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Transcript of Captives slideshare
AN EXECUTIVE SUMMARY FOR RISK PROFESSIONALS
AND THE C-SUITE
ARTOFCAPTIVESCONSULTING
CAPTIVE INSURANCE
WHAT, EXACTLY, IS A CAPTIVE?
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A Special Purpose, Licensed, (Re)insurance Company; formed to (re)insure the risks of its owner(s); in accordance with IRS safe harbor guidelines
ARTOFCAPTIVESCONSULTING
• A Bona Fide Insurance Company, GAAP and Statutory accounting; financials consolidated with owner’s
• A Subsidiary designed to hold and manage the owner’s risks
ARTOFCAPTIVESCONSULTING
WHAT, EXACTLY, IS A CAPTIVE?
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Allows Management to Quantify and Evaluate the performance of every risk management initiative when financed through the captive
ARTOFCAPTIVESCONSULTING
WHAT, EXACTLY, IS A CAPTIVE?
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A Tool for Allocating premiums and deductibles across operating units, divisions, subsidiaries, etc.
ARTOFCAPTIVESCONSULTING
WHAT, EXACTLY, IS A CAPTIVE?
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WHY SHOULD I CONSIDER A CAPTIVE?
• Reduce and Manage the long-term cost of risk
• Successfully Compete in today’s dynamic (re)insurance marketplace
ARTOFCAPTIVESCONSULTING
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Captives Allow a Better Match between premiums and historical losses (very important in a hard market)
ARTOFCAPTIVESCONSULTING
WHY SHOULD I CONSIDER A CAPTIVE?
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• Coverage & Capacity for hard-to-place or impossible-to-place risks
• Access to Reinsurance, (very important & underrated)
ARTOFCAPTIVESCONSULTING
WHY SHOULD I CONSIDER A CAPTIVE?
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• Earn Investment Income on captive
reserves (Interest rates are on the rise!)
• Convert the Risk Management Department into a profit center
ARTOFCAPTIVESCONSULTING
WHY SHOULD I CONSIDER A CAPTIVE?
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Create a Risk Platform where all (or most) of the company’s risks either reside and / or pass through to reinsurers; this is the ultimate control
ARTOFCAPTIVESCONSULTING
WHY SHOULD I CONSIDER A CAPTIVE?
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ARTOFCAPTIVESCONSULTING
WHY SHOULD I CONSIDER A CAPTIVE?
Captives: Unique Among Risk Financing Options:
• No other RF program builds corporate value over time
• No other program creates financial statements that measure the effectiveness of risk management expenditures
• No other program creates favorable (and legal) tax outcomes 11
• You Are Unable (or unwilling) to commit at
least 3 years to the venture
• You Cannot Afford the loss of short-term cash flows
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ARTOFCAPTIVESCONSULTING
YOU CANNOT FORM A CAPTIVE IF...
• The Start-up and Annual Operating Costs are too expensive
• Your Company Cannot meet minimum eligibility criteria
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YOU CANNOT FORM A CAPTIVE IF...
ARTOFCAPTIVESCONSULTING
• You are Unable or Unwilling to allocate the
necessary capital & surplus
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• Your Loss History provides little or no actuarial credibility (Industry data may help alleviate this)
ARTOFCAPTIVESCONSULTING
YOU CANNOT FORM A CAPTIVE IF...
The Golden Rule of Risk Management:
Never Risk a Lot for a Little!
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YOU MUST REMEMBER...
ARTOFCAPTIVESCONSULTING
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Coverages with Small Premiums that provide large limits; e.g., crime, inland marine, etc. should not be considered captive-eligible *See Slide 15
YOU’RE FORMING A CAPTIVE, BUT...
ARTOFCAPTIVESCONSULTING
New Captives Should Not cover weather-related catastrophic risks unless they are designed to do so and are adequately capitalized
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ARTOFCAPTIVESCONSULTING
YOU’RE FORMING A CAPTIVE, BUT...
TYPES OF CAPTIVES
• Single Parent (Pure)
• Group (Owned by the Membership)
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ARTOFCAPTIVESCONSULTING
• Risk Retention Groups
• Agency (Broker Owned Captive)
• Rent-a-captive / Cell Captives
• 3rd Party Business
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ARTOFCAPTIVESCONSULTING
TYPES OF CAPTIVES
• Fronted (by a US Licensed and Admitted insurer)
• Non-admitted Direct-writing
• IRC 831(b)
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ARTOFCAPTIVESCONSULTING
TYPES OF CAPTIVES
SINGLE-PARENT CAPTIVES
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Direct Captive
Parent
Captive
Premiums Claims Payments
Reinsurance
Premiums Claims Payments
Reinsurance Premium
Fronting Fees and Claims
Captive
Insurance Company (front)
Parent
A fronted captive is actually one of the front’s reinsurers. These captive are often referred as “reinsurance” captives
ARTOFCAPTIVESCONSULTING
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Premium
Fronted Captive Group
Members
Captive (Reinsurer)
Premium Claims
Claims
Collateral
Direct Captive
Claims
Premium
Premium
Claims
Reinsurer
Captive (Insurer)
Group Members
Fronting Insurer
GROUP EQUITY CAPTIVES In this context, equity means that the
members own the captive’s stock.
