Ian-Edward Stafrace of Atlas Insurance PCC outlines how protected cells can enable agility in risk financing and captive ownership.

“Adopting an agile approach to captive ownership allows for iterative learning and gains while lowering each step’s financial commitments and risks.”

Captives are traditionally referred to as insurance subsidiaries of non-insurance parents writing risks of the parent. Many more options are available today for risk managers that could be approached iteratively or combined. 

Some choices in captive models that are not mutually exclusive in an overall risk financing programme include:

• standalone or protected cell;
• own staff or management company or shared resources of a Protected Cell Company (PCC);
• direct writing or reinsurance;
• onshore or offshore; and 
• which risks and covers to bring in scope, including whether these are of the parent, employees or customers.

These choices may be daunting for risk managers and could require changing the comfort of the status quo. Risk managers need an agile approach to the ownership and use of captives that lowers any decisions’ financial commitments and risks, providing real options to experiment, learn, iterate and scale. Flexibility allows adaptation to experience and changes in internal needs and external environments.

Pain Points and Desired Outcomes

Risk managers can stimulate reflection on the pain points the organisation may have with its existing risk financing programme and the desired outcomes and measures of success. A small cross-functional team can provide perspectives directly from strategy, finance, HR, sales operations, subsidiaries and other areas. Such a team will help gain different insights, spur innovation and create engagement for any proposed shared solution that would not belong to any one function.

Painpoints with the conventional market often cited by risk managers include the volatility of insurance prices and capacity that may be market driven rather than based on the group’s risk profile and experience. Conventional insurance products can also be seen as inflexible and the services inadequate to the group’s changing needs.

Captive-type solutions, on the other hand, can:

• provide savings and stability in insurance costs;
• provide additional cover or capacity to conventional market;
• facilitate risk reporting and claims control;
• provide more flexibility in the selection of risks to retain or transfer with a higher degree of experience rating;
• give access to the lower-cost higher-capacity reinsurance market, the insurance market’s wholesalers;
• recognise technical reserves as tax-deductible, unlike internal self-insurance risk funds; and
• extend beyond risk financing to provide employee benefits cover or be developed as a profit centre writing customer and other third party business.

Agile organisations increasingly adopt strategic goal-setting frameworks such as Objectives and Key Results (OKRs). Objectives are the outcomes being strived for, the destination. Key Results are the quantitative measures of success determining how close we are to achieving the Objective. The same goal-setting should apply to captive ownership, and the risk manager should strive to integrate the captive’s goals within the organisation’s shared goals. 

Standalone or Protected Cell

Standalone single-parent captives provide the highest degree of control and freedom on objectives. However, for organisations that only use conventional insurance, moving directly to setting up a captive subsidiary may be considered a big bang, high-risk move to put forward to their boards without any prior experience, experimentation or learning.

Increased capital requirements and costs driven by insurance and tax regulations and government authorities’ expectations can hinder the will to explore the formation of captives. 

Another approach is setting up a protected cell in a PCC that requires lower up-front running costs and management time, thanks to sharing of the PCC’s resources. Initial capital could also be lower than a standalone captive. A cell can start as a Minimum Viable Product (MVP) with a narrow scope. The solutions offered through the cell can be iterated on and evolved. Should a single-parent captive become a desired next step, the decision can be based on experience and established relationships.

In this hard market, EU direct writing cells or fronted reinsurance cells often help lower the captive feasibility entry point, opening funded self-insurance options to more organisations than ever.

Protected cells are often more feasible and cost-effective than having a standalone subsidiary. Some organisations see cell structures as a faster, simpler and less expensive means of covering their immediate needs and gaining experience before establishing a single-parent captive. Most eventually prefer to remain within the efficient simplicity and comfort of the PCC. 

Resources

It was considered unusual for any new captive owner to start operations using its staff due to the talent needed and to maintain arm’s length captive management. The skills required can be comprehensively and economically obtained from competent, experienced captive management companies based in the captive domicile. 

