Posts Tagged ‘broker’

Blowing the Dust Off Your Captive’s Business Plan

September 30, 2009

In the new captive formation process the creation of the business plan uses the largest amount of time and intellectual resources.  That’s understandable because the document forms the foundation of the startup.  Front companies, reinsurance and claims administrators all use the statistical data and the narratives of the business plan to set their pricing and terms and conditions.  Domiciles use the information to judge the insurer’s acceptability and its potential to be successful within the location’s regulatory framework.   Once licensed, the business plan is used by auditors and regulators to make sure that the captive is operating according to its original approved plan.  Even years after a captive is licensed, regulatory bodies like the IRS take an interest in the business plan and how a captive is operating currently compared to its original business plan.

A business plan is required of virtually every captive.  The real question regarding a captive’s business plan is whether or not it is a static document or a dynamic document.  Once created and used as a part of the formation process can you just stuff it in a drawer and forget about?

The simple answer is no!  The captive business plan should be a dynamic document that is reviewed regularly.  Let me give you a couple of reasons why…

Stakeholders like the domicile’s insurance department, your audit firm, claimants, reinsurers, the  Internal Revenue Service and the shareholders of the captive’s parent in a publicly traded environment all rely on the accuracy of the business plan to portray the business of the captive.  Unless this document is regularly reviewed and updated it is doomed to be inaccurate and will likely contribute to a problem for the captive and its ownership.  At a recent captive insurance conference session dealing with IRS regulation of captives, the two attorneys conducting the session both emphatically agreed that an updated and accurate business plan was a powerful deterrent to IRS “fishing expeditions” into the taxation status of a captive.

Another reason for periodically dusting off the business plan is to make sure  that the captive is still supporting the parent’s strategic goals.  In my consulting practice I am regularly contacted by firms that own a captive and that have had personnel changes over the course of several years and they find themselves in the unusual position of not knowing why they even have a captive in the first place.  Either the new management is not schooled in the use of captive insurance as a part of a creative risk management regime or the company’s strategic goals have moved so far that the captive is no longer relevant.  A regular review of the captive’s business plan allows the captive to be re-aligned with the corporate goals and to make a powerful addition to accomplishing those goals.  Not only is this recalibration critical in keeping management informed of the captive’s capabilities, it can often contribute to new uses for the captive that keep it relevant and a contributor to overall success.

This review should be conducted every couple of years and should be the product of not only fact checking the captive’s operations against the existing business plan, but understanding the parent’s overall business goals and how  the captive might contribute to achieving them.  If you are interested in discussing how this process works send me an email at and I would be happy to contact you to discuss it.


All Your Eggs in One Basket

September 4, 2009

Don’t Put All Your Eggs in One Basket

Its easy to see how it happens.  Your insurance broker comes to you with a great idea about how to more efficiently finance and manage your insurance risk.  They bring in the brokerage’s experts to conduct feasibility studies and work with you to license a captive insurance company.  The have their reinsurance brokers place the reinsurance and have their captive manager take care of the regulatory and management operations.   Because of their fully integrated capabilities your broker has delivered a captive insurance solution entirely from within the broker’s organization.  That’s good, right?

One of the biggest decisions that face the owners of captive insurance companies is whether or not to consolidate all the insurance and captive management services in one basket.  There are some obvious advantages to doing this.  It is simpler, and may be less expensive initially to let your broker put your entire program together.  They may even be willing to do the feasibility work within the existing fee structures, only charging for the ongoing management and collecting the commissions on the reinsurance placements.  But what are the disadvantages?

