A.M. Best’s ART Market Revie · 2013-06-21 · A.M. Best’s ART Market Review 2013 Edition 3...

A.M. Best’s

ART Market Review2013 EdiTion

A.M. Best’s ART Market Review 2013 Edition 1

Contents

2 FOREWORD By Tina Bukow, Assistant Vice President, Business Development - Ratings

3 BEST’S CREDIT RATINGS: THE RATING PROCESS

4 SAMPLE MEETING AGENDA

6 PROPERTY/CASUALTY CAPTIVES: DATA REQUIREMENTS

7 CRITERIA 7 Alternative Risk Transfer 10 Rating Protected Cell Companies 13 Rating New Company Formations

19 GUIDE TO BEST’S FINANCIAL STRENGTH RATINGS

20 GUIDE TO BEST’S DEBT AND ISSUER CREDIT RATINGS

21 PUBLISHED REPORT: CAPTIVES FEELING THE SQUEEZE AS GLOBAL PRESSURES INTRUDE

29 PUBLISHED ARTICLES 29 Captive Audience 32 Measuring Up 34 Held Captive

37 CONTACT US

Copyright © 2013 by A.M. Best Company, Inc. ALL RIGHTS RESERVED.

2 A.M. Best’s ART Market Review 2013 Edition

Foreword

It’s difficult to find one word that aptly describes the current climate and past year or so for the ART industry: trying, exciting, challenging, robust, interesting, satisfying. “Interesting” sums up the variety of adjectives that

come to mind. Yes, it certainly has been an interesting few years for the ART market since our last Market Review update in 2011.

At last check, six new domiciles had adopted captive legislation, taking the total to 31 states, causing one to wonder if we will see a shift in re-domestications to “home domiciles.” Off-shore domiciles are making a play for Latin American captive companies. Despite another pushback to 2016, Solvency II continues to move toward completion and broadens its reach. Dodd-Frank has been clearly defined and poses a “lesser” threat to captives (or does it?), the onset of Obamacare and increased regulation causes medi-cal professional liability RRGs and hospital captives to increase their finan-cial strength profile to satisfy sponsors and regulatory requirements—all very interesting indeed.

On the risk front, captives continue to work on terrorism and employee ben-efits, and the market explores new risks such as surety and cyber risk, giving captives (and the traditional markets) cause for concern. These and other issues continue to be a source of discussion and debate.

A.M. Best has seen a large increase in the number of captives (single par-ent) seeking a rating, as well as an unprecedented increase in the number of rated RRGs (mostly medical professional liability), taking our all-inclusive rated number to well over 200 and growing. We are proud of our place as the global leader in captive (ART) ratings and remain steadfastly committed to the market. A.M. Best continues to work diligently to follow market trends, address market inquiry and provide additional education on topics such as enterprise risk management and our capital model as we look for innovative ways to meet the very specialized needs of these non-traditional companies.

Regulation and compliance continue to impose more stringent operating guidelines, challenging everyone in the industry to comply while remain-ing cost-effective and transparent. This update to our ART Market Review is part of A.M. Best’s effort to remain transparent about our ratings and the rating process. The publication is designed to be a culmination of current rating criteria, methodologies and general market information that should prove to be useful.

Your feedback is always welcome, and we are happy to answer any ques-tions that can help you better serve your clients, companies, boards and policyholders.

We look forward to the continued growth and success of the market and hope to see you at the various industry events we attend and participate in.

Tina BukowAssistant Vice President, Business Development - Ratings A.M. Best Company


Best’s Credit Ratings: The Rating Process

C ontact an A.M. Best office in your territory—we’ll help get you started by answering your ques-tions and supplying the information necessary to make an informed decision about obtaining a Best’s Credit Rating.

Upon determination of rating feasibility, a contract and quotation of a rating fee will be distributed to the requestor. Once the necessary information and signed contract are returned to A.M. Best, your company will then be assigned an analyst for the interactive rating process to begin.

The Rating Process, Step by Step

STEP 1: Rating Engagement and Contract: A.M. Best explains its rating methodologies and procedures at this stage.

STEP 2: Pre-Rating Preparation: Once a contract is signed and returned, the company is assigned an analyst, and the interactive rating process begins.

STEP 3: Rating Meeting: A.M. Best analysts meet with management from the entity seeking a rating.

STEP 4: A.M. Best’s Analysis: A rating recommendation is determined and taken to the Rating Committee for review and final determination.

STEP 5: Rating Decision and Dissemination: •Theratingiscommunicatedtotheratedentity.

•Oncetheratingisacceptedbytheratedentity,itisreleasedpublicly.

•Thecompanyiscontinuouslymonitoredaftertheratinghasbeenaccepted.Opendialogue with A.M. Best’s analytical team is encouraged and is helpful for the ongoing maintenance of the company’s rating.

STEP 1 Rating

Engagement and Contract(Weeks 1-2)

STEP 2 Pre-Rating

Preparation(Weeks 3-6)

STEP 3Rating

Meeting(Weeks 6-10)

STEP 4A.M. Best’s

Analysis(Weeks 8-12)

STEP 5Rating Decision

and Dissemination(Weeks 11-14)

The Rating Process


Sample Meeting Agenda

I n order to make your rating meeting as complete and comprehensive as possible, A.M. Best’s analytical team has prepared a sample property/casualty meeting agenda, detailing the areas that will be discussed in the initial interactive rating meeting.

Organization Structure •OwnershipandMembershipRequirements •OverviewofCorporateStructure •ManagementandBoardofDirectors

Corporate Governance •MissionStatement •Management’sPerspectiveonKeyRisks •RiskManagementFramework—Roles,Responsibilities&Oversight •BoardInvolvement •Systems/InternalControls

Capital Structure (Holding Company & Operating Company) •Composition •CapitalManagementStrategy •CapitalAdequacy •FinancialLeverage/DebtService •FinancialGuarantees •Sources&Uses(5Years) •Cash&Liquidity

Underwriting •ProductOffering(s) •GeographicFootprint •LimitsProfile •BaseRate&OverallPricingChanges •Retention •CycleManagementStrategy •PriceMonitoring/InternalControls •ExpansionInitiatives •ExternalRiskFactors

Marketing and Business Production •DistributionSources •Diversification •BusinessStrategies;ShortandLongTerm •GrowthStrategiesandTargets

Claims and Loss Reserves •SeverityandFrequencyTrends •ClaimsAdministration(Internal/ThirdParty) •NewPotentialClaimEmergence •LossReserves(ActuarialReport)—Carriedvs.Indicated •Management’sPerspectiveofReserveAdequacy •Asbestos&EnvironmentalReserveAnalysis(ifApplicable)



Reinsurance/Pooling •Pro-Rata/PerRiskExcessofLoss •CatastrophicReinsurancePrograms •LossPortfolioTransfers/AggregateStopLoss(Contracts) •Inter-CompanyReinsurance/PoolingAgreements •CreditRisk •NetRetention

Investments •Strategy&Guidelines •Composition •CreditRisk—PotentialBondIssuerDefault •CapitalMarketRisk—Equities/InterestRates •InvestmentManager(s)

Financial Data •StatutoryFinancialStatement(s) •ConsolidatedGAAPHoldingCompanyFinancialStatement(s)(AuditedifAvailable) •Long-RangePro-FormaFinancials—IncomeStatement&BalanceSheet

Catastrophe Management Framework •Natural&Man-MadeCatastropheExposureAnalysis •CatastropheModel(s)Used •ProbableMaximumLoss(PML)/TailRiskAnalysis •RiskAggregation/Mapping/Geocoding

Enterprise Risk Management* •ERMFramework •RiskCorrelation •ModelingCapabilities—EconomicCapital/DFA/RAROC •RiskTolerance/RiskManagementObjectives

Other •Regulatory •Legislative •Judicial

*A.M. Best’s expectation of a company’s ERM capabilities will vary depending upon an insurer’s scope of operations, size and risk complexity. In some cases, a separate ERM meeting may be required.



Property/Casualty Captives: Data RequirementsU.S., Canada, the Caribbean and Bermuda

1. AnnualReports–LatestFiveYears,ThenAnnually;IftheCaptiveHasRecentlyBeenEstablished, Loss Experience and Premiums from Previous Carriers

2. Audited Financial Statements for Parent and Subsidiary Companies (Annually)

3. Full Actuarial Reports, When Available (Annually)

4. Corporate Structure/Organizational Chart and History (Initially and as Changed)

5. ManagementStructureandKeyExecutiveCommittees(InitiallyandasChanged)

6. Biographical Information on Principal Officers and Board Members (Initially and as Changed)

7. Current Insurance Structure – Net Retention and Policy Limits by Line of Business, Primary and Excess Layers, Aggregates

8. Operating Plan/Five-Year Projections (Annually as Changed)

9. Capital Management Strategies

10. Risk Management Program

11. Investment Guidelines/Strategies

12. Reinsurance Program/Reinsurance Contracts

13. Completed Best’s Supplemental Rating Questionnaire (Annually)

14. Fronting Information – Copy of Fronting Policy/Contract Including: •NameofFrontingCompany,LengthofPolicy,PolicyRenewalDetails,Limits,Termsand Conditions, Exclusions, What Hazards Are Covered, etc. •CollateralorSecurityRequirementsoftheFrontandHowTheyAreBeingMetbytheCaptive

15. AnyOtherInformationRequestedbyA.M.BestCompany,IncludingbutNotLimitedto: •EstimatedImpact(NetandGross)fromCatastropheorOtherUnusualEvent •DetailsofChangesinOwnership,Management,Products,orOperations •RevisedProjectionofYear-EndResults •PlanstoMitigateLossesand/orCorrectanIdentifiedProblem

Captive Data Requirements


PUBLISHED: DECEMBER 27, 2011

Alternative Risk Transfer (ART)

T he purpose of this Alternative Risk Transfer (ART) criteria report is to delineate the rating consid-erations specific to ART vehicles in the following broad categories: Single-parent (or pure) captives, group captives, Risk Retention Groups, and Self-Insurers Funds. Some ART vehicles operate in a man-

ner similar to a commercial insurer, while others operate in a distinct manner that differs substantially from a commercial insurance carrier. Protected Cell Corporations or “cell captives” are covered under a separate A.M. Best criteria report.

There are three distinct features of ART insurers that are more or less universal to all types of captives: theuseandequitytreatmentofaspecifictypeofletterofcredit;theemphasisoncapitalpreservationoveroperatingperformance;andtheemphasisonbusinessretentionovermarketshare.Thelattertwofeatures are also apparent with many mutual insurers where persistency and surplus accretion are key reasons for their long-standing position in the market.

Treatment of Letters of Credit for ART EntitiesLetters of credit (LOCs) take many forms and typically are treated as debt in the rating process, whether for a commercial insurance carrier or for an ART entity (most often a single-parent captive). However, A.M. Best is aware of the use of a particular type of LOC to capitalize an ART entity, and this arrangement is encouraged by a number of captive insurance regulators to assist a regulator in accessing an ART enti-ty’s capital if needed. The details of the LOC must be presented to A.M. Best for capital consideration and determination of equity credit. The LOC generally must have all or most of the following characteristics: stand-alone;irrevocable;evergreen;funded;infavoroftheARTentity;anddrawnonahighlyratedbank.Certain types of LOCs may receive up to 100% capital credit, and that capital credit may not be subject to the usual threshold of 20% of surplus.

By stand-alone, it is meant that the instrument is not part of a credit facility or agreement that may have covenants and terms that can impair the liquidity of the LOC. It should be evergreen and irrevocable, which means that the instrument automatically renews and cannot be canceled except by prior written agreement by all parties. It should be funded with assets on deposit with the bank from which the LOC is drawn, and that bank takes the risk if the assets fall short of the face amount. Finally, the LOC should be drawn on a highly rated bank so that the credit risk of the bank does not cause an undue “haircut” of

equity credit.

It should be noted that under similar conditions, qualifying New York Regu-lation 114 trusts can receive equity credit as well.

Capital Preservation and Operating PerformanceThe ART marketplace was born out of insurance capacity shortages and price volatility of the commercial insurance market that historically have resulted from the vagaries of the underwriting cycle. ART vehicles invariably have the mission to provide consistent, tailored coverage at stable pricing to policy-holder owners. This dynamic results in a focus on capital preservation, with less emphasis on profit and return measures. Rated ART entities generally record solid profitability before policyholder and stockholder dividends. As a result, while ART vehicles may appear to have lower levels of underwriting and net income available to common shareholders, consideration is given in the rating process to return measures both before and after policyholder and owner dividends, depending on the historical use of these dividends.

