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Fronting a captive
Peter Willitts addresses some of the
issues surrounding fronting.
April 2007
When you start looking for an insurance
company to front your captive’s programme,
there will be no shortage of companies
willing to work with you. Be wary of them.
It is not good enough for an insurer to have
worked on something similar to a captive in
the past. A solid captive fronting company
is one that both specialises in captives
and assigns a team of captive-specialist
professionals to your business.
• an underwriter, who is familiar with the alternative market;
• an actuary, who is attuned to the finer points of the programme
and your appetite for risk;
• a credit analyst, who understands the reinsurance collateral
involved;
• a lawyer, who knows how to handle a captive structure; and
• an account representative, who knows that a captive structure is
not a plain cookie-cutter insurance product.
Such a team will become consultants for the life of your captive,
ensuring that you reap the intended benefits of the vehicle.
Underwriting will incorporate loss control into your pricing, and will
make sure your risks are rated appropriately—for contractors in
Minnesota, say, rather than contractors throughout the country—and
collateral management will never become unduly onerous.
Your insurance broker and the Captive Insurance Company
Association (CICA) are both good captive information resources and
can provide you with a list of fronting companies from which to choose.
Some fronting companies will insist on a broker’s involvement, while
others will allow direct placements.
Once you have narrowed your search down to a few captivespecialist
companies, the next benchmark to look for is quality of
paper, which refers to a company’s ratings by Standard & Poor’s or
A.M. Best. Insurance companies with an A rating are usually large
companies with the ability to grow along with your captive. These
are the companies with the capital to secure reinsurance, which can
weather the cyclical ups and downs in the market. They are also
more likely to offer robust programmes—such as those that combine
disability and workers’ compensation—which make your captive
more independent and more within your control.
A key point in your decision to form a captive is the ability to directly
reap the rewards of strong claims management and a successful loss
prevention programme. Therefore, the next step in shopping for a
fronting provider is to look for an insurer with strong competencies
in risk management. Forming a partnership with the insurer’s loss
control team can help improve workplace safety—and investments
in workplace safety will pay for themselves many times over. The advice delivered by the team should include practical, cost-effective
ways to minimise or eliminate workplace accidents, injuries and
property damage. What you want are specialists who will help you
operate more efficiently, be more productive and have fewer losses.
For every dollar not spent on losses, you get to put a dollar of profit
back into your captive programme.
Now that you have winnowed your list of fronting company
contenders, it is time to investigate the minutiae that separate ‘fronts
around for the long haul’ from the rest. The flow of information, data
and premium impacts the level of service your captive will receive and
is critical to a captive’s success. You need to investigate a potential
front’s reputation in the industry for these points to ensure that not
only does the company have good ‘flow’, but that it is able to provide
quality data and to protect that data. A front should have in place
strong systems backups and other safeguards around data to protect
it from loss or damage. It should also be known for passing cash
along to the captive in the short term, and have people experienced
in Sarbanes-Oxley compliance and internal audit.
On the surface, a captive insurance policy looks like any other
insurance policy you have handled for your company. The
reinsurance language, however, is far more intricate and requires
some fairly serious discussions with your underwriter. The more
details you include in your submission, the more able you will be to
have a meaningful conversation that gets your programme up and
running. Some of the things your underwriter will touch upon include
the price of the paper, where the aggregate goes, the cost of claims
handling, and service team specifics.
This is where you will begin to see the importance of having a
captive-specialist team in place. You don’t want an underwriter who
gives you a piece of paper just by looking at the payroll numbers, and
figuring out the number of employees and what they do. A captive
underwriter needs to go beyond that to figure in levels of retention
(and how they change); reinsurance; whether a retrospectively rated
programme is suitable; where to put credit exposure; and other
details involved in more complicated insurance structures.
Other members of the team, such as the actuary and credit analyst,
will determine the amount of secure collateral required. They will
also decide where to let credit exposure go: either as a receivable
from the insured or as reinsurance. Again, you don’t want an analyst
who bases your letter of credit just on the grade of your company.
There are various levels of creditworthiness, and you want someone
who is familiar with differing corporate structures. The amount of
reinsurance you buy influences the required letters of credit, which,
in turn, determine the amount of capital you have to put into the
captive. If the collateral or letter of credit is not available in sufficient
amounts, you won’t be able to get an insurer to provide a policy.
Additionally, the actuary should be used to working with a captive
in order to take into account your company’s dedication to claims
management. Each company has a unique loss history and each
management team has a unique commitment to loss control. A
straight application of development factors will not adequately rate
your company’s unique details and will affect the calculation of your
ultimate loss numbers. This is an important detail, since the ultimate loss number sets off the collateral requirement and is one basis for
your captive programme fees.
A captive-specialist lawyer is flexible and can adjust or create
reinsurance management policy language without becoming mired
down in canned terminology. Your captive account representative
understands your goals and has the skills to help you achieve those
goals. This is the person who helps determine what captive vehicle
is the best fit for your company—one of the various rent-a-captive
options available or an owner-insured.
Lastly, we come to the captive manager. This person is your captive’s
advocate and the one who works closely with the rest of your captivespecialist
team to co-ordinate reporting and information flow. The
captive manager is typically knowledgeable about the similarities
and differences of the various domiciles. It is the captive manager’s duty to ensure there is smooth information flow between the fronting
insurance company and various vendors. This is important, as fast
and effective reporting reduces your captive’s operational costs.
Another responsibility of the captive manager is overseeing your
captive’s annual audits to ensure they are completed without
problem. There are three different types of audit that every captive
faces.
First is the regulatory audit performed by certain domiciles, in
which the insurance commissioner sends in the domicile’s audit
team from its compliance division to ensure you are in compliance
with the domicile’s regulations. Whether or not you have this audit
depends on the domicile where your captive is incorporated and how
long it has been there.
Second is the outside audit, which looks at whether the businesses
you have inside your captive make sense.
And third is the Sarbanes-Oxley audit, in which your captive
is reviewed to determine if it complies with the corporation’s key
operating criteria and if it complies with ‘Sarbox’ regulations as laid
down by the captive’s parent company.
A captive manager can be either an independent consultant
not affiliated with the fronting company or a company embedded
within the insurer. Regardless of employment status, the ultimate
responsibility of the company and its staff is as a fiduciary of your
company, and it will facilitate the services received. The key is that
the manager can influence the insurer so that you receive a fully
integrated service that is not fragmented.
So you have now found a fronting company and an experienced
captive-specialist team. If everything goes smoothly, how long will
it take to get your captive up and running? If you have an existing
captive and are switching fronting companies, it will be a fairly swift
process. If not, it will take two to three months to implement the
captive option. New captives take more time to set up, because
there is an incorporation process. Sometimes new captives fall into
what might be called the ‘What comes first? The chicken or the egg?’
category. This happens when a fronting company will not give you
a quote until your captive exists. At this point, a red flag should be
going up and you should be questioning the fronting company’s
enthusiasm for the project.
It is important to carefully consider whether a captive is the most
appropriate insurance vehicle for your company before implementing
your plan. While a captive is not the right vehicle for every situation,
for the companies where it fits, a captive can be a lucrative longterm
investment that encourages better loss control and allows you
to reap the benefits of retaining your insurance premiums
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