Emerging Strategies

for Cell Captive Structures

Moderator: Craig WatanabeRegional Manager - Strategic Risk Solutions (West)

Thursday, November 7, 2013 * Hapuna Beach Prince Hotel – Island of Hawaii

1

Speakers: Melissa HancockRegional Manager - Strategic Risk Solutions (East)

Cindy BelcherChief Operating Officer - Cooperative of American Physicians Insurance Company, Inc.

Sanford SaitoActing Deputy Commissioner & Captive Insurance Administrator -

State of Hawaii, Insurance Division

Single

ParentGroup

Sponsored

Protected

Cell

2

Parent

Captives

Group

Captives

Cell

Segregated

Cell

Incorporated

Series LLC

Cell Captive Insurance Evolution

1997

Guernsey Protected Cell

Co. (2006: ICC added)

Cayman Protected Cell

1999

Vermont “Sponsored

2005

Jersey Incorporated

Cell Captive

Offshore

Rent-a-

captives1991

Bermuda Separate

Accounts Co. (2000:segregated account Co)

Vermont “Sponsored

Captives”;

Hawaii “Leased Capital

Facility” Captives

3

2009

Delaware

Series LLC;

2011

Vermont ICC;

Tennessee ICC

2013

What ‘s Next?

4

2006 –

DC ICC

Series LLC;

Vanuatu LLC 2010

Malta ICC

What ‘s Next?

-Cayman ICC

-SC ICC

-TN Series LLC

-UT Series LLC

-Others?

• New domiciles added to the mix with cell provisions

– Maine, New Jersey

• Many domiciles expand their law to introduce or improve

cell provisions

– Cayman, Malta, Tennessee, Vermont

5

• Several domiciles considering further expansion

– Delaware formalizing Series LLC structure as part of captive laws

– Tennessee, Vermont and Utah looking at making the Series LLC

structure available in their jurisdiction

– Vermont refining laws around incorporated cell captives

Anguilla Arizona Bahamas

Barbados Bermuda British Virgin Islands

Cayman Delaware District of Columbia

Dubai Gibraltar Guam

Guernsey Hawaii Iowa

Cell Captive Insurance Evolution - Domiciles

6

Guernsey Hawaii Iowa

Isle of Man Jersey Kentucky

Maine Malta Mauritius

Montana Nevada New Jersey

Oklahoma South Africa South Carolina

St. Lucia Utah Vanuatu

Per 2008 Cell Company Handbook – Captive Review (adjusted and not necessarily all inclusive)

Differences Between Domiciles

• Terminology

• Capital Requirements

• Limitations on Business

Sponsor• Sponsor

• Corporate Structure

• Core Liability

• Cell to Cell Agreement

• Incorporated Cells

Growth Has Exceeded Expectations

• All leading domiciles report addition of new cell captives and

a number of new cells

– Delaware now has in excess of 360 SBUs in operation (180 formed in

2012)

• Middle market development is the biggest driver behind cell

captive growth

• Many captive managers and other service providers join the

ranks of cell captive owners or have ownership in multiple

facilities

8

Growth and Increased Usage Brings Up

More Questions/Issues• While clearer, tax treatment of cell captives is still uncertain

– Final Regulations on Series LLCs and Cell companies on IRS

Guidance Priority List

• Are the perceived additional belt and suspender benefits of

incorporated cell structures ultimately worth the hassle?

• New regulatory fees introduced by Delaware on formation

of new SBUs

• How much capital, if any, do you need in your cell

– Regulatory/Operational concerns vs. Tax Treatment concerns

9

Basic Types

OfOf

Cell Captives

Traditional Rent-A-Captive Structure

Rent-a-Captive (Segregated Cell Captive)

• Organized to insure or reinsure the risks of unrelated shareholders;

the cells are “renting” the minimum capital maintained by sponsors

• Each insured utilize underwriting “cell” within the overall company

• Activity in cell is governed by participation agreement or preferred

share arrangement

– No legal entity formed by the insured (traditional cell captive)

– Other legal arrangements are available (incorporated cell)

• Critical tax and collateral issues need to be considered

Why or Why Not a Rent-a-Captive

Pros

• Capital support for risk and ongoing operating costs, no or small

minimum

• Usually faster to form and shut down, depending on the domicile

• Can be used as an incubator for a specific short term projects or as

a way to get your feet wet before forming a wholly owned captive

• A way to legally segregate risks within or between organizations

without the costs of forming and operating multiple captives

Why or Why Not a Rent-a-Captive

Cons

• A certain level of control is relinquished to the sponsor

(investment flexibility, service providers, dividends, etc….)

