In this video, we outline the benefits of a captive and the best organizational candidates for such a structure. For a more detailed conversation, please contact us at email@example.com.
In this video, we outline the benefits of a captive and the best organizational candidates for such a structure. For a more detailed conversation, please contact us at firstname.lastname@example.org.
The coronavirus pandemic will hit every business, and the insurance industry at large, in various areas. When it comes to property & casualty (P&C) insurance coverages, there are several factors that will come into play. The following are a few examples by coverage and for the insurance industry in general:
Personal Lines and Commercial Lines Automobile policies cover both personal and commercial autos, respectively, for liability and physical damage to the insured vehicle. Key drivers of lower claim frequency are lower miles driven and lower traffic density. As average miles driven and traffic density decrease across America, we can expect claim frequency to decrease. This phenomenon could very well continue for many months to come for a variety of reasons.
With fewer vehicles on the road and many American’s staying at home, insurance companies should see fewer claims and consequently downward trending losses and premium levels. This happened in the last major rescission during the housing crisis. This may put some insurers in a position to come to the aid of insureds in the short term who are experiencing financial hard times and may result in significant premium decreases in the long term as opposed to insureds deciding to drop coverage and drive uninsured.
Contingent Extra Expense Coverage / Contingent Business Income Coverage reimburses lost income and extra expenses resulting from damage or operational disruption at the location of a customer or supplier. This might also be referred to as “business interruption coverage”, and is a good option for businesses disrupted due to the inability to supply key materials or goods because employees are out sick, caring for sick family members, or a key manufacturing site has been forced to shut down. Standard commercial insurance would not cover these financial losses. One provision of contingent business interruption coverage is that it can apply to instances of “Civil Authority”, for example when a government enforces an evacuation rule. There are generally two versions of Civil Authority coverage, with one being more liberal than the other.
Version one is more widely used on commercial insurance policies and is more restrictive in nature. In this version, the insurance company will pay for the actual loss of business income sustained and required extra expenses caused by a civil authority action that prohibits access to commercial premises. In general, there are three conditions that must occur in order for coverage to be available: (i) the disruption must be due to direct physical loss of/or damage to property, other than at your physical location, (ii) the disruption must be caused by/or resulting from any Covered Cause of Loss (as defined in the insurance policy) and (iii) the prohibition of access to the commercial premises must be the direct cause of the loss of income.
Generally, the biggest challenge with COVID-19 is that there is no direct loss to property. The loss of income results from the closure of businesses to reduce the spread of COVID-19.
It is possible that a commercial insurance policy may have a “more liberal” version of Civil Authority coverage. In this scenario, two conditions must be met to effect potential coverage. The policy covers the business income loss sustained during the time when access to property is prohibited by order of civil authority. As in the above scenario, this must be the result of a peril that is not excluded under the policy. However, in general, in this situation, direct physical damage is not required in order to trigger coverage.
It should be noted that accommodations under rules and laws may complicate coverage issues. For example, a state or local rule permitting restaurants to remain open on a “take-out” or delivery basis will permit the owners to continue to generate revenue, albeit on a reduced basis. However, this ability may prohibit recovery under a commercial policy.
Business Income/Business Interruption Coverage in the commercial market normally covers a business for lost revenue, rent, relation, loan payments and employee wage due to a slowdown or temporary suspension of normal business operations due to physical property damage of the business. Normally policy endorsements do not cover claims unrelated to property insurance losses. As a result, infectious diseases like COVID-19 are excluded. Some states like New Jersey have introduced legislation to require business interruption covered even if it’s excluded.
Extra Expense Coverage covers additional costs in excess of normal operating expenses incurred while property is being repaired or replaced after being damaged by a covered cause of loss (i.e., flooding or fire). Again, in most instances, COVID-19 is not causing physical damage to business properties. However, if there is contamination to a property from coronavirus exposure, to the extent that it is unusable for its primary purpose, it may result in eligible coverage. We do not believe this is likely to be a common occurrence, but it should be noted that extra expenses incurred to make a work environment or means of production safer for employees may be covered.