RELATED REPORTSCRITERIAUnderstanding BCAR for Property/Casualty Insurers

Rating Protected Cell Companies

Risk Management and the Rating Process for Insurance Companies

RATING ANALYSTSSteven M. Chirico CPA, Oldwick+1 (908) 439-2200 Ext. [email protected]

John Andre, Oldwick+1 (908) 439-2200 Ext. [email protected]

Criteria


Market ProfileMost ART entities have a limited market share and therefore a limited market profile compared with many commercial insurers. While market profile is still important in the rating process for any insurer, A.M. Best recognizes the unique nature of the relationship between the ART entity and the insured and its impact on market profile. ART vehicles can be different in that they can have customized coverages, cus-tomer-specific claims and loss-control solutions, and board representation from owner insureds. Accord-ingly, retention ratios for ART vehicles tend to be much higher than those of commercial insurers, averag-ing more than 90%. ART vehicles gain and retain business by narrow and very specific products that are meant to address specific needs. Historically, the “value added” services such as loss control and engineer-ing, in addition to policyholder dividends, have enabled ART vehicles to hold onto customers even in soft insurance cycles.

Single-Parent (Pure) CaptivesMarket Profile – Given that the customary definition of market profile of a commercial insurer does not apply to a single-parent captive, A.M. Best looks for signs of how well the single-parent captive is entrenched in the risk management and commercial activities of the parent company’s business. The con-tinuum ranges from the captive being used simply as a risk financing tool, which represents a relatively weak substitute market profile, to being used as the platform from which the parent company’s enter-prise risk management program is implemented. A.M. Best will assess the risk management contribution of the captive to the parent company’s business operations in this manner.

Volatility of Operating Results – Since a single-parent captive has a relatively narrow scope of risk, there tend to be periods of very low loss activity contrasted with periods of significant losses. What A.M. Best looks for in these cases of volatility is the parent company’s previous demonstrated support or docu-mented support agreement, which outlines the intent and ability to support the captive with economic resources if needed.

Net Retention to Surplus – Akin to the rating of a commercial writer, an ART rating can be adversely impacted if the company writes a net aggregate per-occurrence limit that is greater than 10% of surplus. This is especially an issue with ART, as the companies often have limited spread of risk and very specific operating plans. For instance, one misinterpretation of building codes can be very problematic to a group captive that specializes in home construction. In the case of a single-parent captive, the probability of the full limit loss is determined, and then financial resources at the captive and the parent company are assessed for their ability to sustain a full limit loss under stress conditions. For instance, if a single-parent captive writes coverage for several properties in one city, the probability of all of these buildings experienc-ing a full limit loss in any one accident year is considered in assessing the capital adequacy of the captive.

Loan-Backs to the Parent Company – A.M. Best recognizes that there are a number of reasons why a cap-tive would want to make a loan of working capital back to the parent organization. Domicile-approved loan-backs must be documented properly with an arms-length loan agreement. Then the loan-back is charged a risk factor that contemplates the risks associated with the loan. The largest risk is generally the credit risk of the parent company, which is assessed via external (credit ratings) and internal financial analyses. Other risks may be present in a loan-back situation, such as the strength of the loan-back agree-ment and the parent company’s cash-flow volatility, and the analyst will assess these on an ad hoc basis.

Group CaptivesGroup captives are ART vehicles that offer insurance to several or many unrelated policyholder owners and can take many forms. Some group captives dedicate themselves to a particular industry, while others choose to write in a limited geographic area, such as a single state. Group captives are the ART vehicle that most resembles a commercial insurer, and the rating dynamics for a group captive are closer to those of a commercial insurer as well.

Criteria


Risk Retention GroupsRisk Retention Groups (RRGs) are governed under the Liability Risk Retention Act of 1986, which is a U.S. federal statute, and therefore states’ insurance departments have less authority over RRGs than they do over state licensed insurers. This fact makes RRGs distinct in some respects and requires particular atten-tion to the analysis of those differences. The major difference between the rating process of a commercial insurer or group captive and that of a RRG is the treatment of substitute forms of capital, particularly qual-ifying LOCs and New York Regulation 114 trusts. RRGs are distinct from other types of insurers in that only owners can contribute capital to the group, and only policyholders can be owners. So a managing general agent (MGA) or third-party administrator (TPA) that runs a program utilizing a RRG for writing the liability insurance cannot make a capital contribution to the organization (MGAs and TPAs don’t make contributions to regular commercial insurers). What they can do is sponsor a qualifying LOC to bolster equity capital. A.M. Best can give a substantial percentage equity credit in these situations if conditions warrant consideration. This includes a detailed analysis of the sponsor’s long-range intentions.

Self-Insurers FundsSeveral U.S. domiciles allow for self-insurers funds as an alternative form of insurance. By definition, these types of ART instruments can write only selected coverages for policyholder owners doing business in that particular state. self-insurers funds have two main differences that set them apart from commercial insurers: joint and several liability for any claims, and being governed under a specific charter where the surplusiswhollycomposedofSubscribers’SavingsAccounts.Jointandseveralliabilityrequiresthatallof the Subscribers’ Savings Accounts and all of the policyholder owners’ assets can be used to satisfy any claims. The joint and several conditions can be compared to an unlimited policy assessment feature. A.M. Best generally gives full equity credit to the Subscribers’ Savings Accounts, depending on the specifics of the individual self-insurers’ fund. These funds, by statute, distribute all net income to the Subscribers’ Sav-ings Accounts, so operating performance for this type of ART entity is evaluated pre-distribution.

ConclusionWhile the rating process is substantially the same for ART vehicles as it is for commercial insurers, there are some key differences in the way these vehicles operate that do get reflected in the rating process of these types of entities.

Criteria


PUBLISHED: MARCH 1, 2012


T he protected cell company (PCC) is a highly complex and flexible structure that can be utilized in a variety of ways by mul-

tiple users and sponsors. It is used to hold any number or combination of insurance and finan-cial operations, transactions or instruments.

Accordingly, the existing criteria used by A.M. Best to rate operating companies and debt issues also are applicable to PCCs. For example, Alter-native Risk Transfer would apply to a single-par-ent captive program that is housed in a PCC.

Evaluating the financial strength of a protected cell or protected cell company requires a clear understanding of the characteristics of the busi-ness that is placed in a PCC, the structure of the PCC, the domicile and the program’s ability to handle the exposures of its sponsoring organization. If the insured organization establishes its own PCC and subdivides its risks into a number of protected cells (PCs) within the PCC, then for all practical purposes it will be treated like a pure captive insurer for rating purposes. Also, if a cell has financial flexibility to access additional funding from its sponsoring organization, this option would be treated on terms equiva-lent with that of a pure captive operation and can be rated in a comparable fashion.

On the other hand, if an organization places its risks into protected cells that either have no access to addi-tional funding and/or are under the umbrella of another entity’s PCC, or core, then that PC must be reviewed carefully to ensure that the anticipated protection will exist should it be needed. It is important to know the quantity of risk transferred to the cell, based on both expected and worst-case scenarios. The generally smaller size and limited scope of individual PCs make stress testing for various adverse scenarios more impor-tant, particularly if financial flexibility is limited. Nonetheless, due to the flexibility allowed in the contractual arrangements in establishing a PC, mechanisms can be incorporated to allow for various means to either fund

the cell adequately up front for all reasonable circumstances, or to have access to on-demand additional funding from the PCC or from the owner of the cell.

The analytical team will examine the PC’s financial condition, its risk pro-file, its actuarially determined loss and IBNR reserves, and the credit expo-sures it has accumulated. In addition, its contractual relationships with other protected cells, if any, and with the core PCC will be reviewed thoroughly. Financial flexibility and the adequacy of the PC’s capital relative to the risks assumed are the critical factors in this analysis. Assuming that designated, individual protected cells exclusively bear all the risks placed with a PCC organization, and that the PCC core does not take any of these underwrit-ing risks, then the analysis will focus on the likelihood of the PCC’s own capital base being eroded from any contractual relationships it has with the member PCs. This could take the form of capital maintenance guarantees, stop-loss agreements or similar arrangements with the PCs. Here too, the contracts need to be examined carefully to determine the extent of these liabilities, as well as the potential for attachment of funds by a regulator or

RELATED REPORTSCRITERIAUnderstanding BCAR for Property/Casualty Insurers


Risk Management and the Rating Process for Insurance Companies

RATING ANALYSTSSteven M. Chirico CPA, Oldwick+1 (908) 439-2200 Ext. [email protected]

John Andre, Oldwick+1 (908) 439-2200 Ext. [email protected]

Information Needed To Rate a Protected Cell Captive

T he information needed will vary based on the particular business/issue placed in the PCC. However, most PCCs would have to provide at

least the following information:

1) Audited financials for the PCC and each cell 2) Actuarial reports 3) Contractual agreements between cells 4) Collateral agreements 5)Reinsuranceagreements 6) Cell sponsor/user information

Criteria


a court of law in the case of any member PC becoming insolvent. In these cases, a financial evaluation of all PCs, which could have a potential material impact on the PCC, needs to be conducted, regardless of whether those PCs are rated individually or not, and the aggregate exposure to the PCC must be com-pared with the PCC’s resources to respond to those needs. A financial strength rating on a PCC does not automatically extend to the individual PCs within the protected cell company structure.

To date, there has not been a full test in a court of competent jurisdiction of the legality of the walled-off structure between any two or more cells within a cell company. The preponderance of legal opinion

Core

CellCellCellCell

CellCell

CellCellCellCell

CellCell

Core

CellCellCellCell

CellCell

CellCellCellCell

CellCell

Ringfencing in Protected Cell Companies

In other jurisdictions, assets of the cell are ringfenced from both the core and other cells.

In some jurisdictions and certain cell company configurations, creditors can claim against the core.

From RACs to SACs

T here are a variety of terms used in reference to protected cell companies and similar structures. With more than 30 different domiciles having promulgated PCC legislation and with the differences among the laws, the multiplicity of terms is not surprising. In addition, the protected cell company may be viewed simply

as a variation of the rent-a-captive structure or even a special-purpose vehicle. There also are several other legal structures that have similarities to the PCC. Hence, the multitude of terms, structures and perspectives may cause confusion, even for the experienced ART practitioner. Below are some of the terms and acronyms used:

PCC Structures:The following list of names and acronyms includes examples of the terminology utilized by various domiciles to refer to actual PCCs.

• Incorporated Cell Captive (ICC) (e.g.,usedinJersey) •Protected Cell Company (PCC) (e.g., used in many U.S. state domiciles) •Segregated Accounts Company (SAC) (e.g., used in Bermuda) •Segregated Portfolio Company (SPC) (e.g., used in Cayman) •Sponsored Captive Insurance Company (SCIC) (e.g., used in Vermont)

Other Structures:• Producer Owned Reinsurance Company (PORC) – Captive reinsurance entity established to provide reinsurance for a producer’s business. •Rent-a-Captive (RAC) – (Re)insurance entity that rents its capital, surplus and license to clients and provides administrative services. Clients’ business is separated by accounting and contractual means. •Special-Purpose Vehicle (SPV) – Corporate entity created to enable a specific business transaction and fulfill a narrow objective. •Special-Purpose Financial Captive (SPFC) – Corporate entity created for the securitization of insurance risk. It may establish protected cells.

Criteria


on the legislation, however, comes in on the side of the protected nature of each cell. Lingering issues remainthatcouldhaveanimpactontheprotectedcellmovement.Theseincludetaxliabilitymatters;insolvenciesofsponsoringcompanies;andrun-offsituations.

Control and monitoring of any protected cell captive program is crucial to ensure that the expectations for response to claim incidents will be met, given the capabilities and limitations of the cell captive. There are certain overriding themes and issues that will have an impact on the utility of such a program for the insured and on the financial strength associated with it. Fronting and reinsurance agreements will be examined in detail to determine whether the protected cell program will be impacted adversely by the provisions contained in those agreements. Other important considerations include the type of protectedcellthatisemployed,whetheropen,closedorsomevariationinbetween;thecontractualrela-tionshipsamongthecellsintheprogramandbetweenthemandthecore;andtheabilityofeachcelltoabsorb shock losses or adverse development. Finally, as all domiciles offering venues for protected cells have some variations among their enabling legislative and regulatory provisions and their enforcement mechanisms, the regulatory framework under which the protected cell company and the PCs are estab-lished will be evaluated and monitored.

Criteria


PUBLISHED: JUNE 6, 2011

Rating New Company Formations

R egulatory and tax issues, as well as market dislocations and consumer demand for new and inno-vative products and services, continue to influence new insurance and reinsurance company formations. As a result, brokers, agents, lenders, capital market participants and corporate clients

continually seek financial information about new entities as they are formed. To meet this demand, A.M. Best Co. provides ratings on new organizations and other risk-assuming vehicles using methodol-ogy outlined in this report. This methodology covers all new company formations, including start-up ventures not affiliated with a currently rated organization, as well as new company formations within a currently rated group.

