Is Inflation Inflating Captive Demand? A Q&A

In April of 2022, the Bureau of Labor Statistics reported that inflation hit a staggering 8.5%. If current projections hold true, this year will have the highest inflation rate since 1981. COVID-19, supply chain problems, Russia’s invasion of the Ukraine, housing price increases, and more predictable market cycles are some of the driving forces behind such high inflation. In our line of work – insurance, risk management, and employee benefits – macroeconomic factors like these are seen in the challenges our clients face and they solutions they prioritize. To complicate things, the property and casualty realm is also subject to things like natural disasters, climate risk, changes in societal litigiousness, and ransomware/cyber risk. That said, we sat down with Peter Johnson, Spring’s Chief Property & Casualty Actuary, to discuss how this challenging environment interplays with his work in the captive insurance space.


Q: Is inflation having an impact on underwriting and pricing?

A: This is case-by-case between captives but as an overall average, yes. A captive in a strong surplus position and favorable historical loss experience will still be able to provide favorable pricing even when the industry is seeing high loss trend and rate increases. Higher frequency and/or severity trends are certainly still impacting pricing needs for certain lines, such as cyber and excess liability where experience isn’t frequent in nature and the credibility of a single company’s experience is low. Specifically for cyber, ransomware loss costs have grown exponentially over the last 3 years and rate increases are being observed by both commercial carriers and captives. Further for both cyber and excess liability where commercial market pricing issues exist capacity has also shrunk and captive are being looked to, to fill the gap.


Q: Is inflation currently impacting reserving and if not, do you think it will in the future?

A: In general, yes, for many casualty lines where loss trends are high or increasing, but this is also a case-by-case basis since captives with good data credibility and stable historical loss experience can respond to their actual loss development and may not have a need for much, if any, reserve increases due to inflation. Cyber liability, commercial auto liability and excess liability are three lines in the industry with increasing severity trends and captive reserving practices often consider industry trends when company experience isn’t fully credible by itself, so I would expect some reserve strengthening for these lines due to trend assumption increases. Supply chain issues have been an obvious issue in the used car market and depending on a captive’s auto exposure and experience, there may be both increasing auto rate levels and reserve levels for the captive.


Q: Some analysts have suggested that while commercial market insurers are concerned about inflation, the impact might be offset to some extent by the benefit of higher interest rates in their investment portfolios. Would you expect captives to realize a similar investment benefit? Would you expect it to be significant?

A: To the extent a captive’s investment portfolio is invested in higher yielding fixed income, securities or other investments that are inflation sensitive then yes, there would be some offset.


Q: Are there specific coverage lines in captives that will be more affected by inflation than others?

A: Cyber, excess liability/umbrella and auto liability have seen higher trends than workers’ comp. Geography is an important factor as well since certain areas have seen noticeably higher/lower trends than the industry average. For example, medical professional liability severity trends have increased, but this varies significantly by region. Some states are seeing double digit severity trends and rate increases while others are experiencing very modest increases. Difference in litigiousness and jury awards drive much of these state-by-state differences. Property is certainly impacted by inflation with increases in cost to build, but natural catastrophes such as hurricanes, wildfire and wind/hail have typically had more of an impact and to compound things the current supply chain and inflation issues immediately after a disaster can lead to even costlier natuaral disasters. According to NOAA National Center for Environmental Information 2021 came is second all-time with 2020 coming in first as far as the total number and total cost of these disasters.


Q: Would you anticipate any changes in captive strategies in response to inflation?

A: For captives with active investment advisors, I’d expect a response on the investment side depending on their current investment profile and the surplus and loss reserve position of the captive. There certainly could be a variety of responses on the insurance risk side, particularly if inflation is driving up claim severity and significantly changing the risk profile of a captive. Capitalization, limits, retentions, reinsurance, and pricing are all potentially impacted and would need to be considered.


Q: Is there any advice you’d offer captive owners regarding inflation strategy?

A: In general, it is important to sensitivity test your proforma projections every few years based on practical adverse loss outcomes and investment income scenarios. These financial projections can consider higher than anticipated inflation trends over a multi-year projection horizon. This will help determine appropriate captive capitalization levels, reinsurance, pricing, and risk margin to protect against possible adverse events.


Q: Any final thoughts on the subject?