• Ability to expand program might be restricted or subject to • Ability to expand program might be restricted or subject to

sponsor approval

• Time commitment for operation and management about

the same as stand alone captive

• Contractual and captive law risk segregation has never

been tested in the courts

Participant

Insured

AAA Co.

Fronting

Insurer

Reinsurance AgreementParticipation

Agreement

Traditional Sponsored Cell Captive

“on behalf of”

Sponsored

Captive

Cell

AAA

Cell

BBB

Cell

CCC

Reinsurance Agreement

(on behalf of Cell AAA)

Supported by Trust

Agreement or Letter of Credit

Agreement

Incorporated Cell Captive

Association of Opihi Pickers

Opihi Insurance

Front - Aloha Insurance Co.

Member AssociationMember Association

Front - Great Hawaiian Ins Co.

Opihi Insurance

Company, Inc. ICC

Incorporated Cell –1

Assumed Coverage Great

Hawaiian

Incorporated Cell 2

Assumed Coverage Aloha

Association of Opihi Pickers offers specialty insurance products to

association members distributed via brokerage partner

SERIES

ASERIES

D

Series LLC Captive

XYZ Series LLC

A

OWNER

B

OWNER

A

OWNER

C

OWNER

D

Multiple Series may be formed, typically

similar in size and risk structure, but not

always

SERIES

C

D

SERIES

B

Cell Captive Types at a Glance

Description Traditional Cell Captive Incorporated Cell Series LLC

Regulatory Governance Captive insurance laws Captive insurance laws Corporate laws

Ownership None (preferred shares

might be issued)

Direct (common shares) LLC Membership Interest

Cell structure created via Contract Contract and Corporate law Contractual and Corporate

LawLaw

Governance None – contractual rights

only

Normal governance – limited

by contract

Mixed – determined by

contract

Operating Agreement Participation agreement Participation agreement Series agreement

Ease of Formation Generally quickest Similar to standalone

corporation

Easy and flexible

Process of Formation Change of Business Plan Full Application Full SBU application, fee may

apply

Liability protection/

segregation

No historical reference Should follow corporate law References to mutual fund/

life insurance industry

Accounting

and and

Regulatory Reporting

Basic Objectives

• Each protected cell or series must be accounted for separately

on the books and records of the captive.

• Annual filing of financial statements detailing financial

experience of each protected cell or series

Annual filing requirements differ by domicile• Annual filing requirements differ by domicile

• Premium tax filings differ by type and domicile

Financial Reporting

• Financial reporting not yet consistent, may be domicile

specific, but standardization emerging as audit firms become

familiar with the structure

• Cell structure is unique under U.S. GAAP and International • Cell structure is unique under U.S. GAAP and International

Financial Reporting Standards (IFRS)

• Cell structures are generally combined, not consolidated

• Inconsistent reporting among captives and domiciles

• Financial statement user needs may need to be considered

Weaknesses

• Issues related to financial information::

– Proprietary and confidential information may be need to be

protected

– Complicated presentation styles

– Possibly unlikely to meet client user needs– Possibly unlikely to meet client user needs

– Audit firm may contemplate each entity or sampling depending

on views & domicile requirements

– Regulatory examination may contemplate each entity or

sampling depending on views domicile requirements

Sample Balance SheetSponsor Cell #1 Combined Cell #2 Cell #3

ASSETSCash and Cash Equivalents 753,373.26 3,608,475.41 4,361,848.67 100,000.00 100,000.00 Funds Withheld - - - 180,000.00 Insurance Balances Receivable - 300,826.42 300,826.42 50,000.00 100,000.00 Prepaid Expenses 4,140.94 10,000.00 14,140.94 - -Due from Other Entities 87,768.28 348,139.34 435,907.62 - 183,333.00 Federal Income Tax Receivable 30,000.00 - 30,000.00 - -Reinsurance Recoverable on Paid Losses - 985,936.27 985,936.27 55,000.00 -Cell 2: Total Assets - - 385,000.00 - -Cell 3: Total Assets - - 383,333.00 - -

TOTAL ASSETS 875,282.48 5,253,377.44 6,896,992.92 385,000.00 383,333.00 TOTAL ASSETS 875,282.48 5,253,377.44 6,896,992.92 385,000.00 383,333.00

LIABILITIES, CAPITAL AND SURPLUSLIABILITIESPayables and Accruals 128,845.67 108,510.90 237,356.57 30,250.00 203,500.00 Losses Payable - 307,396.63 307,396.63 - -Reinsurance Premium Payable - 81,143.32 81,143.32 55,000.00 153,291.28 Loss Reserves - 1,163,970.00 1,163,970.00 100,000.00 -Cell 2: Total Liabilities and Capital & Surplus - - 385,000.00 - -Cell 3: Total Liabilities and Capital & Surplus - - 383,333.00 - -