A.M. Best’s interactive rating process for insurance companies involves numerous quantitative and qualita-tive factors that are grouped into three categories: balance sheet strength, operating performance and busi-ness profile. A.M. Best’s methodology for rating new company formations uses the same assessments of bal-

ance sheet strength and business profile as it does for established companies receiving traditional rating assignments. Similarly, if the new company forma-tion is a member of a rated group, A.M. Best’s methodology Rating Members of Insurance Groups applies as it would for a traditional rating assignment.

New companies are formed for many different purposes, employing a variety of business models. For example, some new companies are an extension or spin-off of an existing operation where the new entity is, in effect, inherit-ing an existing block of business. In other cases, the new company is a more traditional start-up venture where there is no demonstrated track record of operating performance. A.M. Best’s rating approach for new companies recognizes these distinctions and allows appropriate flexibility in the assess-ment and evaluation process. Extensive conversations with, and an assess-ment of, management are central to this process in any new company rating. This assessment of management includes developing an understanding of the organization’s risk management and financial management framework and expertise.

In the case of a true start-up venture, given the additional degree of uncer-tainty and lack of a track record, assessing the long-term sustainability of earnings and cash flows – keys to the interactive rating process – requires additional rigor in certain areas of the rating process, such as the review and analysisofbusinessplans;theassumptionsunderlyingthecompany’sprojec-tions;andoperationalcontrols.Inaddition,toreflecttheheightenedlevelofuncertainty inherent in reviewing a newly formed entity of this nature, more stringent quantitative and qualitative metrics are applied to the rating of a new company formation. In particular, initial and prospective risk-adjusted capital levels (and related capital metrics, including financial leverage) typi-cally will need to be well above the levels expected of a comparable existing company with a history of ongoing operations that is assigned the same rat-ing. This level of relative conservatism applies throughout the development phase of the new company formation, even after factoring in conservative expectations for earnings and investment returns. This additional capital requirement reflects the new company formation’s lack of operating history and resulting operating risk.

RELATED REPORTSCRITERIAUnderstanding Universal BCAR –A.M. Best’s Capital Adequacy Ratio for Insurers

Understanding BCAR forProperty/Casualty Insurers

Understanding BCAR for CanadianProperty/Casualty Insurers

Understanding BCAR for Life/Health

Rating Members of Insurance Groups

Evaluating Country Risk

Insurance Holding Company and Debt Ratings

Analyzing Contingent Capital Facilities

Equity Credit for Hybrid Securities

Best’s Credit Rating Methodology –Global Life & Non-Life Insurance Edition

RATING ANALYSTSRobert DeRose, Oldwick+1 (908) 439-2200 Ext. [email protected]

William Pargeans, Oldwick+1 (908) 439-2200 Ext. [email protected]

Edward Easop, Oldwick+1 (908) 439-2200 Ext. [email protected]

Criteria


Requirements for Proceeding With the Rating AssignmentFor A.M. Best to proceed with an initial rating assignment, certain conditions and factors must be considered:

•Aclearlydefinedfive-yearbusinessplanthatallprincipalsareinaccordwithandarewellqualifiedand capable to implement. The plan includes: —Policystatementsonunderwritingcriteria,investmentguidelinesandriskmanagement; — A thorough description of the products offered, pricing standards and the company’s distributionandmarketstrategy;and — Financial projections, along with the underlying quantitative and qualitative assumptions and the anticipated utilization of capital. •Initialfinancinginplaceorexpectedtobeexecutedwithproceedspaidintothecapitaloftherated (re) insurance entity concurrently with the initial rating assignment. •Stress-testedcapitalizationthatconservativelysupportstheassignedratingthroughoutthebusinessplan. •Management’sdemonstrationofasuccessfultrackrecordofoperatingperformancerelevanttothenew venture’s core business. Experience with organizing new insurance ventures also is factored into the process. •Experiencedmanagementandtheappropriatestaffandoperationalinfrastructureinplace (or adequately addressed in a detailed implementation plan, which may include use of third party servicers) to support initial activities and meet regulatory and rating agency scrutiny. •Management,boardmembers,strategicinvestors,investmentbankers,actuariesandotheradvisers available for discussions with A.M. Best and to provide comprehensive disclosure of requested information. •Afollow-upprocessinplacetomeasuretheeffectivenessoftheinitialbusinessplanandtomonitorthe company’s strategic and financial development.

New Company Rating ProcessThe objective of any Best’s Credit Rating is to provide an opinion of the rated entity’s ability to meet its senior financial obligations, which for an operating insurance or reinsurance company are its ongoing insur-ance obligations. Best’s Credit Ratings include Best’s Financial Strength (FSR), Issuer Credit (ICR) and Debt Ratings. In assigning a credit rating to an established company, A.M. Best looks at balance sheet strength, operating performance and business profile, which is analogous to a review of a new company’s initial and prospective capital, sponsorship, business plans, management and operational controls. For definitions of the various types of Best’s Credit Ratings and a comprehensive explanation of Best’s credit rating process, pleaserefertoBest’sCreditRatingMethodology–GlobalLife&Non-LifeEditiononA.M.Best’swebsite.

The rating analysis of established and new entities is both quantitative and qualitative. Evaluation of key financial ratios is integrated with a qualitative evaluation of the company’s operating plans and philosophies to gain a comprehensive understanding of the company’s initial standing and its prospects.

When rating members of groups, A.M. Best employs a top-down and bottom-up approach for both established and new entities within the group. Every legal entity that maintains an A.M. Best rating is reviewed on a stand-alone basis, i.e., the bottom-up analysis. The group’s overall strengths and weaknesses also are analyzed, i.e., the top-down analysis. The final published rating for each legal entity within the rated group, including a newly formed subsidiary, considers the potential benefit or drag from its affiliation within a larger organization.

In A.M. Best’s credit rating process, all entities, including new company formations, are viewed within the con-text of the particular country risks to which they are exposed. Under these circumstances, A.M. Best utilizes its country risk methodology, Assessing Country Risk, whereby countries are classified into one of five tiers reflect-ing the various economic, political and financial system risks that can affect an insurer’s financial strength. Coun-try risk is one risk factor among many in the rating process. It affects the rating but does not create a ceiling on the rating of the legal entity or group, and some elements of country risk can be managed in the same manner as other risks are managed. A.M. Best’s rating system applies the same rigorous criteria to all insurers, new or estab-lished, offering a means of directly comparing insurers regardless of longevity or country of domicile.

Criteria


Key Rating FactorsThe analytical components of A.M. Best’s interactive credit rating process for new insurers involve numer-ous quantitative and qualitative factors that can be grouped into the two evaluative categories of balance sheet strength and business profile. A third evaluative category of operational controls encompasses the stringent set of qualitative analysis and standards used to assess operating performance, given the lack of a measurable track record of operating performance inherent in a new company formation.

1. Balance Sheet StrengthA. CapitalizationA.M. Best’s assessment of the strength and quality of a company’s balance sheet is the underpinning of any creditrating.Keyfactorstypicallyreviewedtoassessacompany’sfinancialstabilityandflexibilityinclude:

•Initialon-balance-sheetcapitallevel,othercommittedcapitalizationandcomplementaryfinancingsources. •Stress-testedcapitalization,basedontheBest’sCapitalAdequacyRatio(BCAR)modelundervarious scenarios, that conservatively supports the assigned rating throughout the operating plan. •Capitalstructure–equityanddebtfinancing. •Useofreinsurance,creditfacilitiesandotherformsofcontingentcapitalfinancing. •Qualityanddiversityofassets. •Regulatoryconsiderations. •Investorexpectations,includingearningsanddividends. •Capitalgenerationanticipatedfromcorebusinessactivities. •Pricingtargets. •Expectedreservinglevels(conservativeoraggressive). •Investmentstrategyforreservesandcapital.Theinvestmentstrategyshouldbeconsistentwiththemix of business, financial plans, liquidity needs and capitalization. Since investment management is important to preserving capital, A.M. Best will review the quality and diversification of assets and the reputation and experience of the investment managers. •Expertiseandprocessesformanagingassets,liabilitiesandotherdriversofenterpriseriskindividually, as well as the interrelationships among risks. In reviewing initial and prospective capitalization and operating leverage, A.M. Best begins with the capital requirements of the relevant regulatory authorities. This is followed by a rigorous capital analysis using BCAR to assess the capital that is necessary to support the new venture’s operations over a period of time and that is appropriate for the types of business written.

Determining Risk-Adjusted Capital RequirementsThe new company should demonstrate that it can support the execution of its business plan while main-taining risk-adjusted capital adequacy at levels well above what typically would be expected of a more mature company at the assigned rating level throughout the period of the operating plan. The amount of additional capital needed will reflect the risk profile of the business. A higher level of capitalization might be required if the business is subject, for instance, to low-occurrence but high-severity events, or operates in a line of business that typically generates an initial drain on capital due to the slow emergence of prof-its. A.M. Best also will stress test the pace at which the company expects to utilize its capital. At all rating levels, the capital required will reflect the greater risks inherent in a start-up venture compared with an established company’s continuing operations.

As of the initial rating date, A.M. Best expects the new company formation to have adequate on-balance-sheet capital to support appropriate risk-adjusted capital adequacy levels, relative to the rating assigned, considering the company’s projected business activities throughout the five years of the business plan. The BCAR calculated for the new company formation and utilized within the rating process will capture the expected level of business writings, investment and asset risk, general business risk and other ele-ments of risk inherent in the new company’s operations over the five-year period. It is important to note,

Criteria


however, as with any interactive credit rating, that capitalization and the BCAR results are not the sole determining factors in the assignment of a rating. In determining the published initial credit rating, and the corresponding initial on-balance-sheet capital requirement for a specific new company formation, A.M.Bestwillconsiderthetypeofbusinesstobewritten;expectedgrowthpattern(includingwhethertheplancallsfororganicgrowthorgrowththroughblockacquisition);andavailabilityofadditionalfinancial support, as well as risks related to the capital structure of the parent or investor providing addi-tional financial support.

A.M. Best’s assessment of the strength and quality of a company’s balance sheet also incorporates an evaluation of the company’s financial stability and flexibility. The level, quality and permanence of capi-tal, including potential distributions of initial investor capital, are evaluated, taking into consideration the company’s appetite for risk, the structure of its assets, its dependence on reinsurance and its liquid-ity needs. If the organization’s capital structure includes some form of debt, contingent or hybrid capital, additional analysis will be performed in accordance with A.M. Best’s rating methodology – possibly culmi-nating in a public rating on certain debt instruments. For more information, please refer to the following methodologiesonA.M.Best’swebsite:A.M.Best’sRatings&theTreatmentofDebt;AnalyzingContingentCapitalFacilities;andEquityCreditforHybridSecurities.Pleasenote,asmentionedearlier,thattoreflectthe heightened level of uncertainty inherent in reviewing a newly formed entity, higher quantitative and qualitative standards are applied to the rating of a new company formation.

B. Sponsorship and InvestorsA new company’s sponsors and/or strategic investors can significantly affect its success in meeting its objectives. Their experience and commitment to the company over the near and long term, including any potential exit strategies, are key considerations in the rating process.

A.M. Best considers the competitive advantages that a sponsor might provide to a new company, as well as the new company’s expected benefits to the sponsor’s core business, as an indication of the sponsor’s likely long-term commitment to the new company. It is also important to understand the return investors expect and the reasonableness of these expectations relative to the new company’s business plan and existing market condi-tions. For example, if the sponsor is a rated organization that provides turnkey capability to a new company that, in turn, supports the sponsor’s core business, A.M. Best might view that favorably in the rating process.

If the sponsor also provides financial guarantees or reinsurance support that is acceptable to A.M. Best, this too might enhance the rating assessment. A more conservative rating approach is required of situ-ations where investors are looking to make a quick return because of prevailing, favorable market con-ditions, as short-term adversity could lead them to withdraw support. In these situations, regulatory controls on paid-up capital, and the likely underlying attractiveness of the operation to future capital pro-viders, are especially important. Expected dividend policy is a key part of the initial rating analysis, and any subsequent increase in the scale or early introduction of dividends compared with the initial plan will be a negative factor in the rating.

The strength of the sponsor/new company relationship is evaluated by considering a variety of factors, such as:

•Typeofsponsororinvestor–strategic/financialsupport. •Leveloffinancialandoperationalcommitment. •Investors’returnexpectations(reasonableness,timeliness,exitstrategies)andlevelofmanagement interaction (active or passive investor). •Linkageorsynergieswithanexistinginsuranceornoninsuranceorganization,suchasamutually beneficial long-term relationship with the sponsor. •Strategic/operationalsupport(distributionormarkets). •Additionalfinancialsupport(capitalcontributions,financialguaranteesandreinsuranceagreements).

Criteria


For more information on how A.M. Best evaluates potential rating enhancement within an insurance organization, please refer to Rating Members of Insurance Groups at www.ambest.com/methodology. •Financialflexibilityandstrengthofthesponsororinvestor.

