A captive insurance entity is capable of more than many would expect, according to John Thomson of HAI Group
Often companies, as individual entities or members of affiliation groups, look to a captive insurance solution as an opportunity to minimise costs. Perhaps even looking for the captive solution to consistently cost less than the commercial insurance market alternatives. Not only does captive insurance pricing arbitrage create additional risks for the captive owners, it also exposes the captive insurance entity’s financial capital to adverse risk selection, which is ultimately reflected in volatile earnings and potential capital erosion.
A captive insurance programme is established to provide a consistent risk-bearing platform to meet the current and emerging risks of its owners. Traditionally the captive insurance platform addresses issues such as coverage, cost, capacity, claims, and cash flow. Implicit in this is a strategic and long-term view. Success for both the captive insurance entity as well as its owners is not measured in income statement component views alone, but even more importantly—extensive focus on the balance sheet and its components. Hence, the long-term view is essential.
Viewing insurance and risk costs associated with a captive insurance programme as an expense (income statement view) rather than a form of capital (balance sheet view) is not only sub-optimal from a management perspective, it is inappropriate in terms of capital management. Consider this perspective: the insurance contract provided by a captive insurance company provides or introduces financial capital into the business when a covered event occurs. This insurance contract is essentially an alternative form of capital that mitigates the financial impact or volatility associated with a loss or event that might otherwise be uninsured, or the recovery delay or denial of claim from a commercial insurance company.
A captive insurance company is indeed an insurance company
Captive insurance companies face a challenging range of risks and exposures—financial, operational and underwriting. These risks all have significant impacts on the captive’s capital and its related costs.
The critical success factors for a captive insurance programme or solution include: a long-term commitment by the captive owner’s senior management; a strategic versus quarter-to-quarter financial focus; a commitment to managing risks—both operational and enterprise; a strategic and immunised investment strategy; and a partnership approach.
Remember, when you are forming and owning a captive insurance subsidiary, either as a subsidiary or participating in a group captive, you are entering into the insurance business. With this, you have access to a unique business value proposition, and with this comes a specific set of performance metrics, strategic imperatives, business strategies and corporate/cultural behaviours. To properly manage this business model and manage the capital contained in your own or group-owned insurance entity, there is a set of behaviours and best practices to follow in strategic risk and financial management:
• Develop and communicate clear vision, mission and strategic direction for the captive entity, integrated into the corporate enterprise risk management process. Stick to the plan and do not deviate from core competencies and areas of focus. Specific strategic themes include accountability, sustainability and visibility.
• Follow disciplined underwriting and claim processes in establishing pricing integrity and proper valuation of claim reserves, including case reserves and incurred but not reported development. Utilise appropriate advanced analytics to make determinations and estimates, minimising volatility in financial outcomes.
• Establish underwriting philosophies, practices and procedures to guide risk acceptance and pricing decisions, again, minimising volatility in financial outcomes.
• Ensure financial solvency through rigorous capital management to ensure financial solvency and ability to meet contractual obligations to policyholders and stakeholders.
• Conserve and manage valuable capital resources, in all forms.
• Establish a risk management culture that guides behaviours and ensures appropriate risk appetite and tolerances, as well as achievement of strategic objectives.
• Promote teamwork and leadership, and ensure rewards for the right behaviour.
Following these guidelines and best practices will: help to ensure that the long-term strategic and financial viability of your risk bearing entity or company; provide sustained relevance and alignment of the captive insurance operations, products and services; allow a solid foundation for the regulatory and compliance requirements; and enhance the financial performance of your overall enterprise.
In addition, it will provide a vehicle for the emerging risks and additional business opportunities for your organisation, and the ability of your captive insurance company to support your corporate financial and strategic directions.
In essence, your captive insurance entity can be an active company within your corporate structure and could actually be more that you thought it is capable of being. CIT