  • When a captive insurance program is created entirely from within a single organization with no outside input then you get that organization’s cookie-cutter program.  They only do things a certain way and that is what you will get, whether its the best structure for you or not.
  • With no outside involvement there is no “gate keeper” making sure that the broker’s organization is doing everything it can to advantage the captive owner even if it means that it might disadvantage the broker’s organization.
  • Most broker organizations are limited in the number of domiciles that they can effectively do business in which means that they cannot be completely domicile neutral.  You may end up being steered to a domicile that suits their operational characteristics but may not be the best choice for your company.
  • Even in the best of brokerage organizations things slip through the cracks.  The broker is less likely to spend the same amount of time reviewing work done by an internal department then they might work from outside.  The checks and balances of having a diverse makeup in the captive’s support mechanisms are eliminated.
  • Pricing for captive services can often be overstated when billed all together as opposed to being presented on a line by line basis.
  • Brokerage organizations are typically polarizing in the industry.  Some companies get along well with other companies and frankly some don’t get along at all.  An independent manager can often involve service partners that a brokerage could not because of conflicts in corporate cultures.

In my consulting practice I have reviewed programs that have had the captive services completely integrated within one brokerage organization.   My reviews always turn up issues.  In one case a mismatch between the terms and conditions of the policies being written by the captive and the reinsurance treaty could have caused an enormous financial problem for the captive.  In an another case the overall charges for the program were much higher than average because they were being billed in a lump rather than being detailed line by line.

If you are considering a new captive program be sure to weigh the advantages and disadvantages of an integrated approach.  Try to involve at least one outside advisory component to the program in order to mitigate the potential problems.  If you already have an integrated program, hire a consultant to do a review of your captive and make suggestions on structure and operations as well as benchmark your costs.  Its never a good idea to have all your eggs in one basket.

Mad Science or Insurance Laboratory

May 13, 2008

There are so many creative uses for captive insurance initiatives that sometimes its hard to tell whether Mad Science is at work.  In fact, just the use of the word “creative” can give your tax advisers the heeby jeeby’s.

Mad Scientist at Work
(Public Domain Image from Dr. Cyclops (1940))

Captive Insurance programs can help to solve many risk financing problems for an organization.   In fact, one of the primary reasons to utilize a captive is to provide financing for risk that the traditional insurance marketplace is either unable to provide at a reasonable cost or unwilling to provide at all.  Depending on the circumstances many otherwise traditional risk portfolios have found themselves in this position. Among them medical malpractice, trucker’s auto liability, aviation risk and products liability.  In each situation these risk portfolios have been able to turn to an alternative risk financing mechanism in order to find coverage.

Another area of risk that can find a refuge in a captive insurance initiative is risk that is specific to a company’s operational characteristics.  Known as Enterprise Risk Management (ERM) this school of thought identifies the risks associated with accomplishing the strategic goals of a business, assigns a cost to that risk and then identifies how best to mitigate the risk.  Part of the risk mitigation plan may include transferring a part of that risk to a captive insurance company owned by the parent company.  An example of ERM for a global manufacturing and sales company might be currency fluctuations.  A captive may be able to mitigate that risk for the company and help to smooth out the earnings stream, benefiting the investment stability of the company as well as aiding in planning purposes.

As a final thought, a captive that is successful in helping its parent accomplish its own risk financing goals may be beneficial to that companies upstream and downstream stakeholders.  By that I mean a captive may be able to help its parent company’s vendors and clients by applying the same risk solutions to them as it does for its parent.  By helping to solve their common risk problems the parent gets the benefit of “third party” risk that helps to achieve tax efficiency for the captive as well as benefiting its partners in the distribution chain.

Bermuda has long been know as the “World’s Insurance Laboratory” and for good cause.  It has served as the innovation incubator for many insurance practices that are now common place in the industry.  Fortunately, innovation in the captive insurance market is never ending and will continue to move the entire market forward through the innovation of its “mad scientists”.

