Why investing money for captive insurance companies is ... · Captive Academy of the 14 th Annual...

Captive Academy of the 14th Annual Executive Educational Conference

Why investing money for captive insurance companies

is different and the role of an Investment Advisor

Ronnie Dennis

Merrill Lynch


Why investing money for captive insurance

companies is different

• Regulatory constraintsSC 38-90-100 SC 38-12

• Collateral requirementsRestricted assets

• Financial Statement analysis Cash Flow Analysis (float)Liability profile (tail)Asset / Liability Management

• Financial reportingGAAP (FAS 115 & FAS 157)Statutory filings (Schedule D, DA, & E)

• Insurance company taxation

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Regulatory constraints

Title 38, Chapter 90, Section 100 “Applicability of Investment Requirements”

(a) an association captive insurance company and an industrial insured captive

insurance company insuring the risks of an industrial insured shall comply with the

investment requirements contained in this Title.

(b) A pure captive insurance company, an industrial insured captive insurance

company, and a sponsored captive insurance company are not subject to any

restrictions on allowable investments contained in this Title; however, the director

may prohibit or limit an investment that threatens the solvency or liquidity of the

company

(c ) Only a pure captive insurance company may make a loan to its parent company

and only upon the prior written approval of the Director and must be evidenced by

a note in a form approved by the Director.

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Title 38, Chapter 12, Sections 410 – 520 (P&C Section) “Investments of Insurers

Act”

Purpose: To protect the interests of insureds by promoting insurer solvency and

financial strength through application of investment standards which facilitate a

reasonable balance of the following objectives:

1) Preserving principal

2) Assuring reasonable diversification as to type of investments; issuer and

credit quality

3) Allowing insurers to allocate investments consistent with principles of

prudent investment management to achieve a return adequate to meeting

obligations to insured's and financial strength sufficient to cover reasonably

foreseeable contingencies

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General diversification limitations: Unless specifically allowed in SC 38 -12,

investments in single issuers must be limited to 5% of *admitted assets.

Cash - no limit.

Money market instruments - If issued by a government money market mutual fund

or an SVO approved money market mutual fund (Class 1 fund) - Aggregate limit up

to 10% of admitted assets or 75% of total capital and surplus (if approved by SC

DOI).

Fixed Income – If issued, assumed, guaranteed, insured by, or otherwise backed by

the full faith and credit of U.S. Government. No aggregate limit, also not limited by

single issuer restriction (normally 5%).

* Admitted Asset – means an asset that is identified specifically as an admitted

asset within the NAIC manual. Specifically, an asset the RRG is allowed to get credit

for on its financial filing with the SC DOI.


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Credit Limitations:

No aggregate limit for investment grade assets (SVO 1-2)

No more than 20% of admitted assets in non-investment grade (SVO 3-6)

No more that 10% of admitted assets in non-investment grade (SVO 4-6)

No more than 3% in SVO 5-6 and no more than 1% in SVO 6.

SVO ratings are as follows:

Category 1 corresponds to AAA,AA, and A;

Category 2 to BBB;

Category 3 to BB;

Category 4 to B; and

Category 5 or 6 to CCC,C, or D ratings.

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Regulatory constraintsMunicipal Bonds – credit limits apply.

General Obligation Bonds - limited to 10% of admitted assets per issuer.

Revenue Bonds - limited to 5% of admitted assets per issuer.

Corporate Bonds – credit limits apply.

Limited to 5% general diversification, meaning that no more than 5% of admitted assets may b

invested with any one issuer.

Mortgage related securities that are backed by any single pool of mortgages - credit limits ap

Limited to 5% general diversification per issuer pool.

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Regulatory constraintsAsset-backed securities secured by a single pool of assets – credit limits apply.

Limited to 5% general diversification per issuer pool.

Preferred Stock -20% of admitted assets, but only 10% if no sinking fund or rated lower than

SVO 2.

Limited to 5% general diversification and credit limits apply.

Equities - 25% of admitted assets or 100% of surplus (shareholder equity).

Limited to 5% general diversification per issuer.

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Collateral requirements

Fronting

Companies

ACE

ARCH

Chartis

CNA

Discover RE

Hartford

Liberty Mutual

Zurich

Grantor (Captive) -

The entity which has

to establish a trust

for the sole benefit

of the beneficiary.

Beneficiary

(Fronting Company)

– The entity for

whose sole benefit

the trust has been

established.