Liability Coverage: Some industries, like healthcare, may see an increase in medical malpractice claims. In the future, suits based on lack of screening, inadequate treatment and inability to contain the virus may become issues. Certain sectors, like nursing homes, may also see more of an increase than others. Some of this risk could be limited to the extent the predominant cause of the incident relates to issues resulting from federal and local government policies currently in place.
Captive Coverages may provide protection such as business interruption, where gaps exist in the commercial market. Companies that currently insure the above risks through a captive policy with broader policy terms covering virus related events may have funds available to supplement the loss of revenue, employee wage, etc. Captive policies are often designed to supplement commercial market coverage by dropping down to cover events excluded with typical commercial market policies.
Medical Stop Loss claims will likely increase for the industry as a whole. Currently insured individuals with multiple comorbidities will increase claims costs. In addition, long term care and social services costs may increase as well. States like New York have waived copays and cost sharing components for fully insured plans.
How this Will Impact the P&C Industry
In general P&C carriers with large common stock holdings will likely be impacted the most given the recent market downturns. Restrictive language in policy contracts should limit P&C insurers from adverse levels of claims resulting from COVID-19. However, in the business interruption sphere we will see a fair amount of claims, given the aforementioned announcement by the Insurance Services Office and possible state legislation passed to void policy exclusions, but these will likely be treated case-by-case.
According to Moody’s and Fitch, event cancelations will trigger the hardest hit in the insurance market, with perhaps the exception of medical. With the suspension of all major league and college sports (i.e. March Madness), major festivals like Coachella and South by Southwest, there has been an unprecedented amount of economic loss.
As we unpack our suitcases from another successful appearance at the Cayman Captive Forum – our 11th one attended as a company! – I’m also taking the time to unpack my thoughts on the event.
As a sponsor and exhibitor at the conference, which ran from November 27th to the 29th in the Grand Cayman Islands, our team had the pleasure of meeting a range of new faces and familiar colleagues. This is an event that we look forward to each year, and not just because it gives us a break from the cold weather. Drawing over 1,000 attendees, this is a top-notch event catered to captive professionals of all kinds, whether they are seasoned experts or newcomers.
The Cayman Captive Forum is one of many ways that we keep up with trends, priorities and news. So between ice cream socials and poolside receptions, I noted the four most prevalent categories from this year’s educational sessions.
1 – Taxes
No surprise here, as taxes and captives go hand-in-hand. This year, audience members learned about captive considerations for taxable and tax-exempt entities. Further, a group of accountants and lawyers covered US tax reform in detail, highlighting how it all affects captives (i.e. CFC rules, changes to attribution rules, etc.).
2 – Current Events
Naturally, any modern conference would take inspiration from current events, but I noticed quite a few sessions at Cayman that were focused on unrelated topics frequently seen in the headlines.
First, there was “Ridesharing in Healthcare”, which explored the role of transportation in population health management. Then, a panel explained the impact of the “#MeToo” movement on the healthcare industry – addressing harassment, bias and recommended solutions. Thirdly, a team from CHRISTUS Health told audiences of their experiences with Hurricane Harvey and its consequences, arming listeners with suggestions for future catastrophic events. Another session dealt with workplace violence, something we hear about far too often, and, finally, some healthcare specialists provided a defense strategy for an Ebola outbreak.
3 – Blockchain
Blockchain is another hot topic, so it got some spotlight at Cayman this year. In “Blockchain Technology Global Trends”, we learned about blockchain regulations and issues pertinent to insurance and healthcare. Then a panel of accountants discussed the opportunities and challenges presented by blockchain as it relates to insurance.
