Captives should adapt to their parent companies’ changing risk profiles. Following this plan helps risk managers identify and execute necessary changes.

You conducted a feasibility study before forming your captive, establishing long term goals and objectives, determining which risks to write, where to domicile, and how to finance it all.

But that was five years ago.

Since then, your company has made two acquisitions, expanded its workforce, implemented new technology, contracted with new suppliers, and been affected by a new federal regulation. In short, the risk profile has changed considerably.

Is your captive keeping up?

As with all other business matters, your company’s captive needs and goals are likely to change over time, especially with new and emerging risks sprouting up frequently. We recommend a ‘refeasibility ’ study at least every five years to reassess risk appetite and exposure.

A ‘refeasibility’ study ensures your captive insurance company is still serving your organization’s needs and furthering its mission, rather than holding it back. Unlike the initial feasibility study, this periodic checkup must consider your existing captive structure and financing strategies, and take into account how the captive has performed thus far.

To gain a holistic view of your captive’s performance and evaluate the need for change, captive owners should ask themselves these five questions:

1) Do your captive’s goals align with your risk profile?

Evaluating your captive’s goals in the first step of a refeasibility plan. And that begins with collection of data. Claims experience, reserve and surplus levels, loss ratios and other measures of efficiency indicate how successfully the captive has operated and where it has underperformed.

This indicates whether it has met initial goals, and whether those goals should change. This decision is also largely dependent on changes in the insured organization’s risk profile and the subsequent impact on insurance needs.

Moving employee benefits into a captive may be a more efficient way to provide coverage for a larger payroll. Greater reliance on automation or IoT technology may likewise increase the need for cyber coverage tailored to an organization’s specific needs. Emerging risks should be considered in this assessment. For example, new technologies like driverless cars and drones and increasing automation will create both risks and opportunities across various industries.

Performance metrics can help risk managers identify areas where resources can be shifted to support the coverage needs demanded by organizational change and emerging risks.

2) How will proposed changes impact other parts of the captive company?

The second stage of the study considers how adjustments to long term goals affect other pieces of the captive puzzle, such risk financing and use of reinsurance.

Adding new lines of coverage or expanding or reducing existing ones will necessitate an evaluation of risk financing strategies and could lead to changes in an organization’s investment mix or retention levels. This may also impact reliance on
reinsurance as a component of the overall risk transfer strategy.

The best way to pinpoint the extent to which these changes should be made is through stress-testing.

Running through scenarios with reasonable adverse case out comes highlight where more or less financing is needed to service claims and maintain favorable loss ratios.

3) What specific implementation strategies will make your changes stick?

As with any enterprise-wide change, a detailed roadmap lays the groundwork for successful outcomes and can gain the confidence of stakeholders.

This stage identifies lines of insurance that could be moved into the captive or other coverages that would be more cost effective to insure through the traditional insurance market. Along with cyber and employee benefits, some of the most common risks to insure in captives include professional liability, auto liability, reputation, and business interruption.

Capital management strategies should also specify how surplus will be used going forward.

There are several considerations in appropriately managing the capital and surplus levels over the life of a captive, including average cost of capital, retention levels, reinsurance use and taxes, among others. A team of actuaries and consultants could review and develop strategy to address these.

4) Does your existing captive structure still work?

Captives have taken on a number of different forms since their inception — single parent, group/association, rental captives, sponsored captives, non-controlled foreign corporations, etc. The primary differences between these structures center on the way risk is shared among the parties involved and how the captive is financed and regulated.

Sponsored captives, for example, offer a way for companies to take advantage of the established infrastructure of a traditional insurer and avoid the upfront costs of forming a captive — though they are not accepted in all domiciles. Group captives allow companies with unrelated risks to spread out their exposure and reduce their total cost of risk, but can present management challenges.

A captive’s domicile, the scope of risk it seeks to cover, and the financial strength of its parent company all help to determine which structure will work best.

5) Does your captive account for recent case law and regulations?

