A Comprehensive Overview of a Captive Insurance Feasibility Case Study

At the 2024 Vermont Captive Insurance Association (VCIA) Conference, a session titled "Captive Feasibility Study: Step by Step from Concept to Formation" provided a comprehensive look at how Warrior Met Coal, a pure-play steelmaking coal producer, developed its captive insurance strategy. The panel consisted of Michelle D'Amico of Aon, Nicole Killam of Warrior Met Coal, and Jim DeVoe-Talluto from the Vermont Department of Financial Regulation, with Mike Meehan, Milliman, serving as the moderator. 

Why Consider a Captive? 

The presenters outlined several challenges faced by companies that make forming a captive insurance company an appealing alternative to traditional insurance. 

• Increased retentions or deductibles. Many organizations are dealing with increased deductibles and higher retentions in their commercial policies, which makes self-insurance more attractive. 
• Hard-to-insure or uninsurable risk exposures. Certain risks, particularly those related to emerging or niche markets, are often difficult or impossible to insure in the traditional insurance market. 
• Increasing market premiums and volatility. With premiums continuing to rise, especially in hard insurance markets, captives allow businesses to avoid over-reliance on external insurance providers. 
• Desire to retain more risk. Organizations increasingly prefer to retain control over their own risk, and captives allow them to do so while offering potential financial benefits.

These factors, combined with the specific needs of Warrior Met Coal, led the company to explore the formation of a captive insurance program. 

Warrior Met Coal's Background 

Warrior Met Coal operates three key mining sites in Alabama—Blue Creek, Mine No. 4, and Mine No. 7. These mines produce high-quality steelmaking coal, which is essential for global steel production. Steel, as the session pointed out, plays a vital role in modern infrastructure and green technologies such as electric vehicles, wind turbines, and solar panels. 

The decision to pursue a captive was driven by several factors unique to Warrior Met Coal's industry. 

• Continuous rate increases. The coal industry faces significant challenges in obtaining affordable insurance due to the environmental, social, and governance (ESG) concerns that surround it. These concerns have led to escalating premium costs. 
• Lack of capacity. Insurance market capacity for coal-related risks is shrinking, leaving fewer options for coverage. By creating a captive, Warrior Met Coal can secure its own coverage and avoid dependence on the traditional market. 
• ESG concerns. As ESG initiatives grow, many insurers are stepping back from industries like coal, which are seen as less sustainable. A captive allows companies in these industries to maintain appropriate levels of coverage without being subject to these external pressures. 

Warrior's Captive: Key Details 

Warrior Met Coal established its Vermont-based captive in September 2023. Initially, the captive covered deductibles and self-insured retentions for cyber insurance, property, workers compensation, and general liability policies. In 2024, the captive's scope was broadened to include additional policies and coverages, enhancing its risk management capabilities. Key expansions included the following. 

• Additional deductibles and self-insured retentions. Six additional policies were incorporated, extending the captive's coverage across more lines of business. 
• Property excess layer. Offering further protection beyond traditional property insurance. 
• Excess liability self-insured layer. Addressing higher layers of liability exposure that were not fully covered by traditional insurers. 
• Bermuda reinsurance policies. Partnering with Bermuda-based reinsurers workers compensation, general liability, and property risks, providing increased security and capacity. 

Warrior's decision to form a captive started with discussions with Aon in March 2023. The feasibility study was completed by June, and the captive became fully operational by September 2023. 

The Captive Feasibility Study Process 

The case study highlighted the structured process of conducting a feasibility study, which is essential for making informed decisions about whether to form a captive and for satisfying regulatory requirements. 

• Feasibility study kickoff meeting. The process begins with a formal kickoff meeting to outline the study's goals and set expectations. 
• Actuarial forecasting and domicile/structure analysis. Loss forecasting, premium calculations, and an analysis of potential domiciles (in Warrior's case, Vermont) are crucial early steps. 
• Financial analysis and report delivery. A financial analysis is performed, including the development of pro forma financial statements (income statement, balance sheet, and cash flow projections). These projections must cover both expected and adverse scenarios. 
• Prepare captive application. Once the financials are in order, the application to establish the captive can be prepared. 
• Regulatory review and captive license issuance. The regulatory review is the final step before the captive license is issued. The timeline for this phase depends on the domicile's regulatory framework. 
• Commencement of operations. After receiving the license, the captive insurer can begin operations, initially writing its first policies and managing its risks. 

Each stage of this process takes varying lengths of time. For Warrior, the entire process, from the feasibility study to the issuance of the captive license, took approximately 6 months. 

Key Elements of the Captive Application 

The captive application process, as outlined by the presenters, requires several critical elements, as follows. 

• Detailed plan of operations. A comprehensive outline of how the captive insurance company will function, including risk management and claims handling procedures. 
• Five-year pro forma financial statements. These financial projections must cover different potential scenarios, including adverse conditions. 
• Draft policies/reinsurance agreements. Preliminary policies and any applicable reinsurance agreements must be included. 
• Corporate documentation. Articles of incorporation and biographical affidavits for the captive's board of directors are required. 
• Parent company financials. The parent company's financial statements are necessary to ensure the captive's financial viability. 

Common Pitfalls in the Captive Feasibility Process 

The presenters noted several common challenges encountered during the feasibility process. 

• Data collection challenges. Captive feasibility studies require extensive data on loss history, exposure information, and future projections. Inaccurate or incomplete data can delay or undermine the study. 
• Lack of understanding of captive insurance. For many companies, captives are a new concept, and a lack of familiarity with how they operate can lead to internal delays or misaligned expectations. 
• Personnel changes or company shifts. Changes within the organization, such as leadership transitions or shifts in business strategy, can disrupt the captive formation process. 
• Risk tolerance uncertainty. Captive insurance requires a thorough understanding of the parent company's risk tolerance. Misjudging this can lead to inappropriate capital requirements or insufficient coverage. 
• Capital requirements. Captive formations often encounter hurdles related to capitalization, especially when the parent company lacks sufficient liquidity or the captive's lines of business are particularly high-risk. 

Financial Projections and Capital Considerations 

One of the critical components of the feasibility study is the development of pro forma financial statements. These documents help ensure that the captive will have sufficient capital to cover expected losses, operational expenses, and adverse events. According to the presenters, key factors influencing capital requirements include the following. 

• Policy limits and types of risk insured. The risk profile and potential variability in loss projections are key drivers of capital needs. 
• Collateral requirements. In fronted programs, captives may need to provide collateral to their fronting insurers, adding another layer of complexity to capital management. 

The financial projections typically span 5 years and include assumptions about general and administrative expenses, investment return rates, exposure growth, loss payout patterns, and tax considerations. 

As seen in Warrior's experience, a well-conducted feasibility study is critical for ensuring that the captive is a strategic fit for the parent company's broader risk management goals.