A: Firstly, large jury awards remain top of mind for many company executives and boards. Although the impact on industry combined ratios is less obvious based on what I’ve seen, this continues to be a big concern and is part of the driving force behind pricing increases in the commercial market for certain liability lines.

Secondly, as carrier capacity presumably decreases and underwriting profit margins increase for certain carrier lines where rate level increases outpace loss trend, captives will continue to be utilized to insure more risk and recoup underwriting and investment income related profits otherwise going to commercial carriers.


There you have it. While there are many negatives that sprout from inflation, one positive is that it allows captives to continue to elevate their status as a strategic risk management and financial tactic for organizations of all kinds, and help companies better face the difficult economic climate.

Business, Interrupted: Post-Pandemic Policy Lessons

A recap of a presentation by Peter Johnson of Spring, Deyna Feng of Cummins, and Melissa Updike of KMRRG at the VCIA 2021 annual conference.

 

Black Swan Events and Market Capacityblack swan events

Over the last year and a half, the world as we know it has been flipped on its head. Not only did everyone’s day-to-day processes change completely, but the COVID-19 pandemic also stressed the insurance system significantly and resulted in a number of changes across various lines. “Black Swan” events are those that are unexpected, severe and affect a large number of companies and individuals which is exactly what happened with the COVID-19 pandemic. While the healthcare industry faced increasing premiums and alterations to mental health coverage, the property-casualty (P&C) market also was affected in an unpredictable way.

Rewinding back to prior to March 2020, the P&C market was experiencing an all-time high surplus, and was in a 10-year trend of suppressed rates. Therefore, when the “Black Swan” event of a pandemic hit, insurance companies were forced to significantly reduce capacity to mitigate social inflation and high-cost claim issues. In some cases this drop down insured limits by 75 percent or more of their prior year policy limits. This was evident particularly for cyber liability and umbrella coverage. Additionally, rates across lines were seeing double and triple previous years’ numbers.

On the other hand, some P&C lines actually saw improvement in their combined ratio during 2020. This means that where some lines saw increases in cost, other lines saw a drop in utilization, which “evened out” the overall market. This improvement can be seen in commercial and personal lines auto lines over the last year. The auto industry saw a dramatic downturn in utilization due to reoccurring “Stay at Home” executive orders hindering travel as well as other related changes to the industry.

Needless to say, this all yielded a difficult environment for employees and employers. In order to appropriately mitigate these new or changed risks, companies have been turning to policy exclusions as well as captive financing to better protect themselves and their employees from high-cost claims.

 

Policy Exclusions and How They Impact Your Business

During the pandemic, no insurance company or insured was truly prepared for the changes that were to come, and many insureds were faced with unexpected coverage exclusions and were left with potentially catastrophic payments. Some examples of policy exclusions include pandemic situations, interrupted business, long-term care, and others. However, employers who had a captive insurance company set up were sometimes safeguarded from policy exclusions, and companies without a captive increasingly flocked to establish one.insurance policy exclusions

To illustrate the advantages, one captive held their policy exclusions to the standard of COVID-19 claims and were able to mitigate those costs through their reinsurance retention. As another example, the Kentuckiana Medical Reciprocal Risk Retention Group (KMRRG), a captive, was able to flip their exclusion around long-term care, a move which, although it was only a small component of their business, significantly minimized costly losses. The framing of this exclusion allows employers to wrap reinsurance around this risk, specifically if they utilize a captive funding vehicle.

Captives offer more flexibility around policy language and terms, which can be adjusted according to the specific risks of the parent company. It is generally the responsibility of the brokers to let their insureds know which reinsurance renewals were at risk during the pandemic. Most commonly these lines were workers compensation, healthcare programs, and other P&C lines, which can be written into a captive or an RRG solution. Note RRG’s cannot write workers’ comp and can only insure liability lines.

 

Maximizing Captive/RRG Solutions

Captive insurance is not a new concept; however, it is often overlooked as a method for employers to protect themselves against risk. Captives not only better reflect underwriting records but also allow insureds to recoup investment incomes that would normally have been lost to insurance companies.

