Speakers:

Gary Bowers, Johnson Lambert LLP

Nick Dove, R&Q Quest Management Services Ltd.

Bill McMahon, Fleetwood Liquidating Trust

Hugh Rosenbaum, Towers Watson

Property/Casualty: Contemporary Captives-

Two Sides of the Fundamentals

More…

3

What are Captives?

4

Differentiators (in handout)

To regulators (and the NAIC!)

To the IRS

To the DOL (Benefits

To managers and service providers

And…their owners! …or members

Single Owner/Group Captives

5

Group Captive – Direct

REINSURERS

GROUP CAPTIVE

E A B C D

Or Members

Or Administrator

Single Owner – Direct

Subsidiaries

Central RM

REINSURERS

CAPTIVE

Shareholder

Direct or Reinsurance captives

Captive’s reinsurer

Owner(s) Reinsurance

Captive

Fronter

Other Types of “Captives”

7

Risk Retention Groups

Reciprocals

PORCs and agency-owned captives

SPVs and XXX entities

Mini or micro (“831-b”) captives

Pools of Captives

Number of Captives: Continual growth ?

6,000

Source: Best’s, Business Insurance 8

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

More…

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Employee Benefit Captives 2014

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• Estimated Number of

Employee Benefit Captives end 2014

Estimated Premiums Paid to

Employee Benefit Captives in 2014

($ billions)

Why captives? The Key Reasons

11

Cost reduction

Access to reinsurance

Investment income

Administrative tool

More…

12

4. Administrative Tool

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Group

retention

Divisional retention

Member or operating unit retention

$1,000,000

$500,000

$100,000

Funding in captive

4. Administrative Tool (cont.)

14

There might be economies of scale in a group captive

All the previous reasons plus …

The value of shared retentions, shared aggregates, shared services

Example: Risk Retention Groups

-an “escape from fronting”

Risk sharing – obstacle or mutuality

Size of my account….

Expected case After HIS heavy loss year

After MY heavy loss year

100 80 75

More…

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Protected Cell Company Structure

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Owner

PCC Facility

Management company

Several S/H

Single S/H

Cell 1

Cell 2

Cell 3

Protected Cells – How they work

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Surplus (Dividend)

Reinsurance

Cell Retention

Capital (or guarantees)

Advanced Cell Structure

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JOINT VENTURE CELL

Individual Cells

Cell or Captive?

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Captive Cell

Full control More Less

Capital More Less Regulatory fees More Less Management fees Less

Auditor’s fees Maybe none

Directors’ fees None Indirect costs same

Liquidator’s fees lower

More…

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Feasibility (refeasibility) To find out….

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Why do one?

For which audience

?

Who should do

it?

Does it( still) make

sense?

Captives – The Critical numbers

Retention (risk tolerance)

Capital required

Critical premium and loss amounts

23

Comparison to…

next best alternative

Start-up Captives: The Timeline

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Implementation

Fronting Negotiation

Business Plan

Captive Manager

visit

Feasibility Study

Management Approval

Idea

Feasibility: Key Factors

25

Amount Confidence

Claim amounts

Premiums

Capital

Fronting, Reinsurance

Costs

Feasibility: The Output

Factors: (previous slide)

Most important:

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Does it work?

Feasibility: The Numbers!

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Proforma Projections

2012 2014 2014 2015 2016 Total

Underwriting results 1,156,452 1,252,952 1,186,200 1,251,360 1,542,340 6,389,303

Investment Income 94,459 151,402 194,286 238,520 286,213 964,880

Captive net income 1,250,911 1,404,354 1,380,485 1,489,879 1,828,553

Income tax (if any)

After-tax income 1,250,911 1,404,354 1,380,485 1,489,879 1,828,553 7,354,183

7,354,183

More…

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Captives – The Big Issues

Fronting – what, why, how (in 2015)

Domicile and regulation

Captive management

….Tax factors

29

Fronting: 2015 Problem #1

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Reins.

Captive

Rating Agenci

es

Claims

Insureds

Fronter

Security

Fronting Issues

Availability

Collateral – security – guarantees – …investments

Cost of fronting

Insurance/risk transfer

Services

Emerging: Security of captive’s reinsurers

31

Fronting Guarantees – 2015 Concerns

1. Funds transferred by fronting company to a reinsurance captive – will the captive pay?

Loss reserves, IBNR Premium reserves

Schedule F penalties

2. Risk Gaps – must be guaranteed? Expected losses (>100%!)

Aggregate maximum fronting exposure

3. Stacking of years

4. Closing out old years

32

Fronting Guarantees – Types

1. Letters of credit (cost, availability)

2. Reinsurance trusts (lower cost, but fronter reluctance)

3. “Other” including:

Collateral “enhancement”

Factoring plus trade credit (new)

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More…

34

Captive Domiciles

Onshore – offshore: the major factors in 2015

See handout for advantages/disadvantages

Perception

Regulation (..and FATCA – a non-issue for captives)

Tax factors

… Costs

35

Captives by Domicile/Number

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Top 10 = 2/3 of total. US domiciles =1/3 of all captives

2013: the top eight (out of 70!)

Bermuda 831 (862)

Vermont 588 (586)

Cayman 759 (740)

Guernsey 344 (333)

Anguilla 295 (291)

Utah 342 (287)

Delaware 298 (212)

Luxembourg 225 (238)

More…

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Regulation — Differences

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Too much Too little Just Right

More…

39

Tax Factors

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Premium Taxes • State • Federal Excise • Self-Procurement

And… Offshore/onshore

“non-profits” 831-b small ones

More…

41

Taxation – Current Issues

831b structures : use and abuse

More intrusive activity

Example: FATCA

Other issues (Our expert has more)

42

Management Matters

43

Too

little

Just Right Too much

More…

44

Captive Management: How It Works

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Captive

Losses

Dividends

Expenses Investments

Investment Income

Reinsurance

Capital

Premiums

Issue real policies

Limit their losses

Pay claims

Governance Report to regulators

Conduct an audit

Deal with brokers, fronters,

reinsurers

Maintain solvency and ratios

Invest the assets

Captive

What any captive (or its manager) has to do

More…

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Keys to Captive Financial Success

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The right rates (who sets them?)

Low expenses (what expenses?)

The right loss estimates (actuaries!)

Reinsurance protection that works

The right initial capital (how much, what form?)

Surplus accumulation

The right investments (by whom?)

Return on capital (what capital?)

Two more Keys to Captive Success

Long-term dedication

Risk management (of the captive’s risks!)

Captive Endings

Refeasibility!

Novation, LPT, commutation

Redomiciliation, switch managers

Sale, merger

Liquidation

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Our Time-tested Slogan …

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“Captive business is

the best business”