However, regulators and tax authorities are increasingly expecting substance and own staff on the ground in key functions, particularly when the business includes third-party risks. This need is avoided in the context of protected cells since the PCC is one legal entity which will already have substance and resources in the respective domicile. 

With their shared economies of scale, Maltese PCCs provide substance and resources in a Solvency II regulated environment. They give confidence in being onshore in the EU, without a standalone company’s complexities, costs and time, potentially also saving capital.

A PCC could manage the cell or outsource the cell management to global management companies that may provide complementing services.

Direct writing or reinsurance

The current insurance carrier can potentially offer a fronting service, helping in the initial learning and experimentation stages of a captive. Fronting insurers could help with policy issuance, claims handling and settlement, accounting, engineering and loss control. Depending on their domicile and branch network, captives and cells may also be able to provide direct cover in certain countries. 

Malta is the only EU Member state with insurance protected cell legislation providing cells with direct access to the EEA single market. Some PCCs like Atlas can also write UK risks.  

Organisations could have reinsurance capacity lined up but no willing fronting insurers. In such cases, they can set up cells to predominantly front the risks, gradually increasing the retained risk with experience.

Beyond Risk Financing

Many organisations have access to insurance business opportunities emanating from customers. A manufacturer can sell products on Cost Insurance & Freight (CIF) terms providing marine cargo insurance on goods being transported, increasing the profits generated from well-managed haulage risks. Extended warranty insurance or even accidental damage and theft can be an option. Organisations in the event and hospitality sector could provide cancellation, event or more comprehensive travel insurance. Telecommunications companies can sell gadget insurance.

Many companies make substantial commissions on customer business placed with insurers, though there is also generally a significant underwriting profit element they could retain. Regulators are increasingly scrutinising the value provided to insurance customers, pushing for commission levels to come down, increasing the attraction for organisations to evolve, carry the risk, and participate in the underwriting performance and profitability.

International organisations often decentralise the negotiation and purchase of employee medical, dental, accident and disability insurance programs to local insurance markets. A growing number are improving the management and reducing the cost of their employee benefits programmes by extending the use of their captives to insure or reinsure the risks. Employee benefits complement risk financing well because losses tend to be high frequency and low severity, hence less volatile and more straightforward to forecast than property and casualty losses. 

Experimentation and Combining Approaches

Maltese PCCs with an active core can also rapidly front and incubate risks, giving more time to assess and set up a cell, thereby providing another solution within the same entity. The non-cellular core can provide a sandbox facility that improves time-to-market and data gaining. Business plans and projections can be revised based on experience. If tests are unsuccessful, such also allows a low-cost exit.

Many options and solutions have been mentioned. The agile approach is to disrupt the status quo with simple iterative steps, striving for continuous deliverables of MVPs and adapting from experience. Well-resourced PCCs in Malta are highly flexible platforms from which an organisation can embark on this learning journey. 

As discussed, with PCCs like Atlas, an organisation could be able to front or incubate EEA and UK risks either rapidly through the non-cellular core or its established cell and through its cell:

• direct write and retain EEA and UK risks; 
• accept inwards reinsurance for risks across the globe;
• cede risks to the reinsurance market whether outside appetite or to reduce volatility or capital requirements;
• include parent, employee benefits and third-party consumer risks; 
• obtain services from brokers, third-party administrators or captive management companies as desired; and
• gradually bring into scope additional risks and covers.

Consideration could also be given to complementing solutions in other domiciles, such as whether the organisation wishes to write risks outside the EEA or UK without using a fronter.

The organisation could increase the scope of the cell or reduce it. It could eventually decide to close the cell and establish a standalone captive or insurance company to increase the level of control and freedom if deemed valuable. 

Adopting an agile approach to captive ownership allows for iterative learning and gains while lowering each step’s financial commitments and risks. Such flexibility offers risk managers real options and capabilities to adapt to changes in internal needs and external environments.

Article first appearing in Captive Insurance Times October 2022