Captives support the parent company’s risk management overall and provide financial protection and long-term savings, both necessary for any business in ordinary and extraordinary times. Generally, our team sees that, for every $1 of premium that a client converts from a commercial reinsurer to a captive, 10 percent to 40 percent of long-term savings in the form of investment income and underwriting profits are yielded.

captive insurance solution

A captive can step in to help when commercial market rates are unreasonable, such as the 200 percent to 300 percent rate increases, we have seen recently, which of course are impossible for CFOs to plan for. This happened with many insureds’ umbrella coverage. Many companies over the last 20 months were forced to significantly lower their limits and increase their retention levels simultaneously. With changing premiums (mainly increasing) on top of this reduced market capacity, more and more often companies are utilizing captives to get control over these types of high costs and expand coverage.

Additional benefits of a captive or RRG solution include transparency and improved claims management. For example, if COVID-19 claims do develop, with a captive you can react with a very specific claims management strategy instead of relying on a commercial carrier to do so. This allows you to hand select your partners such as attorneys and other advisors. You can also be sure that your discovery responses are consistent. Additionally, group aggregates have hardened even more in the market which has forced captive managers to become more creative than before. An illustration of that creativity can be seen in the example below.

Hospital Professional Liability in a Captive: Many entities were trying to get their mitigation placed, and by increasing primary levels they were able to provide some protection and increase their claims control.

 

Bracing for the Future

In order to be properly prepared for the next “Black Swan” event, employers and employees should consider the major lessons learned from the past year:Captive insurance pandemic

  • Risk Diversification—This is not unique to a pandemic situation. When leveraging a captive, it is imperative to have a wide range of exposures. Our actuaries know that, in line with the law of large numbers, the more risks and more exposures, adverse financial outcomes become less likely and more manageable. Considering the correlation between the risks is equally critical as one risk could lead to a domino effect of triggering another high-cost risk. A general rule of thumb for captives is adding low correlating risk to a captive will lead to more stable year-to-year financial results.
  • Speed to Market—What is your process to quickly adapt to changing market conditions?
  • Analyze Current Structure—Can you withstand another “black swan” event? What are the coverage improvements that can be made internally?
  • Financials—What is your cots of risk and risk tolerance? Do you need an improved insurance/reinsurance strategy?
  • Supply Chain—Has an appropriate strategy been considered?
  • Other—Do you have uninsured/underinsured risks? Is there sufficient market capacity for your exposure?

If there is a positive we can take from COVID-19, it should be that we learned important lessons and won’t be as blind sighted in the future. Looking ahead, companies should ascertain whether they have the right tools in place to better manage risk and financial losses. In addition to the risk structures and their advantages outlined above, considering cross exposures and diversified risks is the best and easiest way for companies to protect themselves and their employees in the event of another “Black Swan” event. Lastly, having an aggregate view of risks across the organization often leads to creating the most efficient and cost effective risk funding programs.

How COVID-19 Will Impact These 8 P&C Policies

The coronavirus pandemic will hit every business, and the insurance industry at large, in various areas. When it comes to property & casualty (P&C) insurance coverages, there are several factors that will come into play. The following are a few examples by coverage and for the insurance industry in general:

Personal Lines and Commercial Lines Automobile policies cover both personal and commercial autos, respectively, for liability and physical damage to the insured vehicle. Key drivers of lower claim frequency are lower miles driven and lower traffic density. As average miles driven and traffic density decrease across America, we can expect claim frequency to decrease. This phenomenon could very well continue for many months to come for a variety of reasons.

With fewer vehicles on the road and many American’s staying at home, insurance companies should see fewer claims and consequently downward trending losses and premium levels. This happened in the last major rescission during the housing crisis. This may put some insurers in a position to come to the aid of insureds in the short term who are experiencing financial hard times and may result in significant premium decreases in the long term as opposed to insureds deciding to drop coverage and drive uninsured.

Contingent Extra Expense Coverage / Contingent Business Income Coverage reimburses lost income and extra expenses resulting from damage or operational disruption at the location of a customer or supplier. This might also be referred to as “business interruption coverage”, and is a good option for businesses disrupted due to the inability to supply key materials or goods because employees are out sick, caring for sick family members, or a key manufacturing site has been forced to shut down. Standard commercial insurance would not cover these financial losses. One provision of contingent business interruption coverage is that it can apply to instances of “Civil Authority”, for example when a government enforces an evacuation rule. There are generally two versions of Civil Authority coverage, with one being more liberal than the other.

