SIGMA Actuarial Consulting Group
Michelle Bradley and Enoch Starnes from SIGMA Actuarial Consulting Group share with John Savage how to successfully set up and manage a captive programme
What are the essential components that make up a comprehensive feasibility analysis when an organisation is considering establishing a captive insurance programme? How do these different elements collectively inform the decision of whether to move forward?
Michelle Bradley: The key components of a feasibility analysis is the domicile selection analysis, the initial programme structure assumptions, the loss projection analysis, and the pro forma statement analysis.
The supporting narrative explanation then allows the prospective captive owner to document and understand how these components relate to one another. Considering these items as a whole is crucial to ensuring their ultimate decision is based on a genuine understanding of all the options available to them.
Selecting the optimal domicile is a critical aspect of captive feasibility. What are the primary strategic, financial, and operational factors that captive owners should carefully evaluate when assessing onshore versus offshore domicile options?
Enoch Starnes: Several items are at play when considering a captive domicile, many of which vary depending on whether the parent is seeking onshore or offshore options. Capitalisation and surplus requirements, as well as solvency ratios, often stand out as key determining factors from a financial standpoint.
From a strategic perspective, one can also consider the regulatory environment's receptiveness and the overall stability of the regulatory framework. For example, prospective captive owners may desire a clear, consistent dialogue or positioning regarding a domicile's long-term direction.
Regulatory flexibility may also be an important consideration, especially with regard to accepted parameters around investment portfolios.
Operational factors can range from more obvious items, such as the quality of local infrastructure and efficiency of business operations, to those that are potentially less clear but nevertheless important, like language and currency compatibility or the domicile's travel accessibility.
No matter what these comparisons look like on paper, something we often recommend to prospective captive owners is to take the time for face-to-face conversations with their potential regulators.
Once they have narrowed down their domicile options, scheduling calls or visits with specific domiciles to discuss the prospective captive and gauge their receptiveness can be extremely helpful.
Such discussions often reveal much more useful information than reviewing a relatively static grid of factors.
The programme structure analysis examines important elements like fronting, reinsurance, and market submissions. How do these interconnected components shape the overall captive design, and what are best practices for captive owners to navigate this complex process?
Starnes: Designing a suitable structure is obviously key to a successful captive formation because it serves as the transition from theoretical to practical. In other words, figuring out whether a captive is still financially viable after determining the ‘external’ pieces, like fronting and reinsurance, is how a captive moves from a good idea to a true, strategic tool.
In our experience, best practices often revolve around proactive communication. On the front end, deciding on key aspects of a captive structure and ensuring all parties are on the same page throughout the feasibility process can have a dramatic effect on the time and resources needed for captive formation.
The actuarial analysis is widely considered one of the most crucial components of a feasibility study. What advanced modelling techniques and data inputs do leading actuaries leverage to provide captive owners with robust projections of the programme's future performance?
Bradley: It is important to consider that some risks have large data sets with years of history and credibility, while others, such as emerging risks or non-traditional risks, may have very little data.
For risks with large data sets, it is common for the analytics to take on standard actuarial approaches. Risks with limited data, on the other hand, may use simulation techniques based on statistical assumptions about potential claim frequency and severity. In the absence of unique company data, these assumptions may include industry databases, risk research, market quotes, and input from company management.
Loss projections generated at both the expected level and varying confidence levels are the key outputs for all risks in the feasibility process, no matter the underlying methodology. Once created, they often flow through the remainder of the feasibility report for pro forma statement modelling.
Feasibility often involves deciding between single-parent, group, or cell captive structures. What are the key strategic and operational distinctions between these captive types, and how should owners evaluate the pros and cons for their specific risk profile and objectives?
Starnes: There is plenty of nuance in the decision around captive types, but often, these disparate factors can be condensed into three primary considerations: scale, control, and flexibility.
Prospective captive owners with relatively large exposures and a desire to control all aspects of their captive programme may opt for a pure captive, whereas smaller parent companies who want to take a few transitional steps into the captive realm might seek opportunities through cell captives.
Of course, any of these options are perfectly viable, so long as the prospective owner has a true understanding of both the short-term and long-term implications of their decision. Group captives are a frequent example of this.
The method and parameters around exiting a group captive are topics we often hear about, and unfortunately, these items may not have been as clear (or at least, well understood) when the group captive was first joined.
As previously discussed, early in the feasibility process, clear and proactive communication can alleviate many of these issues.
Legal, regulatory, and tax factors must be meticulously considered during the feasibility stage. What are the most critical compliance requirements and potential pitfalls that captive owners need to navigate, especially when evaluating domiciles with differing regulatory environments?
Starnes: At the risk of sounding like a broken record, I would say communication and transparency are vital to navigating regulatory complexities. Early and frequent discussions with potential regulators about the aspects of a prospective captive yield significant benefits.
Doing so allows all parties to have a clear understanding of compliance issues, overall receptiveness, and any nuances that might otherwise cause confusion or distress down the road.
Establishing the appropriate capital requirements is a core component of the feasibility analysis. How do leading captive consultants model different loss and growth scenarios to determine the optimal capitalisation, and what are the key trade-offs owners must weigh?
Bradley: Consideration of different assumptions is a significant facet of the pro forma statement analysis within a feasibility study. Key financial metrics should always accompany these discussions.
One can review pro forma analyses under various scenarios, typically presenting them on both an expected and an adverse basis. These pro formas can model several key input assumptions, such as growth rates, initial capitalisation, captive expenses, and reinsurance structure.
Ongoing scenario testing from an analytical perspective facilitates an emerging captive strategy.
What are the essential roles and responsibilities of key stakeholders like the board, underwriters, claims team, finance, and risk management, and how can owners foster effective coordination between these groups?
Bradley: The cross-collaboration process is an inherent part of any enterprise risk management (ERM) process. ERM has had a significant impact on the captive space by constantly developing strategies for both overall risk portfolios and new and emerging risks. As a result, established ERM processes can facilitate collaboration and coordination among key stakeholders. Captive owners should have a clear leadership structure for the captive, and as part of this structure, board education and board presentations are key to ensuring the coordination of all parties.
Once a captive has been established, what are the hallmarks of a robust annual governance cycle, including the key focus areas and deliverables for the financial review, strategic planning, and renewal/reserving meetings?
Bradley: From an analytical perspective, it is important to remember that claims experience, exposure shifts, social changes, and legislative effects constantly change the underlying risk profiles. Therefore, captive owners should review loss projections at least annually, incorporating input from all parties. They should also monitor retention and programme structures based on updated loss projections. Finally, it is prudent to monitor the required reserves for historical liabilities annually, and in some cases, consider quarterly or semi-annual reviews. These reserves have a direct impact on the balance sheet and overall surplus positions.
Beyond the initial feasibility and launch, how can captive owners leverage advanced analytics and optimisation techniques to continuously enhance the performance and strategic value of their captive programme over time?
Bradley: Advanced analytics frequently serve as the core piece of longer-term strategies that incorporate both traditional and emerging risks. These analytics can facilitate an adaptive programme structure that considers overall optimal retention. Advanced analytics help answer three key questions: what are the best retentions, what is the volatility of the entire portfolio of risks, and how do adverse scenarios affect short and long-term financial metrics?
