When it Comes to Captives, Investigate Everything and Assume Nothing
All that goes into successfully establishing and operating a captive insurer distills to one principle: What you don't know can hurt you--and hurt badly.
Keeping that in mind when selecting a captive's various insurance experts, regardless of their cache, is as crucial as underwriting risk prudently through these special-purpose, risk-financing vehicles. Whether appointing a fronting insurer or captive manger, or retaining an actuary or attorney, risk managers are advised to investigate everything and assume nothing.
A large corporate owner of a pure captive insurer recently learned this lesson the hard way, said Bill Whitehead, vice president, ART/Captives for Lexington Insurance Company.
The captive owner had begun offering its customers an insurance policy written by its captive. Because of some regulatory requirements in several states, the captive owner decided to appoint a well-known carrier to front the coverage nationwide, giving all of its customers a policy from a familiar insurer.
The front assured the captive's executives that it had completed the appropriate product and rate filings with all insurance regulators. But it hadn't, putting the captive insurer in a difficult regulatory position in a significant portion of the country.
In response, the insurance regulator in the home state of the captive's parent company issued a cease-and-desist order against the fronting insurer, forcing the captive insurer to scramble for a new carrier and to quickly make all the necessary filings across the country. The fronting insurer was fined, a small portion of which the captive's parent company had to pay. Meanwhile, the captive owner also had to move quickly to ensure that the situation did not damage its reputation with its customers.
The situation resulted in direct costs, significant additional work, and reputational impairment that the captive and its parent should not have faced, Whitehead said.
The captive learned an important lesson--a lesson all risk managers should understand--that greater due diligence on its part can dramatically reduce the odds of substantial problems arising with any of its partners.
A critical element of due diligence that risk managers can often neglect is checking a potential partner's references, Whitehead said. Risk managers typically are reluctant to call references, especially for a service provider with a well-known brand name, likely because of the public trust implicit in the name, Whitehead said.
Checking the fronting carrier's references might have given the risk manager in our case study a sense of how the fronting insurer viewed captive insurers, Whitehead said. Did it treat them as valued clients or as anonymous account numbers? A good indicator is this: What is the insurer's performance in making timely and accurate reinsurance cessions to their captive clients?
"Mistakes will be made, but the important question is the insurer's responsiveness to mistakes and its integrity in getting them corrected," Whitehead said. "There's nothing more sensitive to a captive than the management of their money."
Risk managers also should query fronting insurers and all other partners on their client-retention rates, requesting explanations about client defections. Pricing disagreements demonstrate that former clients treated the fronting insurer's service as only a commodity, so client turnover related to pricing should not be alarming, Whitehead said.
"But I'd be a little suspicious if that was the only reason they said clients left," he said.
If clients had defected due to a service problem, the insurer's willingness to discuss the issue and how it was addressed through process or organizational changes would indicate how the provider would communicate with the risk manager. If the fronting insurer openly discusses a past service issue, "I would initially take that as a positive," Whitehead said. "But I'd follow up on it." References could bear out if the problem indeed had been resolved.
A midsized company that is not ready to form a captive insurer now but contemplates doing so at some point ought to evaluate whether the company's current insurers would be able to step up to the task when needed.
Some insurers have no experience working with clients that adopt alternative risk-financing strategies. As a result, they might not be able to respond well to greater retention levels, expanded actuarial needs, and modified claims-handling demands.
A problem could arise if those incumbent insurers will not unbundle their services, demanding, for example, to be involved in handling claims "from day one," Whitehead said.
Claims handling can be a particularly thorny issue for insurers not accustomed to captives. An insurer handling a captive insurer client's claims and money, "has to think of the client's best interests-- after all, it's their money," he reminds risk managers. That could be difficult for insurers that will not custom design their service offerings for clients, he said.
Other partners also have to be evaluated carefully.
Captive managers--Their core service is handling a captive's accounting function and representing the facility to its captive domicile regulator. But, if the captive's operations expand, can the manager help? For example, if the captive wants to write third-party business, can the manager provide leads? Can it assist in finding reinsurers or excess insurers?
Actuaries--Like attorneys, actuaries have specialties, which mean varying levels of expertise in different kinds of risk. Consider, for example, the owner of an auto dealership or a doctor in a successful medical practice contemplating forming a mini-captive--also known as an 831(b) facility--for estate-planning purposes. Those business owners should carefully investigate whether the actuaries retained by the group captives in which their respective businesses participate have the expertise to assist them.
Of course, before selecting trading partners, every captive insurer should have a mission statement. A mission statement provides direction to trading partners, and every risk manager should ensure that all partners understand what a facility has been designed to do and for what purpose. "Every decision should be tested against that statement," Whitehead said. "Do the actions and decisions support the mission?"
Captives also would benefit from their partners' contributions to the mission statement, which could make the mission more flexible, Whitehead said. "These things don't need to be static."
Essentially, a risk manager has to facilitate communications--not only between the risk manager and each of the captive's trading partners, but also among those various service providers. It's not unlike what happens at a big family gathering, Whitehead said.
"Does your family talk at dinner?"
(The above piece is part of our continuing Perspectives series designed to highlight key products and services to our readers. This paid-for Perspectives was written and edited by Risk & Insurance®
on behalf of our marketing partner. Additional Perspectives can be found on our Web site at www.riskandinsurance.com/.)
March 1, 2011
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