ARTOFCAPTIVESCONSULTING
• $2.2 Max Annual Premium; earnings not taxed, only investment income is taxed
• There are Significant Restrictions on captives making this election
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SMALL CAPTIVE IRC 831(B)
ARTOFCAPTIVESCONSULTING
RISK RETENTION GROUPS
• Regulated under federal jurisdiction
• Can only write liability lines of risk
• Writes direct – no front
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ARTOFCAPTIVESCONSULTING
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Risk Retention
Group
Reinsurer A
Member B
Member C
Member A
Reinsurer B
Reinsurer C
Capital
Premiums
Surplus Assessments
Reinsurance (if any)
ARTOFCAPTIVESCONSULTING
RISK RETENTION GROUPS
CELL CAPTIVE
Cell owners’ assets are segregated by statute
Unincorporated cells are not legal entities
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Captive Owner
Captive
Cell B Cell C Cell A
Reinsurer Reinsurer Reinsurer
ARTOFCAPTIVESCONSULTING
MOVING RISK ON-BALANCE SHEET
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Captive
Funded Self
Insurance
Large Deductible w/Stop Loss
Retro Plan/ Experience
Rated
Guaranteed
Cost/ Fully Insured
ARTOFCAPTIVESCONSULTING
• Moving Risk On-balance Sheet allows control…pricing, service providers, reinsurance, and administration
• The Goal is to Convert fixed expenses into variable expenses
MOVING RISK ON-BALANCE SHEET
ARTOFCAPTIVESCONSULTING
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TYPICAL CAPTIVE RISKS
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• Professional Liability (Med Mal, E&O, etc.)
• Workers Compensation
• Extended Warranty
ARTOFCAPTIVESCONSULTING
• Property & Business Interruption
• General / Products Liability
• Terrorism (TRIPRA)
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ARTOFCAPTIVESCONSULTING
TYPICAL CAPTIVE RISKS
• Environmental Impairment Liability
• Auto Liability and Physical Damage
• Medical Stop-Loss (MSL)
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ARTOFCAPTIVESCONSULTING
TYPICAL CAPTIVE RISKS
• Captives Rarely, if ever, assume a significant limit of liability
• For Any of the Risks Identified here, the primary $250K would be a typical captive limit, (with the possible exception of medical malpractice, which would be higher)
HOW MUCH RISK SHOULD A CAPTIVE INSURE?
ARTOFCAPTIVESCONSULTING
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Excess of the Captive’s Limit of Liability, e.g., $250K, the captive buys reinsurance, or the parent purchases excess insurance
LIMITS ABOVE THE CAPTIVE
ARTOFCAPTIVESCONSULTING
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• Gross Written Premiums should be paid, in cash, in full at policy inception; exceptions exist
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CASH FLOW IMPLICATIONS
ARTOFCAPTIVESCONSULTING
• The Capital & Surplus (C&S) pay-in schedule must mirror that of the premiums
• The Captive may Loan a portion of its cash, back to the parent company
• Loan Backs are short-term commercial
loans, and must carry a market interest rate
ARTOFCAPTIVESCONSULTING
LOAN BACKS
CASH FLOW IMPLICATIONS
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Adequate Funds Must Remain in the captive to pay projected losses without having to renegotiate the terms of the loan
ARTOFCAPTIVESCONSULTING
LOAN BACKS
CASH FLOW IMPLICATIONS
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• Self-insured (non-captive) Losses are usually paid over time, often many years
• Self-insured Losses are tax-deductible only when paid
• 0
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TAX AWARENESS
ARTOFCAPTIVESCONSULTING
A Captive that Conforms with the IRS safe harbor(s), may convert projected self-insured losses into an annual premium, which is tax-deductible in that year
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ARTOFCAPTIVESCONSULTING
TAX AWARENESS
Captive Loss Reserves may be deductible in current year if eligible to use insurance accounting; these involve risk shifting and risk distribution per IRS safe harbor revenue rulings and certain case law
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ARTOFCAPTIVESCONSULTING
TAX AWARENESS
Offshore Captives that Insure US risks are classified into one of 3 categories:
• Controlled Foreign Corporation • Non-controlled Foreign Corporation • Taxed under the 953(d) election
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ARTOFCAPTIVESCONSULTING
TAX AWARENESS
Earnings are Untaxed, but each US shareholder’s portion of the earnings are taxed at their corporate rate
CONTROLLED FOREIGN CORPORATION (CFC)
ARTOFCAPTIVESCONSULTING
TAX AWARENESS