4 – Cyber
Cyber has been top-of-mind for risk professionals for several years. Unfortunately there has been no magical solution, so the subject remained front-and-center once again this year at Cayman. Charles Kolodkin and Rebecca Cady explained how to use Miscellaneous Professional Liability (MPL) to strategize for cyber risk. Their lessons learned included, “hone the ability to manage the claim” and “work with operational leadership and board”. Another session discussed how to control for vendor cyber risks, highlighting the increased interconnectivity between areas like big data, social media, cloud computing and the Internet of Things (IoT) and the role it all plays on cybersecurity.
All in all, the 2018 Cayman Captive Forum was an event to remember. Myself and my Spring team members enjoyed all of the networking and learning opportunities that the event brought about, and are already looking forward to next year’s!
The Spring team is delighted to announce that we will be sponsoring the Cayman Captive Forum which runs from November 27th to the 29th in the Cayman Islands.
While the conference’s location and weather (especially in November) are certainly a treat, we swear that’s not the only reason we’re going. In fact, Spring has been involved with the Insurance Managers Association of Cayman (IMAC, the host group) for over a decade, and its events and resources have never let us down. This year we will be joining over 1,400 other industry professionals to network and share our experiences and best practices. Attending conferences is one of the strongest ways that we keep our pulse on trends, and with such a large captive market in the Cayman Islands, this is one of the best.
A group of impressive speakers will present on topics like:
And much more!
If you are heading to the Cayman Captive Forum too, please stop by booth #7 to say hello to our team. We’ll be giving out a great raffle prize!
The Courts recently made a decision regarding the Reserve case for the IRS. This is the second case of late that has been decided against a captive owner in an effort to crack down on captives the IRS perceives to have a poor fact pattern, and therefore cannot meet insurance tax treatment standards. For example, captives that have been set up to undertake sham transactions or undertaking transactions that do not meet the bona fide insurance company characteristics would fall into this category.
According to the Avarhami v. Commissioner (“Avrahami”) judgement, the court provided four criteria that result in an arrangement constituting insurance. These four criteria were also addressed in the Reserve Mechanical Corp (“Reserve”) v. Commissioner case, and are as follows:
Reserve outlined these four non-exclusive criteria to establish a framework for determining the existence of insurance for federal income tax purposes. The court’s opinion focused on the idea of risk distribution, which led to investigating PoolRe Insurance Corp. (“PoolRe”), the stop loss insurer for Reserve. The judgement discusses the transaction in detail and stated there was a circularity of funds that invalidated the pooling arrangement.
To determine if a captive insurer has met the risk distribution criteria as a standalone captive without stop-loss or reinsurance protection, the courts looked at the total number of insureds and the total number of independent risk exposures. It has long been believed that the “law of large numbers” allows an insurer to minimize its total risk and reduce the likelihood of a single claim exceeding the premium received. In the Avrahami and Rent-A-Center court cases, risk distribution passing and failing thresholds have been observed as follows:
Reserve, an Anguilla-domiciled captive, wrote 11 to 13 policies over the three tax years in question and had direct policies for 3 insureds. Peak Mechanical & Components, Inc. (“Peak”), an S Corp for Federal income tax purposes, was owned in equal 50% shares by two individuals and was the primary insured under all policies. The policies were also issued to two other subsidiaries, although the operations were not significant. Peak operated two facilities and had a max of 17 employees. Reserve did not meet risk distribution based on this exposure profile alone; its exposures were similar in scale to the Avrahami’s. Reserve contended that it still met the risk distribution safe harbor requirements, by having 30% of its gross premium for each of the tax years for unrelated parties via the reinsurance agreement with PoolRe. A similar argument was made in the Avrahami case with their reinsurance pool.