TOTAL LIABILITIES 128,845.67 1,661,020.85 2,558,199.52 185,250.00 356,791.28 CAPITAL AND SURPLUSContributed Surplus 762,500.00 2,810,211.15 3,572,711.15 25,000.00 -Retained Earnings (16,063.19) 782,145.44 766,082.25 174,750.00 26,541.72

TOTAL CAPITAL AND SURPLUS 746,436.81 3,592,356.59 4,338,793.40 199,750.00 26,541.72

TOTAL LIABILITIES, CAPITAL AND SURPLUS 875,282.48 5,253,377.44 6,896,992.92 385,000.00 383,333.00

Sample Income Statement

Consolidated

Sponsor Cell #1 Total Cell #2 Cell #3

UNDERWRITING INCOME:

Net Premiums Earned - 4,725,663.06 4,725,663.06 1,375,693.68 3,854,227.30

UNDERWRITING EXPENSES:

Total Losses Incurred - 3,178,661.86 3,178,661.86 251,714.00 3,369,377.87

Policy Acquisition Expenses - 39,666.38 39,666.38 89,393.87 19,782.00

TOTAL UNDERWRITING EXPENSES - 3,218,328.24 3,218,328.24 341,107.87 3,389,159.87

UNDERWRITING INCOME - 1,507,334.82 1,507,334.82 1,034,585.81 465,067.43

Interest Income - - - 111.66 -

Participation Fee Income 112,511.97 - 112,511.97 - -

Operating Expenses 128,575.16 595,434.78 724,009.94 77,194.97 78,263.07

LOSS BEFORE TAXES (16,063.19) 911,900.04 895,836.85 957,502.50 386,804.36

Federal Income Tax - 129,754.60 129,754.60 - -

Net Loss (16,063.19) 782,145.44 766,082.25 957,502.50 386,804.36

Cell 2: Net Income - - 957,502.50 - -

Cell 3: Net Income - - 386,804.36 - -

TOTAL NET INCOME (LOSS) (16,063.19) 782,145.44 2,110,389.11 957,502.50 386,804.36

Offshore Regulatory Reporting –

Cayman & Bermuda• Cayman captives are required to file:

– GAAP based audited financial statements

– Modular versus Columnar approach

– CIMA INForm – electronic submission of financial information

– Financial information is combined from all core and all cells and submitted in one filing.

• Bermuda Segregated Account Companies are required to file:

– Default requirement is a combined basis presentation for all segregated accounts and general account in

one filing.

– Audited statutory financial return.

– But many companies with segregated accounts that are “fully funded” obtain a “Section 56” exemptions

allowing:

i. Balance Sheet presentation of all Segregated Account assets & liabilities as line items on a combined

basis

ii. Exemption from obtaining actuary loss reserve opinion

Cooperative of American Physicians, Inc. (CAP)

• California consumer cooperative – created in 1975

• Medical Professional Liability (MPL)

affordability and availability crisisaffordability and availability crisis

• Exodus of commercial insurers

• Legislative response

• California Insurance code 1280.7

• Authorization of interindemnity trust

arrangements for MPL

• Mutual Protection Trust (MPT)

• Interindemnity arrangement created in 1977

– 500 members and $10 million

• Mission statement:• Mission statement:

“We support and protect California’s finest physicians.”

• 12,000+ member physicians, >$340 million

• AM Best rating A+, superior

CAP Features

• Risk Management & Patient Safety focus

• CAP Cares program• CAP Cares program

• Experienced claims professionals

• Dedicated law firm

• Tool of binding arbitration

• Subsidiary insurance agency

• CAPSource

• October 17, 2002 - Initially licensed as a Class 1 Pure Captive

• Objectives:

• Supplemental layer of reinsurance for MPT

• Protection from vagaries of reinsurance marketplace

Cooperative of American Physicians

Insurance Company, Inc. (CAPIC)

• Protection from vagaries of reinsurance marketplace

post 9/11

• Aggregate stop loss for MPT

• Smoothing of future pricing fluctuations

• Additional coverages added later

• Direct insurance to CAP

• MedGuard

• Employment Practices

Cooperative of American Physicians

Insurance Company, Inc. (CAPIC)