2. Business ProfileA. Business Plan and StrategyA clearly defined business plan is essential. The success of the company depends on management’s ability to effectively implement the business plan while remaining responsive to changing conditions. The busi-ness plan and financial targets serve as a benchmark against which A.M. Best will measure the company’s success in the first few years. Some of the areas A.M. Best explores include:

•Targetedlinesofbusinessthatareconsistentwiththeexpertiseandtrackrecordofmanagementand,if relevant,thecompany’sstrategicinvestorsoritsparentcompany; •Pricingtargetsandfinancialplansthatarecompatiblewithexpectedreturnsandcapitalprotectionand generation;and •Whetherthenewcompanyissetuptoserveanappropriatebusinesspurposeorasameanstoreduce taxable obligations.

KeyinformationtypicallyreviewedinA.M.Best’sevaluationincludes:

•Well-definedfive-yearbusinessplan; •Targetedclassesofbusiness; •Competitiveenvironmentandthecharacteristicsthatwilldifferentiatethecompany; •Distribution/clientrelationships; •Pricingmethodologiesandmonitoringpractices; •Returnexpectationsvs.marketrealities; •Definedriskmanagementandunderwritingpolicystatements; •Investmentstrategies,bothlongtermandshortterm;and •Projectedfinancialresults,includingbalancesheet,incomestatement,cashflowsandcapitalobligations.

B. ManagementA.M. Best looks at the depth of the senior management in terms of its track record in critical functional areas,suchasunderwritingandclaimsmanagement;financial,investmentandriskmanagement;informa-tiontechnology;andmarketing,salesanddistribution.A.M.Best’sreviewofmanagementconsiders:

•Experienceinmanagingotheroperationsthroughstart-upandchangingbusinessconditions. •Financialandoperationalrisktolerance. •Consistencyofthebusinessplanandinvestmentstrategywiththoseofsponsorsorinvestorsandwith market realities. •Alignmentofincentivecompensationplans,employmentcontractsandmanagementinvestmentswith the attainment of the company’s long-term financial and strategic goals, shareholder value and policyholder security. •Abilityofmanagementtoattractkeypersonnel,establishsoundbusinesspractices,anddevelopformal monitoring processes and the appropriate infrastructure and operating controls to support operations. •Successionplans,especiallyifthefoundingmanagementisinplaceonlytodeveloptheinitialbusinessplan.

3. Operational ControlsOperational controls are important indicators of management’s ability and commitment to the quality and lon-gevity of a new company. These controls should be linked to the monitoring and fulfillment of the business plan. Operational controls also are the means by which the new company’s growth is managed and provide a large measure of risk management. As part of the review of operational controls, A.M. Best considers:

Criteria


•Whetherstatementsoninvestment,riskmanagement,underwritingandaccountingpolicyaredefined clearly, and whether those statements are consistent with the company’s business plan, capitalization and management’s appetite for risk. •Thecompany’svaluationmethodologyforestablishingreserves. •Itsmonitoringofcatastrophicexposuresandmodelingtechniquesused. •Itsprocessformonitoringofpricingandunderwritingdecisions,includingthefrequencyanddepthof the review process. •Itsmonitoringandreportingofinvestmentriskexposures(includingfluctuationsininterestrates, equity markets, inflation and exchange rates) generated by both the company’s asset holdings and its liability structure, as well as the exposure created by the interrelationship of those risks. •Thecontrolstomonitorthenewcompany’sdistributionrelationships,duediligence,productivity, revenue tracking and expense controls.

A.M. Best’s Monitoring ProcessMaintaining a rating on a new company also requires significant ongoing surveillance by A.M. Best, over and above that already required when rating established operations. In assigning an initial rating, A.M. Best and the company agree on a formal plan to monitor the company’s strategic and financial develop-ment. This plan usually entails quarterly reviews with management and other principals on the com-pany’s progress toward its stated objectives. Any changes in strategy are discussed and considered in the ongoing rating evaluation.

As with the initial rating, A.M. Best requires detailed disclosure in monitoring the rating. Companies are asked to provide all information necessary for continuing analysis. This generally includes annual and quarterly statements, reviews of risk management, revisions of business plans and documentation on insurance written.

Criteria


GUIDE TO BEST’S FINANCIAL STRENGTH RATINGSA Best’s Financial Strength Rating is an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance policy and contract obligations. The rating is based on a comprehensive quantitative and qualitative evaluation of a company’s balance sheet strength, operating performance and business profile.

Financial Strength RatingsRating Descriptor Definition

Sec

ure

A++, A+ Superior Assigned to companies that have, in our opinion, a superior ability to meet their ongoing insurance obli-gations.

A, A- Excellent Assigned to companies that have, in our opinion, an excellent ability to meet their ongoing insurance obligations.

B++, B+ Good Assigned to companies that have, in our opinion, a good ability to meet their ongoing insurance obliga-tions.

Vuln

erab

le

B, B- Fair Assigned to companies that have, in our opinion, a fair ability to meet their ongoing insurance obliga-tions. Financial strength is vulnerable to adverse changes in underwriting and economic conditions.

C++, C+ Marginal Assigned to companies that have, in our opinion, a marginal ability to meet their ongoing insurance obli-gations. Financial strength is vulnerable to adverse changes in underwriting and economic conditions.

C, C- Weak Assigned to companies that have, in our opinion, a weak ability to meet their ongoing insurance obliga-tions. Financial strength is very vulnerable to adverse changes in underwriting and economic conditions.

D Poor Assigned to companies that have, in our opinion, a poor ability to meet their ongoing insurance obliga-tions. Financial strength is extremely vulnerable to adverse changes in underwriting and economic con-ditions.

EUnder Regulatory Supervision

Assigned to companies (and possibly their subsidiaries/affiliates) placed under a significant form of regulatory supervision, control or restraint - including cease and desist orders, conservatorship or reha-bilitation, but not liquidation - that prevents conduct of normal, ongoing insurance operations.

F In Liquidation Assigned to companies placed in liquidation by a court of law or by a forced liquidation.

S Suspended Assigned to rated companies when sudden and significant events affect their balance sheet strength or operating performance and rating implications cannot be evaluated due to a lack of timely or adequate information.

Positive Indicates possible rating upgrade due to favorable financial/market trends relative to the current rating level.

Negative Indicates possible rating downgrade due to unfavorable financial/market trends relative to the current rating level.

Stable Indicates low likelihood of a rating change due to stable financial/market trends.

Rating ModifiersModifier Descriptor Definition

u Under Review Indicates the rating may change in the near term, typically within six months. Generally is event driven, with positive, negative or developing implications.

pd Public Data Indicates rating assigned to insurer that chose not to participate in A.M. Best’s interactive rating process. (Discontinued in 2010)

s Syndicate Indicates rating assigned to a Lloyd’s syndicate.

Not Rated Designation

NR: Assigned to companies that are not rated by A.M. Best.

Rating DisclosureA Best’s Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance obligations. The ratings are not assigned to specific insurance policies or contracts and do not address any other risk, including, but not limited to, an insurer’s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder. A Best’s Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor does it address the suitability of any particular policy or contract for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional details, see A.M. Best’s Terms of Use at www.ambest.com.

Best’s Financial Strength Ratings are distributed via press release and/or the A.M. Best Web site at www.ambest.com and are published in the Credit Rating Actions section of BestWeek®. Best’s Financial Strength Ratings are proprietary and may not be reproduced without permission.Copyright © 2013 by A.M. Best Company, Inc. Version 021712

A MBEST

®

OutlooksIndicates potential direction of a Financial Strength Rating over an intermediate term, generally defined as 12 to 36 months.

Guide to Best’s Financial Strength Ratings


GUIDE TO BEST’S DEBT AND ISSUER CREDIT RATINGSA Best’s Debt/Issuer Credit Rating is based on a comprehensive quantitative and qualitative evaluation of a company’s balance sheet strength, operating performance and business profile and, where appropriate, the specific nature and details of a rated debt security.

Long-Term Credit RatingsA Best’s Long-Term Debt Rating, assigned to specific issues such as debt and preferred stock, is an independent opinion of an issuer/entity’s ability to meet its ongoing financial obligations to security holders when due.

Rating Descriptor Definition

Inve

stm

ent

Gra

de

aaa Exceptional Assigned to issues where, in our opinion, the issuer has an exceptional ability to meet the terms of the obligation.

aa Very Strong Assigned to issues where, in our opinion, the issuer has a very strong ability to meet the terms of the obligation.

a Strong Assigned to issues where, in our opinion, the issuer has a strong ability to meet the terms of the obligation.

bbb Adequate Assigned to issues where, in our opinion, the issuer has an adequate ability to meet the terms of the obligation; however, the issue is more susceptible to changes in economic or other conditions.

No

n-In

vest

men

t G

rad

e

bb Speculative Assigned to issues where, in our opinion, the issuer has speculative credit characteristics, generally due to a moderate margin of principal and interest payment protection and vulnerability to economic changes.

b Very Speculative

Assigned to issues where, in our opinion, the issuer has very speculative credit characteristics, generally due to a modest margin of principal and interest payment protection and extreme vulnerability to economic changes.

ccc, cc, c Extremely Speculative

Assigned to issues where, in our opinion, the issuer has extremely speculative credit characteristics, generally due to a minimal margin of principal and interest payment protection and/or limited ability to withstand adverse changes in economic or other conditions.

d In Default Assigned to issues in default on payment of principal, interest or other terms and conditions, or when a bankruptcy petition or similar action has been filed.

A Best’s Long-Term Issuer Credit Rating is an opinion of an issuer/entity’s ability to meet its ongoing senior financial obligations.

Ratings from “aa” to “ccc” may be enhanced with a “+” (plus) or “-” (minus) to indicate whether credit quality is near the top or bottom of a category.

Short-Term Credit RatingsA Best’s Short-Term Debt Rating is an opinion of an issuer/entity’s ability to meet its financial obligations having original maturities of generally less than one year, such as commercial paper.

Rating Descriptor Definition

Inve

stm

ent

Gra

de

AMB-1+ Strongest Assigned to issues where, in our opinion, the issuer has the strongest ability to repay short-term debt obligations.

AMB-1 Outstanding Assigned to issues where, in our opinion, the issuer has an outstanding ability to repay short-term debt obligations.

AMB-2 Satisfactory Assigned to issues where, in our opinion, the issuer has a satisfactory ability to repay short-term debt obligations.

AMB-3 Adequate Assigned to issues where, in our opinion, the issuer has an adequate ability to repay short-term debt obligations; however, adverse economic conditions likely will reduce the issuer’s capacity to meet its financial commitments.

No

n-In

vest

men

t G

rad

e AMB-4 Speculative Assigned to issues where, in our opinion, the issuer has speculative credit characteristics and is vulnerable to adverse economic or other external changes, which could have a marked impact on the company’s ability to meet its financial commitments.

d In Default Assigned to issues in default on payment of principal, interest or other terms and conditions, or when a bankruptcy petition or similar action has been filed.

A Best’s Short-Term Issuer Credit Rating is an opinion of an issuer/entity’s ability to meet its senior financial obligations having original maturities of generally less than one year.

Not Rated DesignationThe Not Rated (NR) designation may be assigned to issuers or issues that are not rated.

Rating DisclosureA Best’s Debt/Issuer Credit Rating is an opinion regarding the relative future credit risk of an entity, a credit commitment or a debt or debt-like security. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. These credit ratings do not address any other risk, including but not limited to liquidity risk, market value risk or price volatility of rated securities. The rating is not a recommendation to buy, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor does it address the suitability of any particular financial obligation for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional details, see A.M. Best’s Terms of Use at www.ambest.com.

Best’s Debt/Issuer Credit Ratings are distributed via press release and/or the A.M. Best Web site at www.ambest.com and are published in the Rating Actions section of BestWeek®. Best’s Credit Ratings are proprietary and may not be reproduced without permission.Copyright © 2013 by A.M. Best Company, Inc. Version 061212

A MBEST

®

OutlooksIndicates the potential direction of a Credit Rating over an intermediate term, generally defined as 12 to 36 months.

Positive Indicates possible rating upgrade due to favorable fi nancial/market trends relative to the current rating level.

Negative Indicates possible rating downgrade due to unfavorable fi nancial/market trends relative to the current rating level.

Stable Indicates low likelihood of a rating change due to stable fi nancial/market trends.

Rating Modifi ersBoth Long- and Short-Term Credit Ratings can be assigned a modifier. Note: The public data modifier did not apply to Short-Term Credit Ratings, which are only assigned on an interactive basis.

Modifi er Descriptor Defi nition

u Under Review Indicates the rating may change in the near term, typically within six months. Generally is event driven, with positive, negative or developing implications.

pd Public Data Indicates rating assigned to a company that chose not to participate in A.M. Best’s interactive rating process. (Discontinued in 2010)

i Indicative Indicates rating assigned is indicative.

