Establishing a captive? What you need to know from application to optimization

A captive insurance company is a licensed and regulated insurance or reinsurance company owned by a non-insurance company for purposes of insuring or reinsuring the risks of its owner or owner’s affiliated companies.

Creating a captive insurance company can provide an innovative solution to your risk financing needs and enhance the financial and operational performance of your organization. But for businesses yet to run a captive, there is much to consider; from understanding the feasibility of your captive and applying for it, to understanding the roles and responsibilities of the board and other functions. You’ll also want to understand the annual reporting cycle and how to get the most value from your captive.

This insight is based on June 2023’s Captive Owners’ Forum (which you can access by completing the form on this page) and covers:

• The captive pre and post application and captive feasibility studies
• Captive application process: Regulatory considerations
• Managing your captive day-to-day
• Annual cycle of captive board meetings: Financials, strategy, renewals
• Optimizing your captive.

Captive pre-application process and captive feasibility studies

A feasibility study is a crucial step in setting up your captive. It will help to define the projected costs of establishing the captive, the ongoing costs of operating it and the wider financial commitment required.

Key stakeholders will be involved in developing the feasibility study with the major components being to understand the losses you are looking to address within the captive and the organizational risk appetite. You should determine both with collaboration across the business and using actuarial forecasting to examine factors included the expected per claim and per occurrence retention, and aggregate protection. This work should also take in the level of confidence over losses, calling on your own and/or industry data.

The feasibility study will also assess expenses, such as fronting fees charged by the insurer to provide all of the services involved with the programme and to assume the credit, operational, regulatory, tax and legal risk. Other expenses you need to consider at this stage include excess insurance/reinsurance, claims administration costs and general captive admin and management costs, such as actuarial, audit and legal, domicile fees/taxes.

The final element to examine is the capital you will need to set up the captive, which will vary between domiciles, with your feasibility study assessing variations between domiciles.

Further factors that influence capital requirements include the lines of business and level of risk you plan to use your captive for. You should make financial projections on capital based on different loss and growth scenarios to make an informed decision as to whether to proceed with the captive or otherwise in light of this and all other considerations.

Captive application process: Regulatory considerations

If your organization goes ahead with setting up a captive, your captive advisors will help you navigate the regulatory application and approval process.

The financial regulator (‘the regulator’) of the jurisdiction where the captive is to be set up will want to know the key objectives for your captive, the lines of business that will be held within your captive. It will assess two key areas in this context: the financial strength of the shareholders and robustness of the business plan, plus the way the company intends to operate.

In assessing the financial strength of the shareholders, the regulator will carry out a detailed due diligence on the immediate parent undertaking (that is, the company that directly owns the captive) and, if applicable, the ultimate parent undertaking if the captive is indirectly, and the ultimate beneficial owners of the ultimate parent company.

The regulator assesses the robustness of the business plan (also known as ‘scheme of operations’) by analysing it in detail.

Your business plan should specify a number of key areas including:

• Three-year business plan, stress-tested under pessimistic and optimistic scenarios
• Three-year capital calculations
• Overview of historical business, if available
• Modus operandi of the insurance company, including details on the internal control system
• Draft outsourced agreements, for example, the insurance management agreement if day-to-day running of the captive vehicle is to be handled by professional captive managers
• Details of any reinsurance arrangements
• Named members of the committee/board and the terms of reference of the committee/board.

The regulator has the following number of pre-defined conditions to grant an insurance licence to which your captive company will need to abide, including:

• The injection of share capital into the insurance company
• The insurance company needing to operate in line with the business plan agreed
• The submission of quarterly management accounts and returns (although frequency might vary by jurisdiction and type of business underwritten)
• The submission of a copy of the signed agreements within one month of operations.

In addition, any changes to the committee members, board directors and shareholders will require regulatory approval.

In terms of timings to establish a captive, this can vary depending on the type of captive, ranging from two weeks to over two years to develop and execute a captive proposal.

Managing your captive day-to-day

Running your captive day-to-day will rely upon a system and structure of governance. A typical arrangement might look like this:

• Board members are likely to be executive directors affiliated to the parent company and independent executive directors, and both sets of members would have been named in the captive application process. The role and responsibilities of the board are to provide leadership, set strategic aims values and standards. The board has responsibility for day-to-day conduct, oversight of outsourced functions and must establish and maintain robust systems and controls.
• Its responsibilities mean the board of directors needs the necessary skills and market knowledge on business strategy, business models and governance. Board directors must also have the requisite financial and insurance expertise, and understand the regulatory framework and requirements.
• Underwriters’ roles and responsibilities include assisting in renewing policies or taking on new risks, liaising with the brokers, fronting insurer and actuaries. Underwriters are also responsible for producing monthly/quarterly underwriting accounts, monitoring premiums as well as unearned premium reserves (UPR), commissions, and issuing policies.

