Financing Of Risk - Crm

Front 1

Feasibility Determination FIRST STEP in Development Process of a Captive

Due Diligence, study factors justify the formation can they remain solvent.

Back 1

Study TCOR, business plan, loss projections, 3-5 yrs financials, structure, identify service providers, tax considerations, establish domicile recs - group members must provide detailed financial info and commit to join

Front 2

Domicile Selection SECOND STEP in Development Process of a Captive -

Legal and regulatory jurisdiction in which the Captive will form and operate

Back 2

- offshore/onshore - how much is put up to get license - how much surplus must we maintain - taxes fees licensing costs, geographic convenience, political climate, investment regulations, permitted business lines

Front 3

Application for the Insurance License is THIRD STEP in Development Process of a Captive

Back 3

Select service providers, prepare business plan, meet regulators, submit application - Once regulators indicate willingness to issue license - can move on to Formation

Front 4

Formation and Funding is FOURTH/LAST STEP in Development Process of a Captive

Back 4

get Sr. mgmnt to commit long term, incorporate, adopt bylaws, elect D&Os, open bank acct, deposit capital, actually get license - group captives est membership and financial guidelines, contract w svce providers, reins, front - Issue policies

Front 5

Components of Simple Projected Captive Pro Forma Financial Statements

Back 5

Income Statement - gross prem, ceding comm, net ceded prem, u/w exp & profits, investment inc, taxes, net inc, earned surplus
Balance Sheet - Admitted Assets, Liabilities, Capital

Front 6

Traditional vs. Finite Risk Characteristics
Typical Finite Program: fully funded on TVM, High Sev/Low Freq/hard to predict cov unavail or exp, dampens eff of catastrophic loss on org financial statements

Back 6

Spread of Risk - TI relies on Law of lge numbers which do not apply to F
TVM - Finite funded on investment inc, not TI
TI annual, F multi yr - to fund infreq loss
Ins vs Uninsurable - F ins anything that can be quantified.qualified funds all losses within agg limit

Front 7

Fronting - use of insurance company (domestic admitted carrier) to issue policies on behalf of captive
-Provides services & use of its license for a fee
-Issues a policy to the insured and pays losses
-Generally requires security (LOC)

Back 7

Used by Captive if:
1. states require insurers to provide policy from licensed and admitted carrier (workers comp/auto)
2. third party requires COI from RATED carriers

Front 8

Six types of Captives

1. Single parent - insures the risks of its owner
2. Group captive - multiple, unrelated organizations

Back 8

3. Association captive - trade association members
4. Agency captive - agency clients
5. Rent-a-captive - Licensed Offshore owned by outside org
6. Risk Retention Group

Front 9

Captive Insurance Companies

Back 9

closely held ins company whose business is supplied & controlled by owners, owner/ insureds are the
beneficiaries - subject to insurance regulation - non admitted & non authorized carriers

Front 10

Risk retention group

Back 10

1. group captive whose business is limited to liability coverage for owner-insureds.
2. domiciled & regulated by one state, permitted by federal law to operate in all other states
3. Ex: Products Liability, Professional Liability

Front 11

Reasons to form a captive

1. Availability of coverage
2. Pricing inequity - instability of ins market cycle

Back 11

3. Need for better loss control, claim settlement
4. Lack of flexibility - cove insufficient for needs
5. Inappropriate regulation of rates & forms
6. Lack of Val - TI exp when losses are predictable

Front 12

Advantages of a captive - provides control over claims, reserving practices and investments made
1. Reduction in the long-term cost of risk
2. Reduced operating costs
3. Investment income and operating profit

Back 12

4. Broader coverage
5. Equitable rating
6. Coverage stability and availability
7. Direct reinsurer access
8. Improved services
9. Fewer regulatory restrictions
10. Enhanced risk management perspective

Front 13

Disadvantages of a captive
1. Internal administrative costs
2. Long-term capitalization and commitment
3. Dependence upon service providers

Back 13

4. Inadequate loss reserves and potential losses
5. Complex taxation issues
6. Increased cost or reduced availability of other
insurance

Front 14

Characteristics of a captive
1. Loss sensitivity is high.
2. retention is 100%
3. Premium certainty is high, owners control rates

Back 14

4. Cash flow benefits - invest prem & reserves
5. Service options are flexible
6. Program flexibility is high
7. Accounting/tax impact is complex - requires knowledgeable tax counsel to avoid problems

