Captive 201September 17, 2007

Se

Moderator:

Kilian Whelan, President, JLT Insurance Management (Bermuda) Ltd

Panelist(s):

Dr. Marcelo Ramella, Assistant Director Research, Bermuda Monetary Authority

Jerry Backstrom, Director of Tax & Insurance, Bunge Limited

Chris Ryan, Senior Manager, McDermott International Inc

William Noonan, Corporate Risk Manager, Structure Tone Inc

Session: Captive 201

The views expressed by the participants in this session are their own and not necessarily the views of their employers or any other organization with which they may be affiliated. If you decide to establish an insurance company in Bermuda you should seek legal and other necessary advice.

Agenda

CAPTIVE 201

• Bermuda Captive Market - BMA Review

• Planning

• Operations

• Evaluation

Overview of Bermuda Captive Market

Dr Marcelo RamellaAssistant Director ResearchBermuda Monetary Authority

mramella@bma.bm

Bermuda Captive Market

Bermuda Captives: Gross Written Premiums (in US$) 2003-2005

3.0

5.9 6.3

15.2

4.15.8

6.8

16.7

4.7

8.7

6.1

19.4

0

5

10

15

20

25

Class 1 Class 2 Class 3 All Captives

Bil

lio

ns

2003

2004

2005

Total number of captive companies = 857 in 2003, 879 in 2004 and 869 in 2005 (only captive companies submitting SFR are counted in)

Bermuda Captive Market

Bermuda Captives: Retention Rates (2003-2005)

81% 81%

71%77%75%

80%

70%74%

79%84%

68%

78%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Class 1 Class 2 Class 3 All Captives

2003

2004

2005

Bermuda Captive Market

Bermuda Captives: Percentage of GWP Assumed from Insurance Carriers (2003-2005)

51%

41%

32%

38%42% 42%

33%38%

42%39%

32%36%

0%

10%

20%

30%

40%

50%

60%

Class 1 Class 2 Class 3 All Captives

2003

2004

2005

Bermuda Captive Market

Bermuda Captives: Geographical Distribution of Underlying Risk Insured (2005)

53%63%

90%74%

39% 15%

14%16%

7%5% 6% 5%

2%4% 3%5%

0%10%20%30%40%50%60%70%80%90%

100%

Class 1 Class 2 Class 3 All Captives

Other

Europe

Global

North America

Bermuda Captive Market

Bermuda Captives: Business Written (2003-2005)

28% 30% 28%

47% 46% 47%

25% 24% 24%

0%10%20%30%40%50%60%70%80%90%

100%

2003 2004 2005

Property

Casualty

Other

Bermuda Captive Market

Bermuda Captives: Business Written, by Class (2005)

5%19%

44%28%

71%52%

34%47%

25% 29% 22% 24%

0%

10%

20%

30%

40%

50%60%

70%

80%

90%

100%

Class 1 Class 2 Class 3 All Captives

Property

Casualty

Other

Bermuda Captive Market

Bermuda Captives: Property Business Written, by Class (2005)

12%

31% 26% 24%

68%

49% 56% 57%

6%8% 6%

7%4%7%

9% 5%11%

0%2%2%

2%3% 0% 3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Class 1 Class 2 Class 3 All Captives

Aviation Hull and Cargo

Marine Hull and Cargo

Offshore Energy PhysicalDamage

Auto Property Damage

Prop Damage & BusinessInterruption

Other

Bermuda Captive Market

Bermuda Captives: Casualty Business Written, by Class (2005)

30%

4%12%

2%

4% 12%6%

19%

20%

32% 24%6%

9%6%

38%

33%

41%

38%

10%

32%

4%14%

2%

2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Class 1 Class 2 Class 3 All Captives

Medical Malpractice & OtherProfessional Liability

Workers Compensation

Auto Liability

General Liability

Products Liability

Other Casualty

Bermuda Captive Market

Bermuda Captives: Asset Composition, by Class (2005)