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Restrictions on Doing Business in the US; ETB rules (ETB: Engaged in Trade or Business)
ARTOFCAPTIVESCONSULTING
CONTROLLED FOREIGN CORPORATION (CFC)
TAX AWARENESS
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• Potential for Branch Profits Tax of up to 30% of earnings if ETB rules violated
• CFC Status is the default tax position for offshore captives unless another option is elected
ARTOFCAPTIVESCONSULTING
CONTROLLED FOREIGN CORPORATION (CFC)
TAX AWARENESS
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US shareholders (US persons owning 10% +, of voting stock) cannot own or control more than 25% of the voting stock
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ARTOFCAPTIVESCONSULTING
NON-CONTROLLED FOREIGN CORPORATION (CFC)
TAX AWARENESS
Captive Earnings Taxed at dividends received rate only when repatriated into the US
ARTOFCAPTIVESCONSULTING
NON-CONTROLLED FOREIGN CORPORATION (CFC)
TAX AWARENESS
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• Allows a CFC Captive to be taxed as if it were an onshore captive
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• Onshore Captives have no choice but to pay US income taxes
THE IRC 953(D) TAX ELECTION
ARTOFCAPTIVESCONSULTING
TAX AWARENESS
To Avoid ETB Restrictions – no business may be conducted in the US if the captive remains a CFC; shareholders pay tax anyway
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WHY WOULD A CFC CAPTIVE ELECT TO BE TAXED?
ARTOFCAPTIVESCONSULTING
TAX AWARENESS
Performance metrics are the various solvency and operating ratios that reveal your captive’s financial performance.
PERFORMANCE METRICS
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ARTOFCAPTIVESCONSULTING
Each Ratio Measures different aspects of financial performance; Major categories: • Liquidity
• Leverage
• Profitability
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ARTOFCAPTIVESCONSULTING
PERFORMANCE METRICS
These ratios measure a captive’s ability to meet its short-term funding needs • Reserves-to-Liquid Assets
• Assets-to-Liabilities
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LIQUIDITY
ARTOFCAPTIVESCONSULTING
PERFORMANCE METRICS
These ratios measure the amount of risk against financial resources
• ROIC (Return on Invested Capital)
• Premium-to-Capital & Surplus
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LEVERAGE
ARTOFCAPTIVESCONSULTING
PERFORMANCE METRICS
• Loss & Expense-to-Earnings (Combined)
• Investment Income-to-Capital
• Operating (combined –investment income ratio)
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These Ratios Reveal Profitability
PROFITABILITY
ARTOFCAPTIVESCONSULTING
PERFORMANCE METRICS
FRONTING & COLLATERAL
• Fronting Insurers Convey their licenses and credit ratings onto captives
• Captives are Usually Licensed only by their domicile, with no credit rating
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ARTOFCAPTIVESCONSULTING
Fronts are Necessary when a counterparty requires certification that your insurance meets the counterparty’s requirements
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ARTOFCAPTIVESCONSULTING
FRONTING & COLLATERAL
You Are Not Required, nor are there moral or ethical reasons, to divulge the fact that you own a FRONTED captive to counterparties
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ARTOFCAPTIVESCONSULTING
FRONTING & COLLATERAL
Because the Captive is (usually) only Licensed in its domicile, and it (usually) has no credit rating, the front requires collateral to secure the loss reserves
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ARTOFCAPTIVESCONSULTING
FRONTING & COLLATERAL
There are two prevalent forms of collateral
• Letter of Credit
• New York 114 Trust
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ARTOFCAPTIVESCONSULTING
FRONTING & COLLATERAL
Often Preferred by Captives (captives’ parents) due to investment flexibility as the captive retains use of the funds
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LETTER OF CREDIT
ARTOFCAPTIVESCONSULTING
FRONTING & COLLATERAL
The LC is the Front’s Preferred form of collateral, as it provides an immediate source of cash if needed
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ARTOFCAPTIVESCONSULTING
LETTER OF CREDIT
FRONTING & COLLATERAL
Assets May be Drawn any time to reimburse the front for paid claims, and to cover reserves for any reason
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ARTOFCAPTIVESCONSULTING
LETTER OF CREDIT
FRONTING & COLLATERAL
The Front has a Unilateral Right to withdraw funds. Captive must restore the security balance within 10 days.
