Cohesive communications among service providers – having a plan
Jack Meskunas (pictured), from Oppenheimer & Co, looks at the crucial communications challenges for captive management.
Those who have ever been pestered by cold calls, have become aware of, and even registered on, the national Do Not Call list. The idea, of course, is to avoid unwanted, largely commercial. Interruptions.
As a service provider in the captive insurance space, if there were a Please Call list, we would all want to be on it. More frequent communication with your service provider can have manifold positive impacts on the performance of the captive, both from the operations and the investment sides.
Over decades in servicing captives and captive managers, multiple conversations have given me additional insights on how to improve communication, feedback and, ultimately, the performance potential for captive insurance investment portfolios. I would like to thank the many captive managers and service providers who have discussed this topic and given me their thoughtful feedback.
Step one, the feasibility study
A feasibility study is conducted when exploring the idea of captive formation. This analysis helps the prospective captive owner, as well as the captive manager, ascertain whether having a captive makes sense from a financial point of view. The better the quality of the input, the more likely the results of the analysis will be accurate and helpful as the document transitions from a proposal to a business plan.
An integral part of the captive’s business plan is the investment policy statement or IPS. A well-crafted and frequently updated IPS explores not only the allowable investments, but also the anticipated liquidity needs. It becomes a hands-on reference for captive investment managers. Paying attention to the asset side of the balance sheet is also critically important. In many cases, I have found that generic assumptions of rates of returns and only cursory treatment of the future investments is addressed. Like the rest of the business plan, the more accurately one can predict how the asset side of the balance sheet will be managed, coupled with accurate modeling of anticipated returns, the more valuable the document will be to the new captive owners and managers.
Captives 101
Captives are insurance companies and insurance companies exist to pay claims when there is a covered loss. If paying claims were the only consideration a captive would stay in cash. However, there are other interests and needs of the captive as well, such as operating expenses. The captive outsources most, if not all, of its operations to third parties. Fees for captive management and other service providers such as accountants, actuaries, financial advisers, as well as claims investigations and processing, are important considerations.
It seems obvious to state, but since a captive is an insurance company, it needs to be invested like one. It should take measured risks in both fixed income and equities – as well as other asset classes, if allowed – to attempt to maximise profits within the guidelines of the IPS. It will also need to match the duration of fixed income maturities and anticipated cash flow events with anticipated claims-paying timetables, at least to the best extent possible.
Captives 201, 301…
A worthwhile financial adviser will want to know more about your captive than just your risk tolerance and what is in your IPS. Understanding the types of risks insured, the expected frequency, severity and payout patterns of claims, and the types and amounts of reinsurance held by the captive can be instrumental in evaluating prospective investments for liquidity and stability. This can help maximise returns while attempting to match the duration and payouts of the claims. This more scientific application to duration matching can help to reduce (but not eliminate) the need to make untimely liquidations where short-term moves in the market could have potential negative effects on the value of securities being liquidated.
Communication between the captive manager, claims manager and investment manager are key to helping guide the financial adviser in setting up the account, as well as managing duration to time bond maturities with anticipated claims payment dates. Communication should not be limited to discussions of specific pending payments. Timely, repeated communication is a safety net, and a liquidity “check-in” call can go a long way towards tweaking portfolios and allowing for liquidations in a timely manner. While most investments found in captive insurance companies are quite liquid, the presence of liquidity does not in any way guarantee the specific value of any investment held at any given moment in time.
More communication – better returns?
When financial advisers and other service providers are in the dark about the insurance experience and operations in a captive, their default reaction is to run the portfolio more conservatively. They typically do this by keeping larger-than-necessary cash balances, or limiting the maturities of fixed income, as well as limiting exposure to equities. Historically the shorter the investment duration and the lower the risk taken, the lower the rate of return.
Given the long anecdotal history of the relationship between risk and return coupled with the value of time in the market, the longer you invest, the more likely you are to have positive returns. This is particularly true over multiple market cycles. Simply put, the longer your investment period, the more investment options are available and the greater the likelihood of better returns.
Prudent financial advisers take less risk in a portfolio if there is a lack of transparency or information flow as to the anticipated cash-flow needs of the captive. Conversely, the adviser could take prudent risk, extend duration and do their best to match the duration if sufficient information were provided initially and on an ongoing basis.
Having a plan
When something happens on the liability side in a captive, there is a strategy in place to deal with it. The captive hires investigators, calls their TPAs, or even engages attorneys under certain circumstances. Whatever happens, they have a plan to react. Why not extend that strategy to include how to handle the asset side of the captive during an event?
The same type of risk philosophy and parameters surrounding insurance can be built into the IPS. This can highlight a framework for two-way communication and explore ways to react and respond to unexpected claims. Having more codified parameters regarding the captive-to-financial-adviser communication expectations – particularly during times of unexpected or unusually large pending claims – would undoubtedly benefit the captive, and all their service providers.
Having an action plan for communication with the financial adviser can help them make the best possible suggestions for equity and fixed-income allocations, as well as lead to a more precise selection of fixed income maturities and durations. Over the long run, this would undoubtedly smooth the variability of returns, the ability to pay claims and the overall performance of the investment portfolio over multiple market cycles. As the captive relies on investment returns to bolster capital and financial strength, having a well-designed communication plan between all interested stakeholders and service providers can be a key component of the overall profitability of the captive – ultimately benefitting both the owners and the insured entities.
Jack Meskunas is executive director – investments, and captive insurance asset management adviser at Oppenheimer & Co. He can be contacted at: jack.meskunas@opco.com.
Past performance is not indicative of future results. All investments involve risk. An investment in this strategy involves a significant degree of risk, including, without limitation, the risk of loss and/or volatile performance.
This article was written by Jack Meskunas, a financial adviser with Oppenheimer & Co. Inc. who can be reached at (203)975-2084 or jack.meskunas@opco.com. This article is not and is under no circumstances to be construed as an offer to sell or buy any securities. The information set forth herein has been derived from sources believed to be reliable and does not purport to be a complete analysis of market segments discussed. Opinions expressed herein are subject to change without notice. Additional information is available upon request. Oppenheimer & Co. Inc., nor any of its employees or affiliates, does not provide legal or tax advice.
Did you get value from this story? Sign up to our free daily newsletters and get stories like this sent straight to your inbox.