Front 15

Pooling Arrangements

Back 15

designed to jointly manage the loss exposures of
two or more organizations that are unable to legally or
feasibly self-insure these exposures - State Specific

Front 16

Advantages of Pooling Arrangements
Cost stability,
Cost reduction,
increased focus on loss control and claims management,

Back 16

Coverage forms can be designed to meet members’ needs,
Rating flexible to reflects group’s combined loss experience,

Front 17

The traditional concepts of a commercially insurable risk
1. Based on law of Large Numbers
2. A loss definite as to time, place, and causation
3. Accidental or fortuitous in nature

Back 17

4. A large loss from the perspective of the insured
5. A calculable or predictable loss
6. A loss not likely to affect a high number of insureds at the same time - non catastrophic
7. Affordable premium

Front 18

Business and Insurance Decisions Affected by Reserves
A. Retention levels
B. Insurance and reinsurance pricing
C. Safety and loss control programs

Back 18

D. Product and services pricing
E. Forecasts of future results for budgeting
F. Tax management
G. Merger and acquisition pricing and terms
H. Financial reporting

Front 19

Finite risk reinsurance

Back 19

is NOT dependent upon the spread of risk and its related contribution of loss funding among many insureds within an annual time frame.

Front 20

The cancellation provisions for a finite risk reinsurance program

Back 20

The insured may cancel at any time if the experience account is not showing a deficit and the insurer cannot cancel the contract because of the requirement for annual funding of premiums.

Front 21

Uses of finite risk reinsurance contracts

Back 21

Loss Portfolio Transfer
Eliminate potential IBNR time bombs
Addresses gaps in coverage purchased in prior periods

Front 22

Disadvantages of Pooling Arrangements
Joint and several liability all members of a group are jointly liable for group responsibilities and each member is individually responsible for total liabilities of the group.

Back 22

1. Increased U/W risk due to political pressure
2. Risk sharing within a smaller universe
3. Joint and several liability
4. Board members may lack expertize
5. Inadequate records - U/w & Financial data

Front 23

Purposes of actuarial services
-Provide statements of actuarial opinion to regulators for self-ins programs and captive formation
-Evaluate the ult value of losses & IBNR losses; key components of loss sensitive risk financing programs

Back 23

-Assure insured organizations that insurance premiums and retentions are appropriate
-Make loss projections used for forecasting and budgeting
-Complete loss reserve reviews

Front 24

Contributing factors to the instability of reserves
Moderate inflation rate,
Low volume, dissimilar claims
Litigious venue
Non Uniform claims adjuster procedures

Back 24

Workers compensation benefit structure revisions
Economic and legal environment changes
Unstable Claims staff and management
Incompetent, unprofessional legal counsel

Front 25

contributing factors to the stability of reserves

Highly competent, professional legal counsel
Non-litigious venue
Uniform claims adjuster procedures

Back 25

Stable economic and legal environment
Consistency in maintaining TPAs or claims offices
Low rate of inflation
Dedicated claims unit
Stable Workers compensation benefit structures

Front 26

purposes of loss triangulation


1. Reflects growth in losses due to IBNR claims

Back 26

2. Determines loss payment pattern over time
3. Captures changes in ultimate value resulting from natural claim development
4. Reflects changes in losses after initial reserve is
established (new information)

Front 27

Basic types of loss triangulation

Back 27

1. Paid loss (severity)
2. Incurred loss (severity)
3. Claim count (frequency)
4. Claim payout (timing)

Front 28

Audit finding with the risk concern;
1. Self-insurance plan - Outstanding liabilities
2. Captive Exists - Infrequent actuarial review
3. Solvency of ins carrier - Recovery of funds
4. Incr ded - No historical losses, adequacy of cash

Back 28

6. Reduced liab lim -Incr in high-level retained losses
7. Decision not to purchase ins -No historical losses, uncovered losses
8. Cash flow plans - Adequacy of cash, o/s liabilities
9. Unchanged prop val - inflation impact , purchases, sales , capital expenditures

Front 29

Two major accounting standards for risk managers

1. FAS 5 for private and public organizations
2. GAS 10 for governmental entities

Back 29

g

Front 30

Three methods of accounting for a structured
settlement:
a. If annuity is in name of entity, the loss reserve
liability should be carried on the balance sheet
b. If annuity is in the name of the claimant, with no

