14 August 2013Analysis

Governing group captives

It all started about a year ago, when you told your insurance broker that you had to get your workers’ compensation costs under control. Based on your loss history, commitment to loss control and claims management and your appetite to assume some risk, your broker recommended that you join a newly formed group captive insurance company to write workers’ compensation risks for you and similar companies. You paid your share of the feasibility study and had even got over the hurdle of combining your losses with those of other companies, some of whom were your competitors. What you didn’t count on was being a director of this newly formed entity.

You and your fellow board members do not possess extensive insurance experience because that’s not your primary business; you probably lack independence because each director is a representative of an insured of the captive; and a significant portion of your captive’s premium has gone to pay fronting fees, reinsurance premium, actuary, legal, accounting, captive management and licensing fees, leaving you feeling that every remaining penny needs to be placed in the captive’s loss fund.

So given the uniqueness of the group captive (the lack of directors with insurance experience, lack of independent directors and limited funds), what corporate governance policies, steps and structures do you need to put in place—and can you put in place—to insure that your newly formed group captive insurance company will run effectively and that you as a director are protected from claims of mismanagement?

For starters, you would be well advised to think of your group captive as a for-profit, regulated, traditional insurance company and encourage it to have the discipline needed to comply with your domicile’s regulations and return a profit to your stakeholders. To achieve that, you first need to determine what regulations apply to your captive, then determine what other guidance might be helpful.

There is a lot of guidance out there, but much of it doesn’t apply to your group captive. Traditional state insurance regulations don’t apply because your captive is not a regulated insurance company and therefore not subject to examination by traditional state regulators. Similarly, National Association of Insurance Commissioners (NAIC) guidelines do not apply because you are not a traditional stateregulated insurance company. In addition, all the corporate governance requirements of the Sarbanes-Oxley Act of 2002 do not apply because your company is not a publicly traded company. So what does apply?

Which guidelines?

Captives should look first to their domicile to see what corporate governance guidelines exist. If you are incorporated, all domiciles both on- and offshore have corporate laws that to a lesser or greater degree set forth fiduciary duty obligations of directors and provide some guidance for fulfilling those fiduciary duties. Likewise, more and more domiciles are promulgating guidelines for the corporate governance of captives, as are some captive trade associations. While they aren’t compulsory, you would be well-advised to look at NAIC guidelines, state regulations applicable to regulated carriers and even the requirements of Sarbanes-Oxley. Generally speaking, you need to focus on the following basic principles.

Qualifications and duties of directors

As a member of the board of directors of a group captive insurance company, you are subject to the corporate laws of your domicile as well as the captive insurance laws. Most likely, the corporate laws of your domicile state that each member of the board of directors has a fiduciary duty and a duty of loyalty to the corporation itself and must act at all times in the best interest of the corporation. This means that your board of directors should comprise individuals who have a fundamental understanding of the business of the captive insurance company and understand and appreciate the regulatory scheme to which the captive is subject.

"Your board of directors should comprise individuals who have a fundamental understanding of the captive insurance company and understand and appreciate the regulatory scheme."

It would also be helpful if those members had working knowledge about the risks insured by the captive, had a working knowledge of financial accounting, were not afraid to ask questions, and especially were willing to challenge management and service provider proposals and assumptions. Those board members should also have an understanding of the risks associated with related party and intercompany transactions. It would be ideal if a few board members were truly independent directors, but in most group captive situations, the board of directors is going to comprise representatives of companies that are insured by the captive.

Use of third party service providers

Your third party service providers should have a high level of expertise in the captive insurance arena. That goes for lawyers, actuaries, accountants and captive managers. It is not uncommon for captives to do a ‘request for proposal’ for those positions and interview service providers periodically. Once the captive hires its service providers, it is important that the board of directors of the captive take control and responsibility for the business of the captive and use their service providers to respond to the board’s questions about the operations of the captive, rather than becoming overly dependent on the service providers. Ultimately it’s the directors who are responsible for the success or failure of the captive.


The work of the board of directors will be facilitated by the development of certain committees. Most captives have a nominating or corporate governance committee, an underwriting committee, a compensationcommittee, and an audit committee. While all committees are important, the most important is the audit committee. Members of the audit committee should have a sufficient grasp of financial accounting to understand the company’s financial statements and ask questions about financial statements.

Many outside guidelines, such as the Sarbanes-Oxley Act, require a certain number of independent directors to be on the audit committee and that the chairman of the committee has financial expertise. While the group captive is not subject to Sarbanes-Oxley, it is not a bad idea to follow some of those guidelines on best practice. All committees should have charters that clearly identify the functions of the committee. Each committee should review its charter on an annual basis and determine whether the committee has complied with the mandates set forth in the charter and whether the charter needs to be amended in any way.

Ensuring the quality of the board

It has become common practice for boards of directors to develop codes of conduct that should be thoroughly understood by each board member and reviewed and signed annually. In addition, many boards do self-assessments in which they try to evaluate whether the board is addressing the significant issues that face the captive and whether the board members are meeting their obligations to the captive. Lastly, there are numerous continuing education opportunities for captive board members relating to coverage issues, reinsurance, accounting and regulatory matters. Board members should be encouraged periodically to attend such educational programmes.

At the end of the day, the group captive insurance company should be treated as a separate entity to which the directors owe their fiduciary duty. While directors may be insureds, they must divorce themselves from doing what is in their own best interest and take action that is always in the captive’s best interest. Those actions should be transparent and done in a way that would stand the scrutiny of the ultimate shareholder insureds and the captive’s regulators.

Scott Penwell is a partner at Rhoads & Sinon. He can be contacted at: