the road less traveled: how to anticipate and avoid group captive potholes along the path to suc...

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The Road Less Traveled: How to Anticipate and Avoid Group Captive

Potholes along the Path to Success

2014 Cayman Captive Forum

Eric I. LarkMember

Kerr, Russell and Weber, PLC

Ronald JordanFinance Committee Chair

FS Insurance, Ltd.

F. Geoffrey Welsher, JrManaging Director

Marsh Detroit

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Introduction

1. Hear a lot about some group captive issues2. Not much on others3. FS Insurance Ltd. 14 years of existence4. A case study, deep dive into potential group captive potholes

Introduction of FS Insurance, Ltd.(The Case Study)

1. Organized by a Global Broker/Captive Manager and U.S. legal counsel

2. Incorporated in the Cayman Islands in 20003. Started with a handful of members4. Make-up:

• strangers, • perhaps competitors, • disparate geographically and philosophically• like herding cats

5. Homogenous group captive – trucking companies (heterogeneous within trucking/transportation industry)

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6. All “driven” by one thing – a strong desire to leverage best in class safety records and take control over their insurance destiny.

7. FS Insurance is a thriving group captive that is entering its 15th year of existence!

8. Structure: See following chart

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Introduction of FS Insurance, Ltd. (cont.)

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a. Structure Onshore (US) Offshore (Cayman)

Owners/Insureds Officers

C.I. Manager

FS Insurance, Ltd., a Cayman Islands insurance

company

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C.I. Counsel

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4

5

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Front/Reinsurer

C.I. Auditor

Board of Directors

OwnershipPremium

Fronting and Reinsurance Agreement

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10+

Under-writing

Committee

Risk Control Committee

Finance/Audit

Committee

Executive Committee

b. Ronald Jordan – Finance Committee Chair• Member – Fleet Car Carriers, Denver, CO• Involvement with the captive

c. Hurdles / Potholes along the way:• 3 fronting/reinsurance companies• Front/Reinsurer downgraded and in runoff• Personnel Turnover;

Initial point person left and tried to take captive Off-Shore point person left and tried to take

administration with him

• First captive president left and created more drama• Lengthy soft market pricing• Member Attrition – 2008 recession & acquisitions

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d. Just a few of the potholes along the path to success –e. Yet, despite the challenges, FS is stronger than ever:• 15 active and engaged members• $26mm in premiums• Benchmarking

Surplus Loss Ratios 12 key transportation metric's vs national averages

(e.g.. OSHA Recordable Injury Rate, Driver TO, Preventable DOT Collision Frequency etc.)

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f. Let us elaborate on some potholes (some not so obvious) to avoid along the path (less taken) to success

g. Title of Presentation – play on Robert Frost’s famous poem, “The Road Not Taken”

The Road Not Taken

Two roads diverged in a yellow wood, And sorry I could not travel both And be one traveler, long I stood And looked down one as far as I could To where it bent in the undergrowth;

Then took the other, as just as fair, And having perhaps the better claim, Because it was grassy and wanted wear; Though as for that the passing there Had worn them really about the same,

And both that morning equally lay In leaves no step had trodden black. Oh, I kept the first for another day! Yet knowing how way leads on to way, I doubted if I should ever come back.

I shall be telling this with a sigh Somewhere ages and ages hence: Two roads diverged in a wood, and I— I took the one less traveled by, And that has made all the difference.

Robert Frost ~1916

Group Captive Potholes Along the Path to Success

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Potholes Along the Path to Success(In Loose Chronological Order)

1. Choosing the Right Captive a. How were you introduced to the captive concept?b. To whom are you talking?

• What are they suggesting?• What is their agenda? • What are their incentives?

c. What are the options?• Homogeneous• Heterogeneous• Agency/Industry Owned• Structure – Pure, Rent-A-Captive, SPC

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d. What kind of information are you being provided?• Written information• Member access• Attendance at meetings/workshops

e. What are you being told? Not told? What’s Important?• Fixed cost ratio• Underwriting Guidelines• Membership Criteria• Historical performance• Closing of policy years• Distributions• Level of participation• Exit strategy!!