As always, please feel free to post your comments here.  If you would like to contact me directly you can reach me by email at

Independent Captive Operational Reviews

May 9, 2008

I was recently interviewed by Michael Moody of Rough Notes Magazine regarding a consulting engagement that I did for Milestone Insurance Company, a Bermuda heterogeneous group captive.  Here is the link to the full article in the on-line version of Rough Notes:

I am a firm believer that a captive should undergo a periodic review from an independent consultant in order to make sure that they are operating with maximum efficiency and taking advantage of every opportunity that a captive mechanism can provide.  In the case of Milestone, Catherine Duffin and the folks at Artex have done an excellent job in managing the costs of the program and providing a very stable insurance platform for the members of that group.

But what can a review do besides just provide a scorecard for the current service providers?

Lets look at some potential results from a captive program review:

  • When there are changes in risk management personnel the folks who championed and understood the captive may be the ones leaving the organization.  The corporate owner of the captive could be faced with owning a sophisticated insurance mechanism that could solve numerous and ongoing strategic risk financing problems but no one that understands it well enough to really use it to its potential.  Sort of like having a Maserati in the garage and no one with a driver’s license.
  • Things change in the business and regulatory environment.  Employee benefits in a captive may not have even been available as an option when the captive was formed.  Certainly things have changed in the business world including possible ownership changes, global initiatives and new products.  A review can help to identify what new opportunities might exist for the captive that could support the owner from both a risk financing perspective and as an overall growth strategy.
  • Third Party liability options in a single parent captive are often the holy grail of reaching favorable tax treatment for the parent’s premiums in the program.  The problem with third party liabilities is just that, they represent someone else’s risk and if you aren’t careful about it you can get burned.  Captive reviews often turn up third party risk assumption potentials in upstream and downstream stakeholders.  Vendors and clients who share common industry characteristics often have the same risk management issues and you’ve already learned how to do with them in your captive.  It is a natural related, albeit third party, risk.
  • Sometimes a captive has just outlived its usefulness and it needs to be shut down.   This is particularly true when the primary motivation for starting the captive was a short term premium savings or some type of tax play.

If you a captive owner or a broker that is responsible for a captive for your client I think there is a lot of value in performing a review of the captive’s operation and its potentials in the current market environment.   If you are interested in discussing this more please email me at or call me at 440.264.9992.


Captive Insurance- Only for the Hard Market?

April 23, 2008

I have to offer my apologies if you are a regular visitor to my blog.  I haven’t been able to post in the last few weeks because frankly I have been so busy with my work with clients.  I don’t offer this as an excuse, and it certainly isn’t a complaint, but I think it is interesting to note that in spite of a soft market, captive insurance initiatives continue to be front and center in the minds of commercial insurance buyers.

I think there are two reasons why the soft market hasn’t put a damper on new captive insurance program development.  First, I think there are several very compelling reasons to use captive insurance mechanisms to manage risk financing that are not cost-related.   Second, I think the current generation of risk management professionals remembers what a hard market looked like and they know that insurance is cyclical.  Let’s investigate these two factors separately.

Too often captive insurance mechanisms are marketed on the basis of reducing premium or as a tax play.  OK, sometimes they can do either or both, but those two advantages are typically short-lived.  Cost related advantages are real, but they are not the only, or the best, reasons to use a captive insurance mechanism.  The market swings soft and all of a sudden traditional insurance prices beat captive insurance prices in the short run or the IRS catches up with a tax loop hole and closes it up tighter than spandex on an overweight body.  If an insurance client is purchasing their insurance on a year-to-year tactical basis then they will live and die by the pricing sword.  What most professional insurance buyers have come to realize is that over a ten year horizon they will end up paying for their own frequency layer losses, a share of the severity losses and the expenses associated with policy and claims administration.  The real question for them is how do they want to pay for it.  Alternative risk mechanisms typically offer much more stable pricing over the course of a typical insurance market cycle.  Relationships are personal with reinsurance support so a company is less likely to be subject to being the “baby tossed out with the bath water” if they are in a tough risk segment but are a better than average player.  You know what I mean, the industry knee jerks on trucking companies for instance and all of a sudden decides that they don’t want to write them, any of them, and the pricing jumps for those few insurance companies that continue to write the risk.  Sometimes specific coverage or specialized forms are available nowhere else but in a captive setting (think abuse and molestation for religious or social service organizations).

