to

what degree does the target domicile value this third party assessment?

Most states now have captive regulation Does your target domicile intend to support the

maturation of the domicile? Some domiciles are working with the Federal gov’t How will such alliances affect your privacy and

freedom to operate without gov’t interference?

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Will Your Domicile Allow for Risks That Matter

Most?

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Example: Putting ERM and Supply Chain to work in your captive

• Captive provides infrastructure for risk mgmt. programs • Naturally progress towards ERM

• Consider establishing a ‘mini’ ERM program within your captive

• Utilize captive profits to , do an ERM gap analysis, fund training, purchase ERM software, etc.

• Systematically assess the downside and upside of risk to: • Reduce Total Cost of Risk (TCOR)

• Maximize capital efficiency for investment in opportunity

• Optimize the portfolio of risk

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A Buyer’s Perspective on Domicile

38 DOES YOUR DOMICILE ACCOMMODATE YOUR

STRATEGIES

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Key Components of Domicile Selection

KPI

INFRASTRUTURE

CAPITAL REQTS

REGULATORY FLEXIBILITY

RISK FINANCING STRATEGY

RISK MANAGEMENT STRATEGY

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Captive Insurance Domicile Study Working Paper

Gre

gg S

gam

bat

i, N

JCIA

@Insurance_ACI

Captive Insurance Domicile Study

Situation

•The formation rate of new captive insurance domiciles has increased in recent years.

•Question: “Will these new domiciles be sustainable?”

•The answers is unclear.

•Some say market conditions are the sole determinant.

•We believe that there are other factors ranging from structural to longevity.

•This report looks at domicile formation from the start of the industry to today.

Gregg Sgambati, NJCIA

@Insurance_ACI

Captive Insurance Domicile Study

Study Intent

• Domicile-neutral captive industry report.

• Designed to understand the growth and development of domiciles from a quantitative and qualitative perspective.

• Compiled by surveys and interviews of industry experts.

• Final report will aid domiciles (particularly new domiciles) plan and strategize for growth.

• The resulting report will hold helpful information to be shared with the industry.

Gregg Sgambati, NJCIA

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Studied Domiciles Ten domiciles selected for the study. Selected on both qualitative and quantitative grounds.

• Bermuda • Cayman Islands • Vermont • Guernsey • Utah • Delaware • Luxembourg • Hawaii • South Carolina • Puerto Rico

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Key Qualitative Characteristics

Objective: Identify Indicators for Domicile Selection

• Regulatory sophistication, responsiveness, accessibility.

• Legal and tax framework

• Ease of doing business.

• Service provider culture.

• Local expertise in complex products.

Gregg Sgambati, NJCIA

@Insurance_ACI

Quantitative Analysis

Objective: Identify Indicators of Domicile Sustainability (Statistical Deconstruction of Domicile Growth)

• Number of years in existence.

• Number of domiciles per year.

• Number of pure captives per year.

• Number of specialty captives per year.

Gregg Sgambati, NJCIA

@Insurance_ACI

Initial Results

Key Indicators of Domicile Selection 1. Legal and tax framework. 2. Ease of doing business. 3. Regulatory sophistication, responsiveness, accessibility. 4. Cost of doing business. 5. Ease of re-domiciling. 6. Captive sophistication. Key Quantitative Indicators of Domicile Sustainability 1. Speed to market (including new structures) 2. Longevity (hence reputation) 3. Number of pure captives per year. 4. (Not) Number of domiciles per year.

Gregg Sgambati, NJCIA

@Insurance_ACI

For Final Report

Contact Gregg Sgambati

gregg@njcia.org

(201) 783-5133

Gregg Sgambati, NJCIA

@Insurance_ACI

Captive Domiciles ---Top Issues • Impact of US Healthcare Reform • New Domiciles • Solvency II • Healthcare captives- Onshore/Offshore

tax differences • Small Captives • NAIC Initiatives • Impact of Low Interest Rates • Dodd-Frank - Still wait and see