Outsourcing arrangements in healthcare captives
A robust regulatory and legal framework, coupled with a supportive government, provided the right environment to encourage insurance managers to set up operations that ultimately facilitated the development of the captive insurance industry in the Cayman Islands.
Of course, there also needed to be a demand from companies that wished to form a captive insurance company, and in the hospital and healthcare sector, the increases in the premiums for medical malpractice risks charged by the traditional commercial insurance providers, provided the catalyst for many institutions to consider alternative insurance arrangements.
The Cayman Islands has been successful in attracting healthcare captives and according to the latest statistics provided by the Cayman Islands Monetary Authority (CIMA), there are now 225 healthcare-related captives, writing premium income in excess of $3 billion and with total assets over $14 billion.
The purpose of captives is to provide insurance cover for the risks of the groups to which they belong and they are an important risk management tool, adding flexibility to enable the risk manager to manage and mitigate the risks faced by the entity in a cost-efficient manner.
These cost-efficiencies often arise through the outsourcing of a captive’s key functions to professional companies which can ensure that a broader and more appropriate level of expertise is available to assist with the effective management of the captive.
However, the use of an outsourced service provider can present risks, particularly when the board of directors, who are ultimately responsible for the captive’s operations, become overly reliant on the service providers. It is essential that appropriate internal governance arrangements are put in place to provide proper oversight of the outsourced function.
The board needs to ensure that, as a body, it has sufficient resources and expertise to oversee the outsourcing arrangements and to review and challenge decisions made and actions taken by the outsource provider.
While outsource providers may play a significant part in managing the captive’s key functions, the areas where the captive board retains responsibility include:
Setting the strategic qualitative and quantitative objectives of the captive;
Establishing and documenting all policies and procedures for corporate governance including the risk management framework and a formalised document that defines the design and operation of the board itself;
Checking, communicating and documenting guidelines and instructions on how the company should be operated;
Ensuring that there is satisfactory control of the captive’s financial reporting and management of assets;
Ensuring that the captive complies with all applicable laws and regulations;
Defining the Internal Control policy; and
Defining the outsourcing policy.
In practice we, at RSM, see many of the above functions delegated to an insurance manager and boards should be cognisant of the fact that the outsourcing of functions cannot result in the abrogation of their responsibilities. The board should comprise members who are of good repute and integrity and who have the appropriate qualifications, knowledge and experience to provide sound and prudent management of the captive.
In providing sound and prudent management, boards should apply their collective knowledge and experience of the parent hospital or healthcare provider to provide meaningful insights to help set informed objectives for the captive. Too often we do not see evidence that the board has had sufficient input into the key governance processes.
For example, apart from when the case is being made as to whether to establish a captive insurance company or not, we do not see evidence of board involvement in the business planning process. Often the formal plan reads as if it is a regulatory necessity prepared from a ‘boilerplate’ template by the insurance manager.
As a result, many of the benefits which may be derived through the setting of qualitative and quantitative standards against which the captive’s strategic performance may be judged are potentially lost.
Standards
In the case of qualitative standards, we would expect the business planning process to consider developments at the parent hospital or healthcare provider and to assess how this may influence the captive. We have seen instances where there has been material adverse loss development within the captive and where little analysis has been performed to ascertain the root cause for this, nor consideration of the implications for the captive in the future.
In the health sector there is a lot of industry data, such as the Aon/ASHRM Hospital and Physician Professional Liability Benchmark Analysis, which boards can use in analysing the captive and setting the qualitative standards. We realise that a lot of this analysis will be occurring at the parent level, but the captive insurance company is a separate legal entity where there is a regulatory requirement for boards to be intimately involved in the planning process.
From a quantitative standpoint, the main measure we see is in respect of premium rating. In the best plans we see evidence of challenge of the actuarially determined rate. This challenge takes the form of understanding the sensitivity of changes in the rates from setting these at various percentile levels and the formal consideration of the captive’s financial strength and its ability to absorb losses, should experience be worse than that assumed when the rate was set.
The latter necessitates that the board has a view of the economic, as opposed to regulatory, capital that is required within the business.
The quantitative measures within the business plan also provide the financial benchmarks against which performance may be assessed and our experience is that, too often, boards may not have sufficient understanding of why actual performance is better or worse than the initial plan and then consider the implications for the business.
A high quality and well considered business plan is essential for helping the captive articulate its strategic objectives. The captive’s policies and procedures hang from this and although these will be developed in conjunction with the insurance manager and other outsource providers, it is the board which is ultimately responsible their design and for ensuring that they are being complied with.
Compliance
Providing evidence of compliance with appropriate policies and procedures is becoming increasingly important because of CIMA’s inspection regime. Generally, we see boards confirm compliance through the performance of either a formal or informal self-evaluation process, and we question whether this process could be improved.
For example, most hospitals or healthcare providers which have a captive insurance vehicle are sizeable organisations with an established internal audit function who could be commissioned to look at the way in which the captive complies with its stated policies and procedures. Alternatively, the review could be sub-contracted to a third party provider with the particular experience of the captive insurance sector.
The benefit of a review by the internal audit function or third party provider is that they can carry out an independent assessment of the captive’s business-critical policies and procedures, including a review of its outsourced activities.
The self-assessment or internal audit review should help the board ensure that:
The framework for outsourcing, including the outsourcing policy, is correctly and effectively implemented and is in line with the applicable laws and regulation, and with the captive’s risk appetite;
The risk appetite, risk management and control procedure of the outsourced service provider are in line with the captive’s strategy;
The appropriate involvement of governance bodies; and
The appropriate monitoring and management of outsourcing arrangements.
In conclusion, captives are a cost-efficient way for hospitals and other healthcare providers to manage their risks. These efficiencies are often derived through the use of outsourcing arrangements.
However, management, including the board, must guard against the risk that it becomes over-reliant on the outsource service provider. This can be achieved through the board’s retaining ownership of the development of the captive’s strategic objectives and through the establishment of comprehensive outsourcing policies and procedures.
These should define key performance indicators, key control indicators and the other service delivery reports that the board can use in managing its relationship with its outsource suppliers. l
Philip Alexander is a partner at RSM. He can be contacted at: philip.alexander@rsm.ky
