A careful choice - the captive decision
Forming a captive is something that few companies rush into. Much debate around the dynamics surrounding risk management, financial planning and corporate strategy will have occurred before the decision is made. Robust business plans and financial forecasts will usually be carried out. Most companies will form a captive because they believe it will save them money and allow them to manage their risks and exposures better.
Yet for all the forethought and planning that goes into a strategic decision such as this, few companies give as much consideration to the advisers they then use to help them achieve these goals. This can be a mistake. Sound advice from advisers experienced in dealing with captives can make a big difference to the success of such a vehicle and its future contribution to that business.
Specifically, companies should carefully consider the actuary they use and the role they require the actuary to play. That is the advice of Gregory Fanoe, consulting actuary at Merlinos & Associates, one of the largest independent property and casualty actuarial consulting firms in the US. Fanoe believes that few companies appreciate the added-value services actuaries can offer, which can make a big difference to the success of a captive scheme. And, he pointed out, not all actuarial firms are equal in the service they offer clients.
“The traditional services offered by actuarial firms when it comes to captives revolve around setting premium levels, advising on what the correct capitalisation levels should be, and estimating required claim reserves,” Fanoe said. “Most actuarial firms are capable of offering these services and are qualified to do that.
“But the role of an actuary can go much further than simply offering these services, in ways that can make a big difference. Companies also need to consider the level of service they are getting. Some actuaries, for example, will simply present the numbers they have arrived at with little advice or communication about why the figures are what they are, or how the business might be able to adjust matters to its benefit.”
Fanoe says that Merlinos & Associates prides itself on its ability always to go that step further. It has a breadth of experience covering all types of captives and risk transfer mechanisms and is able to offer a range of value-added services. On top of that, the company endeavours to offer its clients a consistently responsive level of service.
“We like to see ourselves as much more than actuaries,” Fanoe said. “We have a breadth of experience that enables our clients to get the most from their captive. We advise on retention levels and the placement of reinsurance, for example. We want to go beyond the numbers and work with our clients in a far more personal way.”
He suggested that when companies choose between actuaries, they should structure their engagement process in a way that allowsactuarial firms to demonstrate how well they communicate and how proactive they are. “I would be looking for three key qualities: level of service, breadth of experience and an ability to communicate clearly,” said Fanoe.
Thanks to a mixture of economic, regulatory and industry issues, it is more important than ever that companies select the best advisers— tough decisions are being made about the use of captives and it is important to base these on accurate information and good advice, said Fanoe.
The soft commercial market has not helped matters, however. “For potential newcomers to this form of risk transfer, it is certainly hard to justify the up-front cost of forming a captive when insurance rates are so low,” he said. “But equally, even companies that already own captives are being forced to question the costs of running such vehicles when they are being offered insurance coverage in the open market so cheaply.
“Nonetheless, the core reasons for forming a captive—stable premiums and better control over exposures—are still applicable in any type of market. For that reason, it is a risk management strategy that many companies still adopt. Forming a captive requires a commitment—the regulators do not allow companies to chop and change—but we are seeing companies still willing to plan for the long term.”
Fanoe said one factor driving many companies towards considering forming captives is the introduction of the Patient Protection and Affordable Care Act (PPACA). One aspect of the legislation is to motivate companies to offer their workforce healthcare benefit plans. This will mean that more companies will be obliged to consider their risks and exposures and how they can best manage them. One option is the use of captives.
“We have definitely seen a response to the act,” said Fanoe. “A lot more companies are looking to self-insure their health plans and put a portion of their health insurance through captives now. They see the advantages of implementing strong wellness and disease management programmes. It means their costs are more under control and less likely to fluctuate compared with experience in the open market. For some companies this is becoming a huge risk and expense.”
Fanoe added that it is not just big companies that are taking this route: businesses with as few as 150 employees are looking at captives to manage this risk better. He indicated it makes perfect financial sense—even for companies of that size.
He noted that for many companies, insurance is becoming their second biggest cost after payroll. “When you add in the liability and property coverage with workers’ compensation and directors & officers, and now the PPACA scheme on top, it adds up.
“For companies committed to controlling their loss exposure and costs, a captive can be a natural solution. You don’t have to worry about rates suddenly increasing and if the captive is structured correctly, it can prove a better solution.”
Fanoe noted that for US companies considering captive insurance, there are a growing number of US states that can now play host to such entities. “With more than half the states being captive domiciles, it is more important than ever to choose a domicile that best suits your needs,” he said.
Finally, he gave a word of warning for captive owners—another reason companies should choose their advisers with care. With new legislation imminent on both sides of the Atlantic, he encouraged captives to ensure they are compliant with any new rules and that the way they use the captive is clearly communicated. “That is another reason it is worth finding advisers with a proactive approach and a breadth of knowledge,” he said. “We have a wealth of talent here at Merlinos & Associates and that is exactly what captives should be looking for in their service providers.”
Gregory Fanoe is a consulting actuary at Merlinos & Associates. He can be contacted at: firstname.lastname@example.org