Potholes Along the Path to Success1. Choosing the Right Captive - continued

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f. Incentives/Disincentives of program administrator/brokers

g. Other considerationsh. Unpleasant consequences of choosing the wrong

captive

Potholes Along the Path to Success1. Choosing the Right Captive - continued

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2. Fronting / Reinsurance Company Selection

a. Commitment to captives/alternative risk• History with group captives• Current group captives• Ultimate decision makers• Underwriting Experience with groups

b. Familiarity with your industryc. Culture/outlook/vision/philosophy• Underwriting• Collaborative outlook or heavy-handed• Goals for captives – aligned with yours?• Corporate Reporting Structure• Channel Conflict

Potholes Along the Path to Success

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d. Collateral issuese. Unbundlingf. Pricing philosophy and considerationsg. Flexibility on attachment pointsh. Financial Stability and Ratings• The FS Insurance Situation – Dealing with a

front/reinsurer that implodes

Potholes Along the Path to Success2. Front / Reinsurance Company Selection - continued

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3. Reinsurance Agreement Issues

a. Do members see the reinsurance agreement? Binder?b. Captive is reinsurer, but takes the first loss layers (beyond

any deductibles)• Front paper is used• Aggregate limits for captive• Front takes the excess layer beyond captive layer• So in many ways it is the captive that is in essence

reinsuring to the program insurer, Yet the agreement is not set up that way


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c. Follow the fortunes issues• Concept and logic behind it• Application to group captive situation• Claims administrators – bundled or unbundled

d. Other provisions• Collateral and collateral release upon exit• Choice of law, jurisdiction and dispute resolution• Other issues

3. Reinsurance Agreement Issues - continued


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4. Collateral Issues

a. Understanding the requirements going inb. Types of collateral• Deductible• Schedule F• GAP

c. Forms of member collateral • Incoming collateral

d. Forms of company collateral • Outgoing

Trust options (114 Trusts and similar) Pro’s and con’s of LOC’s vs. trusts

e. Collateral surplus vs. distributions


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f. Collateral implications when changing Fronting Company• Collateral releases from departing front• Collateral flexibility from new front• FS experience on this issue

g. What is the collateral release policyh. Other collateral issues


4. Collateral Issues - continued

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5. Unbundling: Talking the Talk vs. Walking the Walk

a. Could do an entire seminar on thisb. Many talk the talk but don’t walk the walk• Key Control Issue• Members become less reliant as captive matures

Understand captive better Overcome obstacles and learn

• Common bundling situations Structure may dictate amount of bundling One-stop shop Front with in-house claims administrator Program admin/broker/captive manager Bank/investment manager Pre Loss Risk Control


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c. Pro’s and con’s of bundling vs. unbundling• Profit built in?• Accountability on decision making• Bundled - You are stuck• Knowing delegation vs. blind reliance• Meeting Expectations

5. Unbundling: Talking the Talk vs. Walking the Walk - continued


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6. Service Provider Internal Turnover

a. Turnover and intra-company transfers not unusual in the insurance industry

b. FS Insurance – On-shore captive administrator (point person) who was on the team who helped in forming the captive left after the first 3 years Very disruptive because of the infancy stage of the

captive Geoff brought in to shore up unrest

c. FS Insurance – Off-shore Captive Manager who was on the team who helped in forming the captive left after the first 5 years


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6. Service Provider Internal Turnover (cont.)

d. Do you stay with the person or the organization?• Program Administrator – In the early 2000 the ‘on and

off shore’ administrators left their role• TPA Point-Person left their role in the early years• Fronting Carrier underwriting team left their roles in

the early years


e. What can you do about this?• Gauge commitment• Captive controls and procedures in place• Exact concessions to make up for disruption• Know your service provider bench strength• Knowledge/understanding of all aspects of the captive

is key

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7. Dealing with Difficult and Inactive Members

a. Financial difficulties• Macro-economic issues – the Great Recession• Industry challenges – multiplied in homogeneous

programs• Company-specific issues• Ability to meet captive obligations• Cost cutting – rippling affect (safety, LOC etc.)• Financially distressed member focused on survival not

captive partners


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Group Captive Potholes

b. The member with increasing losses• Potential Loss-sharing with other members• Impact on relations with program insurer• Established process for dealing with the member