Guide to Best’s Debt and Issuer Credit Ratings


PUBLISHED: AUGUST 6, 2012

Captives Feeling the SqueezeAs Global Pressures Intrude

A composite of 209 U.S. captive insurance entities and alternative risk vehicles followed by A.M. Best (hereinreferredtoascaptives)saw2011netincomedecreaseby$537million,or21%(seeExhibit 1). The decline is attributable to decreases in underwriting income, net investment income and realized

capital gains (see Exhibit 5). Other items also contributed to the decrease in net income, such as increases in other expenses and income taxes. Clearly, captives are starting to feel the squeeze of a continuing soft market, low investment yields and continuing global financial malaise.

Underwriting income for 2011 decreased because of increases in loss- and loss-adjustment expenses (LAE) incurred ($318 million, or 6%) and underwriting expenses incurred ($129 million, or 8%), partially offset by a decrease in dividends to policyholder/owners of $129 million, or 29%, and an increase in net earned premiumsof$59million,or1%.

The increase of incurred loss and LAE primarily reflects decay in losses in the medical professional liabil-ity insurance (MPLI) line of business. Written (see Exhibit 1) and earned (see Exhibit 7) premiums for 2011wereessentiallyunchangedcomparedwith2010.ThepurelossratioforMPLIincreased5pointsin2011 due to rate decreases and increased loss activity in this line of business. Most other lines of business experienced declines in pure loss ratios or small increases that were driven by deterioration in premiums as well as some increases in incurred losses.

The increase in underwriting expenses is attributable to increased net commissions incurred of $46 million, or 16%, coupled with an increase in other underwriting expenses of $83 million, or 7%. Other underwriting expenses are com-posed of items such as premium taxes, salaries, rent and equipment, and other expenses. All expenses except salary expense were essentially flat between2011and2010,andsalaryexpenseincreased$57million,or11%, in 2011 compared with 2010.

Netinvestmentincomedecreasedin2011by$95million,or7%(seeExhibit 5), due to a 30-basis-point decrease in yield on fixed-income

ANALYTICAL CONTACTSteven M. Chirico +1 (908) 439-2200 Ext. [email protected]

EDITORIALMANAGEMENTBrendan Noonan

Exhibit 1U.S. Captive Insurance – Financial Indicators (2007-2011)($ Thousands)

Year

NetPremiums

Written%

Chg

Pretax Operating

Income/(Loss)

% Chg

Net Income/

(Loss)%

ChgAdmitted

Assets%

ChgLoss & LAE

Reserves%

ChgYear-End Surplus

% Chg

2007 $9,683,233 -4.8 $2,667,915 17.8 $2,279,438 -13.7 $50,459,400 2.1 $19,538,588 1.6 $19,198,827 3.4

2008 9,234,026 -4.6 2,468,906 -7.5 755,509 -66.9 47,837,954 -5.2 19,567,150 0.1 18,181,104 -5.3

2009 8,490,182 -8.1 2,301,998 -6.8 1,706,088 125.8 48,786,169 2.0 18,474,533 -5.6 20,144,403 10.8

2010 7,663,915 -9.7 2,239,300 -2.7 2,551,049 49.5 49,303,682 1.1 17,905,692 -3.1 21,829,394 8.4

2011 8,354,468 9.0 1,875,235 -16.3 2,014,351 -21 50,837,503 3.1 17,994,797 0.5 22,727,166 4.1

5-Year CAGR -3.6 0.6 -1.3 4.3

5-Year Change -13.4 1.0 -1.1 0.7

Source: A.M. Best research

Published Report


Exhibit 2U.S. Captive Insurance – Profitability Analysis (2007-2011)(%)

Year

Return on Invested Assets Return on Revenue Return on Equity Underwriting & Operating Ratios

Investment Yield

Net Inv Inc (W/Realized

Capital Gains)Total ROIA

Pretax Oper Inc/ NPE

Net Inc/ NPE

Total ROR

Pretax Oper Inc/ PHS

Net Inc/ PHS

Total ROE

Loss &

LAEUnderwriting

Expense

Combined (After

Policyholder Dividends) Operating

2007 4.5 5.6 5.1 27.2 23.3 21.1 14.1 12.1 10.9 66.2 22.0 94.3 74.3

2008 4.1 1.2 -2 25.3 7.7 -6.7 13.2 4.0 -3.5 67.4 21.5 93.2 75.1

2009 3.6 3.7 6.9 25.9 19.2 33.8 12.0 8.9 15.7 67.4 21.6 91.8 74.9

2010 3.3 5.0 5.7 27.5 31.4 34.9 10.7 12.2 13.5 65.4 20.3 91.2 73.6

2011 3.0 4.4 3.3 22.9 24.6 18.3 8.4 9.0 6.7 68.8 20.1 92.9 76.6

5-Year Avg

Captive 3.7 4.0 3.7 25.8 20.8 19.6 11.6 9.3 8.8 67.0 21.1 92.7 74.9

Industry 4.6 4.5 4.2 14.0 11 10.2 11.2 8.8 8.2 70.9 29.8 101.1 85.7

10-Year Avg

Captive 3.7 4.4 4.5 17.3 15.7 16.0 8.8 8.0 8.1 75.3 20.3 99.8 83.3

Industry 4.8 4.9 5.0 11.1 9.4 9.6 10.3 8.7 8.9 73.7 28.5 102.5 87.9


Exhibit 3U.S. Captive Insurance – Investment & Liquidity Analysis (2007-2011)(%)

Year

Investment Portfolio (% of Invested Assets) Investment Leverage (% of PHS) Liquidity & Cash Flow Ratios

Long-Term Bonds

Total Stocks

Cash & Short-Term

InvAffiliated

InvAll

OtherCommon

StocksNon-Affiliated Inv Leverage

Affil Inv Leverage

Quick Liquidity

Current Liquidity

U/W Cash Flow

Operating Cash Flow

2007 66.2 13.6 6.5 3.9 9.8 31.0 52.2 9.2 44.2 141.3 106.2 116.1

2008 67.2 8.4 8.5 5.2 10.6 18.7 41.3 12.2 36.8 137.0 100.4 111.0

2009 65.7 11.0 8.7 5.5 9.1 23.4 42.5 11.9 43.7 145.9 95.4 109.1

2010 64.9 11.2 8.0 5.9 10.0 22.4 43.5 12.2 46.5 156.2 95.3 111.8

2011 64.2 10.8 8.8 5.6 10.6 21.5 44.8 11.4 48.7 157.5 100.9 115.8


securities, which was only partially offset by a 3.4% increase in invested assets. Asset allocations explain thedecreaseinnetinvestmentincome,sincebondandstockallocationsdroppedfrom59.1%and10.2%ofinvestedassetsfor2010,respectively,to58.4%and9.8%ofinvestedassetsfor2011,respectively(seeExhibit 9). Cash and short-term investment allocations increased from 7.3% to 8.0% of invested assets for 2011 compared with 2010. The changes in allocation have further strained investment yields and net investment income, but they make sense in light of the flat yield curve coupled with most captives’ investment philosophy, which considers preservation of asset value as the principal objective. These reallocations provide for a relatively safe investment portfolio that is somewhat insulated from downside valuation shocks at the cost of yield. It should be noted that captives’ investment portfolios performed sig-nificantly better than commercial insurance companies’ portfolios during the crisis of 2008-2009.

Net realized capital gains, while still positive, decreased by $94 million, or 13%, for 2011 compared with 2010 (see Exhibit 5). The decrease is attributable to the leveling off of the stock market, coupled with steady, albeit very low, interest rates. The general sense resulting from A.M. Best’s rating meetings with captive management teams is that realized capital gains will continue to decrease over the next few years, unless there is some form of significant government intervention in the financial markets.

Published Report


Exhibit 4U.S. Captive Insurance – Underwriting Leverage & Loss-Reserve Analysis (2007-2011)(%)

Year

Underwriting Leverage Ratios Loss-Reserve Ratios

NPWNet

Liab Net Ceded GrossBusiness Retention

Reserves/PHS

Reserves/NPE

Developed/Original

Developed/PHS

Accident-YearCombined

(Calendar Year-Accident Year)

2007 0.5 1.6 2.1 0.5 2.6 83.3 101.8 199.6 -17.8 -17.5 91.2 3.0

2008 0.5 1.6 2.1 0.5 2.6 81.9 107.6 200.7 -15.0 -15.6 98.8 -5.6

2009 0.4 1.4 1.8 0.5 2.3 79.5 91.7 207.8 -10.8 -9.7 95.2 -3.3

2010 0.4 1.2 1.6 0.4 2.0 81.4 82.0 220.2 -5.8 -4.7 94.4 -3.2

2011 0.4 1.2 1.6 0.4 2.0 81.6 79.2 219.7 - - 96.1 -3.3

Industry 0.8 2.3 3.0 0.9 3.9 81.5 152.9 195.4


Exhibit 5U.S. Captive Insurance – Sources of Earnings & Surplus Growth (2007-2011)($ Thousands)

YearNet Underwriting

IncomeOther Income/

(Expense)Net Investment

IncomePretax Operating

Inc/(Loss)Realized Capital

Gain/(Loss) Income TaxNet Income/

(Loss)

2007 $585,816 $125,820 $1,956,280 $2,667,915 $455,815 $844,292 $2,279,438

2008 773,013 -67,398 1,763,291 2,468,906 -1,227,707 485,690 755,509

2009 811,040 -18,878 1,509,836 2,301,998 32,381 628,291 1,706,088

2010 810,516 421 1,428,363 2,239,300 734,324 422,574 2,551,049

2011 551,739 -9,830 1,333,326 1,875,235 640,673 501,557 2,014,351

5 Yr. $3,532,123 $30,135 $7,991,096 $11,553,354 $635,487 $2,882,404 $9,306,436

YearUnrealized Capital

Gain/(Loss) Total ReturnOther Surplus

Gain/(Loss)Contributed

CapitalStockholder

DividendsChange in

SurplusYear-EndSurplus

2007 $(215,776) $2,063,662 $91,625 $425,275 $(1,956,442) $624,120 $19,198,827

2008 -1,408,607 -653,098 172,973 94,417 -632,014 -1,017,723 18,181,104

2009 1,294,659 3,000,747 -65,010 13,424 -985,862 1,963,299 20,144,403

2010 290,302 2,841,351 -79,991 115,360 -1,191,730 1,684,990 21,829,394

2011 -512,220 1,502,131 -54,819 768 -550,308 897,772 22,727,166

5 Yr. $(551,643) $8,754,793 $64,778 $649,244 $(5,316,357) $4,152,459


Income taxes incurred increased $79 million, or 18.7% in 2011 compared with 2010 (see Exhibit 5). Income taxes represented 27% of pretax operating income for 2011, compared with 19% for 2010. The increase is attributable to the decreased utilization of net operating loss (NOL) carryforwards that were generated by losses for some captives in 2008. As these NOL items are used up, income taxes will return closer to the 2007 amount of 32% of pretax operating income over the next few years.

Net premiums written increased $691 million, or 9% in 2011 compared with 2010 (see Exhibit 1). Net pre-miumsearnedincreased$59million,orlessthan1%forthesameperiod.Theincreaseinnetpremiumswritten is attributable to a 2% increase in rates and a 7% increase in exposure base. According to a number of captives interviewed for this analysis, the exposure base increased not necessarily from an increase in insureds or their payrolls, revenue or receipts, but from a drive toward the most efficient use of existing cap-tives by taking on more risk retention and purchasing less reinsurance, and/or taking lines of coverage into their captives that previously had been placed in the commercial market. This last efficiency has been noted particularly for single-parent captives. The rate increases captives experienced in 2011 were derived from certain lines of business that have shown some hardening, such as workers’ compensation and property.

Published Report


Exhibit 6U.S. Captive Insurance – Underwriting/Operating Ratios (2007-2011)(%)

YearPure Loss

Loss-Adjustment

Expense

Loss &

LAECommission

ExpenseOther

Expense

Total U/W

Expense

Combined Ratio Before Policy-

holder DividendsPolicyholder

Dividends

Combined Ratio A/

PHDS

NetInvestment

RatioOperating

Ratio

2007 49.5 16.7 66.2 5.1 16.9 22.0 88.3 6.0 94.3 20.0 74.3

2008 51.0 16.5 67.4 5.0 16.5 21.5 88.9 4.3 93.2 18.1 75.1

2009 48.5 18.8 67.4 3.5 18.0 21.6 88.9 2.9 91.8 17.0 74.9

2010 45.8 19.5 65.4 3.7 16.5 20.3 85.6 5.6 91.2 17.6 73.6

2011 48.6 20.2 68.8 4.0 16.2 20.1 88.9 3.9 92.9 16.3 76.6

5-Yr. Avg.