COVID-19 p&c coverage

Version one is more widely used on commercial insurance policies and is more restrictive in nature. In this version, the insurance company will pay for the actual loss of business income sustained and required extra expenses caused by a civil authority action that prohibits access to commercial premises. In general, there are three conditions that must occur in order for coverage to be available: (i) the disruption must be due to direct physical loss of/or damage to property, other than at your physical location, (ii) the disruption must be caused by/or resulting from any Covered Cause of Loss (as defined in the insurance policy) and (iii) the prohibition of access to the commercial premises must be the direct cause of the loss of income.

Generally, the biggest challenge with COVID-19 is that there is no direct loss to property. The loss of income results from the closure of businesses to reduce the spread of COVID-19.

It is possible that a commercial insurance policy may have a “more liberal” version of Civil Authority coverage. In this scenario, two conditions must be met to effect potential coverage. The policy covers the business income loss sustained during the time when access to property is prohibited by order of civil authority. As in the above scenario, this must be the result of a peril that is not excluded under the policy. However, in general, in this situation, direct physical damage is not required in order to trigger coverage.

It should be noted that accommodations under rules and laws may complicate coverage issues. For example, a state or local rule permitting restaurants to remain open on a “take-out” or delivery basis will permit the owners to continue to generate revenue, albeit on a reduced basis. However, this ability may prohibit recovery under a commercial policy.

Business Income/Business Interruption Coverage in the commercial market normally covers a business for lost revenue, rent, relation, loan payments and employee wage due to a slowdown or temporary suspension of normal business operations due to physical property damage of the business. Normally policy endorsements do not cover claims unrelated to property insurance losses. As a result, infectious diseases like COVID-19 are excluded.  Some states like New Jersey have introduced legislation to require business interruption covered even if it’s excluded.

Extra Expense Coverage covers additional costs in excess of normal operating expenses incurred while property is being repaired or replaced after being damaged by a covered cause of loss (i.e., flooding or fire). Again, in most instances, COVID-19 is not causing physical damage to business properties. However, if there is contamination to a property from coronavirus exposure, to the extent that it is unusable for its primary purpose, it may result in eligible coverage. We do not believe this is likely to be a common occurrence, but it should be noted that extra expenses incurred to make a work environment or means of production safer for employees may be covered.

Liability Coverage: Some industries, like healthcare, may see an increase in medical malpractice claims.  In the future, suits based on lack of screening, inadequate treatment and inability to contain the virus may become issues.  Certain sectors, like nursing homes, may also see more of an increase than others. Some of this risk could be limited to the extent the predominant cause of the incident relates to issues resulting from federal and local government policies currently in place.

Captive Coverages may provide protection such as business interruption, where gaps exist in the commercial market. Companies that currently insure the above risks through a captive policy with broader policy terms covering virus related events may have funds available to supplement the loss of revenue, employee wage, etc. Captive policies are often designed to supplement commercial market coverage by dropping down to cover events excluded with typical commercial market policies.

Medical Stop Loss claims will likely increase for the industry as a whole. Currently insured individuals with multiple comorbidities will increase claims costs.  In addition, long term care and social services costs may increase as well.  States like New York have waived copays and cost sharing components for fully insured plans.

How this Will Impact the P&C Industry

In general P&C carriers with large common stock holdings will likely be impacted the most given the recent market downturns. Restrictive language in policy contracts should limit P&C insurers from adverse levels of claims resulting from COVID-19. However, in the business interruption sphere we will see a fair amount of claims, given the aforementioned announcement by the Insurance Services Office and possible state legislation passed to void policy exclusions, but these will likely be treated case-by-case.

According to Moody’s and Fitch, event cancelations will trigger the hardest hit in the insurance market, with perhaps the exception of medical. With the suspension of all major league and college sports (i.e. March Madness), major festivals like Coachella and South by Southwest, there has been an unprecedented amount of economic loss.

The 4 Biggest Themes from the 2018 Cayman Captive Forum

As we unpack our suitcases from another successful appearance at the Cayman Captive Forum – our 11th one attended as a company! – I’m also taking the time to unpack my thoughts on the event.