Watch list, Probation, Remedial action plan, Termination from program

c. The difficult member• Active Member

Power hungry Separate agenda (role for member may dictate) Personality, Encourages factions, FS examples Defense: stick to established procedures and

protocols

7. Dealing with Difficult and Inactive Members - continued

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• Separate agenda (role for member may dictate)• Personality• Encourages factions• FS examples• Defense: stick to established procedures and

protocols The inactive member conundrum Inherent conflict in goals between the captive

and its inactive members Collateral issues/collateral policy Exit strategy



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• Level of corporate participation of inactive• Board, committee, shareholder participation

Fiduciary duties vs. self-interest A “cancer” in the boardroom Impact on active members, prospects Spreading confidential/proprietary information of

the captive To captive competitors To competitive service providers Early buyout of the “squeaky wheel”



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e. Defenses against the difficult member• Adhere to established protocols and procedures• Research your new partners• Carefully screen and underwrite incoming members

Follow strict underwriting protocols: Avoid exceptions

Gauge outlook, understanding of the captive Strive for good fit (organization, philosophical,

personality) and captive decides Don’t grow for the sake of growth!

raise the bar mandate commitment



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8. Loss of Control over Loss Control (and Claims Handling)

a. Controlling losses – The rason FS overcame obstaclesb. #1 reason captives fail – bad lossesc. Strict underwriting coming in:

• Financial• Safety, loss control, claims• Management commitment to safety• Like kind and quality


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d. Take control of loss control and claims handling• Pro-active approach to each• Active loss control committee

Safety Claims

• Accountability of each member and consequences• Loss control workshops – mandatory• Established procedures for underperforming

members• Benchmarks, safety awards, priority

e. Do not compromise best in class for growth or to satisfy a service provider agenda

f. FS and Risk sharing – a tweak to the program


8. Loss of Control over Loss Control (and Claims Handling) - cont.

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Group Captive Potholes9. Lack of Good Corporate Governance/Internal Controls

a. Employ corporate best practices to avoid, anticipate and handle problems• Will insulate directors and the captive from scrutiny• Will ensure that fiduciary duties (care, loyalty) are not

breachedb. Some suggested best practices• Basic captive governance documentation is in order

and followed Memorandum and Articles of Association Offering documents Shareholder/participation agreements

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9. Lack of Good Corporate Governance/Internal Controls (cont.)

• Engaged directors – knowledgeable and committed• Independent directors - possibly• Informed delegation to service providers, advisors• Form committees of the board and use them

Types of committees Role of committees – decisions, reports and

recommendations to full board• Charters, duties and responsibilities• Meetings, minutes• Interplay between committees clearly defined

Issues may cross into several committees

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Group Captive Potholes 9. Lack of Good Corporate Governance/Internal Controls (cont.)

• Board, shareholder, committee meetings occur regularly Minutes Maintain confidentiality

• Significant governance principals in writing Minutes and resolutions Policies and procedures

• Establish, test and maintain internal controls/standards• Clarify and define reporting lines, responsibilities.• Stay engaged, involved and informed!

Do not drink the Kool-Aid As Reagan said, “trust but verify”

• Other protections -For directors and officers -For captive

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9. Lack of Good Corporate Governance/Internal Controls (cont.)

• Goal is to avoid surprises, anticipate troublesome issues and handle surprises/issues when they do occur

Other FS Surprises How they were handled

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10. Distributions, Policy Year Closure and Exit Strategy

• Distributions well reasoned policy Board flexibility What form – dividends, policyholder returns,

credits tax consequences to members, insureds, captive

• When too early, too late enough, not enough Case Study

• Impact on surplus and implications• Consistency or lack thereof

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Group Captive Potholes10. Distributions, Policy Year Closure and Exit Strategy (cont.)

b. Closing of Policy Years – Well reasoned policy How long? Too soon? Too long? Flexibility or firm?

• Ability to profit from your own loss control efforts and good loss

performance• Tail funds, closing into current year, selling the tail

c. Understand the exit proposition• Exiting the company as a shareholder• Clear collateral release policy

Timing and expectations Balance protection of captive with ability to exit

• One-off buyouts Sparingly – precedent issues

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Anticipating as many potholes and roadblocks as possible, utilize established and tested procedures and principles, this journey has allowed FS Insurance Ltd to stay the course along the road less traveled, and that has made all the difference!

Thank you!

the road less traveled: how to anticipate and avoid group captive potholes along the path to suc...

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