Recognizing the inflection point
Helping the client "find their efficient frontier"
Transitioning from one type of captive to another should be viewed as part of a long-term risk financing strategy. While there is no single premium threshold or organizational milestone that determines when a company has "outgrown" its group captive, there are several developments that should prompt a broader discussion around the company's risk profile and strategic objectives.
Scale: As an organization grows, the economics of establishing its own captive can become increasingly compelling. A member may also become large relative to the rest of its group, while still operating under a governance model in which each participant has an equal voice.
Risk appetite: Mature organizations may be prepared to retain more risk than a group's standardized program permits, or they may be interested in different retentions for specific lines of coverage or business units.
Coverage needs: Business expansion, emerging exposures or a change in market conditions can create coverage requirements that the existing group captive was never designed to address.
Performance: Companies with strong and credible loss experience may want a greater ability to capture the economics of their own performance, rather than continuing to participate extensively in pooled results.
Complexity: Acquisitions and business growth can leave an organization participating in multiple group captives or commercial programs. Consolidating these exposures within a single captive may provide better visibility, efficiency and governance.
Control: Perhaps most importantly, growing and sophisticated organizations sometimes reach a point where they seek more authority over underwriting, claims, investments, service providers and the general long-term direction and strategy of their captive.
While none of these markers or factors automatically means the organization is ready to transition away from the current group captive structure, they can be signals for sophisticated brokers to begin a dialogue with their clients.
Cell captives: Greater control, shared infrastructure
A single parent captive isn't the only alternative for organizations seeking greater control over their risk financing strategy. A cell captive can provide many of the same benefits with less capital, complexity and operational responsibility.
A cell captive allows an organization to participate in a legally segregated captive structure without establishing and governing its own insurance company. This can make it an attractive option for clients, while remaining mindful of costs and administrative requirements.
A cell captive may be worth exploring when a client:
- Wants more flexibility than a group captive can provide but isn't yet ready for a standalone SPC.
- Is testing a new line of coverage or captive strategy before making a larger commitment.
- Has sufficient premium volume to benefit from greater customization but lacks the scale to justify a standalone structure.
- Seeks to gain experience with captive ownership and risk retention while limiting start-up costs and governance obligations.
For clients currently participating in a group captive, a cell arrangement can also serve as a transitional structure. It allows them to move away from pooled risk and gain greater visibility into their own underwriting performance while building the experience and data needed to evaluate whether an SPC may be appropriate in the future.
Importantly, a cell captive shouldn't be viewed simply as a stepping stone to an SPC. Many organizations find that a cell structure continues to meet their needs over the long-term. The right solution depends on the client's objectives, risk profile, capital position and appetite for managing their own captive operations.
Calculating the cost of risk
An insured's total cost of risk (TCOR) is particularly useful in steering the group versus SPC or cell captive discussion. The TCOR calculation includes premiums, retained losses and ancillary costs like third-party administration and legal fees. The cost of any claims that your client chooses not to report should be included as well.
While this is a discussion of groups versus SPCs and cell captives, depending on their needs, your client may be better served by a different strategy along the risk-financing spectrum.
The spectrum of risk financing
Moving across the spectrum means retaining more risk, but with progressively more control, better economics and greater strategic flexibility.
Going solo
For organizations evaluating whether transitioning from a group captive to an SPC, cell captive or another structure is the right strategic fit, the first step is to conduct a feasibility study through a reputable captive manager. The goal of the study is to help the client find the most appropriate position on the risk-financing spectrum.
A typical feasibility study includes start-up requirements (capital and compliance), a financial analysis of past, current and projected earnings and actuarial forecasts. In addition to being an extremely useful exercise, many domiciles expect the parent company to submit a study as part of the licensing process.
Guide your client's search for the right captive manager by understanding their unique needs. Your client's risk profile, industry exposures and long-term financial goals will dictate the specific operational capabilities a manager should provide.
For US-domiciled captives, certain states, including Vermont, maintain a list of pre-approved captive managers to which your client is limited. Other states require that the captive manager have a physical presence in that state.
Beyond creating a short list of potential managers, a broker can support the selection process by conducting due diligence, coordinating interviews and comparing proposals. It's crucial that your client understands how each manager supports compliance, reporting and strategic use of their SPC or cell captive. Done right, this is a collaborative process between you, your client and the captive manager.
Location, location, location: Picking the right domicile
Domicile is a much more significant consideration for forming an SPC or cell captive than when joining an established group. How a particular domicile handles regulation and taxation, as well as the local service provider network's bench strength, can affect the success of an SPC or cell structure in achieving the parent company's goals. A captive manager that operates in multiple US and offshore domiciles is best positioned to understand the nuances of the potential locations.
In addition to traditional offshore domiciles such as Bermuda and the Cayman Islands, many companies now evaluate onshore US options. While Vermont remains the world's largest domicile by captive formations and premium volume, there is growing interest in domiciles such as Delaware, North Carolina and Utah.
Increasingly, home state domiciles are gaining traction because of self-procurement taxes. This is a state-level levy on insurance purchased from non-admitted carriers, which can materially change the economics of staying offshore or out of state.
A matter of strategic fit
Group captives remain one of the most efficient and effective alternative risk solutions available, and for many organizations, they can deliver value for decades through pooled risk, shared infrastructure and a peer network of like-minded business owners.
But the best captive structure isn't necessarily the one a company started with, and a company's risk financing strategy should always evolve alongside the business itself. Growth, stronger loss performance, changing coverage needs, and a desire for more control can all alter the appropriate balance between risk retention, risk transfer, capital and control.
For brokers, the opportunity lies in recognizing when that client's growth and evolution have created an inflection point. Helping your client objectively evaluate their options — whether that ultimately means remaining in the group, moving into a cell, or establishing a single parent captive — can position you as a trusted, strategic advisor for the clients that need it most.
The most important captive question may be the simplest one: If you were starting from scratch today, would you build the strategy the same way?
To learn more about how you can best support your clients with captives, get in touch with us today.