Before it is determined whether Reserve distributed risk through the agreement with PoolRe, they evaluated whether PoolRe was a bona fide insurance company. In the eyes of the court, a captive should be able to answer “yes” to each of these questions and provide adequate support to:
The court’s conclusion in Reserve’s case provided details of the concerns with evidence in support of the first six questions listed above, and concluded that the PoolRe quota share arrangement provided the appearance of risk distribution without actual risk distribution. The court summary also highlighted the following:
One of the major concerns the IRS addresses with the Avrahami and Reserve cases is that a one-size-fits-all rate for all participants in the pool/reinsurance agreement isn’t valid. The court also addressed an alternative ground for the case, which would have been to evaluate “Insurance in the Commonly Accepted Sense”. To determine if an insurance arrangement exists, the following factors come into play:
The court summary pointed out several issues in Reserve’s support for answering the above questions, such as:
These cases provide us and other captive professionals with guidance and clarity. As the industry grows, cases like these will form the cornerstones of how to properly operate and conduct business as a captive insurance company.
The IRS clearly has problems with some of the pooling structures used to qualify captives as meeting the risk distribution safe harbor tests. They are concerned that the premiums ceded to the pool and the transfer of risk into the insurance pool are not commensurate with one another, and that the pools are only being utilized to circle premiums to the captive participants, with each assuming no or minimal losses from the pool.
There should be clear documentation of premium determination by an actuary, illustrating why premiums are reasonable and that sufficient risk transfer exists. Over time, if the total loss experience and premium ceded to the pool doesn’t produce a long-term average loss ratio consistent with the commercial marker, then the pool’s support in having arm’s-length contracts with each of the participants becomes weak and difficult to defend. Long term average commercial market loss and loss adjustment expense (“LAE”) ratios for most lines of business generally fall in the range of 50% to 75%, hence the 70% loss and LAE ratio threshold in IRS Notice 2016-66 used to identify captive transactions of interest.
Finally, it is important to show sufficient support in a captive’s business plan, policies, and feasibility studies to address the questions above about an insurer/pool being a bona fide insurance company.
The Vermont Captive Insurance Association (VCIA), founded in 1985, is the largest trade association for captive insurance in the world. As such, it’s no surprise that their annual conference yields both an impressive turnout and range of educational sessions. A long-time sponsor and member of VCIA, Spring anticipates the August event each year.
The VCIA 2018 Annual Conference, themed “Where the Captive World Comes to Meet”, was just as high-caliber as past years, but each event tends to build its own unique motif. This year, as about 1,100 insurance professionals gathered in Burlington, Vermont, and 40 presentations were made, the three-day conference seemed to emphasize “the future” most notably. The sessions below, along with general conversations I had with a range of people at the conference, are what led me to identify this theme.
This presentation, including Spring’s Managing Partner, Karin Landry, urged audience members to consider emerging risks like climate, and highlighted ways in which one captive has and continues to prepare for the future. Then, Andrew Braille of AES Corporation outlined the organization’s plans for the future, including a 50% reduction in carbon intensity.
An experienced panel led this discussion on how to nurture and attract captive talent to ensure a bright future for the insurance industry, one that is aging and failing to appeal to millennials. Tips like developing mentoring relationships and utilizing updated technology were given.
VCIA attendees, myself included, learned a lot about blockchain during this Wednesday morning session. The presenters defined blockchain and explained how it will impact captives and the insurance industry at large in the years to come. Good news – experts expect blockchain to reduce costs, lower risks, increase trust, and save time for insurance professionals as it continues to evolve.
Todd Cunningham and Carol Murphy highlighted the efficiencies to be gained by moving from a traditional insurance structure to an integrated model, where 1st excess coverage across lines all operates within the same system. They explained that this is the direction they see the industry will and should go.
Tracy Hassett of edHEALTH, and two others informed attendees about how A.I. will affect insurance risks and the labor market, and explained the role that predictive analytics and “The Future of Mobility” will have. A special focus was made on driverless cars and their impact on insurance.
To be clear, these are only a handful of informative and strong presentations (you can read about the others here), but the underlying theme is gear up for what’s to come.
I hope you enjoyed the summary, whether you were at VCIA or not. As you can see, I did manage to learn quite a bit despite the bike rides and cocktail receptions!
