Actuarial Considerations In Connection with Captive Insurance Companies

September, 2007

George LevineKPMG LLP

George LevineKPMG LLP

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Scope of Actuarial Involvement with Captives

1. Captive Feasibility Study

2. Captive Formation Process

3. Process Reviews

4. Loss Reserve Review

5. Actuarial Opinion on Reserves.

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1. The Captive Feasibility Study

Define Objectives – Financial and Business

Forecast Ultimate Retained Loss Costs

Perform NPV/Cash Flow Analysis of Alternatives

Develop Program and Optimal Ownership Structure of Captive

Domicile Analysis

Analyze Tax Issues

Deductibility of Captive Premium

Tax Treatment of Captive Income

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2. The Captive Formation Process

Business Plan

Forecasts of Annual Expected Losses

Program Structure (Premiums, Limits, Capitalization)

Pro forma Captive Financial Statements

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2. The Captive Formation Process, continued

Financial Impact to Parent

Cash Flow Requirements to Prefund Premium

Capitalization of Captive – Cash or LOC

Cost of Capital Eliminated through Intercompany Loans from Captive to Parent

Accrual of Liabilities (Case Reserves and IBNR)

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3. Process Reviews

Underwriting Risk

Cash Flow/Recording Risk (Payments to TPAs)

Monitoring Loss Payments/Expense Payments

Timing Risk

Collectibility of Insurance/Reinsurance Risk

Interest Rate Risk (If Discounting)

Risks may have Sarbanes-Oxley 404 Implications

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Claims Data Sorted by Insured

Reports produced generating loss triangles, etc. to estimate accruals

Claims Limited to Self-Insured Retention

Claims recorded into General Ledger

Bills received from TPA

Claims are received or estimated

Injured Party Receives Payment

Insurance Company/TPA Indemnified Party

Transactional Data Systems

Captive Systems

Claims data placed into Actuarial Data Base

Claims data delivered to actuary

Claims paid to TPA

RECONCILIATION

3. Process Reviews, continuedCash Flow/Recording Risk: Captive Claim Payment Process

Claims Billed to Self-Insurer

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3. Process Reviews, continuedTiming Risk

Timing of Payments

Timing of Analysis

At which valuation date should review be performed?

Valuation Date – For Example, 12/31/XX, or 9/30/XX and Roll-forward

Audit date is often six months after year end

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4. The Actuarial Reserving Process

Information Available

Losses

From Third-Party Administrator, Client’s Parent, or Captive Manager

Timing – What Valuation to Use

Premiums

Exposure Data

Financial Statements

Unaudited Statements

Audited Statements (internal)

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4. The Actuarial Reserving Process, continued

Unique Issues for Captives

Availability of Data

Quality of Data

Reconciliation of Paid Data for Timing Differences

Small Size of Organization

Solvency of Reinsurer or Fronting Insurer

Complex Programs

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4. The Actuarial Reserving Process, continued

Some Generally Accepted Loss Methodologies

Chain-Ladder Methods

Use of Industry Data

Bornhuetter-Ferguson Methods

Loss Limitations: Large Losses

Berquist-Sherman Type Adjustments

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4. The Actuarial Reserving Process, continued

Actuarial Deliverables

Depend Upon Domicile’s Requirements

Statement of Actuarial Opinion

Vermont Requirement – With audited financial statements, six months after fiscal year end

Actuarial Report/Workpapers

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4. The Actuarial Reserving Process, continued

Limitations of Captive Reviews

Timing of Reviews – At Year End or Before Year End (discussed before)

Gross or Net of Insurance?

Range of Reserves – Where to Carry Reserves

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4. The Actuarial Reserving Process, continued

What is a Range of Reasonable Reserve Estimates?

Range Defined in Actuarial Standard of Practice # 36 – Section 3.6.4

Range of Estimates that could be produced by appropriate actuarial methods or alternative sets of assumptions that the actuary judges to be reasonable

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5. Actuarial Opinion on Reserves

Actuarial Opinion Requirements by Domicile

Bermuda

Actuarial Opinion from Loss Reserve Specialist

Cayman Islands

No formal Opinion Requirement, unless Authority Requests a Review, then Report

Vermont

Actuarial Opinion and Workpapers on Site of Company

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5. Actuarial Opinion on Reserves, continued

Actuarial Standard of Practice # 36Five Types of Opinions (Section 3.3.2)

Reasonable (If carried reserves are within a range of reasonable reserves)

Deficient or Inadequate (Not Reasonable)

Redundant or Excess Provision (Not Reasonable)

Qualified

No Opinion

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Presenter’s contact details

George Levine

KPMG LLP

www.kpmg.com

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2007 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. 15444PHL