Back 30

release of liability, no balance sheet entry is
required; however, a note disclosing the
outstanding amount is necessary
c. If annuity is in the name of the claimant, with a
release of liability, no entry or note is necessary

Front 31

Loss Reserve - accounting rules state we need to set up reserve for any expected future payment for any claim which has already occurred prior to the date of the financial statement (ex: 12/31/14)

Back 31

Loss Reserve = Case Reserve plus the IBNR

Front 32

Case Reserve: funds established to pay claims of
which the insurance company has knowledge but has
not yet been settled

Back 32

Individual reserves are established by

a. TPAs
b. Carrier claims adjusters
c. In-house staff

Front 33

IBNR - Incurred but not reported - three parts:
PURE IBNR - truly occurred prior to date but not reported so carrier does not know it exists
Adverse development on known claims 1 out of 5 back injuries will be severe

Back 33

Re-opened Claims - claim closed by end of term, but re-opened due to additional treatment needed

Front 34

Loss and Loss Expense Reserves

Back 34

Allocated - attributed directly to a specific claim

Unallocated - any other exp related to settling the claim - adjuster salaries, ovehead for running claims dept

Front 35

Gross Reserves or Net Reserves

Back 35

affected by salvage, reinsurance
and/or other recoveries

Front 36

Undiscounted and discounted reserve values
either discounted for anticipated investment income or undiscounted - ex: NCCI just closed out last payment from all claims which occurred in 1918

Back 36

most reserves are undiscounted true expected total cost - discount reserve by anticipated investment income - discounted much smaller number

Front 37

Case reserving philosophies

Back 37

a. Stair-stepping (adjuster changes reserve as
additional information comes in - bumps up every yr)
b. Reserve to ult (uses development factors - inflation)
c. Automated - predictive modeling programs /pro forma

Front 38

Total reserve = Total Reported Losses x Development Factors+ Pure IBNR reserves

Back 38

Reserve additions
a. Case reserves are normally inadequate for setting
estimates of ultimate liability to the organization
b. Industry experience shows case reserves are
inadequate and IBNR estimates are required

Front 39

Business & Insurance Decisions Affected by Reserves:
A. Retention levels
B. Insurance and reinsurance pricing
C. Safety and loss control programs
D. Product and services pricing

Back 39

E. Forecasts of future results for budgeting
F. Tax management
G. Merger and acquisition negotiation (pricing and terms)
H. Financial reporting

Front 40

Income:
GAAP: Income is recognized when the sale is made
SAP: Income is recognized gradually over the policy term. Prem is constantly being transferred from u/e prem to e/p with the passage of time

Back 40

Expenses:
GAAP: recorded over the term of the policy.
SAP: charged against income when incurred. Expense associated w selling the policy is recorded when sale is made, although most prem is u/e

Front 41

Assets:
GAAP: All assets are recognized on the balance sheet
SAP: Intangible and non-liquid assets (e.g., real property, tax credits)
are not recognized on the balance sheet

Back 41

Equity Value:
GAAP: Retained earnings is recorded as stockholder equity
SAP: Retained earnings are recorded as statutory policyholder surplus

Front 42

Ratios:
GAAP: Underwriting ratio is calculated by dividing underwriting
expenses by net premiums earned
SAP: Underwriting ratio is calculated by dividing underwriting
expenses by net premiums written
When these are

Back 42

The Impact on the Risk Manager: A risk manager must be aware of the
differences between the accounting process for the organization and the
accounting process for the organization’s captive or for the organization’s
third-party insurers.

Front 43

Triangulation is a study of changes, the relationship of one period to a previous period. The process involves graphs in which the data is displayed in an inverted right triangle, hence, the term “triangulation”

Back 43

1. Summary loss data obtained
2. Raw data is displayed in a triangulation format
3. Calculate age-to-age factors (the change from one period to the next for each year)
4. Calculate average age-to-age factors for each valuation interval (12 to 24, 24 to 36, 36 to 48, etc.)
5. Chain multiply the average age-to-age factors to obtain age-to-age ultimate factors
6. If a tail factor is provided by an actuary or other source, include the tail factor in the chain

Front 44

1. Custodial account - Ties up capital/credit line and is not bankruptcy proof
2. Pre-funded deductible plan Ties up cash and additional funds must be deposited with an adverse loss.

