Leading experts Diana Hardy, Adam Miholic, and Mike Meehan unravel the intricacies of hybrid insurance programmes
Diana Hardy, CPA, CFE
Audit partner
RH CPAs
From a regulatory perspective, what challenges or considerations arise when a captive insurance company and an admitted carrier co-exist within the same insurance programme?
A key area is assessing how the captive looks to the admitted carrier on its books, if the carrier is retaining some of the risk in a captive.
There are different rules for Statutory Accounting Principles (STAT) primarily SSAP 97 and Generally Accepted Accounting Principles (GAAP) which under Financial Accounting Standards Board Accounting Codification Topic 810 may require consolidation where STAT really never requires consolidation.
Another major concern is the collateral necessary. STAT accounting principles establish a Credit for Reinsurance, known as Schedule F penalties for property and casualty carriers, and Schedule S for life and health carriers.
Therefore, under STAT accounting principles do not allow for a credit for reinsurance unless the reinsurer is “authorised” or there is collateral sometimes in the form of a letter of credit, investments/cash posted, and sometimes a trust for the benefit of the admitted carrier.
How does the presence of a captive insurance company impact the financial reporting and taxation requirements for the overall insurance programme?
It depends. The taxation typically does not have much of an impact, there are certain elections to have consolidated tax filings or not and life carriers have much more complexity.
Financial reporting is significantly different from admitted carriers who report on STAT versus GAAP. STAT under SSAP 97 records the value of the investment into a captive, assuming it is an insurance entity which is a subsidiary, controlled affiliate is measured at STAT equity, even though the captive would report to the regulatory authority on a GAAP basis.
There are significant differences between GAAP and STAT ranging from reserving methodology to the manner in which deferred acquisition costs are recorded to the carrying value of investments, to deferred income taxes.
A careful evaluation of the impact should be conducted anytime there is a captive arrangement with an admitted carrier.
Can you discuss any potential conflicts or areas of overlap between the accounting practices of a captive insurance company and an admitted carrier?
The conflicts are abound, to properly account for these types of transactions, it can be simple as in a traditional fronting carrier to significant differences with multiple types of books STAT/GAAP/Tax, you will likely have a few sets of books, which is a bit of a pain.
For instance, a captive may have consolidated reporting on a GAAP basis, but there are no consolidations on a STAT basis.
Adam Miholic
Senior consultant, Global Captive Solutions
Hylant Global Captive Solutions
What are the practical implications of integrating a captive insurance company with an admitted carrier in terms of policy administration, claims handling and risk management?
Any situation where a captive insurance company is participating in a programme with an admitted carrier, communication and clear delineation of expectations and responsibilities is paramount. Considering many captive insurance companies are non-rated and operating on a non-admitted basis there are numerous situations where this partnership is not only efficient but also contractually or regulatorily required.
In these situations it is important that the captive manager, captive shareholders and carrier representatives are all aligned on the programme details. Oftentimes, this also includes other service providers such as third-party administrators, loss control operations, brokers and legal.
While these situations often add additional layers of complexity in both operations and logistical terms, a strong partnership between a captive insurance company and their admitted carrier partners will frequently lead to increased captive utilisation for the shareholders as well as improved financial, strategic and operational benefits for both parties.
How does the interaction between a captive insurance company and an admitted carrier affect the allocation of premiums and claims within the insurance programme?
The allocation of premiums and claims should not be altered from the sheer fact that a captive insurance company interacts with an admitted fronting carrier. For example, a captive that takes a deductible reimbursement position does not have any bearing on the admitted companies rates, premiums, or claims responsibilities. In this situation, the captive is purely acting as a financial mechanism by which the insured is electing to accrue for their deductible or retention responsibilities. If, however, the captive insurance company is participating with the admitted carrier in the risk transfer of any liability then the allocation of both premium and claims must be properly accounted for in the actuarial study setting both measures.
To give an example, if the captive insurance company is participating as a 20 per cent quota share reinsurance company with the admitted carrier, then both the written premium and anticipated claims must take into account this allocation.
Could you provide insights into the governance structure and decision-making processes when both a captive and admitted carrier are involved in the same programme?
In most cases, governance-related items and decision-making processes are distinctly outlined in the contract between the captive insurance company and the admitted carrier. As previously discussed, clear and concise communication around roles and responsibilities in this relationship are key to its short- and long-term success.
The contract between the parties should clearly outline each of their respective responsibilities, scope of authority, liabilities and rights. In these situations it is always my recommendation that each party have their respective legal representatives thoroughly review all contract and governance documents to ensure alignment and agreement. While every effort should be taken to ensure fair and equitable conditions, I often defer to whichever party assumes more risk and liabilities as the primary participant.
Mike Meehan
Principal
Milliman
What considerations should be taken into account when assessing the risk profile of a hybrid insurance programme involving both a captive and admitted carrier?
Hybrid insurance programmes have proven to be a successful model for financing the risks of both individual organisations and for group programmes.
When a captive and a traditional carrier work together to provide the coverage needed by the parent organisation it may mean that the traditional carrier and the captive insure separate lines of coverage. It could also mean that the traditional carrier fronts the insurance policies and reinsures all or a part of the risk to the captive, or the traditional carrier may provide reinsurance coverage to the captive.
When assessing the value of hybrid risk financing models, there are several considerations. First and foremost, is the financial strength of each organisation involved in the programme. In hybrid models, both the captive and the carrier need to be confident that the other party will be able to meet its financial obligations under the terms of the insurance contracts. In certain situations, where one party is not able to, the other party could be responsible.
Secondly, is the experience of the carrier in the specific market. Other considerations would include the alignment of risk appetite and philosophy of the organisations as well as the evaluation of any operations issues, such as the systems and technology.
From the perspective of a captive, it is important for the carrier partner to have relevant experience to ensure proper underwriting. For fronted insurance programmes, the captive should also consider the fees and collateral requirements of its fronting partner.
How does the interplay between captive insurance and admitted carriers impact the actuarial modelling and calculations of expected losses and reserves?
The terms of the insurance contracts are key in the development of an actuarial model. That would include understanding the reporting provisions of claims, how loss adjustment expenses are treated, and the application of any reinsurance which could be on an excess of loss or quota share basis.
In addition, the captive and carrier have flexibility with respect to the administering of the hybrid programme through the unbundling of services, including claims handling. The programme could elect to have claims administered by the carrier, an outside third-party administrator, or, in certain cases, internally by the captive’s parent organisation.
Claims handling techniques and procedures can impact the closure rates and settlement costs which in turn can materially impact the loss forecasts and reserve estimates calculated by the actuary.
Therefore, it is critical that the party responsible for handling claims has the necessary level of expertise in the specific lines of coveragey.
Can you explain the implications of having a captive insurance company alongside an admitted carrier for the determination of appropriate insurance rates?
In hybrid insurance programmes, the captive will often refer to the carrier as its “reinsurance partner” or “fronting partner”. That partnership can lead to a more open discussion and information exchange about the risks of the captive’s parent organisation.
While carriers will generally have more experience in a particular line of coverage, the parent company will likely have a more detailed understanding of its own specific risk, which can be beneficial when determining the appropriate rates.
Ultimately, when determining the appropriate rates of a specific insurance programme, it is important to consider the risks being insured, the cost of any reinsurance, including the profit provisions of the carrier as well as other factors, such as claims handling.
