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Courtesy of Atlas Insurance Management
One of the most important functions of any captive management professional is assisting clients in the correct choice and design of the captive's insurance program. Too often this is left to the brokers and consultants, with the manager being presented a fait accompli. This is a mistake. At both the initial feasibility and the business plan change stages, the manager must be closely involved in the design of the structure, as this may influence the company's success, or lack thereof. The experience that a qualified and insurance-literate manager can bring to these discussions can be crucial. Not only can the insurance manager assist in the design of a structure that optimizes the capital requirements, but in addition the manager is fully aware of the Insurance Regulator's solvency requirements that are impacted by the design structure.
At the outset of discussions, any potential captive owner is faced with a host of decisions (such as domicile location, insurance manager, auditor, banking, directors, etc.) and far too often the easier choice is to renew "as is." This negates the many benefits of owning a captive, such as risk smoothing, tax deferral and investment income. However, experienced consultants and captive management personnel can guide the client through these choices.
Thereafter, once the supplementary requirements have been determined, the most important decisions are the actual structuring of the insurance and reinsurance program, and whether the captive undertakes a "fronted" program or a "direct write" program. To a great extent this decision is dependent on the nature of the proposed insurance covers — and the type and nature of the underlying risks.
If the risks are located in the United States, the state and federal regulations have to be adhered to. As such, for covers such as workers compensation or automobile liability, there is no choice but to have a reinsurance program for the captive. These are statutory covers that have to be issued by U.S. authorized and admitted insurance carriers, and therefore the captive is unable to provide this type of cover on a direct basis, unless this is part of a deductible reimbursement.
With statutory covers, it's the function of the captive manager to work with the insured's insurance broker to identify and locate an admitted fronting carrier in the states where cover is required, and then to agree on the terms of the cover, the reinsurance agreement and any other supplemental requirements such as letters of credit for Schedule F collateral (or alternatively a 114 trust account), the policy issuance procedures, program managers and risk management requirements.
The logistical considerations can be more complicated for a direct written program. Care must be taken not to breach any surplus lines or self-procured regulations in the states involved — specific policy covers are generally negotiated outside of the state, and for an offshore captive outside of the United States.
The most common form of direct policy written by a captive is the "deductible reimbursement." This type of self-insurance is allowed under state regulations for large insureds with sophisticated workers' compensation programs. Direct procurement is also popular with non-standard covers such as reputation risks, brand protection, financial losses and product recall. Typical "standard" direct write covers include directors and officers' liability, medical malpractice and certain property HPL or deductible programs where the function of the captive is to access the reinsurance markets. The structuring of these programs may be influenced by requirements of interested third parties who may insist on having a cut-through clause instead of approved insurance paper; for example, mortgage lenders for property covers or hospitals in the case of physician groups.
Once the initial policy type is determined, the second stage is the design of the reinsurance protection. There are two types of captive reinsurance protection: excess of loss and stop loss/aggregate reinsurance.
In most cases a combination of these two reinsurance protections will be used in the structure. The captive manager will offer advice as to the levels for the attachment points and the related cost. This is key for a couple of factors: the long-term stability of the program and the levels of capital required at the outset.
Under an excess of loss reinsurance policy, the standard captives exposure for an individual claim is usually between $100,000 and $250,000, with reinsurance above these levels up to the statutory amounts required. The stop loss reinsurance protects the overall financial position of the captive, generally expressed as a percentage of the premium. This is to ensure, for example, that the captive's total losses in any one year do not exceed more than 150 percent of net retained premium income.
Generally a combination of excess of loss and stop loss is included in the captive program design, and the cost and levels of the reinsurance covers determine the capital requirements.
As the captive evolves so will the insurance program. In time, there may be a combination of direct and reinsurance covers in place, often with different carriers and insureds. At this juncture the cell captive should be considered, so that different years and programs are ring fenced from each other. The more complicated the programs and structure, the greater the reliance on the insurance manager — not only for specific guidance, but to track the results of each program to ensure that the company remains financially healthy. All too often reinsurance recoveries or investment accounts used as collateral for the early years are overlooked as the company grows and develops. Just as the captive manager provides assistance with the design and negotiation of new covers, they also need to have a good back office function to ensure that the retrospective aspects of a program are kept in an orderly and financially viable state.
Atlas Insurance Management
Independent Captive Management
Offices in Anguilla, Bahamas, BVI, Cayman Islands, Nevis
John Williams, tel: 284-494-2728 johnwilliams@caribbins.com
Martin Eveleigh, tel: 345-945-5556 meveleigh@britgroup.com
Nick Leighton, tel: 345-945-5556 nleighton@britgroup.com
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