Before you build a captive, build your risk financing strategy

Danielle Bourgeois, Courtney Hylant and Claire Richardson of Hylant looks at why companies need to stay up to date with their captive needs at all times.

As the risk manager finished presenting her regular report to the board, one of the company’s directors looked around the room, then spoke: “Remind me again why we have this captive.”

For days after the meeting, the risk manager imagined a much better answer than the stumbling response she delivered. But that’s excusable, because the request was startling. No one ever questioned whether the captive was functioning. Claims were being paid. Premiums were being collected. Required meetings took place. Financial reports looked fine.

Eventually, the realisation struck. The directors and executives who had championed the captive had retired or moved on. New directors joined, and new execs were brought onboard. Fewer people understood how the captive fitted into the company’s broader business strategy.

Asking the wrong question

Most organisations begin by asking the wrong question. It isn’t whether your organisation should have a captive. It’s whether your overall risk financing strategy accurately reflects the way you do business today and how you’ll do it tomorrow. A captive might play an important role in that strategy, but it shouldn’t be where you begin the conversation. Step one involves asking a more fundamental question: How should we best finance risk to support our long-term business objectives?

That question is equally critical whether you’re thinking about establishing a captive or have been using one for years. Your company and your marketplace are in an ever-changing world, and that creates strategic inflection points. New risks emerge as your operations expand. The commercial insurance market hardens and softens. Acquisitions and divestitures reshape your balance sheet. New leaders bring different visions. Yet too many organisations continue financing risk in familiar ways, simply because the system is already in place. Too often, organisations revisit their risk financing strategy only after one of those inflection points forces the conversation.

Anticipating before acting

A strategic assessment gives organisations the opportunity to anticipate those inflection points rather than react to them. Typically, that assessment combines analysis of historical loss data, financial risk-bearing capacity, business objectives, existing insurance programmes and operational plans to determine the most effective financing approach. It’s not only about evaluating a captive – it’s all about evaluating the business. 

That involves asking tough questions that demand research. What risks does your organisation face today? Which risks are predictable enough to retain? Which are best transferred? How much volatility can your balance sheet comfortably absorb? What is your true economic cost of risk – not just insurance premiums, but retained losses, collateral requirements, capital commitments and financial uncertainty? Those questions establish the framework for every decision that follows.

For organisations without a captive, such an assessment helps determine whether a captive is appropriate for the overall financing strategy. Does the organisation have sufficient scale? Are its losses predictable enough? Would a captive improve financial outcomes compared with traditional insurance? Just as important: are there reasons why another approach would be more suitable today?

These questions are crucial, no matter whether the answer is yes, no, or maybe. And the answers create real business value because they’re driven by thorough analysis rather than simple assumptions.

Evolution doesn’t stop

Organisations that already operate captives need to ask many of the same questions, although they may approach them from a different perspective. Has the captive kept pace with the business? Is it financing the right risks? Are there opportunities that didn’t exist when it was first established? Has the company’s appetite for retaining risk changed?

Taking the “set it and forget it” approach to a captive can be a recipe for poor performance and inadequate risk mitigation. It’s easy to understand why. As noted in the scenario that opened this article, captives often become part of the organisation’s infrastructure. Premiums are paid, claims handled, board meetings occur. Everything functions as expected.

Meanwhile, the business and its industry continue to evolve. Was doing business different a decade ago? Of course, and everyone talks about how rapidly the pace of change is accelerating. Your company has changed its business practices in response. Yet the captive often remains largely unchanged, still structured around assumptions that might no longer reflect today's business.

Why ask about that?

One recent strategic assessment illustrates how easily companies can overlook potential opportunities. As they reviewed a client’s existing captive, our consulting team began asking questions about the organisation’s employee benefits programme.

The client’s response was immediate. “Why are you asking about that?” That question revealed just how narrowly the organisation had come to think about its captive. Until that conversation, the client had viewed the captive exclusively through the lens of property and casualty insurance. Broader strategic possibilities and additional lines of coverage that were well-suited for inclusion in the captive were never discussed.

Our experience reveals that such moments and responses aren’t unusual. While it’s true that a captive is an insurance company, viewing it that way limits its potential to support the company’s strategic business objectives. When a captive is properly integrated into an organisation’s overall financing strategy, it becomes a much more versatile financial tool than many executives realise.

Making the most of surplus

The same basic principle applies to how a captive’s surplus is managed and used. While having a healthy surplus is often viewed as evidence that a captive is succeeding, all that accumulated capital is really valuable when it’s being deployed intentionally and strategically. After all, your objective shouldn’t be to accumulate surplus for its own sake.

Depending upon the organisation’s objectives and leadership’s comfort level, excess surplus might support expanding the captive into new lines of coverage, investing in loss prevention initiatives, enhancing claims management capabilities or even making strategic loans to the parent organisation to support initiatives for future growth. Every organisation may be different, but its objective should be exactly the same: putting capital to work where it creates the greatest long-term value.

Education matters

There’s another common finding in our team’s strategic assessments. It’s one that’s not particularly technical, but equally important: with time, knowledge fades. Drawing again on the exchange between the director and the risk manager, people retire or take jobs elsewhere. Directors leave the board. They’re replaced by capable executives and directors who inherited a captive they weren’t involved in creating and might not fully understand. That’s when people say things such as: “Remind me again why we have this captive.”

Analysis is critical. So is education. Helping leadership reconnect the captive to the organisation’s broader financial strategy often accomplishes far more than simply recommending changes to coverage, capital or governance.

In fact, what might be the most encouraging aspect of a strategic assessment is that it doesn’t begin with a predetermined destination. When it’s complete, the recommendation could be to establish a captive. Maybe it will be to expand one. Or it might involve restructuring, recapitalising or changing the domicile of an existing captive. Sometimes, the recommendation is to leave the current structure largely unchanged because it already aligns well with the organisation’s objectives. Those aren’t different products. They’re different answers to the same business questions.

Strategy comes first

That’s why organisations should reframe their questioning to be all-inclusive: What risk financing strategy best supports the business we’re trying to build?

When you put strategy ahead of the vehicles you can use to implement that strategy, the role and the value of a captive usually becomes much clearer. Even better, when the captive follows your strategy rather than trying to drive it, it becomes one of the most powerful tools available for getting there.

The above information does not constitute advice. Always contact your insurance broker or trusted adviser for insurance-related questions.

Danielle Bourgeois is a senior captive consultant at Hylant. She can be contacted at: Danielle.Brown@hylant.com

Courtney Hylant is a business risk consultant at Hylant. She can be contacted at: Courtney.Hylant@hylant.com

Claire Richardson is a senior captive consultant at Hylant. She can be contacted at: claire.richardson@hylant.com

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