Exploring the Opportunities Captives Can Offer in Challenging Markets

A session during the recent 2021 Western Region Captive Insurance Conference (WRCIC) titled "Level Up—Expanding Captive Utilization" surveyed some of the unique opportunities captives can provide in being leveraged to overcome market obstacles faced by their owners.

Moderated by Adam Miholic of Hylant and including panelists Jon Soules of Big-D Construction Corp. and Mark Wiedeman, Utah Captive Insurance Division assistant director, the session offered a brief overview of the typical options an established captive can provide, noting that many captive insurance companies will offer dividends or profit distribution and possibly take on more risks.

Mr. Miholic also inquired into what else captive insurance company owners should look at and what other options they might consider that had not been thought of before.

Mr. Miholic said that it is critical to "know your exit strategy and have a long-term vision for the captive." To do this, benchmarks must be set at the board level (e.g., profit distributions, investment guidelines, regulatory ratios, etc.). Mr. Miholic further noted that while realistic goals and objectives should be set, these will need to be revised as "the captives can and should change with the parent company over the years." He emphasized that "parent company changes should be in lockstep with changes in the captive … it becomes a core component in how they finance risk."

It was suggested that captive insurance company owners and boards take things step-by-step and include regulators in the conversation early on. Mr. Wiedeman noted that regulators "want to see a solid business plan, solid actuarial methodology being applied in both adverse and expected scenarios, and adequate pricing."

Business plans should be dynamic, as a captive is a tool to respond to challenges in the market, but it is necessary that owners understand what risk they are taking on. "We are in a very fluid time in our necessity to assess our risk," suggested Mr. Wiedeman.

Owners want to see the captive insurance company grow and take on more risk, but that all depends on the goals of the captive itself and its growth potential.

The panelists agreed that business plan changes should not be considered if there are issues with solvency, or common notions of insurance—especially in times of transition, or if there is significant adverse loss development, or if wealth transfer or estate planning is considered a goal of the captive. Finally, competing costs of capital and commercial market timing should also be taken into account if business plan changes are being considered.

"If a captive has been successful in building up surplus, a board of directors might look at the money in the captive and use it to make an acquisition or purchase, and this can result in competing interests, so it is important to have a position on how to navigate that," said Mr. Soules. This position must be founded on the long-term goals of the captive.

Mr. Wiedeman noted that "regulatory red flags" for any changes in the captive insurance program are centered primarily around concerns of solvency. "If you're writing lines that don't make sense or have unsupported pricing, or if you have improper investments, negatively impacting liquidity, this will cause great concern for regulators," he said. He added that "writing off premium collectibles or loan receivables will get more regulatory scrutiny, as will forgiving premiums. These actions or attempted actions in the captive will lead regulators to ask the question of captive owners: 'Do you really want to be an insurance company?'"

Other reasons to consider a business plan change include trending exposures, traditional lines, emerging lines, and third-party risk. "It is critical to know if a domicile will even allow certain risks to be written in a captive. If not, redomestication could take place," noted Mr. Miholic.

Furthermore, a captive can be leveraged to address unforeseen gaps in coverage that went unnoticed or misunderstood and can properly be accounted for if they are not explicitly denied in the statute.

"While the traditional market is reactive," stated Mr. Miholic, "in the captive industry, we try to get on the other side and be proactive, asking the question, 'What else can I do now to protect my company from the next major catastrophe?'" Posing hypothetical questions and building on the responses now are ways that captives can be proactive, he said.

Mr. Miholic further addressed the audience, suggesting that "service providers should help clients do threat analysis and take a look at what risks a company has that might impact the balance sheet. If you can boil that down to a particular risk and draft contract wording to address this, you may want to consider placing it in the captive."

Mr. Soules noted that "in a captive, you're only going to get out of it what you put into it."

As surplus accrues, captive insurance company owners need to know what they can do with their captives. Options will include increased limits, lower deductibles, covering additional exposures, closing out legacy risks/claims payment aggressiveness, limited loan back provisions, distributing profits, reducing loss funding/premiums, and providing for the payment of risk management expenses (direct management expense to reduce claims—expenses that will impact claims experience). Tapping into the equity of the captive can offer many creative responses that would not otherwise be available without a well-thought-out, goal-oriented captive program.

The WRCIC session ended with remarks that expense ratios must be in line with what regulators want to see and reiterated that relationships with regulators and partners are key—that it is an ongoing conversation that must be nurtured with consistency and openness. And as long as there is communication and trust, "We want to see creativity remain with captives," Mr. Wiedeman concluded.