As a sponsor and exhibitor at the conference, which ran from November 27th to the 29th in the Grand Cayman Islands, our team had the pleasure of meeting a range of new faces and familiar colleagues. This is an event that we look forward to each year, and not just because it gives us a break from the cold weather. Drawing over 1,000 attendees, this is a top-notch event catered to captive professionals of all kinds, whether they are seasoned experts or newcomers.Cayman Captive Forum

The Cayman Captive Forum is one of many ways that we keep up with trends, priorities and news. So between ice cream socials and poolside receptions, I noted the four most prevalent categories from this year’s educational sessions.

1  –  Taxes
No surprise here, as taxes and captives go hand-in-hand. This year, audience members learned about captive considerations for taxable and tax-exempt entities. Further, a group of accountants and lawyers covered US tax reform in detail, highlighting how it all affects captives (i.e. CFC rules, changes to attribution rules, etc.).

2  –  Current Events
Naturally, any modern conference would take inspiration from current events, but I noticed quite a few sessions at Cayman that were focused on unrelated topics frequently seen in the headlines.

First, there was “Ridesharing in Healthcare”, which explored the role of transportation in population health management. Then, a panel explained the impact of the “#MeToo” movement on the healthcare industry – addressing harassment, bias and recommended solutions. Thirdly, a team from CHRISTUS Health told audiences of their experiences with Hurricane Harvey and its consequences, arming listeners with suggestions for future catastrophic events. Another session dealt with workplace violence, something we hear about far too often, and, finally, some healthcare specialists provided a defense strategy for an Ebola outbreak.

3  –  Blockchain
Blockchain is another hot topic, so it got some spotlight at Cayman this year. In “Blockchain Technology Global Trends”, we learned about blockchain regulations and issues pertinent to insurance and healthcare. Then a panel of accountants discussed the opportunities and challenges presented by blockchain as it relates to insurance.

4  –  Cyber
Cyber has been top-of-mind for risk professionals for several years. Unfortunately there has been no magical solution, so the subject remained front-and-center once again this year at Cayman. Charles Kolodkin and Rebecca Cady explained how to use Miscellaneous Professional Liability (MPL) to strategize for cyber risk. Their lessons learned included, “hone the ability to manage the claim” and “work with operational leadership and board”. Another session discussed how to control for vendor cyber risks, highlighting the increased interconnectivity between areas like big data, social media, cloud computing and the Internet of Things (IoT) and the role it all plays on cybersecurity.

 

All in all, the 2018 Cayman Captive Forum was an event to remember. Myself and my Spring team members enjoyed all of the networking and learning opportunities that the event brought about, and are already looking forward to next year’s!

Captive Insurance

Spring to Sponsor 2018 Cayman Captive Forum

The Spring team is delighted to announce that we will be sponsoring the Cayman Captive Forum which runs from November 27th to the 29th in the Cayman Islands.

While the conference’s location and weather (especially in November) are certainly a treat, we swear that’s not the only reason we’re going. In fact, Spring has been involved with the Insurance Managers Association of Cayman (IMAC, the host group) for over a decade, and its events and resources have never let us down. This year we will be joining over 1,400 otherCayman Captive Forum industry professionals to network and share our experiences and best practices. Attending conferences is one of the strongest ways that we keep our pulse on trends, and with such a large captive market in the Cayman Islands, this is one of the best.

A group of impressive speakers will present on topics like:

  • Risk distribution
  • Tax considerations
  • Regulatory updates
  • Cyber risk
  • Telemedicine

And much more!

If you are heading to the Cayman Captive Forum too, please stop by booth #7 to say hello to our team. We’ll be giving out a great raffle prize!

Continued Pressure from the IRS on Bad Fact Patterns – How to Avoid Trouble

The Courts recently made a decision regarding the Reserve case for the IRS. This is the second case of late that has been decided against a captive owner in an effort to crack down on captives the IRS perceives to have a poor fact pattern, and therefore cannot meet insurance tax treatment standards. For example, captives that have been set up to undertake sham transactions or undertaking transactions that do not meet the bona fide insurance company characteristics would fall into this category.

