Interview with Shanna Lespere of the Bermuda Monetary Authority

Best Practices for Captives
At the session with this title at this year’s WCF, the panelists will first be confronted with the topic itself. Just what do we mean by “best practices?” There seem to be several different ways of answering this general question, and these lead to the kind of general definition that the panel may be addressing. Or not, as the discussion will be open to challenge and enhancement from the audience!

Way One: The first way of answering the question starts with the position of the captive . There are four positions that will make the definition of “best practices” different. We see these four positions as:

#1: Size: Large, small, intermediate

#2: Activity, lines of business: WC, Property, Benefits…. and direct or reinsurance mode

#3: Culture: This means the owners’ culture in terms of

Single or multiple owners (RRG, reciprocal, closely-held….)

For profit or not-for-profit (healthcare, for instance!)

The kind of business they are in (services, manufacturing, hospital….)

Whether their risks are global or domestic in scope

#4: Commercial Insurance? How closely the captive is to being a commercial insurance company, in other words, how much third party business is written.
Once the positions have been identified, then we can start in on the individual best practices for that particular mix of positions. It is worthwhile noting right here that all captive owners believe deep down that theirs is unique and doesn’t compare with others, exactly. See our article “Captive Differentiators” that gives more than 50 ways they may be different.

Way 2: The second way of answering the question, and this way is borrowed from accounting practices, is to define in advance the purpose or objective of the captive. These could be, for instance

To reduce overall costs for the original insureds (Accessing reinsurance and other nonstandard markets is part of this one)

To show a healthy bottom line (or a good return on capital)

To make available the best coverage (including terrorism, for instance)

To support the financial objectives of the shareholders of the owners (or to support their business objectives, which is a lot vaguer and harder to pin down. Or supports corporate strategy, another vague one)

To support risk management (possibly involving the “cost of risk”, which would bring us back to the first one)

Third way: A third approach is to set down a predetermined set of ratios. Tillinghast proposed some in the 1980s, called GACS (Generally accepted captive standards). AM Bests has another set in their guidelines for captive ratings. Most regulators have some, too. It’s not worth putting down the list of ratios, yet, because that will probably be one of the topics debated in the session!

In this third way are included all the attempts to survey and benchmark captives. Most of these suffer from data dispersion, incomparability (from the differences in way one, above) and unhomogeneous respondents. The CICA annual survey on fronting is a good example: Each year there is a different group of respondents, yet they draw conclusions about how best practices have changed from year to year. The same applies to the small universe of rated captives AM Bests uses for its captive standards.

Fourth way: At the end of any of these “best practices” will be a list of negatives. Captives should not be involved in some things, and if they are, these are things that, if not avoided, detract from the best practices score. Here are some examples.

Getting audited by the IRS (and losing big time)

Getting warnings from the state examinations, or failing a SAS70 report from an outside entity.

Getting involved in member disputes (for group captives)

Loaning back too much money (some is okay – but how much?)

Losing a rating, getting put on a watch list, or worse

The working definition: The panel, therefore will start with something like this

For a given kind of captive, and kind of owner

With a defined purpose or objective

How well has the captive achieved these purposes or objectives?

First, what are the signs of achievement, and who validates them? (Who says, in other words?). These will be the short list of “best practices”

Second, the signs that top management (or the membership) agree and approve (What are those signs? These are “best practices second level”)

Third, do these best practices for the captive prove that its programs compare favorably with the next best alternative? (How do you know this is best practice, in other words?)

Modus operandi: It is evident that this kind of approach must select one or two key topics and discuss best practices in terms of them. The panel will first ask the audience for topics to discuss, and then propose some of its own.

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