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ARTOFCAPTIVESCONSULTING
LETTER OF CREDIT
FRONTING & COLLATERAL
• The Trust’s Annual Costs are close to LCs at low levels; they become less expensive at higher fund levels
• The Front is the Trust’s beneficiary
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NY REG. 114 INSURANCE TRUST
ARTOFCAPTIVESCONSULTING
FRONTING & COLLATERAL
• The captive’s reserves fund a Trust Account
• Fund assets often equal 102% of the captive’s liabilities
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ARTOFCAPTIVESCONSULTING
NY REG. 114 INSURANCE TRUST
FRONTING & COLLATERAL
CAPTIVE DOMICILES
All captives, whether onshore or offshore, must be formed in a jurisdiction that has specific enabling legislation
ARTOFCAPTIVESCONSULTING
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All Captive Domiciles Require that certain professional service providers be resident of the domicile
• Captive Manager • Attorney • Auditor
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DOMICILE SERVICE PROVIDERS
ARTOFCAPTIVESCONSULTING
CAPTIVE SERVICE PROVIDERS
• Tax Counsel • SEC Attorney* • Actuary
*Only if needed for a group captive
• Captives Consultant • Broker
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CAPTIVE SERVICE PROVIDERS
NON-DOMICILE SERVICE PROVIDERS
ARTOFCAPTIVESCONSULTING
MAJOR ONSHORE
• Vermont • Washington DC • South Carolina • Hawaii
And about 25 more states
• Delaware
ARTOFCAPTIVESCONSULTING
CAPTIVE DOMICILES
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• Bermuda • Cayman • BVI • Panama
• Luxembourg • Ireland • Isle of Man • Guernsey
ARTOFCAPTIVESCONSULTING
MAJOR OFFSHORE
CAPTIVE DOMICILES
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Q. I only care about how low I can force insurance premiums each year.
Does a captive make sense for me?
A. No
QUESTIONS & ANSWERS
ARTOFCAPTIVESCONSULTING
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Q. What are the start-up costs and annual operating costs of a captive?
A. Start-up costs can run from $150,000 to $500,000+. Annual operating costs can run from $100,000+
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
70
Q. How much capital will I need?
A. For many captives, a 5:1 premium-to-capital & surplus ratio will suffice. Some fronting insurers require 3:1
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
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Q. As a captive owner, what’s the most money I could lose in this venture?
A. Your capital contribution and the captive’s expenses are the most you can lose.
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
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Q. How long before I can realize any dividends from the captive?
A. Assuming the Board declares a dividend, about 3 years
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
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Q. What are the minimum premium qualifications to form a captive?
A. For a single parent captive, about $1.5 million in ceded premium. For a cell captive, about $750,000.
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
74
Q. The insurance markets are pretty soft; is there any reason to form a captive aside from a hard market?
A. Absolutely. See Slides 6-11
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
75
Q. I hear that captives can earn underwriting profit – how does that work?
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
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A. The captive must sell insurance to unrelated 3rd parties to earn profits; excess premium payments are often incorrectly thought of as profits
A. Direct captives are free to write anything. Fronted captives must conform to the conventions of the fronting company.
Q. What is the captive’s relationship with insurance coverages?
ARTOFCAPTIVESCONSULTING
QUESTIONS & ANSWERS
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SUMMARY OF STEPS TO CAPTIVE FORMATION
1. Feasibility Study (Captives Consultant + Actuary)
2. Domicile Selection
ARTOFCAPTIVESCONSULTING
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3. Engage Captive Manager (will immediately run due diligence on you, the captive’s parent)
4. Engage the other Domicile Service Providers
ARTOFCAPTIVESCONSULTING
SUMMARY OF STEPS TO CAPTIVE FORMATION
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5. The Consultant and Captive Manager will write the business plan and complete the application to the regulator
6. Attorney will draft the company’s legal documents
7. The Manager then submits the application
to the regulator
ARTOFCAPTIVESCONSULTING
SUMMARY OF STEPS TO CAPTIVE FORMATION
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8. Once the regulator approves the application the captive is formed and the client deposit the capital
Please Note: The captive formation process is far more detailed than this summary portrays.
ARTOFCAPTIVESCONSULTING
SUMMARY OF STEPS TO CAPTIVE FORMATION
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Contact Information
Donald (Don) J. Riggin CPCU, ARM President, The ART of Captives, LLC
+1.978.594.8762 Office +1.978.880.8805 Mobile
ARTOFCAPTIVESCONSULTING
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