The cyclical nature of the insurance industry makes for a very compelling strategic reason to be involved in an alternative risk mechanism.  Rather than being subjected to roller coaster pricing, captive participants see a more stable pricing base.  Are the lows as low?  No, but niether are the highs as high.  This makes for a better financial planning environment.   

In my opinion many insurance companies run their businesses by looking in the rear view mirror.  Its not surprising.  They price their current business by watching their historic losses, they invest long into the future for maximum potential return.  The problem is that losses happen in the here and now and insurance companies often get caught holding the dirty end of the stick between historic loss performance and future investment performance being worse than projected.  Once they see themselves heading for the ditch they have to react quickly and this more than often ends up as knee jerk pricing and market service decisions.  At the end of the day the insurance buyer ends up paying the price. 

I think the experience of the risk management community coupled with the availability of captive insurance initiatives to the middle market insurance buyer is driving the current rush to control costs through alternative risk mechanisms.  Knowing that behind every soft market is a looming hard market, risk managers are positioning themselves to avoid the next hard cycle.  Considering that there is a development period of between 6 and 12 months for programs like this, now is the time to consider an alternative to the traditional marketplace, and that is exactly why I am so busy today.

Ibi est Vox in Sermo

March 31, 2008

In conversation there is power. 

I want to thank everyone who visited the weblog in our inaugural week last week.  The emails and comments were very encouraging  and have convinced me that I need to continue posting about the fundamentals of captive insurance programs. 

Let me invite you to offer your own opinions, questions and additional thoughts to the postings.  I think the current insurance market is reaching rock bottom and now is the time to begin thinking strategically about how captive insurance initiatives can be utilized to the advantage of good risks in a developing hard market environment.  It is this type of collaborative effort that I want to strive for on this blog.

You can reach me by email at Our web-page is and our Bermuda captive management sister company, Cedar Management Limited, has a website at

I look forward to your continued interest. 

Supply and Demand- It’s Impact on Insurance Pricing

March 31, 2008


 Insurance is a supply and demand type of product.  In order to provide insurance coverage the insurance company has to pledge assets to support the losses on that insurance.  Depending on where the insurance company is domiciled there are different standards for how much surplus has to be leveraged to support insurance premiums.  Most US traditional insurers leverage their surplus between 1:1 and 2:1, premiums to surplus.  The limiting factor for overall insurance capacity then is how much surplus is available.  Surplus is contributed to insurance companies by investors, for the large part shareholders of the publicly traded stock insurers.  Shareholders are drawn to a particular investment because there is a good chance of earning a significant return from the investment.  Insurance companies connect these dots and then make decisions on which insurance segments they will deploy their surplus into in order to get the best return on investment.

All this works well for market segments that exhibit stable and profitable results overall.  But what if you are a good player in an otherwise iffy market segment?  In a soft market the differences between good and iffy are not as distinguishable, but in a hard market, where premiums are rising as a result of external pressures, insurers have to start making tough capital deployment decisions.  Remember they can only write insurance premium in an acceptable ratio to their surplus.  Markets that are iffy get the short end of the allocation stick and as a result the reduced capacity for that market makes the prices jump dramatically for that segment.  Think trucking, medical malpractice, tough workers compensation exposures, residential home-builders, product’s liability, coastal property, etc….Remember that we are not talking about all risk in these industries.  Let’s face it some accounts deserve the pricing they get, but there are accounts that represent excellent risk characteristics in every market, regardless of what that market’s averages are, and these are the prime targets for captive insurance involvement.

A captive insurance arrangement in essence creates capacity for its owner-insureds and it often does so in a regulatory environment that supports premium to surplus ratios that far exceed that of traditional insurance companies.  These leverage ratios can be as high as 5:1, making for a very efficient use of corporate capital to support risk transfer needs.

