Pooling arrangements, such as Marsh’s Green Island Reinsurance Treaty (GIRT), have been around for some time, and interest in them is increasing among captives and their parents.
Pooling arrangements, such as Marsh’s Green Island Reinsurance Treaty (GIRT), have been around for some time, and interest in them is increasing among captives and their parents.
Marsh’s annual captive benchmarking report, The Evolution of Captives: 50 Years Later, found that third party risks were insured in 18 percent of the 664 captives analysed. In the US, the number of captives writing third party risks has been increasing.
Mark Dugdale sat down with Donna Weber, senior vice president, captive solutions at Marsh, to find out more. Nick Parillo, vice president of global insurance at Dutch retail group Ahold, whose Vermont-domiciled captive The MollyAnna Company is a member of GIRT, also provided insight.
Mark Dugdale: What are the benefits of risk pooling?
Donna Weber: Risk pooling arrangements, such as GIRT, provide multiple benefits to participants, relating to both economic and tax issues.
Through participation in a pooling arrangement, captives share their loss experience by transferring a portion of their risk in exchange for a percentage share of the risks of other pool members. This allows members to diversify their underwriting portfolios by assuming third party premiums. Pooling should also reduce expected loss variability, because each captive writes a smaller portion of a large pool of losses. This reduction in variability should create a more stable portfolio, which in turn serves to stabilise captive cash flow.
Further, risk pooling arrangements, such as GIRT, can help captive owners to meet certain risk-distribution requirements, which, in turn, enable them to meet certain US Internal Revenue Service (IRS) safe harbours, allowing a captive to be considered as an insurance company for tax purposes.
Dugdale: In practice, does participation in a pooling arrangement bring multiple benefits?
Nick Parillo: GIRT provides the flexibility to effectively and substantially increase the captive’s capacity to underwrite highly desirable third party business and a highly diversified portfolio of well managed risks to the captive.
Dugdale: What should a captive consider before joining an arrangement?
Parillo:They should look for participants with a strong and successful commitment/philosophy to loss control, safety and claim management best practices.
Dugdale: What are the potential risks of participating in a risk pool?
Weber: As with any underwriting or insurance decision, captives considering entering into a pooling arrangement should bear in mind the potential risks that may affect their outcome. Members have no control over the underlying loss control and claims management of other member captives, yet they assume their losses. Prospective members should be comfortable that all counterparties’ profiles have been reviewed and vetted to ensure the mitigation of both underwriting and credit risks. A well structured pooling arrangement, such as GIRT, will address such risks and mitigate them to the extent possible.
Prospective members should seek out pooling facilities that offer:
Parillo: The management of the facility must not only demonstrate superior management skills and a proven track record of success but must also assemble a strong team of actuarial, legal, and accounting expertise to address the diversified operational and business needs of its participants.
Participants must also be willing to engage in discussions involving best practices and display an ongoing dedication to protocols and processes that contribute to the overall reduction in the cost of risk.
Dugdale: How does GIRT work?
Weber: The calculation of a participant’s share of treaty losses is performed by dividing each company’s individual premium by the full treaty premium. An independent actuarial firm used by GIRT calculates each participant’s premiums prospectively based on the unique loss and exposure data of that individual participant, so that premiums reflect the individual’s expected losses.
Using the same, consistent review method for all participants means that subjectivities are kept out of the rating process. Changes in loss experience are answered through the actuarial rating process that takes place each policy period.
Pooling arrangements can be comprised of different lines of coverage. Clearly, those pooling arrangements with relatively high frequency, lower severity risks should have more stable results than facilities offering low frequency, catastrophic lines. For example, GIRT reinsures the first $200,000 per occurrence of US casualty, specifically workers’ compensation and Federal Employers Liability Act (FELA), as well as general and auto liability. The treaty, which has 21 captive members, now writes $670 million in premium, up from $59 million in 1997 when GIRT launched with seven founding members.
Generally the more members and premium pooled, the more diversified and stable the underwriting results of the pool will be. GIRT includes a diverse group of companies representing more than seven industries with geographically dispersed risks. While Marsh manages GIRT as a contractual reinsurance agreement between its participants, each participant (regardless of size) has a vote in deciding the overall direction of the program. New members are carefully considered and to be accepted, they must garner a 75 percent or greater approval from member participants.
The interactive nature of GIRT participation allows the structure to address the unique situations encountered by its members.
Dugdale: What are some of the recent trends in risk pooling?
Weber: There would appear to be an increasing number of captives being formed that elect to be taxed under Internal Revenue Code (IRC) §831(b) (which allows the captive to write up to $1.2 million per year in premiums without paying income tax on underwriting profits). Many of these captives participate in smaller pooling facilities.
These smaller pooling facilities more typically target higher-severity, lower-frequency risks instead of more predictable long-tail lines. Coverages often exchanged in these facilities include excess liability, product liability, environmental, cyber liability, supply chain, terrorism, etc.
The IRS has apparently taken an interest in some of these arrangements. In December 2013, it made known that it was not willing to rule on certain pooling arrangements involving what appear to be a group of IRC §831(b) captives. Further, in 2014, an IRS representative indicated that taxpayers should not rely on certain favourable private letter rulings issued in 2012 in connection with certain pools in which IRC §831(b) companies had participated.
The IRS has not been specific in connection with its concerns relating to these various situations, but it would appear that these concerns relate to the adequacy of the risk distribution and the nature of the risks assumed by the electing companies and exchanged in the smaller pools.
Dugdale: What do you see as the future of pooling arrangements?
Weber: We see continued growth in the popularity of well-structured pooling arrangements for captives of all sizes given the inherent benefits of risk diversification and underwriting stabilisation.
Before utilisation of a pooling arrangement, it’s crucial that captive owners perform due diligence to ensure that the pooling facility under consideration is truly providing the insurance risk transfer and diversification elements promised, makes sense from an overall economic standpoint, and is operationally transparent.
