As with traditional insurance, captives are keen to have enough capital to cover potential losses or claims that may arise in order to protect the business. That’s why sufficient capitalization is important for the solvency and success of any captive insurance company.

But how can a captive be sure it’s remaining above board?

“Minimum capital standards are designed to ensure financial stability and solvency,” said Dan Petterson, Director of Examinations, Captive Insurance Division, Department of Financial Regulation, Vermont.

These standards are typically statutorily driven and they set the minimum amount of capital and surplus an insurance company must maintain to legally operate. However, meeting minimum capital standards do not necessarily mean there will be sufficient capital and surplus to meet a company’s strategic objectives or to provide a buffer in the event of an adverse financial event.

In order to ensure adequate capital and surplus and to help maintain financial stability, captive owners can work with their insurance team and service providers to determine what level is appropriate based on the captive’s risk profile.

 

Meeting Captives’ Unique Needs

It’s one thing to say that captives should meet a minimum capital standard; but every captive is unique, which means while that minimum might exist, each captive and its management team must review what makes the most financial sense for them.

“The minimum capital requirement is the baseline,” Petterson said. “Captives are considered insolvent if they are below that level, for regulatory purposes, which requires action on our part. What we’re focused on is solvency and the protection of policyholders and stakeholders.”

Having an almost rigid mandate can feel like a burden, but it is anything but. That baseline acts as a jumping-off point for captives to have a full sense of the financial requirements necessary for successful and continued operation.

Before even starting a captive, businesses will have a detailed discussion with their insurance team to prepare for their unique financial needs.

“We have very detailed discussions with clients when we’re setting up the captives about capitalization – yes, there is a statutory minimum requirement, but that is only there should regulatory action need to be taken with your company. We discuss that a remediation plan needs to be put in place,” said Jay Curtis, Associate Director, Aon.

“The actual recommended capital and surplus levels is more dependent upon other factors, such as the limits of insurance the company’s writing, the lines of business it’s writing, the credit worthiness of reinsurers, and other business operations of the company,” he added — in essence, the company’s investment portfolio.

These discussions look at the minimum capital requirement, as well as desired surplus levels for the captive so that it remains solvent, financially strong and have the ability to take on any additional risk in the future as it grows.

“With the volatility of the commercial market, more and more companies are looking to expand the captive utilization,” said Curtis. “We work with clients to show the advantage of maintaining excess capital and surplus in the company.”

 

Reviewing for Success

Captives must maintain capital standards, which involves reviewing capital levels on a regular basis, including by regulators as well. Vermont captives are reviewed by Department analysts annually and in some cases quarterly depending on the captive type. Captives are required to file financial statements to the Department, and according to Petterson, this is when captives’ capital is reviewed by the regulatory team. The Department also performs exams every 3-5 years, which provides another opportunity to evaluate capital management and overall capital and surplus adequacy.

For more frequent reviews, captives can look to their actuarial partners for that eagle eye on capital as well: “From an actuarial perspective, we are constantly reviewing the captive’s surplus,” Lisa Poulin, Consultant, Milliman, said. She added this is typically done with the issuance of the captive’s annual statement of actuarial opinion on its loss reserves.

“Part of our analysis includes review of the financial statements, so we will look at the capital and surplus, as well as certain metrics to make sure things look in check,” Poulin said.

A key safeguard to capital solvency is the efforts of the captive manager. This is the person who will communicate to the state if minimum statutory requirements are or are not being met.

“If there’s any material deviation from the approved capital levels, which are reviewed on a monthly or quarterly basis, captive managers have an obligation to communicate that even in the interim periods,” said Curtis.

Petterson agreed: “As captive regulators, we generally consider the captive manager as the first line of defense given their close involvement and familiarity to the companies they manage.”

 

Role of a Captive Manager

The captive manager is a key source for communication and information. It is within their role that actions for the captive are derived, because they act as its leading voice.

In terms of maintaining sufficient capital, the captive manager should be communicating with the actuaries and regulatory board that oversees the captive’s operations. Should the captive choose to take the necessary steps toward covering new risks or expanding coverage for existing ones, the captive manager will take the lead.

“They’re in a position to ask us their questions and to help make sure that we’re comfortable with what’s being proposed,” Petterson said. “We’re placing reliance on what the captive manager is telling us.”

Captive managers will also work with their actuarial team to model loss projections or how the captive could go about funding a new risk. Here, necessary capital can be determined, which will then be communicated to regulators as well.

“For certain coverages, we may suggest that the premium includes a risk load or that the loss component of the premium is set at a higher probability level, where there’s more variability in the loss estimates,” Poulin shared.

The regulations in place and the action of the insurance team and regulators is all in an effort to make sure the captive is placing funds in the right places to thrive.

 

Experiencing the Captive Gold Standard

Captive utilization continues to be on the rise. More and more enterprises are looking into this area of self-insurance to help keep their businesses going. The minimum capital requirement established by regulatory bodies like Vermont is there to aid captive insurance companies as they build up the necessary funds to operate.

Vermont has been at the forefront of the captive industry for 44 years, working diligently to provide clients with the tools they need. The team knows a thing or two about having adequate capital to grow.

“Having an experienced regulator like Vermont is critical for any company. We have a lot of companies that choose Vermont because of its experience, its flexibility in approving not only the capital levels but in reviewing captive programs. That’s why Vermont continues to be a leader in the captive industry across the world,” said Curtis.

“There’s a lot that goes into captives from a regulator’s perspective and into the decisions that we have to make around capital. We rely on the individuals that we work with, our partners, our actuaries, our captive managers, to make it a team effort,” said Petterson.

“Capital levels can be impacted significantly, and very quickly, from a number of factors—economic factors, things that could potentially pop up in the reserves,” he continued. “For the sophisticated well-capitalized, well-run company, navigating changing times is that much easier with sufficient capital.”