Taking ‘Captive’ out of Captives

Over the past 28 years, the captive insurance market has grown phenomenally. December 1978 marked the first public offering of a Bermuda insurance company, which was meant to reinsure captive insurance companies being forming in Bermuda. The prospectus explaining offshore insurance tax laws was worth more than the initial stock price.

It certainly put Bermuda on the map, coming just after a July 1978 business article in The New York Times, “Captive Insurers Slip Their Chains,” by Lisa Bergson. It was the formal beginning of the captive insurance industry, and its recognition as providing another insurance solution for the risk manager.

In 28 years, much has happened within the captives industry. One development is the evolution of the risk manager’s role; in some instances, they have needed to become CEOs of insurance companies. On this basis, they must supplement their functional understanding of the insurance industry. Listed below are a few major areas the industry is concerned with moving forward.

CAPTIVE CONSIDERATIONS

Capitalization of the captive insurance company, as well as its ability to maintain a good financial rating from the various rating organizations, needs to be considered. Also, demands by parent corporations to dividend out the capital of the captive need to be tempered, especially at the board level.

Captives need to negotiate and place adequate reinsurance protections with financially secure reinsurance companies. This requires the industry to do more analysis of concepts such as selecting a reinsurance broker or buying reinsurance direct from professional reinsurance companies.

Industry members should consider expanding into new coverages that captives should be providing to the parent corporation; such coverages may not have been included in the original feasibility study. They should also look into manuscripted policy forms and the use of actuarial firms for insurance pricing.

There are also issues around the phenomenon of captives renegotiating “fronting” fees. What is the benchmark to be used? What does a proposal to a “front” look like? How do you find the new “fronting” insurance companies? How do you avoid doing “fronting” business with downgraded insurers?

More thought should be given to the acquisitions of insurance entities, and the need for strategic decision-making. In this context, board members of captives might ask themselves the following: ‘Does my captive need to purchase the “third party administrator” handling the claim? Do I need to acquire a domestic insurer? Should my captive start its own insurance agency?’

Board members also need to be aware of the business environment in which captives operate. Currently, that environment is very focused on ethical considerations. Captive boards should therefore ask: ‘Is our captive guilty of illegal business practices? Was the captive part of a bid-rigging scheme?’ Captives might be wise to focus on risk management measures such as, for example, understanding the correct approach to placing excess casualty coverage in the captive.

Many captive owners focus on key functional areas that are critical to a captives long-term success. These include underwriting, loss control, financial management and corporate governance. More emphasis on acquiring practical experience in each of these areas is necessary as the captive continues to grow in asset value.

MOVING FORWARD

Captives often do not have a forward-thinking business plans, as their existence is largely predicated based on reaction to the insurance market. When the traditional insurance market failed to provide coverage at reasonable pricing, risk managers turned to captives as the solution. But captives now need to plan for future profit center opportunities, especially as they become available in the changing market place.

Along these lines, we expect to see the solid growth of captive insurance companies as they provide the risk management department endless new opportunities. Captive management’s appetite for risk must be consistent with its capital, and then the captive will prosper.