By further connecting underlying captive insurance capacity with reinsurance placements a significant amount of capacity can be created in a market segment that might not have had any reasonably priced capacity available at all.  The best accounts in a market segment can leverage their own investment in loss control and risk management in order to take control of their risk financing costs even in the hardest part of the insurance market cycle.

Do That Voodoo That You Do So Well

March 26, 2008

There are many reasons why an insured might consider being involved in a captive insurance program.  Over the next few days I’ll try to unpack those reasons in a way that makes sense.  Today I want to address the potential premium advantages of a captive.

I think one of the most frustrating things about captive insurance is that it is so misunderstood.  There is a sense of smoke and mirror magic about how a captive might solve the risk financing ills of an insured and often captives come out of the agent’s bag of tricks as a means of reducing premium for loss-distressed clients.  Let’s try to debunk some of the mystery around who should be involved in these kinds of insurance programs in today’s post.

In any insurance product offering, captive or traditional, there are several elements to cost that are standard.  There is a cost associated with paying claimants for loss and the costs associated with adjusting those claims.  There is a cost to the administrative work associated with the underwriting and issuance of policies and to the maintenance of compliance and regulatory issues associated with licensing in the various states.  There are premium taxes, boards, bureaus and assigned risk charges levied on the policy’s premiums.  While the litany of frictional costs on an insurance program are standard, the percentage that each of these items consume is relative.

Assuming that a traditional insurer has made his frictional cost as efficient as possible the one cost that has a sense of uncertainty is the costs associated with the payment to claimants for damages they sustain through the fault of insureds.  Actuarial work is either Voodoo or science depending on who you talk to, but it is an insurer’s best method for determining the correct price to charge for the loss cost element of a policy.  Actuaries pour over loss data and determine statistically, based on a specific set of circumstances, what the correct costs per exposure unit should be for risk in a particular market.  The “Theory of Large Numbers” is the basis of actuarial accuracy.  It says that the more data you pour into the analysis the more accurate the results will be for the insurance company taking risk on those results.  Herein lies the good news for captive insurance!


The Dart Board Theory

If insurance companies price their products based on pooling a large database of losses in a particular industry then their pricing is an “average” for that industry.  If you are an average risk then you are paying the right amount of premium based on the risk you present.  If you are below average then you are getting a deal and if you are above average, you are paying more than you should be.  Obviously insurance companies mitigate this inequity by offering credits and debits off of the standard price for accounts with certain attributes.  These adjustments are most prevalent when there is a lot of competitive pressure either because of a soft insurance market or a lot of demand on the part of insurance companies for the type of risk being considered.    If your client is in a market segment that is not highly sought after by insurance companies they can often be left behind in the pricing rush.

Back to our dartboard.  Imagine a horizontal line across the center of the board.  Any darts above the line are above average and any darts below the line below average.  The problem here is that the pricing for all the darts is essentially the same within +/- 20%.  The over-pricing for the really good accounts is being used to offset the under-pricing for the not-so-good accounts.  From the insurance company’s perspective the result is good, on average just what they expected, and the actuarial staff will probably get a great bonus.  The insured’s perspective depends on where they fall on the dartboard.  Poor risk management is rewarded and good risk management is punished.

So, what have learned about the best clients for a captive program?  They are the ones that are consistently good performers, above average from a risk management perspective and typically involved in activity that the insurance market does not actively compete for.  Think trucking, medical malpractice, residential construction etc…. Now, here is where agents get it wrong.  Not ALL companies in these industries should be involved in alternative risk structures, only those who have earned their chops from a risk management perspective.  Certainly no client with a history of poor loss control and risk management results should consider an alternative risk structure until they have fixed their problems and seen positive result trends.

By assuming risk where there is a relatively high frequency of low severity loss potential a good risk is able to leverage their investment in risk management and loss control to reduce the cost of risk financing by a factor equal to the amount that they are better than the industry average price.