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Financial Statement analysisOrthoForum Insurance Company (A Risk Retention Group)

Pro-Forma Income Statement

For the Policy Periods Incepting 2012 through 2016 - Adverse Case

2012 2013 2014 2015 2016

Underwriting Income:

Premiums Written....................................................................................18,532,628$ 18,995,944$ 19,470,842$ 19,957,613$ 20,456,554$ Reinsurance Ceded....................................................................................(4,462,021) (4,573,571) (4,687,910) (4,805,108) (4,925,236) Net Premium Earned 14,070,607$ 14,422,373$ 14,782,932$ 15,152,505$ 15,531,318$

Underwriting Expenses:

Loss and LAE Paid.......................................................................................151,574$ 963,760$ 3,259,575$ 6,346,833$ 8,953,143$ Change in Loss, LAE, and IBNR Reserves.........................................................................12,479,619 11,983,213 13,011,072 6,923,814 4,649,271 Claims Handling Fees………………………………………………………………………………………………………………………….152,978 156,803 160,723 164,741 168,859 Premium Tax Expense / Government Fees………………………………………………………………………………………………………………………….74,131 75,984 77,883 79,830 81,370 Total Underwriting Expenses 12,858,302$ 13,179,760$ 16,509,254$ 13,515,219$ 13,852,643$

Net Underwriting Income 1,212,305$ 1,242,613$ (1,726,322)$ 1,637,286$ 1,678,675$

General & Administrative Expenses:

Management Fees.......................................................................................554,783$ 568,653$ 582,869$ 597,441$ 612,377$ Legal Costs………………………………………………………………………………………100,000 102,500 105,063 107,689 110,381 Audit & Tax Fees.................................................................................... 50,000 51,250 52,531 53,845 55,191 Actuarial Fees.......................................................................................... 70,000 71,750 73,544 75,382 77,267 Board & Miscellaneous ……………………………………………………………………115,000 117,875 120,822 123,842 126,938 Loss Control………………………………………………………………………..92,663 94,980 97,354 99,788 102,283 ad hoc Loss Control budget………………………………………………………………………..277,989 284,939 292,063 299,364 306,848 Annual Registrations………………………………………………………………………..26,000 26,650 27,316 27,999 28,699 Total General & Administrative Expenses 1,286,436$ 1,318,597$ 1,351,561$ 1,385,350$ 1,419,984$

Net Operating Income/(Loss) (74,131)$ (75,984)$ (3,077,883)$ 251,936$ 258,691$

Other Income

Interest Income.........………………............................................... 471,139 851,501 1,201,763 1,518,906 1,730,306 Net Other Income/(Loss) 471,139$ 851,501$ 1,201,763$ 1,518,906$ 1,730,306$

Net Income (Loss) Before Taxes 397,008$ 775,517$ (1,876,120)$ 1,770,842$ 1,988,997$

Federal Income Tax Expense/(Benefit) ...........................................................................(4,228,914) (3,922,694) (5,210,517) (1,803,540) (931,096)

Net Income/(Loss) 4,625,922$ 4,698,211$ 3,334,397$ 3,574,382$ 2,920,093$

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Financial Statement analysis

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I. Asset / Liability study

II. Asset Allocation policy

III. Investment policy development / review

IV. Investment policy implementation

V. Tactical asset allocation

VI. Investment review

VII. Portfolio reporting

Role of the Investment Advisor

Investment Process

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Section 38-12-50. Board of Directors responsibilities; adoption of written investment

policy and review of Portfolio.

(A) The Board of Directors shall adopt a written plan for acquiring and holding

investments and for engaging in investment practices that specifies guidelines

as to the quality, maturity, and diversification of investments.

(B) Investment practices engaged pursuant to this Chapter must be held under

the supervision and direction of the Board of Directors or committee of the

board charged with the responsibility to direct its investments.

(C) On not less than a quarterly basis, the Board of Directors or committee of the

Board of Directors shall:

(1) receive and review a summary report on the insurer’s investment

Portfolio.

(2) review and revise, as appropriate, the written plan.

Role of the Board

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F. Ronald Dennis

First Vice President - Wealth Management

International Financial Advisor

Ronnie Dennis is a senior partner of the Dennis Johnson Folline King Group at Merrill

Lynch and is a member of the firms Global Institutional Consulting group. Ronnie’s

practice is focused on serving the complex needs of wealthy families and captive

insurance companies. He provides counsel in the areas of financial risk management,

investment strategy and the implementation of tax efficient investment strategies. He

joined Merrill Lynch in 1994 and has spent his entire career at the firm. Ronnie holds

the Certified Investment Management Analyst (CIMA) designation and is an

Accredited Investment Fiduciary through the Center for Fiduciary Studies. Ronnie is a

graduate of the International Center for Captive Insurance Education (ICCIE) program.

Ronnie has a BS in Finance and Real Estate from the University of South Carolina. His

outside interests include reading, running, bird hunting and offshore fishing.

About the Presenter

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