Back 44

3.Letter of credit - Cost and availability depends on the insured's credit rating.
4. Opportunity costs Cash or cash equivalents

Front 45

Advantage and disadvantage of top-down pricing

Advantage – rates are usually based on a very large statistical sample, the premium will be actuarially souns

Back 45

b. Disadvantage – the data used to establish the base rates may not properly reflect the unique exposures
of the insured or the effect of specific

Front 46

Advantages bottom-up pricing

1) The loss rate will represent the correct loss projection if the data is large enough and credible

Back 46

2) Claim charges and variations can be more accurately assessed since claim counts are more specific
3) Loss control will be specific to the insured
and probably better suit the insured’s needs

Front 47

disadvantages of bottom-up pricing

1) Rates inaccurate if the prediction of the losses is flawed, actuarially unsound, or if the data is skewed by largely unpredictable or severe losses

Back 47

Underwriters must be experienced and use sound judgment to correctly project losses. Since expense factors are a percentage of the loss rate or the loss
projection, the expense charges will be inaccurate

Front 48

Retrospectively Rated Plans Characteristics

Rates are fixed, premiums are adjusted retrospectively based upon losses

Back 48

2. Modified ILR -Uses development factors to modify incurred losses -Residual market plans for large workers compensation accounts (<$200,000).
Used to terminate retro plans prior to all claims
being closed

Front 49

1. Incurred loss retro (ILR) plan
-Incurred losses (paid + case reserves) – used to
calculate the indicated retro premium
-Deposit premium – generally the standard premium

Back 49

Apparent total cost of risk – less variation from
year to year because incurred losses tend to
gradually increase over time until they reach
ultimate values

Front 50

2. Paid loss retro (PLR) plan - only paid losses are used in the periodic premium adjustments
b. Deposit premium – basic premium + full amount of the premium tax loading on the standard premium + escrow to pay claims

Back 50

c. Apparent total cost of risk – subject to greater
variability on a year by year basis
d. Cash flow – generates the greatest cash flow
savings in earlier years and less cash flow in later
years as claims are concluded

Front 51

Retro Plan Analysis: – retention varies greatly btwn plans and is affected by maxi/min prem & by per occ loss limitations
-premiums can vary greatly from plan to plan
-Cash flow can be worse than other plans inc GC

Back 51

Loss sensitivity is high if high max prem, no per occ
loss limitation; low if there is a narrow
min/max range and a low per occ loss limitation
Service - Flexibility – same as underlying policy

Front 52

Qualified self-insurance - subject to state regulation, State regulators must approve and issue certificates of authority to operate, Excess insurance is generally required, reserve adequacy and fund balance sufficiency are required

Back 52

Non-qualified self-ins - often combine GL, CAU
WC & misc lines with no per occ stop loss or loss limitation, Larger org elect use to assume all of losses (exp losses/“burning” layer), useful both freq and severity of losses are predictable

Front 53

Fully self-insured - Used by larger organizations to assume management of all exposures

Useful when losses for both frequency and severity are predictable

Back 53

c. Often gl, misc lines are combined with no per occurrence stop losses

d. An all-lines aggregate cover may or may not be
purchased.

Front 54

Self Insurance Advantages:
1. Collateral is subject to negotiation and not statutory control
2. Loss control and claims managed solely by the org using external providers or internal staff

Back 54

Disadvantages - Insured pays claims beneath the SIR or pre-fund claim settlements, Few services provided loss control & claims sole responsibility of the org, organized claims handling procedures must be in place; or issues may occur w carrier

Front 55

GAAP emphasizes standardized or accepted ways
of treating transactions so users can make
comparisons between organizations in financial
decision-making; GAAP treats the organization as
a going concern

Back 55

SAP emphasizes liquidity and solvency for the
protection of policyholders; SAP treats the
insurance company as if it were about to be
liquidated

Front 56

The effect on financial statements – SAP tends to
overstate exp & lia while understating inc & assets compared to GAAP. SAP is more conservative
Assets: GAAP: recognized on the balance sheet
SAP: Intangible and non-liquid assets

Back 56

Income: GAAP: recognized when the sale is made SAP: recognized gradually over the policy term.
Expenses GAAP: recorded term of the pol. SAP: charged against income w the exp is incurred.