Your 6-Step Plan to Captive Optimization

You conducted a feasibility study before forming your captive insurance company, establishing long-term goals and objectives, determining which risks to write, where to domicile, and how to finance it all.

But that was 5 years ago.

Since then, your company has made two acquisitions, expanded its workforce, implemented new technology, contracted with new suppliers, and been affected by a new federal regulation. In short, the risk profile has changed considerably.

Is your captive keeping up with these changes?

As with all other business matters, your company's captive needs and goals are likely to change over time, especially with new and emerging risks sprouting up frequently.

With all of the corporate and market changes in that time horizon, a "refeasibility" may be necessary to better equip management with where the captive can interface within the current culture, risk tolerance, and financial outlook.

A refeasibility study ensures that your captive insurance company is still serving your organization's needs and furthering its mission, rather than holding it back, becoming status quo, or even a program whose benefit is no longer understood. Unlike the initial feasibility study, this periodic checkup considers the existing captive structure and financing strategies and takes into account how the captive has performed thus far.

To gain a holistic view of the captive insurance company's performance and evaluate the need for change, captive owners should ask themselves these six questions.

1. Do your captive's goals align with your risk profile?

Evaluating your captive's goals is the first step of a refeasibility plan. That begins with collection of data. Claims experience, reserve and surplus levels, loss ratios, asset makeup, current commercial insurance program, and other measures of efficiency indicate how successfully the captive has operated and where it has underperformed.

This initial review indicates whether the captive met the preliminary goals and whether those goals should change. This decision is also largely dependent on changes in the insured organization's risk profile and the subsequent impact on insurance needs.

Many feasibility studies focus on just a few lines of coverage. Over time, coverages such as medical stop loss and other deductibles should be considered for inclusion. These traditional lines of coverage along with emerging risks can be evaluated within the refeasibility study.

Things such as the rise in remote and hybrid workforce trend as well as increasing concern around climate risk also pose unique exposures for consideration.

Developing performance metrics can also help risk managers identify areas where resources can be shifted to support the coverage needs demanded by organizational change and emerging risks.

2. How will proposed changes impact other parts of the captive company?

The second stage of the refeasibility study considers how adjustments to long-term goals affect other pieces of the captive puzzle, such as risk financing and use of reinsurance.

Adding new lines of coverage or expanding or reducing existing ones will necessitate an evaluation of risk financing strategies and could lead to changes in an organization's investment mix or retention levels. This may also impact reliance on reinsurance as a component of the overall risk transfer strategy.

The best way to pinpoint the extent to which these changes should be made is through stress testing.

Running through scenarios with reasonable adverse case outcomes may highlight where more or less financing is needed to service claims and maintain favorable loss ratios.

3. What specific implementation strategies will make your changes stick?

As with any enterprise-wide change, a detailed road map lays the groundwork for successful outcomes and can gain the confidence of stakeholders.

This stage identifies lines of insurance that could be moved into the captive or other coverages that would be more cost effective to insure through the traditional insurance market. Along with cyber and employee benefits, some of the most common risks to insure in captives include professional liability, auto liability, reputation, and business interruption.

Capital management strategies should also specify how surplus will be used going forward.

"There are several considerations in appropriately managing the capital and surplus levels over the life of a captive, including average cost of capital, retention levels, reinsurance use, and taxes, among others," said Karin Landry, managing partner, Spring Consulting Group. "A team of actuaries and consultants could review and develop strategy to address these."

4. Does your existing captive structure still work?

Captives have taken on a number of different forms since the captive concept initiated—single parent, group/association, cell captives, sponsored captives, noncontrolled foreign corporations, etc. The primary differences between these structures center on the way risk is shared among the parties involved and how the captive is financed and regulated.

Sponsored captives, for example, offer a way for companies to take advantage of the established infrastructure of a traditional insurer and avoid the up-front costs of forming a captive—though they are not accepted in all domiciles. Group captives allow companies with unrelated risks to spread out their exposure and reduce their total cost of risk but can present management challenges.

A captive's domicile, the scope of risk it seeks to cover, and the financial strength of its parent company all help to determine which structure will work best.

5. Does your captive account for recent case law and regulations?

The technology industry isn't the only one that is always changing. Laws, regulations, and court cases, especially lately, have an impact on captives and need to be considered as you are taking a fresh look at your strategy.

Federal tax changes continue to impact offshore domiciles differently than onshore, particularly in relation to parent-subsidiary consolidation.

There continues to be pressure on certain captive structures with hundreds of Tax Court cases pending, and the outcomes continue to provide guidance on qualifying and nonqualifying structures.

Domicile-related regulations are also changing. Is yours compliant with your current domicile, and have you looked at the new domiciles available? It is important to understand where the Dodd–Frank Wall Street Reform and Consumer Protection Act and state reforms intersect, specifically the self-procurement tax, to ensure the captive is appropriately aligned.

6. Are the changes having the effect they're supposed to?

Now there are newly identified opportunities for the captive, supported proposed changes with data and stakeholder feedback, and developed detailed and holistic plans to move forward. But you're not done.

The final step of any refeasibility study is to measure outcomes. Collect data again to see if newly established goals are being met and how the rest of the captive organization has been impacted.

A great deal of this stage relies on solid industry benchmarks against which to measure current and future captive performance. Furthermore, it's important that the optimization team takes this data and edits their implementation plan accordingly to keep captive performance on track, making actionable recommendations for staff to follow.

To Execute Your Plan, Turn to Expert Help

These findings should serve as a baseline for measurement going forward, but look for a team of experts ranging from employee benefits and risk management to actuarial services to walk through the steps and, ultimately, implementation. This is especially important as new risks continue to emerge and evolve; routine maintenance on a captive insurance company is important, just like it is on your car!