The technology industry isn’t the only one that is always changing. Laws, regulations and court cases, especially lately, have an impact on captives and need to be considered as you are taking a fresh look at your strategy.

Firstly, there’s tax reform. The tax rate reduction under the Trump administration has had a direct impact on captives, and a consolidated tax return that includes a captive insurance company should have its tax sharing agreement reviewed.

Further, payments to a foreign captive should be reviewed to determine if the Base Erosion Anti-Abuse Tax (BEAT) is applicable, and anyone in the U.S. with an owner’s interest in a foreign insurance company needs to review their holdings. IRS Notice2016-66 with respect to microcaptives should also be considered, which leads us to our next point.

In light of two recent court cases – Avrahami vs. Commissioner and Reserve Mech. Corp. v. Commissioner – we now have more insight into what the IRS believes to be the criteria for a bona fide insurance company. As a result, we recommend going through a checklist of sorts to ensure the following regarding your captive:

• Is the captive created for a non-tax business reason?
• Is comparable coverage available in the market?
• Are the policies valid and binding?

Domicile-related regulations are also changing. Is yours compliant with your current domicile, and have you looked at the new domiciles available? Lastly, it’s imperative to take a look at the Dodd Frank Act, specifically the self-procurement tax to ensure your captive is appropriately aligned.

6) Are the changes having the effect they’re supposed to?

You’ve identified new opportunities for your captive, supported proposed changes with data and stakeholder feedback, and developed detailed and holistic plans to move forward. But you’re not done.

The final step of any refeasibility study is to measure outcomes. Collect data again to see if newly established goals are being met and how the rest of the captive organization has been impacted.

A great deal of this stage relies on solid industry benchmarks against which to measure current and future captive performance. Furthermore, it’s important that the optimization team takes this data and edits their implementation plan accordingly to keep captive performance on track, making actionable recommendations for staff to follow.

To execute your plan, turn to expert help!

These findings should serve as a baseline for measurement going forward. But look for a team of experts ranging from employee benefits, risk management and actuarial services to walk you through the steps and, ultimately, implementation. This is especially important as new risks continue to emerge and evolve; routine maintenance on your captive is important, just like it is on your car!

Check out this article on Risk & Insurance; where our Managing Partner, Karin Landry explains ways to revaluate if your captive is up to date, and how ‘refesibility’ studies can help employers reduce risk and cut costs.

You’ve had your P&C captive for years and it has continued to perform well throughout. So, what next? How do you capitalize on this success and build on your captive or rebuild an underperforming aspect of it? One word: Refeasibility. Okay, so ‘refeasibility’ isn’t really a word (according to Oxford Dictionary). At least it hasn’t been traditionally, but it is one that needs to be on the tip of the tongue of every captive owner. It is a word that has become somewhat synonymous with captive optimization and very accurately describes what captive owners need todo with an older captive: conduct a new (re)feasibility study.

The Importance of Refeasibility

As with all other business matters, your company’s captive needs and goals are likely to change over time, especially with new and emerging risks sprouting up frequently. Much like your family car, a captive should have a check up on a periodic basis. As a captive matures and companies evolve, captives need to be re-examined to determine if changes should be made to align with current organizational needs. Key reasons for this re-examination include the following:

• Positive or negative experience
  • Example: unexpected adverse loss experience, such as supply chain interruption, resulting in business income loss not covered by insurance
• Surplus release or addition
  • Example: surplus growth for the captive has been good and, as a result, there is now opportunity to add/expand coverages insured in the captive
• Opportunities to add new lines of coverage (that perhaps didn’t exist or weren’t relevant before)
  • Example: Employee benefits or cyber risk
• Change in the risk profile of various risks
  • Example: Litigiousness is on the rise in the insured’s industry and additional protection is needed
• Changes in the regulatory environment
  • Generally speaking, regulatory changes have impacted business directly or indirectly, resulting in loss of revenue. This is a leading concern for small business owners.
• Changes in law (such as those resulting from case law outcomes like the recent Commissioner vs. Avrahami case)

To address all these potential changes, our Spring CARE (Captive Analytical Risk Evaluation) team recommends a captive evaluate its risk appetite and risk exposure at least every five years. Are you still writing the right lines in your captive? Are you still in the right domicile? Would a different structure be more profitable? Would other service providers make a difference? Have your claims changed significantly? Have regulations changed over the years? All this and more can be answered with a good review of your captive by a professional consultant.