According to the Avarhami v. Commissioner (“Avrahami”) judgement, the court provided four criteria that result in an arrangement constituting insurance.  These four criteria were also addressed in the Reserve Mechanical Corp (“Reserve”) v. Commissioner case, and are as follows:

  • The arrangement must involve insurable risk
  • The arrangement must shift the risk of loss to the insurer
  • The insurer must distribute the risk among its policy holdersIRS captives
  • The arrangement is insurance in the commonly accepted sense

Reserve outlined these four non-exclusive criteria to establish a framework for determining the existence of insurance for federal income tax purposes.  The court’s opinion focused on the idea of risk distribution, which led to investigating PoolRe Insurance Corp. (“PoolRe”), the stop loss insurer for Reserve. The judgement discusses the transaction in detail and stated there was a circularity of funds that invalidated the pooling arrangement.

To determine if a captive insurer has met the risk distribution criteria as a standalone captive without stop-loss or reinsurance protection, the courts looked at the total number of insureds and the total number of independent risk exposures. It has long been believed that the “law of large numbers” allows an insurer to minimize its total risk and reduce the likelihood of a single claim exceeding the premium received. In the Avrahami and Rent-A-Center court cases, risk distribution passing and failing thresholds have been observed as follows:

  • Rent-A-Center ultimately showed distribution of its risk by insuring the risk for 14,000 employees (workers’ compensation), 7,100 vehicles (auto coverage), and 2,600 stores (general liability coverage) in 50 states
  • Avrahami didn’t show distribution of risk by insuring 3 jewelry stores, 2 key employees, and 35 total employees. Further, one of the stores had 5 low frequency coverages and the other 2 stores had 2 low frequency coverages

Reserve, an Anguilla-domiciled captive, wrote 11 to 13 policies over the three tax years in question and had direct policies for 3 insureds.  Peak Mechanical & Components, Inc. (“Peak”), an S Corp for Federal income tax purposes, was owned in equal 50% shares by two individuals and was the primary insured under all policies. The policies were also issued to two other subsidiaries, although the operations were not significant. Peak operated two facilities and had a max of 17 employees. Reserve did not meet risk distribution based on this exposure profile alone; its exposures were similar in scale to the Avrahami’s.  Reserve contended that it still met the risk distribution safe harbor requirements, by having 30% of its gross premium for each of the tax years for unrelated parties via the reinsurance agreement with PoolRe.  A similar argument was made in the Avrahami case with their reinsurance pool.

Before it is determined whether Reserve distributed risk through the agreement with PoolRe, they evaluated whether PoolRe was a bona fide insurance company. In the eyes of the court, a captive should be able to answer “yes” to each of these questions and provide adequate support to:

  1. Is there no circularity to the flow of funds?
  2. Are the policies developed in an arm’s length approach?
  3. Did the captive charge actuarially-determined premiums?
  4. Does the captive face actual exposures and insurance versus business risk?
  5. Is the captive subject to regulatory control, and did it meet minimum statutory requirements?
  6. Was the captive created for non-tax business reason?
  7. Was a comparable coverage in the market place more expensive, or even available?
  8. Was it adequately capitalized?
  9. Were claims paid from a separately maintained account?

The court’s conclusion in Reserve’s case provided details of the concerns with evidence in support of the first six questions listed above, and concluded that the PoolRe quota share arrangement provided the appearance of risk distribution without actual risk distribution.  The court summary also highlighted the following:

  • Circularity of funds was exhibited with PoolRe receiving and distributing the same amount of money to Reserve
  • There was no evidence that the premium payments to PoolRe by Reserve and the other participants were determined by actuaries
  • Contracts were not determined in a like manner, nor using objective criteria

One of the major concerns the IRS addresses with the Avrahami and Reserve cases is that a one-size-fits-all rate for all participants in the pool/reinsurance agreement isn’t valid.  The court also addressed an alternative ground for the case, which would have been to evaluate “Insurance in the Commonly Accepted Sense”. To determine if an insurance arrangement exists, the following factors come into play:

  • Was the insurance company organized, operated and regulated as an insurance company?
  • Was it was adequately capitalized?
  • Were the policies valid and binding?Captive Checklist
  • Were the premiums reasonable and a result of an arm’s-length transaction?

