Bruce Whitmore of Willis Towers Watson provides an overview of the skills captive consultants must develop and the questions to be asked on a daily basis.
I just said to a client: “You do realise that sometimes we just make this stuff up, right?” I’m simultaneously being tongue-in-cheek and deadly serious. The broker and actuary in the room blanch and give me a look that says: “I can’t believe you just said this to my client!”
The follow-up explanation is simple. With captives, this is quite commonplace. If we look back to the early days of Lloyd’s of London, the formation of the mutual insurance companies in the early 1900s, or the development of physician-owned malpractice insurers in the 1970s, a common theme emerges.
There wasn’t a solution available at the time, so someone had to “make it up”. As captive consultants, we have a depth of examples and experiences that guide us, even when they don’t provide a time-tested solution. That’s the great part of this job—it doesn’t get boring.
Curiosity and creativity
Captive consultancy starts with being curious enough to gain an in-depth understanding of the underlying risk financing problems that need a solution:
- Risk challenges: is the issue one of the cost of the coverage, or is the coverage simply not available? Or is it that the real exposure is subject to exclusions?
- Risk appetite: how much risk is the insured willing to bear? If claims come in at the upper end of those limits, how much disruption will it cause to the organisation?
- Current organisational structure: are they a for-profit, not-for-profit or tax-exempt entity? Are they private or publicly traded? Do they have private equity investors? How many subsidiaries, brother-sister and parent-child related entities are involved? How are those entities taxed?
- Cash flow impacts: do they have the cash to put in the captive to pay future claims or would they rather bear the risk in the form of large deductibles or retentions? Would they prefer to pay the losses out of short-term cash flows sometime in the future? How will the directors of the organisation respond to loss volatility at the expense of earnings? Is it too disruptive to their quarterly financials, stock valuations, or lender relationships to pay the losses when they become due?
- Regulatory and contractual considerations: is carrying the coverage required by statutes, loan requirements or bond covenants? Must coverage be issued by a licensed or authorised insurer?
- What other client-specific issues might impact the recommended risk financing solution?
Second, you must cultivate your creativity. As a captive consultant, the next thing we have to do is ask the questions “What if we…?” and “Why not?”. This is the time to remain open to all possibilities, no matter how improbable they may seem.
It is the time to set aside, to the greatest extent possible, preconceptions and personal preferences and ask questions such as:
- Can the captive issue the policies directly, or will it be prohibited by statute, contractual requirements or the need for evidencing rated coverage?
- If the insured bears more risk, will the commercial insurers offer better coverage or more reasonable terms, or will the coverage exclusions still remain?
- Is there a way for organisations facing similar challenges to pool their risk together to provide “real” coverage when the commercial carriers won’t?
- What happens if the large losses exceed the captive’s loss funding and capital? Is that outcome substantially worse than if the insured’s financials directly absorb the loss?
- Are there ways to creatively approach the excess and reinsurance or capital markets that would provide a solution that is not currently available?
“Captive consultancy starts with being curious enough to gain an in-depth understanding of the underlying risk financing problems that need a solution.” Bruce Whitmore, Willis Towers Watson
Outside your comfort zone
There are two common uncomfortable sensations that commonly arise during more complex captive consulting engagements, and are actually to be relished.
The first is going beyond your comfort zone. It usually begins with a thought such as: “What did I get myself into this time?”. It’s normal to feel this way. It happens because no matter how experienced a captive consultant may be, every client is different.
Projects will likely involve a different sub-sector of the consultant’s area of direct expertise, or an entirely new industry. For almost every project, it means the rules change in some form or fashion. In industries where the use of captives is uncommon or just emerging, the learning curves can be quite steep.
It’s important to admit the limits of your knowledge and reach out to brokers, actuaries and other experts in the field to figure out what you don’t know about financing risk in the particular industry or sub-sector.