Captive 48.8 18.2 67.0 4.3 16.8 21.1 88.2 4.6 92.7 17.9 74.9

Industry 57.1 13.8 70.9 11.2 18.7 29.8 100.8 0.3 101.1 15.3 85.7


Exhibit 7Product Line Loss Experience

Rank Product Line:2011 NPE

($000)

Pure Net Loss Ratio (%) Better/(Worse) Than Industry (Points)

2011 2010 2009 2008 20075-Year

Avg 2011E 2010 2009 2008 2007

1 Medical Professional Liability $3,608,615 36.9 31.9 33.4 33.5 43.6 35.9 -1.8 0.4 0.4 -0.8 -6.4

2 Other Liability 987,331 36.8 38.9 33.4 38.5 40.9 37.7 11.7 17.9 22.2 9.7 12.4

3 Auto Warranty 469,684 55.1 57.2 58.6 58.8 60.2 58.4 16.6 11.5 8.8 10.8 1.2

4 Commercial Multiperil 397,442 86.8 90.4 103.0 171.6 44.6 98.6 -23.0 -38.4 -54.7 -99.9 -1.2

5 Workers’ Compensation 366,055 61.5 65.7 66.5 61.2 57.8 62.5 9.5 6.7 2.9 1.2 4.9

6 Auto Physical Damage 215,180 87.1 81.8 57.9 60.4 56.1 62.2 -22.2 -23.3 -0.1 - 1.5

7 Commercial Auto Liability 214,960 43.6 72.2 47.5 39.9 48.0 50.0 14.0 -18.3 7.4 14.4 4.5

8 Inland Marine 177,254 56.2 40.6 45.2 50.2 40.2 46.6 1.4 5.5 2.5 4.7 2.1

9 Private Passenger Auto Liability 173,248 67.9 12.5 69.7 56.9 61.5 58.3 -3.1 54.0 -3.0 7.6 1.3

10 Allied Lines 75,185 85.4 56.2 83.6 68.9 57.5 70.1 -2.4 -1.8 -30.7 10.1 -19.3

All Other 404,176 67.2 48.5 45.5 60.9 57.8 57.0 - - - - -

Total $7,089,131 47.4 43.2 46.4 49.9 49.8 47.6 19.5 17.9 13.8 15.2 6.1


Surplus increased in 2011 by $898 million, or 4% compared with 2010 (see Exhibit 1). The increase is attributabletothegenerationofnetincomefor2011of$2.014billion,offsetby$512millionofunrealizedcapital losses and other surplus items and stockholder dividends net of contributed capital of $604 million (see Exhibit 5). Net stockholder dividends were the result of amounts captives paid to owner/policyholders in an effort to provide the lowest possible insurance cost. The unrealized capital losses are attributable to the turbulent financial markets. It should be noted that these captives generally have very good liquidity, as evidencedbyaquickliquidityratioof49%andacurrentliquidityratioof158%(seeExhibit 3). Therefore investments that are under water can be held for quite some time in hopes that their prices will recover.

Underwriting leverage remained at 0.4 to 1.0 for 2011, exactly the same as in 2010 and 2009 (see Exhibit 4). This amount is half of the commercial composite of 0.8 to 1.0, illustrating captives’ relative conservatism. In fact, net reserve leverage for captives for 2011 was 1.2 to 1.0 for 2011, compared with the commercial composite of 2.3 to 1.0. Captives, by the nature of their conservative operating strategies, compare very favorably with the commercial composite. This conservatism offsets the diversification benefits most com-mercial insurers enjoy.

Published Report


Single-Parent Captives Close the Loop for Owners

A lmost all large corporations have their own captives to insure and manage their risks. Naturally, the corporation and its captive share an identical mix of business. Exhibit 10, however, shows the indus-try diversification within A.M. Best’s single-parent captive universe. There is a heavy concentration

within the single-parent captives in the energy (27%) and auto (14%) industries, both of which rely more heavily on ratings because of their larger retentions and dependence on reinsurance. In addition to regula-tory and transparency benefits, ratings provide them with cost efficiencies and enhanced risk management.

Exhibit 8U.S. Captive Insurance – Asset Composition (2007-2011)

YearLong-Term

BondsPreferred

Stocks (%)Common

Stocks (%)Total

StocksReal Estate & Mortgage

Cash & Equivalents

Short-Term Investments

Other Invested Assets

Non-Affiliated Invested Assets

2007 $29,857,063 3.4 96.6 $6,153,686 $73,591 $1,557,731 $1,362,695 $4,335,132 $43,339,899

2008 28,331,643 3.6 96.4 3,536,899 97,252 1,686,665 1,913,238 4,377,502 39,943,200

2009 28,681,856 2.2 97.8 4,814,238 131,136 1,877,305 1,917,674 3,829,108 41,251,318

2010 29,161,470 2.2 97.8 5,009,305 131,916 1,840,316 1,754,207 4,351,660 42,248,874

2011 29,705,832 2.0 98.0 4,996,062 149,911 1,968,877 2,083,620 4,770,499 43,674,801


Exhibit 9U.S. Captive Insurance – Asset Allocation (2007-2011)Percentage of total admitted assets.

Year

Long-Term

BondsTotal

Stocks

Real Estate &

Mortgages

Short-Term Investments

& CashAll

Other

Non-Affiliated Invested

Assets

Affiliated Invested

Assets

Total Invested

Assets

Agents & Premium Balances In Course

of CollectionDeferred Not Due

Non-Invested

Assets

2007 59.2 12.2 0.1 5.8 8.6 85.9 3.5 89.4 2.1 3.1 5.5

2008 59.2 7.4 0.2 7.5 9.2 83.5 4.6 88.1 2.0 3.2 6.6

2009 58.8 9.9 0.3 7.8 7.8 84.6 4.9 89.5 1.7 3.0 5.8

2010 59.1 10.2 0.3 7.3 8.8 85.7 5.4 91.1 1.8 2.3 4.8

2011 58.4 9.8 0.3 8.0 9.4 85.9 5.1 91.0 2.0 2.3 4.7

Industry 62.9 3.2 0.6 2.7 4.7 74 9.4 83.4 3.2 5.5 7.9


Exhibit 10U.S. Captive Insurance – Distribution of Rated Single-Parent Captives by Industry (2011)

0

5

10

15

20

25

30

Tran

spor

tatio

n

Tele

com

mun

icat

ion

Reta

il

Relig

ious

Phar

mac

eutic

al

Man

ufac

ture

r

Insu

ranc

e

Insp

ectio

n, W

aste

Hum

an S

ervi

ces

Hosp

itals

Fina

ncia

l Ins

titut

ion

Ente

rtai

nmen

t

Ener

gy

Cons

truc

tion

Chem

ical

Auto

Airli

ne

Agric

ultu

re


(%)

Published Report


Comparing Captives and Commercial LinesFor most large and midsize corporations, having a captive is no longer an option but rather a necessity, as it becomes a part of the fabric of the entire corporation’s risk and enterprise risk management culture. Unlike commercial insurers, the captive enables the corporation to be nimble in addressing risk financing issues aris-ing continually in the ever changing business environment. Single-parent captives can offer unique and fully customized solutions to their parents’ particular risk profiles, and since only the parent itself has the knowl-edge and expertise on its risks and various ways to mitigate them, the two – captive and parent – match per-fectly. A single-parent captive harmonizes rather than substitutes for the parent’s current insurance program, by providing a funding mechanism for existing self-insured or retained risks. It accomplishes this simply by taking a higher deductible or self-insured retention and paying losses as they occur. Anything exceeding the self-insured portion must be reinsured by a panel of well-capitalized and highly rated reinsurers.

Among the many forms of captive insurers, single-parent or pure captive, which is the focus of this section, brings many unique attributes due to the relationship with the captive owner. Simply put, this type of captive is a fully owned subsidiary of its parent: The parent knows its risks and how to mitigate them, and the captive manages these risks and their mitigation processes more efficiently than most every commercial insurer.

As Exhibit 11 shows, A.M. Best’s uni-verse of rated single-parent captives outperforms commercial industry prof-itability measures by substantial and impressive margins. As for the policy-holder dividend, although it appears to be unfavorable in the table, it is in fact favorable to the organization as it is paid to the parent.

There are a number of reasons for the differences in operating performance measures. Starting with the loss and LAE ratio, it is apparent that single-parent captives significantly outper-form the commercial lines industry by a wide margin. What may not be so apparent are the reasons why losses and loss-adjustment expenses are substantially lower for single-parent captives compared with the commercial lines industry. This is because of the lower frequency and sever-ity of losses, as well as the significantly lower claims mitigation costs of losses that do occur.

Losses are generally of lower frequency because of customized, proactive loss-control programs that are designed for one type of business unit. These programs concentrate on analyzed risk areas that are ger-mane to the business, versus the generalist approach most commercial insurers undertake. Additionally, there is generally a feedback loop between a single-parent captive’s underwriting, claims and loss-control areas that analyzes losses and designs ways to prevent or minimize them in the future, as well as adjust-ing premiums charged to the parent company’s business units. This feedback loop, over a relatively short period, produces minimized loss frequency and severity, as well as pricing that addresses the financial aspect of claims that do occur. Commercial lines companies of any size struggle to create a loss informa-tion feedback loop that works as well as those employed by most single-parent captives. In most commer-cial lines companies, claims and underwriting have minimal interaction.

Loss-adjustment expenses tend to be very low for single-parent captives compared with the commercial lines industry because of the significantly lower unallocated loss-adjustment expenses (adjuster costs) and litigation

Exhibit 11U.S. Captive Insurance – Key Ratio Comparison (2007-2011)5-year pure captive proxy vs. commercial composite.

Single- Parent

CaptivesCommercial

Composite

VarianceFavorable/

(Unfavorable)

Loss & Loss-Adjustment Expense Ratio 60.7 71.3 10.6

Underwriting Expense Ratio 7.2 29.0 21.8

Combined Ratio (Before Policyholder Dividends) 67.9 100.3 32.4

Policyholder Dividends 16.1 0.8 (15.3)

Combined Ratio (After Policyholder Dividends) 84.0 101.1 17.1

Net Investment Ratio 20.9 16.0 4.9

Operating Ratio 47.0 85.1 38.1


Published Report


costs, partially offset by higher expenses such as investigation costs. For example, parents of single-parent cap-tives almost never sue their captives for coverage issues and similar, third-party related defense costs.

Single-parent captives tend to use a surgical approach to claims adjusting that utilizes experts in a particu-lar claim mitigation area. This minimizes the general and administrative expenses involved in sustaining a generalist claim staff. Those specialized adjusters tend to perform a more robust claim investigation to not only assess coverage and damage, but also gather information on causes and prevention that can be used to minimize similar losses in the future. These activities may lead to a higher LAE billed to the claim file, but that cost can yield substantial economic benefit in the future.

The single-parent underwriting expense ratio is a fraction of the commercial lines expense ratio. The main cause, by far, is the elimination of the agency and brokerage costs incurred to produce business. The commercial composite includes approximately 12 points of these costs, versus zero for the single-parent captive composite. The other cost savings involve overhead expenses,which are often high in a commer-cial insurance company but are minimized in a single-parent captive. Costs such as executive compensa-tion, filing and licensing, marketing and business development, and financial reporting and legal expenses are minimized in a single-parent captive. Essentially, it is expensive to run a modern insurance company, and these costs need to be passed on to insureds.

Captives write a variety of product lines, and they generally retain a smaller portion of such coverage while reinsuring the remaining limits. As such, the captive retains flexibility in its coverage decisions and is in a better position to assess risk as results occur, while simultaneously taking a proactive approach to resolving claims. Also, the traditional reasons for forming a captive are the ability to control and manage coverage and the expenses related to claims and losses. Therefore, from a financial perspective, the dol-lars that ordinarily would be spent outside the enterprise on commercial premiums are used to fund the captive and return excess profits to the parent.

Policyholder dividends are significantly larger for single-parent captives than they are for commercial insurers. The main reason is the high motivation for a single-parent captive to return excess capital derived from accumulated profits to the parent company. A commercial insurer, on the other hand, has three masters. First, management incentive compensation reduces retained profits that owners can receive. Second, owners in a stock insurer require their cut of accumulated profit. Finally, policyholders seek competitively priced premiums. Within the composite of mutual commercial insurers, it is interesting to note that after backing out the agency and brokerage costs, the expense ratio of a mutual commercial insurer looks somewhat akin to that of a single-parent captive.

The net investment income ratio, on average, is somewhat higher for a single-parent captive than for a commercial insurer. This is attributable to two issues:

•Firstistheuseofinterest-bearingloanbacksthatagoodpercentageofsingle-parentcaptiveshavewith theirparentcompanies.Theseloanbacksgenerallyhaveinterestratesinthe5%to10%range, depending on the parent company’s cost of capital. Commercial insurers are tied to a risk--adjusted return that continues to be affected by global economic events, as well as flattening of the yield curve that encourages short-term investing. •Theothercauseisthatsingle-parentcaptives,onaverage,tendtobemuchmorerobustlycapitalizedthan commercial insurers. This leads to a higher invested asset base that partially experiences the same depressed yield environment as commercial insurers do, but with more assets to invest for each dollar of premium written. While single-parent captives are best to handle and manage their parent’s risk, they may not be ideal to handle and manage their investments. A.M. Best has noted that almost all of the single-parent captives allow their parents to manage their investments, based on the parent’s superior expertise, scale and knowledge in investments, which is reflected in better returns compared with the commercial industry.