The court summary pointed out several issues in Reserve’s support for answering the above questions, such as:

  • Reserve had no employees of its own performing services and the board members did not know how claims were made or handled.
  • There’s no evidence that activities were performed in its domicile.
  • Claims must have supporting documentation, yet there was no addendum for the program until after the policy date. An employee from the insured signed the checks as opposed to the insurer.
  • Binding and valid policies – policies must, at a minimum, identify the insured.
  • There were peak paid commercial market premiums of $95,828 in 2007 versus $412,089 to Reserve in 2008. This is a 330% increase in insurance premiums. In addition, Peaks premiums vary from year to year with no explanation.
    • Note, the Avrahamis similarly had significant increases in premium spend, with almost an 800% increase over a several year period.

These cases provide us and other captive professionals with guidance and clarity. As the industry grows, cases like these will form the cornerstones of how to properly operate and conduct business as a captive insurance company.

Key Takeaways

The IRS clearly has problems with some of the pooling structures used to qualify captives as meeting the risk distribution safe harbor tests. They are concerned that the premiums ceded to the pool and the transfer of risk into the insurance pool are not commensurate with one another, and that the pools are only being utilized to circle premiums to the captive participants, with each assuming no or minimal losses from the pool.

There should be clear documentation of premium determination by an actuary, illustrating why premiums are reasonable and that sufficient risk transfer exists.  Over time, if the total loss experience and premium ceded to the pool doesn’t produce a long-term average loss ratio consistent with the commercial marker, then the pool’s support in having arm’s-length contracts with each of the participants becomes weak and difficult to defend.  Long term average commercial market loss and loss adjustment expense (“LAE”) ratios for most lines of business generally fall in the range of 50% to 75%, hence the 70% loss and LAE ratio threshold in IRS Notice 2016-66 used to identify captive transactions of interest.

Finally, it is important to show sufficient support in a captive’s business plan, policies, and feasibility studies to address the questions above about an insurer/pool being a bona fide insurance company.

5 Ways VCIA is Future-Focused

The Vermont Captive Insurance Association (VCIA), founded in 1985, is the largest trade association for captive insurance in the world. As such, it’s no surprise that their annual conference yields both an impressive turnout and range of educational sessions. A long-time sponsor and member of VCIA, Spring anticipates the August event each year.

The VCIA 2018 Annual Conference, themed “Where the Captive World Comes to Meet”, was just as high-caliber as past years, but each event tends to build its own unique motif. This year, as about 1,100 insurance professionals gathered in Burlington, Vermont, and 40 presentations were made, the three-day conference seemed to emphasize “the future” most notably. The sessions below, along with general conversations I had with a range of people at the conference, are what led me to identify this theme.

  1. Future-Proofing Your Captive

    This presentation, including Spring’s Managing Partner, Karin Landry, urged audience members to consider emerging risks like climate, and highlighted ways in which one captive has and continues to prepare for the future. Then, Andrew Braille of AES Corporation outlined the organization’s plans for the future, including a 50% reduction in carbon intensity.

  2. Succession Planning: Bridging the Next Generation of LeadersEmerging Risks

    An experienced panel led this discussion on how to nurture and attract captive talent to ensure a bright future for the insurance industry, one that is aging and failing to appeal to millennials. Tips like developing mentoring relationships and utilizing updated technology were given.

  1. Blockchain & Distributed Ledger Technology

    VCIA attendees, myself included, learned a lot about blockchain during this Wednesday morning session. The presenters defined blockchain and explained how it will impact captives and the insurance industry at large in the years to come. Good news – experts expect blockchain to reduce costs, lower risks, increase trust, and save time for insurance professionals as it continues to evolve.

  1. Integrated Solutions: The Future of Risk Management

    Todd Cunningham and Carol Murphy highlighted the efficiencies to be gained by moving from a traditional insurance structure to an integrated model, where 1st excess coverage across lines all operates within the same system. They explained that this is the direction they see the industry will and should go.

  2. The Cognitive Captive: Artificial Intelligence for Smarter Insurance

    Tracy Hassett of edHEALTH, and two others informed attendees about how A.I. will affect insurance risks and the labor market, and explained the role that predictive analytics and “The Future of Mobility” will have.  A special focus was made on driverless cars and their impact on insurance.

To be clear, these are only a handful of informative and strong presentations (you can read about the others here), but the underlying theme is gear up for what’s to come.

I hope you enjoyed the summary, whether you were at VCIA or not. As you can see, I did manage to learn quite a bit despite the bike rides and cocktail receptions!