5% 5%12% 7%

6% 4%

6%5%

27%20%

14%19%

0%

2%

12%6%

26%55%

39%44%

35%

14% 16% 19%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Class1 Class 2 Class 3 All Captives

Cash

QuotedInvestmentsUnquotedInvestmentsAdvances toAffiliatesPremiumsReceivablesOther Assets

Bermuda Captive Market

Now you have your captive you need good planning to ensure a smooth road ahead

• Who should be on the “Captive Team”

• Educating the team

• Establish communication lines

• Map out the annual calendar

• Consider Board appointed Committees

Planning

PLANNING

Captive

Internal External

Risk Management

Accounting

Treasury

Tax

Legal

Executive

Captive Manager

Audit

Actuarial

Brokers

Fronting Cos.

Claims/TPAs

Who should be on the team?

Lawyers

Planning

Educating the team

• Basic “Captive” 101 training

• Bermuda regulations

• Insurance accounting and consolidation

• Communicating the captives’ business plan and objectives

Planning

Lines of communication

• Clearly define responsibilities and information flows

• When does executive management need to be informed?

• Regular team meetings – internal and with service providers

• Team chart with contact details

Planning

Deadlines and Calendar

• Clear Financial Reporting Deadlines– Management accounts– Audited Accounts– Statutory Filings– Budgets– Forecasts

• Renewals – Plan a clear renewal process, your captive needs to be actively involved

• Schedule Board meetings and Annual General Meeting

• Hold working meetings (e.g. monthly calls) to discuss ongoing issues.

Planning

Consider constituting Board appointed Committees

Committee members will vary but typically may include:

- Underwriting – Risk Manager, Captive Manager, Broker

- Claims - Risk Manager, Captive Manager, Broker, Actuary

- Investment – CFO, Treasurer

- Audit – CFO, Risk Manager

Planning

The captive is established, the team is in place…what’s next?

• Technology – how to make the process efficient

• Ongoing considerations

• Profitable captive programs

• Managing multiple captives

• Retention setting

• Negotiating with the market

• Collecting reinsurance claims

Operations

OPERATIONS

Technology

What IT is now being used to manage captives:

• Integrated insurance and general ledger accounting systems

• Captive extranets

• On line declaration systems

• On line claims reporting systems

• On line banking and investment reporting

• Electronic document management systems

Operations

Ongoing considerations

• Investment policy – don’t expose both sides of the balance sheet

• Match investment horizon with tail on liabilities

• Before establishing loans to parent consider– Tax implications and impact on deductibility– Regulatory approval

• Manage Collateral Requirements - LOC, Trust Accounts

• Dividend policy – protect the captive’s balance sheet also need to ensure compliance with regulatory requirements

Operations

Ongoing considerations cont’d.

• Premium allocation to operating units – what method to use?

• Consider actuarial analysis for reserving – it’s not just a statutory requirement

• Maintain the business plan – corporations constantly change and evolve, the captive purpose needs to be re-evaluated in tandem.

• Periodically assess business development opportunities – wrap brainstorming exercise around AGM

Operations

Profitable captive programs

• Is it a case of robbing Peter to pay Paul?

• Profitable programs strengthen long term ability to assume more risk

• Premium negotiation with local operating units can be difficult if excessively profitable

• Consider giving something back when selling new programs e.g. fund loss control programs on property program

• “Controlled” third party business can add significant value to group as a whole.

Operations

Managing multiple captives

• First of all why would I have multiple captives?– Inherited via acquisition– Strategic

• Write US risks only• Direct writing into Europe• Rest of the world

– Joint venture– Legal reasons– Branch – Employee benefits– Shareholder structure

Operations

Managing multiple captives cont’d

What do I need to consider when owning multiple captives?

• Total capital available to take on risk is diluted

• Compliance in multiple jurisdictions may be complex

• Duplication of administrative costs– Management fees– Audit fess– Actuarial Fees– Legal fees

• Increased senior management time required

• Consider cell structure as alternative

Operations

Retention setting

• Traditionally retention setting is a function of the market– Market premium v corporate retention

• As a captive grows, so too does the ability to influence the negotiation process.