The claims function is concerned with:

• Claim protocols for notification of an incident/claim to the board
• Receiving a bordereaux of claims notified, that is a listing of claims outstanding and claims to be paid
• Accounting for claims paid, recoveries received and reserve movements, ensuring these have been correctly paid and reserved for
• Processing claims payments and establish outstanding loss reserves
• Ensuring consistency with the agreed business plan.

The financial and regulatory reporting function, meanwhile, is required to:

• Assist in group forecasts, budgets, and cash-flow statements
• Produce monthly/quarterly management accounts
• Maintain the bank accounts, effect payments, prepare reconciliations
• Produce the annual statutory accounts
• Manage the external audit process
• Work with other functions to complete all regulatory reports.

The compliance area is required to consider aspects of compliance, including compliance with all regulatory filings.

The risk management function should set out an annual risk management plan, assist the board in developing a risk management strategy and framework, define the risks existing in specific areas, develop written risk management policies and procedures, as well as identify and assess new emerging risks. The risk management function must also prepare both the Own Risk and Solvency Assessment (ORSA) which is the Board’s assessment of the capital required to write the relevant lines of risk, as well as internal and supervisory reports.

Finally, the actuarial function must deliver effective implementation of the risk management system, Regulatory Solvency Captive Requirement (SCR), which is the capital required by the regulator and input into the ORSA process, amongst other responsibilities.

Annual cycle of captive board meetings: Financials, strategy, renewals

For a ‘typical’ captive there will be three key board meeting per year focused on financial review, a mid-year strategic review, and an end-of-year meeting centered on renewals and reserving:

• The financial review is when audit and financial statement work will be completed and approved. It’s also the meeting where the board will update or prepare the relevant Own Solvency Capital Assessment (OSCA) or ORSA, complete and submit regulatory annual returns and complete and submit company returns.
• The strategic review meeting is about answering key questions such as: is the captive operating in line with the expectations with the feasibility study, do you expect changes in the near future, and are you receiving claims line with feasibility study? Specifically, this the juncture to evaluate the company’s capacity to retain additional risk (bearing in mind its level of regulatory solvency capital and risk tolerance), model the existing risks giving comparability and full range of outcome, and analytically review the current retentions and identify the optimal risk retention.
• The strategic review provides a clear audit trail to enhance decision making and improve your captive governance. It’s also the forum to review existing and new risks and review recent loss and exposure data to identify key trends. This will indicate if the movements in data are sufficiently material to warrant updating the existing actuarial models or construct new models to forecast future losses and review your current insurance covers.
• The (re)insurance renewals and reserving policy meeting is concerned with engaging brokers and the parent company to align the renewal program with the strategic review, and completing (re)insurance renewal program and issue policy documentation. This is also the stage where there should be a full review of claims data and trends and where the year-end reserving policy will be approved. The board may also undertake a review of the corporate governance and procedure manual.

Optimizing your captive and next steps

Once your captive is up and running, using analytical tools and methods can identify patterns and discover hidden value in your captive risk portfolios. This might include predictive modelling of risks on single line or portfolio bases, looking again at risk tolerance and/or developing the risk appetite. Alternatively, this can focus on specific optimization themes such as climate risk quantification using scenario modeling, to identify new potential revenue streams.

Analytical optimization exercises can improve your decision-making, risk prioritisation and capital allocation by using clear, consistent and quantified analysis of the uncertainty around financial projections and strategic plans. This can improve corporate governance, senior stakeholder management and related communications and ensure your captive continues to deliver demonstrable value.

To get more detail on how analytical optimization works in practice with a worked example, as well as more insights on how to apply for, operate and govern your captive, watch the Captive Owners’ Forum webinars by filling in the form at the top of this page.

To understand smarter ways to optimize risk within a captive, get in touch with WTW Captive specialists.

Authors

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Peter Carter

Head of Climate Practice &
Head of Captive and Insurance Management Solutions,
WTW

email Email phone +44 20 3124 6300

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Jody Bisson

Director, Captive and Insurance Management Solutions, WTW

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Simon Paris

Director, Captive and Insurance Management Solutions, WTW

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Elizabeth Carbonaro

Regional Director, Western Europe, Captive and Insurance Management Solutions, WTW

email Email phone 00356 9985 3588

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David Stebbing

Senior Director, Strategic Risk Consulting, WTW

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