Each year, the Risk Management Society (RIMS) hosts one of the largest industry events. The annual conference and tradeshow brings together thousands of insurance and risk experts, and for the 11th year in a row, the Spring team was among them. We were happy to take a break from Boston’s not-so-springy weather and head to San Antonio for RIMS 2018.
Over the course of the 3-4 days, I was able to a) meet and greet insurance colleagues, both new and familiar, b) party like a true Texan (in case you thought Risk Managers would make for a dull crowd – you may want to rethink this notion), and c) get a gauge on the most popular industry trends and concerns.
For this writeup, I’m focusing on point C, because between various networking and social events, there was a lot to learn at the RIMS annual conference, and I’d love to share some takeaways. Here are the most buzz-worthy topics, in my opinion.
As it has with conferences and news headlines over the past 5-10 years, technology took center stage at RIMS. However, I’m using “technology” as an umbrella term to represent a range of digitally-centric, Internet of Things (IoT) subjects, such as:
During Berkshire Hathaway, Inc.’s annual shareholders meeting, Warren Buffett Chairman, President and CEO said, “Insurance is very early in the game in determining how to cover the risk of data breaches, ransomware and other hacking perils”. He then went on to say that the risk itself is a “very material risk” that didn’t exist 15 years ago one that will get worse. The world of cyber threats and attacks continues to keep risk professionals up at night. From my actuarial perspective, the probability and severity of cyber loss events are becoming better understood, although there still is tremendous uncertainty due to the rapidly changing nature of the risk. The following Cyber sessions were presented at RIMS:
b) Autonomous Vehicles
In March, a self-driving Uber car killed a pedestrian in Arizona, and an autonomous Tesla vehicle caused another death in California. These two incidents are just a couple of many news headlines involving self-driving cars, which certainly pose a variety of risks. As such, they were discussed on several occasions at this year’s conference.
c) Social Media & Mobile Apps
Considering the recent Facebook privacy scandal, it was important to look at social media and mobile issues from the perspective of risk management and mitigation.
e) Drones & Other Tech Matters
In 2017, the U.S. was hit hard with Hurricanes Maria, Harvey and Irma as well as wildfires in California. Outside the U.S., the Caribbean was crushed with those same hurricanes, a devastating earthquake hit Mexico, extreme flooding impacted areas like Bangladesh and Sierra Leone, and areas of China suffered from landslides and typhoons. Unfortunately, this is not an exhaustive list.
Compliance is always a key concern in this industry. What changes year to year are the specific areas of compliance focus, some of which are below.
If you were able to make it to the RIMS conference this year, I hope this helps you retain they event’s key takeaways. If you couldn’t make it to San Antonio, well, now it’s almost as if you were there!
Please feel free to reach out with any questions, actuarial or otherwise. In the meantime, put RIMS 2019 on your calendar – April 28th – May 1st – in Boston (our backyard). We’re already excited for it!
You’ve had your P&C captive for years and it has continued to perform well throughout. So, what next? How do you capitalize on this success and build on your captive or rebuild an underperforming aspect of it? One word: Refeasibility. Okay, so ‘refeasibility’ isn’t really a word (according to Oxford Dictionary). At least it hasn’t been traditionally, but it is one that needs to be on the tip of the tongue of every captive owner. It is a word that has become somewhat synonymous with captive optimization and very accurately describes what captive owners need to do with an older captive: conduct a new (re)feasibility study.
The Importance of Refeasibility
As with all other business matters, your company’s captive needs and goals are likely to change over time, especially with new and emerging risks sprouting up frequently. Much like your family car, a captive should have a check up on a periodic basis. As a captive matures and companies evolve, captives need to be re-examined to determine if changes should be made to align with current organisational needs. Key reasons for this re-examination include the following:
To address all these potential changes, our Spring CARE (Captive Analytical Risk Evaluation) team recommends a captive evaluate its risk appetite and risk exposure at least every ? ve years. Are you still writing the right lines in your captive? Are you still in the right domicile? Would a different structure be more profitable? Would other service providers make a difference? Have your claims changed signi?cantly? Have regulations changed over the years? All this and more can be answered with a good review of your captive by a professional consultant.