• Employment Practices

• Supplemental Professional Liability

-

2011 - CAP’s Need for Product Diversify

• Ever-changing healthcare environment

• Larger, integrated medical groups• Larger, integrated medical groups

• Geographic areas crossing state lines

• Need for a more traditional insurance framework

• Potential for new risks not typical to medical

professional liability

-

Cooperative of American Physicians

Insurance Company, Inc. (CAPIC)

• January 1, 2012 - Converted to a Class 3 Risk Retention

Captive Insurance Company

• Objectives

– Primary MPL insurance product for larger groups

– Supplemental reinsurance to MPT– Supplemental reinsurance to MPT

– Direct insurance to CAP for MedGuard and EP and

Supplemental Professional Liability

-

Cooperative of American Physicians

Insurance Company, Inc. (CAPIC)

2012

• CAP successfully partners with a national carrier for the

purpose of writing hospitals in California.

• CAPIC RRG faces regulatory hurdles

– Varying regulatory practices in nondomiciliary states

– Differing interpretations of the LRRA

– Hurdles make marketing the product difficult

• National carrier agrees to partner on large medical groups

Cooperative of American Physicians

Insurance Company, Inc. (CAPIC)

• May 29, 2013 – CAPIC converted to a Class 4 Sponsored

Captive Insurance Company

– Continue to provide reinsurance to MPT

– Continue to provide direct coverage to CAP

– CAPIC participates in the reinsurance in the large group – CAPIC participates in the reinsurance in the large group

and hospital space through a quota share agreement with

our partner

– Cells may be useful tool in the future

Class 4 – Sponsored Captive

Insurance Companies

• HRS Chapter 431, Article 19, Part 300

• Concept initially enacted in 1999 as “Leased

Capital Facility”Capital Facility”

• Subsequently amended to generally be

consistent with other U.S. captive domiciles

35

Basic Requirements for a

Sponsored Captive Insurance Company

• Minimum statutory capital of $500,000, and

provided by one or more sponsors

• Qualification of Sponsor:• Qualification of Sponsor:

– Hawaii licensed insurer, reinsurer or captive insurer, or

– Any other person, company, or organization approved by

the Insurance Commissioner

• A risk retention captive may not be a sponsor or

participant

36

Participant Requirements

• Associations, Limited Liability Companies,

Partnerships, Trusts and other Business Entities

approved by Insurance Commissioner

• Sponsor may also be a Participant• Sponsor may also be a Participant

• Participant does not have to be a shareholder or

member of the sponsored captive or any affiliate

thereof

• Participant shall insure only its own risks through a

sponsored captive insurance company

37

Protected Cell Requirements

• Sponsored captive may establish one or more protected

cell(s)

• Protected cell can be organized and operated as an • Protected cell can be organized and operated as an

association, corporation, LLC, partnership, trust or other

business form authorized by Insurance Commissioner

• Separate accounting for each protected cell

• Assets of a protected cell not chargeable with liabilities

from other insurance business conducted by the

sponsored captive

38

Protected Cell Requirements<continued>

• Sale, exchange, or other transfer of assets require consent of protected cells and sponsor, and approval of Insurance Commissioner

• Written notification to the Insurance Commissioner • Written notification to the Insurance Commissioner within 10 days of insolvency or inability of any cell to meet its claims or expense obligations.

• Participant contracts and addition or withdrawal of protected cells require prior approval of the Insurance Commissioner

39

Protected Cell Requirements<continued>

• Annual audited financial statements, with accounting

of financial experience of each protected cell.

• Investment requirements:• Investment requirements:

– Assets of 2 or more protected cells may be combined for

investment purposes, and not construed as defeating the

segregation of assets for accounting or other purposes

– Must otherwise comply with Article 19-110 requirements

• Sponsored captives are subject to Article 15

40

Sponsored Captive Demographics

• Actively Licensed Sponsored Captives => 4

• Industry Participation:

– Healthcare, Financial Services, Transportation & Distribution

• Geographic Distribution:Geographic Distribution:

– U.S. based sponsors => 4

– Non-U.S. sponsors => 1

• Types of Risks Insured

– Professional Liability

– Mortgage Reinsurance

– Life Reinsurance

– Medical Stop Loss

41

Emerging Strategies

for Cell Captive Structures

Moderator: Craig WatanabeRegional Manager - Strategic Risk Solutions (West)

Thursday, November 7, 2013 * Hapuna Beach Prince Hotel – Island of Hawaii

42

Speakers: Melissa HancockRegional Manager - Strategic Risk Solutions (East)

Cindy BelcherChief Operating Officer - Cooperative of American Physicians Insurance Company, Inc.

Sanford SaitoActing Deputy Commissioner & Captive Insurance Administrator -

State of Hawaii, Insurance Division