23 August 2019

The captive utilisation review: a necessary tool

Since risk finance, business strategy and market conditions are all subject to change, it is important to periodically review a captive on a regular basis, to ensure it continues to meet the desired objectives of insured parties, owners, and other stakeholders.

A captive utilisation review will help assess if the captive is being used optimally by first examining the rationale for the captive’s formation, and then comparing this to the current state that the captive finds itself in.

A formalised captive utilisation review is a periodic process designed to ensure a captive is being utilised optimally in support of the parent company’s risk-financing goals and enterprise risk management strategy.

It should be performed by a party that is not involved in the daily management of the captive. The subjectivity and independence of using someone other than the captive manager to provide these studies is essential, as a manager may be too close to the client and captive to truly recognise opportunities for change and expansion, nor do they have the breadth of knowledge needed to assess multiple lines, domiciles and structures.

While no two captives are alike, it is generally recommended that a utilisation review of every captive be commissioned by the board or the parent at least every five years. Captive insurance industry best practice approaches to a captive utilisation review should be considered under the following circumstances:

  • For existing captives that have not had a review in over five years;
  • Any time there are material changes to the parent’s business profile such as:
    • Rapid growth or reduction in annual premium written by the captive;
    • Significant acquisitions, divestitures or mergers; and
    • Fundamental change in business goals or strategic direction;
  • When considering offering additional lines of coverage;
  • In conjunction with updates to the captive operating plan;
  • Insurance market cycle changes; and
  • When excess surplus has been created in the captive which may drive discussions on best deployment and return on investment of those assets at either captive or shareholder level.

Key components of a captive utilisation review
A captive utilisation review will help assess if the captive is being used optimally by first examining the rationale for the captive’s formation, and then comparing this to the current state that the captive finds itself in.

This process entails an examination of the continued relevance of the current captive programme to any developments in the parent company’s business. The review may also consider the captive’s financial strength at a high level, reviewing the financial condition of the captive to determine the potential leverage of its capital base to support any potential expansion of the captive programmes.

A review will also include an overview of insurance market conditions to identify particular issues that are likely to impact the role of the captive in the corporate insurance programmes or in funding uninsured or underinsured risk exposures. A review of the parent company’s current re/insurance programmes is important to identify opportunities for new and expanded captive participation.

Analysis to determine the optimal level of risk retention and risk transfer of the identified insurance programmes should be performed to minimise the total cost of risk. The resulting analysis may help to reduce the risk-financing spend of the company and identify how the captive can play a pivotal role in achieving this savings.

This analysis will assess the value of any proposed changes and address the practicalities of implementing them. It then serves as a benchmark against which future captive performance can be measured and provides the blueprint for the development of the captive.

Potential benefits
It is not uncommon for utilisation reviews to result in valuable adjustments being made to the captive’s operating plan. Areas of interest can include:

  • Reduction in external premium spend and overall reduction in total cost of risk;
  • Introduction of efficiencies into process leading to reduced expenses;
  • Streamlining of number of captives in operation through merger, run-off and closure resulting in a more effective captive strategy;
  • Review of capitalisation, collateral and reinsurance support so that the captive’s financial position is optimised for its current business plan; and
  • Adoption of efficient governance processes (board committees, stewardship reviews of service providers and regular engagement with domicile regulators) to ensure the captive maintains its position as a beneficial tool for risk-financing for the parent organisation.

Some examples of real-world outcomes help illustrate the inherent value of periodic utilisation reviews.

ABC Construction
As a result of prior risk-financing plans and acquisitions of companies with captives, ABC found itself with six captives around the world. Collaborating with ABC, and after working with them to understand the current and future exposures of each of the captives, a strategic review was performed.

The results of the study determined that there were certain strategic, financial and risk management benefits to ABC to reduce the number of captives to two: one domestic captive insuring North American risks; and one non-US captive for the non-North American risks. All other captives transferred their liabilities to the two continuing captives through a loss portfolio transfer.

As a result, ABC realised annual savings of $200,000 in operating costs as well as eliminating $50 million in surplus.

FIZ Food & Beverage
FIZ inherited liabilities through a company acquisition and already had an established captive in the US. FIZ decided to embark on a comprehensive study to review:

  • The performance of their captive inception to date;
  • Whether to expand the captive to include the liabilities acquired;
  • Whether to establish a completely new captive for the acquired liabilities and operate two captives; and
  • Whether to explore additional lines of business to be written by the captive, including funding property and casualty retentions and generating additional revenue by writing third party business.

The study culminated in a master strategy for the parent organisation that included loss projections, pricing analysis and a cost comparison for FIZ to consider.

This resulted in greater participation by the captive in the risk-financing programme of FIZ, including funding retentions and insurance medical stop loss and cyber. Operations were tightened up and better aligned with FIZ with the formation of an operating committee at the captive level.

PDQ Transportation
PDQ operates several captives and wanted an independent assessment of its options for an alternative domicile for one of its captives. The captive domicile study considered the following:

  • Ease of entry and exit from current and prospective domiciles and administrative processes;
  • Ease of captive operation and the regulatory/compliance regimes;
  • Capitalisation requirements;
  • Ability to reinsure controlled third-party risks;
  • Ability to write insurance on a direct basis;
  • Fronting options and structures;
  • Control of claims and third-party administrators; and
  • Local and US domicile taxes, fees and charges.

The study also assessed current operations of the captive in order to recommend ways to streamline annual costs, capital requirements and operational processes for each domicile under review. PDQ’s tax, legal, finance and risk management teams were involved in order to understand potential internal challenges and to determine the best solution from all perspectives.

The result was a recommendation to move the captive from an offshore location to an onshore jurisdiction which produced certain strategic, financial and risk management benefits for PDQ.

Captives are formed for many reasons including control of insurance programmes, as a strategic risk management tool to benefit from cost efficiencies, and gain access to reinsurance markets, premium reductions, and risk finance expense control among others.

In order to ensure these objectives are still being met, to adapt to various business and market changes, to continually meet company risk-financing objectives and operate efficiently, a periodic review of the captive’s operations, results and business plan should be explored through a well-documented utilisation review.

Elizabeth Steinman is head of Aon’s risk finance and captive consulting team in the US. She can be contacted at: