Mapping the Journey to a Successful Captive

This article originally was published on Captive.com and is reprinted here with permission.

Most risk managers and organizational leaders investigating innovative ways to finance their risk these days have heard about a captive insurance solution. As leaders face ever-increasing insurance premiums and worry about risks and liabilities that could challenge the status quo, their curiosity intensifies. They begin exploring what’s involved in establishing a new captive insurance company.

Yet few stakeholders realize just how much learning is ahead of them. There’s a tremendous educational component to evaluating the efficacy of a captive strategy, and even more industry exposure once a decision is made to proceed.

The captive journey usually starts with a risk manager or CFO talking with a captive consultant to gather enough information to take to the board or top management with a recommendation to explore the concept. Captives represent a significant shift in risk philosophy, so it’s important to ensure leadership supports the approach.

Next, there is a deep dive into exactly what captives are and how they work. This stage involves exploring the key differences between risk retention and risk transfer. From there, the discussion turns to the specific goals and objectives the organization has for its captive and reviewing its current insurance program, coverage attributes and premium volume.

It’s crucial for the captive consultant to help each organization understand the various captive structures: group captives, risk retention groups, segregated cell captives and single-parent captives. This in turn will aid in identifying the appropriate structure for the firm’s goals. For example, if a firm wants to cover medical malpractice and is comfortable sharing risk with others, joining a risk retention group could be the optimal solution. However, if a firm wants to write property damage and business interruption coverage with specific coverage attributes, a cell captive or single parent captive is typically a more advantageous solution. No two organizations, nor their needs, are identical; therefore, a deep understanding of the specific details of each client situation is critical.

Many factors attract companies to the captive solution. An initial factor is financial, through which firms can replace a sunk premium expense with an investment opportunity where the firm has the potential to recoup a portion of their insurance costs in favorable claims years. The second factor is control; primarily the ability to control premium volatility and claims handling, rather than waiting to see how much of an increase this year’s renewal will bring. In addition, the ability to control costs by accessing additional capacity can help drive optimal results for an organization. Finally, there’s the inherent flexibility when it comes to risks insurance carriers aren’t interested in covering affordably. If the risk can be quantified, then there’s a mechanism to insure it, perhaps by writing a tailored policy through the captive.

Captives are well-suited to traditional lines such as workers’ compensation, directors and officers liability coverage, and employment practices. A captive can also assist in providing specialized coverage for specific situations in executive risks, voluntary benefits and medical stop loss.

Following education and an initial evaluation, the next step is a comprehensive feasibility analysis. Also known as a feasibility study, this is an analysis of the company’s historical claims data and exposure units; an evaluation of possible captive domiciles; engagement with third-party providers, such as the captive advisor, an actuary and an attorney; and preparation of pro forma financial statements outlining the viability of a captive for the firm over a five- or ten-year period. During the analysis, the captive advisor will study existing insurance coverage to determine and quantify the specific risks the company holds. From there, the advisor will brainstorm solutions to determine which provides the greatest and longest-lasting advantages for the organization, with the domicile whose regulatory framework best fits the needs.

If the organization decides to move forward with a captive recommendation, it’s time to oversee the captive’s establishment and implementation. The captive manager works closely with the domicile to ensure the alignment of all compliance requirements and that the developed structure meets the expectations of all involved. Once these boxes are checked, and the captive is licensed, it’s time to proceed with the initial capitalization of the captive entity.

Organizations considering a captive strategy need to have an internal champion or manager capable of serving as the primary point of contact and empowered to make the many small (and facilitate large) decisions when establishing a captive insurance company. Typically, whoever is responsible for risk management leads the process, but some boards invest the responsibility in the hands of the CEO, CFO or general counsel. No matter who is selected, it’s vital to have clear lines of communication with accounting, tax, legal, risk management and human resources to ensure that the gathering of information and implementation of decisions have minimal impact on operations.

The final phase is ongoing captive management. The most successful captives have strong partnerships with the parent company, the captive consultants who assisted the company in designing and evaluating the captive, and the captive managers who oversee its day-to-day operations. A positive, collaborative relationship between all three groups will ensure efficiency and satisfaction. While it’s true that the feasibility study takes quite a bit of time and resources at the beginning of the process, all parties will have ongoing responsibilities to ensure the captive has proper management and can adapt to the organization’s ever-changing needs. A best practice for effective and efficient management of a captive is to continue to evaluate and update the strategic plan for optimizing the use of a captive.

The captive journey entails a significant change in how a company approaches risk. That’s why success demands a thoughtful and innovative approach by everyone involved.

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.

Authored by

Ben Hale - Captives Intern