Captive Insurance Performance: AM Best Ratings and Benchmarking Insights

At the 2024 Vermont Captive Conference, Becky Aitchison from the Vermont Department of Financial Regulation and Kourtnie Beckwith from AM Best discussed how benchmarking helps captive insurance companies evaluate financial performance and meet regulatory standards. Moderated by Katrina Smith from Marsh and coordinated by Travis Terzer from CapVisor Associates, the session provided insights into key financial ratios and trends.

Aggregate Financials and Key Ratios

According to the panel, benchmarking plays a crucial role in evaluating the financial health and performance of captive insurance companies. Captives are often asked by regulators how they rank in terms of assets, surplus, and premiums, as well as how their key ratios compare to industry standards. These benchmarking requests help captives assess their position in the market and make informed strategic decisions.

The panel highlighted several critical ratios used to measure captive insurance companies' performance, particularly in areas such as surplus management, premium growth, and profitability. For instance, the reserves-to-surplus ratio provides a snapshot of how much risk a captive's surplus can support, while the premiums-to-surplus ratio assesses a company's capacity to underwrite new policies. These ratios provide insights into a captive's ability to manage risk and expand its underwriting capabilities.

The panel also discussed the importance of the loss ratio, which compares incurred losses to earned premiums and is a vital metric for measuring how efficiently a company handles claims. Another key measure, the change in surplus, tracks the growth or decline in a company's surplus over time, reflecting its financial strength. Similarly, the change-in-premium ratio evaluates material shifts in premium volume, helping to identify operational trends or management decisions impacting the captive's overall stability.

AM Best Ratings and Financial Strength

The panel emphasized that AM Best-rated captives rely on the Best's Capital Adequacy Ratio (BCAR) as a central tool for evaluating financial strength and overall risk profile. BCAR assesses the relationship between a captive's available capital and its net required capital, factoring in balance sheet strength as well as operational risks. The stronger the BCAR score, the better positioned the captive is to withstand stress scenarios and attract favorable ratings.

In addition to BCAR, the panel explained that AM Best evaluates other key components to determine balance sheet strength. These include liquidity, asset-liability management, reinsurance dependence and quality, financial flexibility, and the effectiveness of stress testing under various risk scenarios. The appropriateness of a captive's reinsurance program and its use of internal capital models also play a role in determining its financial strength.

According to the panel, BCAR scores can vary significantly depending on the type of captive. For instance, established single-parent captives typically achieve BCAR scores in the 60–80 range, largely due to their ability to accumulate surplus and withstand stress tests designed for low-frequency, high-severity risks. In contrast, newer single-parent captives often score lower on BCAR, typically in the 25–50 range, because their higher retention-to-surplus ratios make them more vulnerable in stress scenarios.

Captives versus Commercial Casualty Companies

The panel highlighted the importance of comparing the financial performance of captives to traditional commercial casualty companies to illustrate where captives excel. The data from AM Best-rated captives show that captives maintain a stronger financial position. In particular, single-parent captives consistently post lower operating ratios, with an average of 55.4 percent over the past 5 years, compared to 86.9 percent for the commercial casualty composite. Operating ratios are crucial indicators of financial efficiency, as they reflect how well a company manages its expenses in relation to premium income.

According to the panel, this efficiency in single-parent captives is driven by appropriate loss ratios, low expense ratios, and benefits from net investment income. These factors, combined with consistently strong revenue returns, help single-parent captives build surplus or distribute dividends when appropriate. Additionally, their low return on equity reflects strong surplus and capitalization, making them well-positioned to handle low-frequency, high-severity events.

In comparison, the panel noted that risk retention groups (RRGs) tend to have higher operating ratios, averaging 86.3 percent over the past 5 years (compared to 79.6 percent for all AM Best-rated captive insurance companies and more in line with the commercial casualty composite of 86.9 percent). This is because RRGs strive to keep premiums lower for their members, which often drives higher loss ratios, as a greater proportion of premiums is used to cover claims. The combination of higher loss ratios and modest expense management results in higher operating ratios compared to single-parent captives. However, RRGs manage to balance this by efficiently attracting new members and leveraging knowledge-sharing to aid in loss prevention and mitigation, helping to stabilize premiums over time.

Actuarial Benchmarking and Credibility

The panel further discussed how actuarial benchmarks provide captives with a deeper understanding of their risk profile and loss performance. Captives regularly compare key actuarial metrics such as claim frequency, loss ratios, and ultimate loss estimates to those of similar companies within their industry.

To ensure meaningful actuarial benchmarks, it is essential, as noted by the panel, to derive credible comparisons from datasets with similar characteristics to those of the captive. For example, an airline captive in the Southwest United States would need industry-specific benchmarks rather than broad market averages. By analyzing both internal and industry-wide actuarial benchmarks, captives can better gauge their performance and make informed strategic adjustments.

As the industry continues to evolve, these benchmarking tools will remain essential for captives striving to outperform traditional insurers and achieve long-term success.