Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
56 Cards in this Set
- Front
- Back
Feasibility Determination FIRST STEP in Development Process of a Captive
Due Diligence, study factors justify the formation can they remain solvent. |
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
|
|
Domicile Selection SECOND STEP in Development Process of a Captive -
Legal and regulatory jurisdiction in which the Captive will form and operate |
- 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
|
|
Application for the Insurance License is THIRD STEP in Development Process of a Captive
|
Select service providers, prepare business plan, meet regulators, submit application - Once regulators indicate willingness to issue license - can move on to Formation
|
|
Formation and Funding is FOURTH/LAST STEP in Development Process of a Captive
|
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
|
|
Components of Simple Projected Captive Pro Forma Financial Statements
|
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 |
|
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 |
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 |
|
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) |
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 |
|
Six types of Captives
1. Single parent - insures the risks of its owner 2. Group captive - multiple, unrelated organizations |
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 |
|
Captive Insurance Companies
|
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 |
|
Risk retention group
|
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 |
|
Reasons to form a captive
1. Availability of coverage 2. Pricing inequity - instability of ins market cycle |
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 |
|
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 |
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 |
|
Disadvantages of a captive
1. Internal administrative costs 2. Long-term capitalization and commitment 3. Dependence upon service providers |
4. Inadequate loss reserves and potential losses
5. Complex taxation issues 6. Increased cost or reduced availability of other insurance |
|
Characteristics of a captive
1. Loss sensitivity is high. 2. retention is 100% 3. Premium certainty is high, owners control rates |
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 |
|
Pooling Arrangements
|
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 |
|
Advantages of Pooling Arrangements
Cost stability, Cost reduction, increased focus on loss control and claims management, |
Coverage forms can be designed to meet members’ needs,
Rating flexible to reflects group’s combined loss experience, |
|
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 |
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 |
|
Business and Insurance Decisions Affected by Reserves
A. Retention levels B. Insurance and reinsurance pricing C. Safety and loss control programs |
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 |
|
Finite risk reinsurance
|
is NOT dependent upon the spread of risk and its related contribution of loss funding among many insureds within an annual time frame.
|
|
The cancellation provisions for a finite risk reinsurance program
|
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.
|
|
Uses of finite risk reinsurance contracts
|
Loss Portfolio Transfer
Eliminate potential IBNR time bombs Addresses gaps in coverage purchased in prior periods |
|
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. |
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 |
|
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 |
-Assure insured organizations that insurance premiums and retentions are appropriate
-Make loss projections used for forecasting and budgeting -Complete loss reserve reviews |
|
Contributing factors to the instability of reserves
Moderate inflation rate, Low volume, dissimilar claims Litigious venue Non Uniform claims adjuster procedures |
Workers compensation benefit structure revisions
Economic and legal environment changes Unstable Claims staff and management Incompetent, unprofessional legal counsel |
|
contributing factors to the stability of reserves
Highly competent, professional legal counsel Non-litigious venue Uniform claims adjuster procedures |
Stable economic and legal environment
Consistency in maintaining TPAs or claims offices Low rate of inflation Dedicated claims unit Stable Workers compensation benefit structures |
|
purposes of loss triangulation
1. Reflects growth in losses due to IBNR claims |
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) |
|
Basic types of loss triangulation
|
1. Paid loss (severity)
2. Incurred loss (severity) 3. Claim count (frequency) 4. Claim payout (timing) |
|
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 |
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 |
|
Two major accounting standards for risk managers
1. FAS 5 for private and public organizations 2. GAS 10 for governmental entities |
g
|
|
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 |
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 |
|
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)
|
Loss Reserve = Case Reserve plus the IBNR
|
|
Case Reserve: funds established to pay claims of
which the insurance company has knowledge but has not yet been settled |
Individual reserves are established by
a. TPAs b. Carrier claims adjusters c. In-house staff |
|
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 |
Re-opened Claims - claim closed by end of term, but re-opened due to additional treatment needed
|
|
Loss and Loss Expense Reserves
|
Allocated - attributed directly to a specific claim
Unallocated - any other exp related to settling the claim - adjuster salaries, ovehead for running claims dept |
|
Gross Reserves or Net Reserves
|
affected by salvage, reinsurance
and/or other recoveries |
|
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 |
most reserves are undiscounted true expected total cost - discount reserve by anticipated investment income - discounted much smaller number
|
|
Case reserving philosophies
|
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 |
|
Total reserve = Total Reported Losses x Development Factors+ Pure IBNR reserves
|
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 |
|
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 |
E. Forecasts of future results for budgeting
F. Tax management G. Merger and acquisition negotiation (pricing and terms) H. Financial reporting |
|
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 |
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 |
|
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 |
Equity Value:
GAAP: Retained earnings is recorded as stockholder equity SAP: Retained earnings are recorded as statutory policyholder surplus |
|
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 |
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. |
|
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”
|
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 |
|
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. |
3.Letter of credit - Cost and availability depends on the insured's credit rating.
4. Opportunity costs Cash or cash equivalents |
|
Advantage and disadvantage of top-down pricing
Advantage – rates are usually based on a very large statistical sample, the premium will be actuarially souns |
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 |
|
Advantages bottom-up pricing
1) The loss rate will represent the correct loss projection if the data is large enough and credible |
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 |
|
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 |
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 |
|
Retrospectively Rated Plans Characteristics
Rates are fixed, premiums are adjusted retrospectively based upon losses |
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 |
|
1. Incurred loss retro (ILR) plan
-Incurred losses (paid + case reserves) – used to calculate the indicated retro premium -Deposit premium – generally the standard premium |
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 |
|
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 |
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 |
|
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 |
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 |
|
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
|
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 |
|
Fully self-insured - Used by larger organizations to assume management of all exposures
Useful when losses for both frequency and severity are predictable |
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. |
|
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 |
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
|
|
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 |
SAP emphasizes liquidity and solvency for the
protection of policyholders; SAP treats the insurance company as if it were about to be liquidated |
|
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 |
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. |