Captive optimization starts with a captive refeasibility study. Every refeasibility study is different to varying degrees; the scope and resources required to conduct the study are dependent on the captive’s current structure, the events (if any) that triggered the study and the goals of the company. That said, through our Spring CARE system, we follow a carefully-constructed evaluation structure when our team works through the process of evaluating captive client’s existing captive. Generally speaking, we follow and recommend the following process in conducting a refeasabiity study, starting with goals and ending with measurement.

Goals Stage

In this initial stage, it is important to focus on confirming the goals and objectives of your captive, both new and old. Have the older goals been achieved? How have the goals changed over the years? This is acritical step in laying the groundwork and direction of your refeasibility project. Also critical at this early point is the collection of data. We consider the data to be collected here as not only the stats and facts of the captive, but also the more subjective (non-paper) data that can be gleaned through management interviews and informal stakeholder surveys. Finally, in any good refeasibility study, it is very important to identify changes in your risk profile. The risk matrix to the right shows the four classic actions a company can use to handle each of their risks (DeLoach 2000).

Typically, high probability or high impact risks should be considered for insuring in your captive. Some of the most common risks to insure in captives are listed below . Emerging risks should also be considering in this assessment. For example, A new technology like driverless cars will create both risk and/or opportunities across various industries.

Coverages commonly written into captives:

Impact Stage

You want to be sure you have a clear idea of what you’re looking to accomplish, and to what extent. The Impact Stage of a refeasibility study involves looking at all the different pieces of t he captive puzzle to determine how they would be affected by the changes you’re considering. A few activities that a professional captive optimizer would look to accomplish in this phase would be:

• Conducting an analysis of your risk financing optimization
• Reviewing your current reinsurance levels and optimizing your reinsurance use
• Stress testing of the captive with reasonable adverse case outcomes

Strategies Stage

It’s important to outline the methods you plan on utilizing in your captive refresh; in this Strategies Phase, a professional captive optimizer would first analyze any additional lines of coverage that could be insured by your captive.

Secondly, a surplus management strategy would be developed. There are various considerations in appropriately managing the capital and surplus levels over the life of a captive, including average cost of capital, retention levels, reinsurance use, taxes and a number of others that a team of actuaries and consultants would review and develop strategy to address.

Structure Stage

Now that you know what you want to do and how, it’s time to take a closer look at how it will all work together in a logical structure. Market changes should give you some food for thought. For example, pure captives are increasingly changing to sponsored entities. In this Structure Stage, it is important to identify investment management best practices as well as the optimal collateral structure.

Measurement

Finally, all sound captive projects end with measurement. This is the time to collect new data and determine to what extent goals were met, and impacts made. A great deal of this stage relies on the creation of solid industry benchmarks to measure current and future captive performance against. It is also important in the Measurement Stage for the optimization team to develop implementation plans based on their findings and make actionable recommendations for helping you achieve the goals that were established in the first phase of this project. At the conclusion of the measurement phase, a professional captive optimization team, such as our Spring CARE team, would produce a refeasibility report for your captive. In this report, all of the findings of the refeasibility study are outlined and reviews along with the recommendations developed in this phase. These findings can serve as a base line for measurement.

Conclusion

Regardless of how old or new your captive is, there are a number of internal and external factors that have changed since it was created. With all the changes taking place in the industry, it is a great time to have a professional come in and not only take a snapshot of how your captive is currently performing, but also help you project and strategize where your captive should be in the future. Now is a great time for a captive refeasibility study.