This is a great time to remind yourself that by doing a “deep dive” into the project and ensuring you become comfortable explaining all the relevant issues, you will have learned something new and taken one more step to becoming an “expert” in captives for the given industry. Captive consultants should have an innate passion for learning something new.
The second sensation is the sense of being overwhelmed. A project may evolve into a larger and more complex project than originally envisioned. The internal client politics can become multifaceted. A large number of industry or regulatory considerations may emerge that need to be compared and contrasted to develop meaningful recommendations.
Uncertainties will usually creep in that need to be thoughtfully explained. It can be helpful at times like this to remind oneself of the adage: “How do you eat an elephant? One bite at a time, of course!”
To help with the feeling of being overwhelmed, look to the structural aspects of prior reports to remind yourself where to start. Remember how prior projects looked overwhelming, but have become success stories. Review prior projects for commonalities.
Look to other colleagues’ work to help you understand what you do, and—more importantly—what you don’t, fully understand about the current project. Figure out how to research the things you need to know to develop the solution. With every small step, the project gains clarity and becomes more digestible. The elephant then begins to look more like a large meal.
You must also bring your individuality to the project and be prepared to present your recommendations differently. Sure, there are common captive concepts that need to be covered in a typical feasibility study, but that doesn’t mean that boilerplate language is the best approach.
Good captive consultants gain an understanding of their client’s businesses and the manner in which they prefer complex issues to be explained. Some clients want to know the logic behind every recommendation and the source for every number. Others will want to cut directly to the executive summary.
Any way you think about it, a competent captive consultant needs to be able to answer how they arrived at the particular conclusion and how the given recommendation compares to the other options.
Preparing for difficult questions is vital. The client will more than likely ask:
- “Couldn’t I bear that same risk myself without forming the captive and incurring the captive expenses?”
- “How does the captive compare on an apples-to-apples basis to what we’re doing now from a financial perspective?”
- “Why won’t the captive save me money in the first year?”
- “What is the downside to your recommended approach?”
- “What will the captive evolve into in three, five and 10 years from now?”
Most times it’s best to simplify the answer and then offer the counterargument. Of course, the organisation could probably retain the risk. However, there likely are qualitative, non-quantifiable questions to consider that will shed light on the value of the captive such as:
- What would be the impact on the cash flows and stock value when the big claim has to be paid?
- How will the directors react to risk managers who simply choose to bear risk on the financials with what will inevitably seem like a lack of preparation or proactive consideration?
- If the risks are retained on the balance sheet, how will the organisation apply discipline and governance to anticipate and manage the risks?
- If the commercial carriers dramatically increase pricing or add exclusions, how will the organisation anticipate and manage those changes in coverage availability?
Captives evolve over time and can cost more in the first year to set up when compared to buying commercial insurance. Many times, the answers will require artful explanations of the nuances that are not well answered by boilerplate language.
Becoming a captive consultant
There are some excellent educational programmes such as the International Center for Captive Insurance Education, as well as some very good college courses, but most consultants grow into the role through on-the-job experience.
Brokers become exposed to captives either because their clients incur challenging market conditions, or they lose an account to another broker who offered a captive solution.
Companies who form and manage group captives recruit producers, client managers and other staff to support new and existing programmes. Insurers venture into supporting captives through fronting, reinsurance or claims third-party administrator services and need staff to learn the nuances.
Extroverted actuaries may realise they are better suited to client-facing, self-insured opportunities. Captive management companies may want staff that can offer more creativity and go beyond the accounting and management functions.
If you are employed by a relatively large company, reach out internally. It is quite likely there are some colleagues that have captive experience to draw from. Feel free to reach out to consultants and captive management firms.
Research the educational programmes and ask if your company will pay for the tuition. Attend domicile and captive trade conferences in your area, introduce yourself and ask questions. Captive professionals like to teach people, and want to attract new talent to the industry. You will find us to be a very welcoming group.
Willis Towers Watson, Captives, Insurance, Reinsurance, Bruce Whitmore, North America