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The failure of a captive can often be traced to a breakdown in quality corporate governance. Ben Whitehouse, senior counsel at Butler Snow, outlines the important attributes of good captive governance.
A good captive board is one whose members are qualified, understand and embrace their responsibilities, represent a diversity of background and experience, and who receive regular training.
It is the governing board of a regulated entity, so good captive board members understand that this regulatory oversight carries with it additional expectations beyond those of other corporate and nonprofit boards that they might serve on.
Responsibility to the regulator
Without its licence, a captive insurance company can’t exist. By obtaining a captive insurance licence from a regulator, that company agrees to abide by a set of rules and be held accountable by a governmental entity charged with protecting the public.
Implicit in the grant of this licence is the expectation that the captive and its stakeholders, including its board of directors, will follow these rules.
It should be readily apparent that captive boards do not operate in a vacuum. Regulators and examiners will scrutinise board meeting minutes and review dividend payments. Captive managers are expected to report back to the regulator if the captive took an action in violation of an applicable law.
While the consequences for failing to meet these expectations vary, one of the most important, and unique, in our business is the loss of reputation. The captive insurance industry covers the globe and yet is a very small community. Domicile regulators rely on the captive manager to educate other captive stakeholders and hold them accountable.
While captive insurance companies are typically given an extraordinary amount of flexibility in ordering their affairs compared to traditional insurance companies, regulators have the ability to take this flexibility away when appropriate.
General board member qualifications
The minimum qualifications for any captive board member should include the ability to exercise commonsense business judgement and a degree of financial literacy.
The business judgement rule means that directors are expected to act in a manner they reasonably believe to be in the best interests of the captive. Financial literacy does not require a potential board member to hold an accounting or finance degree, but it does require that the person understands how to read a balance sheet and is capable of making prudent financial judgements.
In addition to these minimum qualifications, a serving board member has a duty of candour, a duty of loyalty, and a duty of care. All three duties are to the captive and to the board as a whole, even if these duties run counter to the desires of the parent company/insured.
The duty of candour means that the board member must honestly share pertinent facts and reasonably formed conclusions to the board as a whole.
The duty of loyalty is exemplified in the board member’s duty to the captive, and not necessarily to the parent company. This can create a conflict of interest when a board member is an employee or principal of the parent company.
Such potential conflicts of interest should be disclosed and, where appropriate, may require recusal or resignation from the board.
Under the duty of care, board members are expected to be attentive of information presented to them and to ask probing questions when called for. In short, board members should bring a healthy degree of scepticism with them when carrying out their duties.
Board member training
Every captive should have a board member training programme. Usually organised by the captive manager, this programme should include both an initial orientation for new captive board members and ongoing training at the annual meeting.
Topics should include an overview of the regulatory process for captive insurance companies, and updates to domicile-specific captive insurance laws and industry best practices. It is also helpful to bring in service providers over time, such as legal counsel, actuaries, reinsurance brokers, and investment advisers, to provide a more in-depth discussion about their role with the captive.
Captive board members should also take advantage of the many training opportunities available. These can include service provider conferences and webinars, industry publications, and attending major captive conferences, including the captive conference put on in their own domicile.
Setting the strategic goals for the captive
The organising company of a new captive will often set it up to address a specific issue, such as wanting to self-insure a specific line of coverage. During the four to six months (often longer) it takes for a captive to get up and running and during the initial few years of operation, the parent company/insureds can sometimes drift away from the original purpose.
It is incumbent upon the captive board to best understand the needs of the insured and to make appropriate adjustments in the captive’s strategic goals when appropriate. While this process often is spearheaded by the captive manager, it is the board’s duty to direct the captive manager and other stakeholders to seek out new options and opportunities and reset the captive’s strategic goals when appropriate.
Challenges to good governance
When a captive fails, the failure can often be traced to a breakdown in quality corporate governance. A captive board that is inexperienced and does not deploy the resources necessary to fulfil its duties of loyalty, candour and care can run into serious pitfalls.
This issue can be aggravated when the board defers too much so that service providers effectively control all the levers of information and decision-making within the captive. Board members who bring a ‘trust, but verify’ approach can go a long way toward ensuring solid captive board governance.
A captive board should regularly review its effectiveness. Potential items to include in this self-evaluation are:
- Does the board review the company’s business and strategic plans and assess implementation of and performance against these plans?
- Do board members understand their oversight and policymaking roles and functions independent of the service providers and officers?
- Does the board monitor the company’s operating and financial performance?
- Do board members understand the key issues and challenges facing the company and use this understanding to assess and guide the company’s performance?
- Are minutes of the board meeting taken and do they accurately reflect the matters discussed and the actions taken?
- Are board members identifying risks and opportunities critical to the company’s success and taking initiative in giving appropriate direction to service providers and officers?
- Does the board receive clear and concise agendas and background materials in advance of meetings, and are such materials helpful and objective?
- Does the board conduct meetings in a manner that promotes candid and constructive dialogue, meaningful participation, and timely resolution of issues?
- Does the board have the right mix of expertise, skills, experiences and background?
Openly and honestly answering these questions can help guide the board to ensuring that its members are fulfilling their ethical and legal obligations to the captive, the regulator, and other stakeholders.
Ben Whitehouse is senior counsel with the law firm of Butler Snow in Nashville, Tennessee. He previously served as counsel to the state of Tennessee Captive Section. He also serves on the faculty of the International Center for Captive Insurance Education where he teaches business ethics in the Captive Insurance Industry Course.
Corporate governance, Captive insurance, Butler Snow, North America