Captive optimisation starts with a captive refeasibility study. Every refeasibility study is different to varying degrees; the scope and resources required to conduct the study are dependent on the captive’s current structure, the events (if any) that triggered the study and the goals of the company. That said, through our Spring CARE system, we follow a carefully-constructed evaluation structure when our team works through the process of evaluating captive client’s existing captive. Generally speaking, we follow and recommend the following ? ow process in conducting a refeasabiity study, starting with goals and ending with measurement.
In this initial stage, it is important to focus on con? rming the goals and objectives of your captive, both new and old. Have the older goals been achieved? How have the goals changed over the years? This is a critical step in laying the groundwork and direction of your refeasibility project. Also critical at this early point is the collection of data. We consider the data to be collected here as not only the stats and facts of the captive, but also the more subjective (non-paper) data that can be gleaned through management interviews and informal stakeholder surveys. Finally, in any good refeasibility study, it is very important to identify changes in your risk pro?le. The risk matrix to the right shows the four classic actions a company can use to handle each of their risks (DeLoach 2000).
Typically, high probability or high impact risks should be considered for insuring in your captive. Some of the most common risks to insure in captives are listed below . Emerging risks should also be considering in this assessment. For example, A new technology like driverless cars will create both risk and/or opportunities across various industries.
Coverages commonly written into captives:
|Employee Benefits Risks||Property & Casualty Risks|
|Life/Loss of Key Employee||Business Interruption|
|Long-Term Disability||Directors & Officers Liability|
|Medical Stop-Loss||General Liability|
|Voluntary Benefits||Professional Liability|
|Retiree Benefits||Property (deductible or excess layer)|
|Pension Buy-Outs/Buy-Ins||Trade Credit|
|Commercial Policy Excluded Risk|
You want to be sure you have a clear idea of what you’re looking to accomplish, and to what extent. The Impact Stage of a refeasibility study involves looking at all the different pieces of the captive puzzle to determine how they would be affected by the changes you’re considering. A few activities that a professional captive optimizer would look to accomplish in this phase would be:
It’s important to outline the methods you plan on utilizing in your captive refresh; in this Strategies Phase, a professional captive optimizer would ?rst analyse any additional lines of coverage that could be insured by your captive.
Secondly, a surplus management strategy would be developed. There are various considerations in appropriately managing the capital and surplus levels over the life of a captive, including average cost of capital, retention levels, reinsurance use, taxes and a number of others that a team of actuaries and consultants would review and develop strategy to address.
Now that you know what you want to do and how, it’s time to take a closer look at how it will all work together in a logical structure. Market changes should give you some food for thought. For example, pure captives are increasingly changing to sponsored entities. In this Structure Stage, it is important to identify investment management best practices as well as the optimal collateral structure.
Finally, all sound captive projects end with measurement. This is the time to collect new data and determine to what extent goals were met, and impacts made. A great deal of this stage relies on the creation of solid industry benchmarks to measure current and future captive performance against. It is also important in the Measurement Stage for the optimization team to develop implementation plans based on their findings and make actionable recommendations for helping you achieve the goals that were established in the first phase of this project. At the conclusion of the measurement phase, a professional captive optimization team, such as our Spring CARE team, would produce a refeasibility report for your captive. In this report, all of the ?ndings of the refeasibility study are outlined and reviews along with the recommendations developed in this phase. These ?ndings can serve as a base line for measurement.
Regardless of how old or new your captive is, there are a number of internal and external factors that have changed since it was created. With all the changes taking place in the industry, it is a great time to have a professional come in and not only take a snapshot of how your captive is currently performing, but also help you project and strategize where your captive should be in the future. Now is a great time for a captive refeasibility study.