There is tension at the heart of every captive insurer. This fundamental tension arises from the fact that for every captive shareholder is also in some way, shape, or form the captive’s client. If we step back and consider the relationship between shareholder, insurer, and insured in the commercial world the relationship between the parties is clear.
At its simplest: the insured buys a policy from the insurer with a view to securing its financial future should the worst happen; the insurer issues multiple policies to multiple insureds with a view to making a profit from the application of the law of large numbers; the shareholder invests in the insurer to enjoy dividend streams and capital growth arising from the profitable underwriting of the insurer. The captive model both simplifies and complicates things. The simplification arises from the alignment of interest between all three parties. The captive insurer is purely established in order to benefit the risk financing function of the shareholder/insured. With such an obvious and simple alignment of interests, where does the complication come from?
As any captive professional will tell you, a captive insurer is a ‘bona fide’ insurance vehicle, and as such is subject to regulatory oversight. Generally speaking as a licensed entity, the captive will be subject to specific requirements, the intention of which are to promote its independence of decision making in pursuit of maintaining its ability to meet its liabilities as they fall due. Regardless of the clarity of thinking that has got us to this position (especially if we consider pure first party captives writing property risks) each captive board is required to demonstrate the way in which ensures that its activities and the day-to-day operation of the company comply with regulatory standards. Hence the rise and rise of guidance, rules, and regulations pertaining to the governance of captive insurers.
In this article I want to reflect on just one aspect of captive governance: the relationship between the board of directors and the insurance manager. It is not uncommon for the captive board to outsource all key functions to the insurance manager. This will include core activities such as: underwriting; claims settlement; accounting; company secretarial; compliance; internal audit; risk management; actuarial. It is perhaps not surprising that in some instances, as noted in the Guernsey Financial Services Commission’s letter of 17 February 2022 to all directors of licensed insurers under its bailiwick:
“Confusion can arise between the respective roles of the insurer board, (and) the insurance manager … Our observation is that we sometimes see a board in effect handing over the running and direction of the company to an insurance manager. In fact, the board alone remains accountable for the company and always needs to oversight a manager.”
In order to ensure that such confusion does not obscure its operation, the captive board can follow these simple steps:
- Employ a competent insurance manager who has sufficient and capable resource.
- Ensure that manager applies a business model that allows those staff members sufficient time to dedicate to both carrying out those core activities listed above, and documenting the service fulfilment so that the board can evidence due and proper oversight
- Regulate the activity of the insurance manager via the application of a comprehensive service agreement that clearly sets out the services to be delivered and the standard of delivery that should be maintained
- Put in place a comprehensive corporate governance framework that contains the principles and board practices that govern how the company operates. This document should be supplemented by a comprehensive business plan, risk management framework, risk register, solvency calculation process, extensive set of policies and procedures.
- Ensure that a full compliance monitoring programme is established, to ensure that the manager’s performance is in line with the standards set out above, with regular reporting to the board on compliance/non-compliance
- Undertake a meaningful review all corporate documents on at least an annual basis to ensure that they remain appropriate for the business of the company and the changing regulatory and commercial environments.
By undertaking these simple steps a board can be confident that its own responsibilities are being properly fulfilled by way of controlled delegation to the insurance manager.
One final point to make concerns the potential for conflict between the role of the insurance manager and other third-party service providers. Good insurance managers are clearly essential to the delivery of the client group risk financing strategy through the efficient execution of the captive strategy that is handed down to them by the board. It is not unusual for such an insurance manager to be instrumental in the establishment of the captive strategy in the first instance. Insurance managers often provide captive feasibility or captive utilisation studies alongside their management services. This advisory workstream will include analysis of the client group’s risk profile and appetite, historic losses, attitude to risk and some form of conclusion as to an optimal risk financing structure. In the course of providing such advice the insurance manager’s role can overlap with that of the insurance broker. The overlap of advice does not necessarily give rise to conflict. Indeed, if handled properly advice received from different consultants coming from slightly different perspectives can be instructive to the captive owner as it makes conclusions on key risk financing decisions.
An area where the “overlap” can potentially be more contentious arises from the direct relationships that are forged between insurance managers and insurance markets. Many markets are keen to establish relationships with captive managers to more directly engage with sophisticated buyers of the kind of fronting and reinsurance services that they provide to captive insurance companies. Managers are keen to maintain these relationships because it enables them to provide holistic solutions to captive buyers/owners. Some managers are able to act in an intermediary capacity for their captive clients under the terms of their insurance management license.
At the same time captive owners contract with brokers to engage with markets on their behalf, and often this remit extends to acting on behalf of the captive itself. This gives rise to potential for confusion as to exactly who is acting for whom and at what capacity. The key, as in so many walks of life is to ensure clarity at the outset. It is essential that there is full transparency between all parties as to the various roles being played, and the various remuneration agreements that are in place. All parties can play their part in this, but ultimately the captive board has the responsibility to ensure that all service provider relationships are subject to clear and full service contracts so that they have a complete understanding of this sometimes complex nexus.