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Congratulations to Vermont Captive Insurance Association (VCIA) as they mark their 40th anniversary. At Willis, a WTW business, we are proud to continue our partnership with the association and celebrate their remarkable contribution to the captive industry.
Captive insurance companies more than five years old often suffer from a sort of “mission drift” – over-accumulation of surplus, under-utilization, a lack of focus/direction in investment strategy, or all the above.
The reasons for it are manifold:
- Senior “C-level” executives go back to their “day jobs,” and the close attention that was paid to the captive’s business plan gives way to the routines of overseeing the corporation’s risk management strategy.
- The business environment changes, and the parent company finds itself in a dramatically different risk-taking position in the face of market developments, changes in the parent’s business mix, tax, statutory and regulatory changes.
- Finally, there may be managerial reasons for captives sitting atop a healthy earned surplus and for the captive’s governing body to keep their heads down and avoid coughing up dividends to the parent – out of fear that these funds may not be available at a future time when they are needed.
Nevertheless, it still makes sense to make periodic check-ups on mature captives, asking some basic but important questions:
- Is the captive still accomplishing the goals set out for it by the parent? (….and is the captive equipped to do so?)
- Does the business need that led to the captive’s creation still exist? (…or have the needs changed?)
- Are there new, unfulfilled opportunities that the captive might address? (...and what changes in the captive need to occur for that to happen?)
Sometimes a captive governing body will embark on a complete top-to-bottom study of the captive, examining nearly all the decisions that owners make in designing and implementing a new captive: coverages, retentions, domicile, investment strategy, use of reinsurance, surplus levels and tax position.
This type of analysis is valuable, and necessary every few years. But there are other types of analyses that may be worthwhile every two years or even annually. A capital adequacy simulation model might stress-test three major risk areas facing the captive, at multiple confidence levels:
1. Reserve risk: The risk that existing loss reserves are insufficient to cover future costs on past policy years;
2. Premium risk: The risk that premium funding is insufficient to cover costs associated with the current policy year (including catastrophes), and
3. Investment risk: The risk that investments perform below expectations.
By modeling all three of these risks together in an iterative simulation analysis – stressing each risk category simultaneously -- the analyst can estimate the risk of ruin at multiple confidence levels. Some single-parent captive owners may prefer that the captive be funded to a 98th percentile level of security, while others may be comfortable enough with 90th or 95th percentile. Group captive leadership may look to protect against all but the most remote situations, opting for a 99th percentile. Modeling all the risks together allows the captive to benefit from the portfolio diversification of risks insured by the captive – the notion that “worse case” scenarios for individual segments of the business are highly unlikely to occur at the same time, and the captive owner may experience capital relief as a result.
A growing number of captives use capital adequacy testing technology for their captives on an annual or biennial basis. Some are using the technology to quantify possible dividends that the captive can pay back to the parent, and others are using the technology to identify and model possibilities for expanding the captive’s writings (e.g., new coverages, higher levels of retained risk).
Capital adequacy testing is a tool that more captive owners should use in monitoring and maintaining the general health of the captive insurer – preventing it from becoming bloated or emaciated – and meeting the needs of its constituent owners.
Congratulations once again to VCIA. Thank you for your leadership in shaping the captive insurance industry in Vermont and beyond!
To discover a smarter way to manage and optimize your risk, get in touch with Willis’ captives specialists.
Jason Palmer
Regional Head of Captive and Insurance Management Solutions, United States – Willis
jason.palmer@wtwco.com
Ed Koral
Captive Consulting Lead, North America – Willis
edward.koral@wtwco.com