• Key factors to consider are:– Market conditions– Loss experience – Loss control initiatives – Recent acquisition/divestments – do you know your

risk?

Operations

Retention setting cont’d

• Key factors to consider cont’d:– Lines of business – predictable exposure?– Corporate v local risk appetite– Captive balance sheet – ability to write more risk– Reinsurance – do I need aggregate stop loss?– Avoid dollar swapping and excessive associated

overhead costs built into market premium

Operations

Negotiating with the Market

• The relative ease or difficulty of renewals vary with the market cycles

• Using a captive gives another string to your bow in the negotiation process

• Following risk retention analysis, use the captive to smooth the effect of market cycles

• The strength of your relationship with markets may aide implementation of captive programs e.g. if fronting required

• Use reinsurance of captive – to facilitate favorable terms and policy wordings– protect captive from catastrophic losses.

Operations

Collecting reinsurance claims

• Captive structures are complex with multitude of contractual relationships

• Due to number of contractual relationships discrepancies can cause problems in the event of a major claim

• In extreme circumstances….claim may be denied

• How can there be multiple contracts?– Master policy wordings – Local wordings– Fronting wordings– Reinsurance wordings

Operations

Collecting reinsurance claims cont’d

• What road to settlement can the captive take?– Holistic approach – parent/reinsurer and captive is

irrelevant– Contractual approach – by the book– Flexible approach – agree at the outset how to

proceed– See what happens!

• Problems occur when documentation does not provide “back to back” coverage

• Remember - Reinsurers deal in large claims everyday, they know how to play the game if so inclined!

Operations

Collecting reinsurance claims cont’d

• What happens when coverage issues arise?– Each party establishes contractual rights and

obligations to the claims– Captive appoints reinsurer approved loss adjuster– Reinsurers will seek to “control” adjustment– Parties ascertain extent to which policy and

reinsurance will respond as circumstances of claim emerge

– Each party prepares for worst case – arbitration or court proceedings

Operations

Collecting reinsurance claims cont’d

• Typical claims problems– What contract law prevails?– What is the jurisdiction for arbitration/suit?– What language prevails in contradictory documentation– What influence or control do reinsurers have on the

adjustment process?– What assistance are the brokers or captive managers

obliged to give?– What authority does appointed loss adjuster have?– What influence does the parent company have?

Operations

Collecting reinsurance claims cont’d

• Other issues that may complicate the process:– Previous year wording is the basis of current year,

but current year policy has not been issued– Wording not agreed with reinsurers – Broker slip does not give clarity– Master policy wording not issued – but reinsurers

have agreed to it!

Operations

As with any undertaking the over time the success or failure of the venture should be evaluated

• Monitoring effectiveness

• What causes a captive to fail

• Exit strategies – what are my options?

Evaluation

EVALUATION

Monitoring effectiveness

How do you gauge the effectiveness of the captive strategy?

• Compare financial results to business plan/budgets

• Has captive reduced total cost of risk?

• Impact on market premiums

• Indirect benefits – Effective risk management – Internal awareness of risk– Improved loss control– Market leverage

Evaluation

Evaluation

How could it not have worked?!

What causes a captive to fail?

• Poor underwriting – get the price right

• Poor claims management

• Bad investments – don’t play the stock market!

• Market changes

• Lack of internal support or understanding

• “Pot of gold” mentality by senior management

• Bad luck!

Evaluation

Exit Strategies – what are my options?

• Run off the entity

• Amalgamate with another existing captive (if any)

• Sell to a third party

• Novation

• Loss portfolio transfer

• Commutation

Evaluation

Exit Strategies – what are my options?

Key considerations in choosing strategy:

• Complexity - number of contracting parties

• Loss of claims control

• Time to complete

• Finality

• Price!

Evaluation

Captive 201September 17, 2007