Improving your captive: 8 questions to ask

Luzern’s head of risk, Judah Max Dobrinsky (pictured), shares a report card of factors that can drive better outcomes for a captive insurance program.

Many business owners want better performance from their captive. That's often because results stall when the entity operates as a set-it-and-forget-it policy, rather than a dynamic financial tool. So, what can be done to get the most out of this asset?

That’s a question you’ll want a great answer to no matter your role in the captive ecosystem, whether you’re an owner, broker, service provider, or captive manager.

At Luzern, we think about optimising a captive through two equally important lenses: the quantitative and the qualitative. That means evaluating both the direct financial inputs and performance, as well as the captive’s operations. By focusing on both, seasoned and prospective owners alike can be confident their captive is set up to achieve their goals.

Below is a report card of factors that you can use to grade your captive when looking to improve performance. While experiences vary widely, odds are a given captive owner has assessed some of these factors but not others, or not for some time.

Quantitative Factors

The quantitative aspects of your captive are the measurable financial inputs that impact your bottom line. Each of the following can be considered a lever to pull when looking to improve your outcomes.

Are you retaining the right amount of risk?

The first place to start in analysing any captive is risk retention. Risk is a deeply personal matter. Many take comfort knowing that their insurance is guaranteed cost with a third-party carrier. Others want to take all the risk they can, and then some, with no carrier involvement.

Wherever you land on the spectrum, there are quantitative strategies to assess risk retention and management. A regular retention analysis – reviewing items like the overall pricing impact to your insurance program, the marginal upside of risk retained, and balance sheet protection through reinsurance or excess limits – informs what is appropriate to keep in your captive and what to finance with third parties.

Is your captive structured appropriately?

Ultimately, insurance is the capital structuring of your risk. Just as you’d analyse the appropriate amount of debt and equity and what type of each to have in your capital structure, you should do the same with your risk.

For example, you may have started with a Rent-a-Captive/Protected Cell for initial capital considerations, but over time, has your program grown enough to justify moving to a Single-Parent Captive? Could your captive writing casualty be better off as a Risk Retention Group (RRG)?

Are you trapping capital unnecessarily?

Once you’ve assessed how much risk to retain and the structure of your captive, your next stop is how to finance that risk. Capital requirements are influenced by a number of factors. The domicile of your captive will typically have a minimum statutory amount, it may have additional methods to assess solvency over time, and the amount and nature of the risk will also require a certain level of capital that is actuarially developed.

Capitalisation goes far beyond a simple premium-to-surplus ratio and is heavily domicile-dependent. It’s important to understand the proposed domicile’s requirements for capital and solvency and their understanding of the underlying risk. Poor domicile planning often leads to trapped capital on the balance sheet that could be deployed elsewhere.

Is your tax planning prudent?

Each captive requires a thorough analysis to ensure that tax liability is structured and mitigated prudently. It’s well known that while some domiciles charge a premium tax, others don’t. However, a deeper look is needed to understand the impacts of self-procurement tax, which depends on the state of the parent company. For offshore captives, one must also consider 953(d) elections vs. Controlled Foreign Corporation (CFC) Subpart F income. That decision has implications for tax efficiency, compliance costs, and profitability.

To front or not to front? (That is the question…)

The requirement and cost of fronting is often overlooked and needs legal advice to assess. While a front is sometimes necessary or even desired, there may be ways to avoid one depending on the nature of the transaction and how it is structured. That approach can reduce operating expenses and also free up capital that had been used for collateral. 

The Qualitative Side

Qualitative attributes focus on how your captive operates. Efficient operations can prevent headaches and free up attention to focus on expanding opportunities and protecting against emerging risks. 

Do you have good workflows, data, and analytics?

A convoluted process for managing the captive or reporting on risk and losses creates extra work and often introduces errors. Implementing the right workflows, supported by good data and analytics, leads to better and faster decision-making. Operational clarity also helps to reveal when and where to retain profitable risk. 

Are your regulators supporting your business?

Your relationship with regulators should be productive and positive. The ideal domicile is one where regulators have experience in your industry. They should be demonstrably interested in your success, through their engagements with you and the regulations they pass. Secondary considerations, like the appeal or convenience of a new location for annual board meetings, can also play a role for some owners in generating more value out of their captive.

Are claims being handled well?

This essential process influences the function and outcomes of your captive. Who is handling claims? How is notice of loss reported? If a TPA is handling claims, what are their turn-around times? What authority does the TPA have to settle claims?

An experienced TPA that closes claims quickly saves tremendous frustration and money. Often, the longer a claim remains open, the more it costs. Loss control and a tighter grip on claims are central to why businesses look towards captives, yet the opportunity often goes to waste.

Summing Up

By systematically reviewing the qualitative and quantitative factors that influence captive performance, you will gain clarity on where your organisation is succeeding, and areas for improvement. The insights you develop will serve you well in discussions outside parties including brokers, captive managers, TPAs, and regulators. At Luzern Risk, we are available to you as a partner in this exploration, so don’t hesitate to get in touch.

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