Published Report


The overall profitability of single-parent cap-tives, combined with their ability to generate capital internally, allows them to provide their parents with dividends without any negative impact on the captives’ surplus levels. Inter-nal capital generation has driven growth in surplusoverthepastfiveyears;infact,forU.S.-domiciled captives, their five-year average surplusincreasedby10.5%ayear.

The single-parent universe analyzed for this report maintains adequate liquidity as measured by the current liquidity ratio, which remains better than those of the commercial casualty industry composite. In fact, all liquidity measures compare as favorably with those of the commercial casualty industry. Exhibit 12 takes into account key liquidity measures and operating cash-flow ratios and compares them with those of the commercial industry. As is clear, these measures for single-parent captives surpass the commercial lines industry.

Furthermore, the single-parent captives main-tained excellent overall risk-adjusted capitalization, as measured by Best’s Capital Adequacy Ratio (BCAR) and shown in Exhibit 13. While the BCAR score slightly declined for the commercial composite from 238% in 2010 to 236.1% in 2011, for single-parent captives BCAR actually improved from 327.3% in 2010 to 340.6% in 2011, due, among other things, to more profitability, internally gener-ated surplus and lower weather-related losses in 2011 than their commercial property peers.

A.M. Best recognizes that single-parent captives often maintain relatively stable ratings, despite being occasionally subject to relatively large losses. The parent’s commitment and the captive’s mission often overcome these challenges. Consequently, A.M. Best’s outlook for single-parent captive rat-ings is stable. Exhibit 14 shows A.M. Best’s current ratings distribution of U.S. single-parent captives. These companies tend to maintain ratings in the A and A- range because management maintains strong capitalization and consistently solid operating perfor-mance. These measures allow captives to achieve the rating levels necessary for the requirements of their lines of business and licensing, and to meet approval standards imposed on these companies.

Exhibit 12U.S. Captive Insurance – Liquidity & Cash Flow Comparison (2007-2011)5-year pure captive proxy vs. commercial composite.

Single-Parent Captives

Commercial Composite

Variance Favorable/ (Unfavorable)

Quick Liquidity 44.3 24.3 20.0

Current Liquidity 170.0 116.3 53.7

Operating Cash Flow 133.9 107.1 26.8


Exhibit 13U.S. Captive Insurance – 2-Year Best’s Capital Adequacy Ratio Comparison (2010-2011)Pure captive proxy vs. commercial composite.

Single-Parent Captives

Commercial Composite

Variance Favorable/ (Unfavorable)

2011 BCAR Score 340.6 236.1 104.5

2010 BCAR Score 327.3 238.0 89.3


05

101520253035404550

B+B++A-AA+Source: A.M. Best research

Exhibit 14U.S. Captive Insurance – Best’s RatingDistribution of Single-Parent Captives

Published Report


PUBLISHED: BEST’S REVIEW, MARCH 2013

Captive AudienceCaptives are gaining attention in Latin America as increasingly sophisticated risk managers explore alternative risk financing options.

by Kate Smith

When she started her career in the insurance industry, Maria Escobar was in constant search of new solutions and risk management tools. Not once did captives appear on her radar.

That was two decades ago, though, and back then captives weren’t even considered as a solution by Latin American companies.

“If we had this conversation 20 years ago, or 10 or15,Iwouldhavetoldyouthatnooneusedcap-tives because it was something unknown in Latin America,” said Escobar, now the head of Marsh’s captive solutions team for Latin America and the Caribbean. “When you were trying to talk to the local brokers, no one was aware of the real oppor-tunities of that tool.”

Over the past few years, however, the conversa-tions have changed, and captives have become a frequent part of the dialogue for more and more companies in Latin America.

A decade of explosive economic growth and glo-balization has created a market for captives in Latin America, and the evolving regulatory sys-tems at play within the region are making it fea-sible for more companies to use this tool.

“On a recent visit to Brazil, I was struck by the thirst for knowledge for alternatives to traditional market solutions,” said Brendan Duggan of Wil-lis’ Global Captive Practice. “The market is in a dynamic phase, and Willis expects to see a con-tinuing upward trend in captive development.”

Captives increasingly are piquing the interest of the region’s sophisticated risk managers and attracting attention from growing corporations that have shifted their attitude toward insurance and are weighing the potential benefits of risk retention. Once limited to gas and oil companies, captives are now finding appeal from across industry sectors and for many insurance lines.

Largest Corporations in Latin AmericaDynamic growth of corporations in Latin America points to a growing interest in forming captive insur-ance companies.US$ million (2011 figures)

2012 Rank

2011 Rank Company Country Sector Revenues

1 1 Petrobras Brazil Energy $130,171.7

2 – PDVSA Venezuela Energy $124,754.0

3 2 Pemex Mexico Energy $111,734.6

4 3 Vale Brazil Mining $55,014.1

5 4 America Movil Mexico Tech $47,700.1

6 5 BR Distribuidora Brazil Energy $37,980.1

7 6 Telefonica Spain Tech $37,832.7

8 8 Odebrecht Brazil Holding $33.585.7

9 12 Ecopetrol Colombia Energy $33.194.6

10 7 JBS Brazil Food $32.944.2

11 9 Wal-Mart de Mexico Mexico Retail $27,309.8

12 10 Grupo Ultra Brazil Energy $25,941.6

13 15 CBD Brazil Retail $24,839.8

14 13 Pet. Ipiranga Brazil Energy $22,509.8

15 40 Copec Chile Energy $21,124.6

16 14 CFE Mexico Energy $20,930.5

17 11 Carrefour France Retail $19,516.1

18 18 Volkswagen Germany Auto $19,293.5

19 17 Gerdau Brazil Steel $18,875.6

20 26 Braskem Brazil Chemical $17,686.4

21 23 Eletrobras Brazil Energy $17,625.2

22 24 Codelco Chile Mining $17,515.3

23 25 General Motors* USA Auto $16,877.0

24 22 Carrefour Brazil Retail $16,027.5

25 53 Telefonica** Brazil Tech $15,528.7

*Revenues do not include Mexico**Rebranded, includes shares of former Telesp and VivoSource: Latin Trade

Published Article


“Things have dramatically changed because of the region’s growth,” Escobar said. “We have been trying for several years to help our clients understand the benefits of captives. And I think the time has now come for captives in Latin America.”

Catching UpLatin America historically has lagged behind more mature markets in the utilization of alternative risk financing tools. Not only was there a dearth of the large enterprises that tend to be more interested in such strategies, but there also were more regulatory barriers to entry in the market.

“There have historically been barriers to entry to captives from local regulators—non-admitted insurance rules, exchange controls restricting ability to centralize risk and premium outside the country of origin, restrictions on establishing the legal entity in traditional captive-friendly domiciles,” Duggan said. “This com-bination has made captive formation less attractive. Many global firms with significant exposures in the Lat-Am region have persevered in seeking to export risks and premiums to their captive successfully, but these firms have an established culture of captive utilization, and that knowledge and experience gives them the confidence to stick to their strategy.

“Brazil is the classic example in this regard. Although the rules have now changed, historically all Brazil-ian exposures were required to pass through the former state reinsurer, IRB, who could impose vertical underwriting pricing on risks, so that the premium rate provided to local [reinsurers] could be significantly higher than the premium rate ceded [via retrocession] to the captive. So corporations required a lot of patience to centralize their Brazilian risks in the captive.”

The economic environment also limited the traditional pool of candidates for captives.

“Therehavehistoricallybeenveryfewlarge$5billionrevenuecorporationsintheregion,anditistheselargerfirms that have generally been most innovative in their approach to risk financing,” Duggan said.

The dynamic growth of the past 10 years, however, has created a broader base of candidates for the captive market.Inthepastfouryearsalone,thenumberof$5billioncorporationsinLatinAmericahasincreasedby 144% while the number of $1 billion corporations has expanded by 117%, according to calculations basedontheLatin500,anannualrankingoftheregion’slargestcorporationscompiledbyBrazilianconsult-ing firm Economatica.

When the 2012 list was released last summer, it included 421 companies with revenue in excess of $1 billion and110withrevenueexceeding$5billion.Bycontrast,the2008listhad194companieswithrevenueofmorethan$1billionandjust45withrevenueofmorethan$5billion.

“Tostatetheobvious,theregionhasexperiencedveryrapideconomicgrowthinthelast10to15years,”Duggan said. “This means a greater insurance spend on average, but importantly the growth has created a larger number of global-size corporations. This allows them to create economies of scale on all areas of their business, including risk financing.

“Equally, these global-size firms have expanded outside the region, organically and by acquisition, so finance directors and risk managers need to look at best practice on a global basis or in some cases they will have acquired overseas firms who have captives. This broadens the knowledge base and also allows firms to view captives from the inside for the first time.”

One of the fastest-growing segments of the region’s corporate world is “multilatinas,” which are multina-tional companies whose parents are Latin American. As these corporations have expanded, both within the region and overseas, their managers have been exposed to international practices.

Published Article


“These companies are trying to have a worldwide perspective in thinking and growing, comparing them-selves with the big ones around the world,” Escobar said. “And they find out that a captive is a good way to do risk management financing strategy.

“Companies are becoming more sophisticated,” she added. “They are growing and have shareholders from other parts of the world, so they start to learn how their peers in the industry manage risks, manage premi-ums, the total cost of risk, the balance between retention and transferring to the market.”

This education is causing a paradigm shift in the way corporations approach insurance.

“Market norm was to view insurance tactically—‘I have this much to spend on insurance, how much can I buy?’—rather than strategically—‘what is my total cost of risk, and how can I get the curve on the graph to decline over time?’,” Duggan said. “One consequence of this is that local business units may tend to pur-chase low-deductible insurance policies, which may serve the interests of the local entity, but from a group perspective, this simply adds costs and creates the wrong incentives.”

Heating UpBrazil, Mexico, Peru, Argentina and Chile all are seeing spikes in inquiries about captives, but the strongest interest has been coming from Colombia.

“In Colombia, the risk managers are very well educated in the risk financing tools,” Escobar said, “and they are more active in finding different ways to approach risk.”

With the Colombian market set to open this year to nonadmitted insurers, the interest is expected to spike.

“For the moment, you need a fronting local company and you need a reinsurance company to front the local company before going to the captive,” Escobar said. “By the middle of this year, the regulation is going to be open. And from that moment, you won’t need a local fronting company. Those kinds of changes make it easier to use a captive, and more effective because you reduce costs of all the operations.”

Duggan also sees several hot spots.

“With dynamic regional growth, and the growth of large non-energy firms in places like Brazil and Colombia, we are seeing demand to be strongest in these countries,” he said. “However, we are also seeing inquiries from Chile and Argentina amongst others.”

Corporations are forming captives to retain more risk in property and liability lines, Escobar said, but they also are using them to address some of the more difficult risks to cover, such as supply chain and malicious tamper and damage.

“Some risks are difficult to cover in the local market because they are more sophisticated or the insurance com-panies need a lot of information to cover that kind of risk, such as supply chain or malicious tamper and dam-age,” she said. “With a captive they can put an insurance program in the way they want, and they can use their own capital to insure those risks. Right now maybe they are self-insuring those risks because the market doesn’t give them a solution, so the captive is a good way to start putting together some capital to cover those risks.”

Escobar said she expects captives for extended warranty and political risks to be on the rise. “In some coun-tries, the local insurance companies are not allowed to write political risk,” she said. “But in some Latin American countries there are still political risk exposures. If you’re thinking Venezuela, thinking Bolivia, thinking Argentina, political risk is still an issue. With the right decision and the right approach to the cap-tive, political risk could be an additional line.”

Published Article


PUBLISHED: CAPTIVE INSURANCE TIMES, JANUARY 23, 2013

Measuring UpCIT goes behind the scenes of A.M. Best with Steven Chirico to discover how the ratings process really works.

What information do you need to rate a protected cell captive?The information is not dissimilar to the information that we would need for any rating that A.M. Best car-ries out. We would require audited financial statements from all the cells and the general cell, and an actu-ary report for all of them. We’d also get the reinsurance and vendor contracts for all the cells. We basically treat them as discrete entities from a ratings perspective. We consider each individual cell as a separate company, so we get a look on a standalone basis of what each cell looks like.

Other information that we require is management biographies. We would have to understand the cell cap-tive and its operations from a qualitative perspective and then the purpose of each cell. Sometimes cell captives are grouped together with disparate businesses and some of them are businesses that are related in some way, but either way we have to understand from a qualitative perspective why this cell exists, what its purpose is, how it is functioning and how it is used.

There are other bits of information that we would require if we had specific questions, such as liquid-ity or if there’s substitute capital in the form of letters of credit, we would have to understand those and get those documents, but those are particular to certain scenarios. Finally, we always require a meeting, almost always face-to-face on an initial rating, and that’s any rating, so it would also apply to cell captives.

There are a lot of different terms for protected cell companies and similar structures depending on the domicile—are they all rated in the same way?It’s a little bit of a different process because of the caveat with cell captives. The legislation in all of the domiciles that we are aware of wants to make each cell discrete financially from any other cells, so that you can’t use the assets of one cell to satisfy the liabilities of another cell.

But the problem is that whether you are in the British system or the US system, the Cayman Islands or Guernsey, and you have cell captive legislation, there hasn’t been one good court case to look at when a cell or a number of cells have gone bankrupt, that the assets of another cell could or could not be used to satisfy those obligations. So the permeability of those cell walls is still open to the subjectivity of a court.

Because of this, we take a little bit of a different approach. We do an analysis on each individual cell from a capital strength (risk-adjusted capitalization) perspective, and then we rank them in order from weak-est to strongest cell. This gives us an idea of how weak the weak cells are and how strong the strong ones are, and the probability of the weaker cells becoming compromised becomes part of the ratings determi-nation. We have to be confident that the weak cells aren’t going to be able to drag down the strong cells. In my view, it is the most unique kind of rating that we do.

How does rating captives differ from rating traditional insurance companies, and what are the key issues to consider?From a raw financial perspective, there is very little difference. We use the same capital model that we would for a commercial insurer.

We evaluate operating performance in a similar way, but we take a little bit of a different look at operating performance, for example, net income, as we understand that captives have a different mission. A cap-tive’s number one mission is not to make money, but to provide as low a cost and stable coverage for its

Published Article


parent company, or if it’s a group captive, its policyholder owner/s, as possible.

So we’ll look at dividends to policyholders, or a dividend from a single-parent captive to its parent com-pany, and view operating performance in certain cases before those events happen. We’ll also look at pre-dividend operating performance and particularly if the captive has the ability to not pay a dividend to its parent company or to its policyholder and they have the willingness and the ability not to do that. We base that on financial flexibility, and we give them a different take on operating performance, as making money is third or fourth on the list for a captive as opposed to its main goal.

Do you physically visit every captive before rating it?That is an interesting question for captives because sometimes the captive manager is where almost all the work is done. Some captives are virtual, meaning they have no employees and no physical pres-ence—they’ll just have a mailbox in Bermuda or Vermont! If this is the case, we visit the captive manager because that’s where all the work is done. In a single-parent captive, we like to go to the parent compa-ny’s home office, so generally on an initial rating there is a face-to-face meeting. They also have the option to come to the A.M. Best offices for their rating meeting.

In subsequent years, we either visit or we conduct conference calls depending on the size of the com-pany, the complexity and what’s going on in a particular year. Sometimes nothing changes for a captive, and we just do a conference call with management. But sometimes captives have a lot of stuff going on, such as putting in new lines of business, having a tax challenge from the US Internal Revenue Service, or planning to re-domicile, and in those types of scenarios, an interactive meeting would be required.

Why would a company decide to leave the rating process?Captives generally leave the rating process because they don’t need the rating anymore. For example, say a captive was writing a line of business and the decision was made to write that business in the commer-cial market, and a captive wrote other lines of business that really don’t need a rating, it may look at the frictional cost of a ratings fee and decide to halt the process.

Another reason is that if a company merges with or acquires a business, it could end up with two cap-tives while only needing one, so it will put one of the captives into run-off and continue on with its main captive. Sometimes, depending on where a company is in the world, it might decide to refocus where its risk management activity is done, so a global company would have its risk process decentralised in each of the large countries in which it does business, and then make the decision that it is going to consolidate risk management activities. And if it consolidates it in, for example, an Asian market, then the rating is not really required. Frankly, we are a little bit of a pain as we require a lot of information and communication and we ask a lot of questions, so it takes quite a bit of time for any rated company to maintain its rating.

Company ratings are currently voluntary. Do you think there will come a time when the rating process becomes mandatory?I think that there’s going to be a higher level of global insured solvency work being done, but I’m not sure if it is going to be done through ratings agencies, governments or associations. In Europe, there’s Sol-vency II and there’s an implementation process and it is quite complex, and while some would argue that there are quite strong benefits to it, others would say that there are actual anti-competitive components of it that aren’t any good. I think that there is definitely an eye toward better global insurer and solvency regulation, and I think that ratings could absolutely be a part of that.

I think that we’re moving towards a more robust analysis being done. Where that’s done is frankly less important, but the answer is that insurance companies should be well capitalized for the risks that are being rated and how you get there remains to be seen. Until Solvency II is implemented in the EU, I think we’ll only be able to guess, and after it is implemented, we’ll see what solutions are proposed.

Published Article


PUBLISHED: BEST’S REVIEW, JUNE 2012

Held CaptiveCaptive insurers played no part in causing the financial meltdown; nonetheless they now must contend with ‘reform’ measures.

by Les Boughner

C aptives continue to be an effective integral contributor to the global insurance industry. In 2011, despite a fragile worldwide economic

environment, captive formations increased, with a netgainof158oragrowthrateof3%.

They are a financial subset of the self-insurance industry,whichrepresents50%ofthecommercialinsurance marketplace. Consumers of insurance, whether individuals or corporations, all use a level of self-insurance to manage the economics of the transaction. Properly structured, captives are an effective financial tool, preserving the beneficial accounting techniques of insurance companies while optimizing the economics between retained and transferred risk.

The financial meltdown in 2008 painfully exposed the weaknesses of the regulation of global financial institutions. This did not occur in the insurance industry. Despite the well-publicized crises at American International Group, the solvency of its insurance subsidiaries was never in question. AIG’s insurance subsidiaries continued to underwrite coverage and continue to be a major force in the global commercial insurance marketplace. State regulatory oversight, guided by the National Association of Insurance Com-missioners, performed superbly throughout the financial crisis.

Regulation of captives performed in a similar manner. There were not any large-scale systemic failures and it is notable that in most cases the captive subsidiaries of financial institutions performed better than their parents.

In spite of the validation of existing insurance and captive regulatory oversight, there are several regula-tory initiatives that may result in overregulation of the captive community. There is confusion surround-ing the final application of Solvency II and the incorrect applications of the nonadmitted provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Solvency II’s Impact Solvency II’s objective is to update and to strengthen regulatory requirements for insurance companies’ capi-tal and risk management by aligning capital requirements with risk profile. This will apply to any insurance company, including captives, wishing to underwrite insurance in the 27 countries of the European Union. The European Insurance and Occupational Pensions Authority has responsibility for its implementation.

Solvency II will require insurance companies not only to maintain proper financial solvency ratios but also to prepare detailed annual reports and a comprehensive Enterprise Risk Assessment of their operations.

Contributor Les Boughner is managing director of Willis’ captive and consulting practice for the Americas and is based in Burlington, Vt. He can be reached at [email protected]

500

1,000

1,500

2,000

2,500

3,000

20102009200820072006

U.S. Captive Insurance – Net Income(2006-2010)($ million)

Source: A.M. Best Co. research

Published Article


Captives, providing insurance in the EU as insur-ance companies, are governed by the principles of Solvency II. However, to what degree has not been established. Imbedded in Solvency II is the principle of proportionality, governing its application to the relative size of insurance companies.

The proportionality principle, specifically in Article 41 (2) of the Solvency II Directive, introduces a requirement for the system of governance to be pro-portionate to the nature, scale and complexity of the insurance and reinsurance undertaking. Article 86 (h) of the Solvency II Directive allows for simplified methods and techniques to calculate the technical provisions to ensure that methods are proportionate to the nature, scale and complexity of the risk.

Furthermore, given that they only cover risks associated with the group to which they belong, Solvency II specifically recognizes in Article 13 (2) and Recital 21 of the Directive that the principle of proportionality does apply to captives. However, the degree to which it will apply to captives still has not been determined.

The objective of a captive is to provide a valued risk management service to its parent. It is not an insurance company in the traditional sense, but a financial tool with a very specific purpose. Some of the financial measurements of Solvency II handicap the necessary capital for a captive. Concentra-tion, lack of diversity and underwritten profitability are by their nature integral to a dedicated cap-tive’s strategy, but could increase the amount of required capital as applied by the current proposed formulas for Solvency II.

Non-EU countries can agree to have their insurance regulatory regimes reviewed in order to achieve equivalency,whichwillallowthemtoprovidereinsurancesupportintheEU.Switzerland,JapanandBermuda have undergone such a review. In the United States, the NAIC appears to be taking the posi-tion that existing and proposed solvency regulation in the United States is sufficient to qualify for equivalency in the EU.

A Clue in Bermuda?Despite intense lobbying by the European Captive Insurance and Reinsurance Owners’ Association, final regulations have yet to be established—although Bermuda’s experience as to how captives will be treated may be encouraging. EIOPA’s draft report of August 2011 clearly stated that commercial insurers catego-rized as Class 3A, 3B and 4 will achieve regulatory equivalence with the new Solvency rules for the large commercial reinsurance sector. By implication, although the captive market was specifically identified as representingmorethan50%ofthecompaniessupervisedbytheBMA,captivesrepresentedasClass1,2or 3 would not qualify for equivalency.

What is interesting and encouraging is that the two categories were separated, which may be an acknowl-edgement of the unique nature of captive insurance companies by EIOPA.

The remaining captive domiciles are closely monitoring the developments of Solvency II but several have taken a different position. Some, such as Guernsey and Cayman, have clearly taken the position that they will not seek equivalency.

U.S. domiciles will continue to follow the lead of the NAIC that solvency regulation is equivalent.

Source: A.M. Best Co. research

0 800 1,600 2,400 3,200 4,000

Workers' Compensation

Auto Warranty

Commercial Multiperil

Other Liability

Medical Professional Liability

U.S. Captive Insurance – Top Product Lines (2010)

2010 Net Premiums Earned ($ million)

Published Article


The concerns about Dodd-Frank stem from the Nonadmitted and Reinsurance Reform Act, which was enacted in 2010 as part of Dodd-Frank. Unlike the lack of specificity provided by Solvency II, the confus-ing terminology of Dodd-Frank has resulted in considerable confusion on the application of direct place-ment and its impact on captives.

Hard to FigureDodd-Frank was intended to streamline the collection of Excess and Surplus Lines taxes by transferring thecollectionanddistributionofpremiumtaxesfromtheE&Sbrokerstotheinsured’shomestate.Dodd-Frank does not create a new tax. Rather, states looking for additional revenue are attempting to extend the interpretation to provide them with the authority to tax and collect Independent Procurement taxes.

The irony is that the steps taken by corporations to deal with this confusion may result in additional cap-tives and lower tax revenues.

The Independent Procurement Tax is not new. It’s applied to an insurance transaction conducted with an insurance company not licensed where the insurance is provided. However, all negotiations and claims are negotiated in the state where the insurance companies are located, and 39 states have independent procurement tax legislation.

Most parent companies with captives qualify for an Industrial Insured exemption providing them with the authority to directly procure coverage for their company from an insurance company not licensed in the specific state where the exposure exists. Historically, where a state has an independent procurement tax, the insured has the responsibility to pay the tax directly.

Several states are aggressively interpreting Dodd-Frank as providing them with the authority to collect independent procurement taxes.

States that have enacted captive legislation are encouraging captives—in some cases strongly—to redomi-cile to their home state so that the insured is only subject to the captive premium tax.

The irony is that captive premium taxes are typically lower than independent procurement taxes, which could reduce overall tax revenues. In several cases, companies have formed subsidiary or branch captives, thereby increasing the number of captives.

Neither issue presents a fatal threat to the future of captives. However, credit should be given to benefit captive regulation, not penalize it, as captives did not contribute to the financial crisis.

Clarity would be helpful so as not to distract or handicap the captive industry from the valuable role it provides the self-insurance industry.

Published Article


ALAN KANDELBusiness Development Manager

A.M. Best Company (908) 439-2200, ext. 5036 [email protected]

JIM FOWLERBusiness Development Manager – Canada, Cayman Islands, Hawaii

A.M. Best Company (908) 439-2200, ext. 5744 [email protected]

For more information about A.M. Best’s ratings of captives and alternative risk transfer vehicles, please contact:

Contact Us

TINA BUKOWAssistant Vice President,

Business Development - Ratings A.M. Best Company

(908) 439-2200, ext. 5825 [email protected]


Notes

A.M. Best Company is the world’s oldest and most authori-tative insurance rating and information source. For more information, visit www.ambest.com.

Copyright © 2013 by A.M. Best Company, Inc. ALL RIGHTS RESERVED.

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