CAPTIVE DIFFERENTIATORS
Modus operandi Startup
Offshore
In a ‘captive domicile’ with special regulations
Direct writing
Writes some low frequency high-severity business
Own management Takes risks
If reinsurance modus operandi, takes gross cession
Business plan has changed over the years
If a cell, a closed cell (shares no risk)
Doesn’t write terrorism
Writes or reinsures employee benefits
Writes some liability, long-tail
Writes some workers’ compensation (excess liability)
Risk manager negotiates reinsurance
Buys a lot of reinsurance, including aggregate annual stop loss
Risk manager on the captive’s board, or is president
Breaks even Does not pay dividends
Investable assets >$10 million
Guarantees are mainly letters of credit
Some free assets Solvency II-compliant
Uses internal model for own risk and solvency assessment
Mature Onshore
Regulated like a commercial insurance company
Reinsurance
Writes mainly low-severity, higher frequency business
Contract management Low risk profile Takes net cession Stable, unchanging business plan
Open cell (shares some risk, usually the credit risk)
Writes terrorism to gain access to TRIA or Pool Re
Doesn’t Writes only property, short-tail Doesn’t Captive manager does it
Buys little reinsurance, no aggregate stop
Risk manager not an officer or director
Makes significant profits Pays dividends Investable assets <$10 million
Guarantees include reinsurance trusts, other alternatives to letters of credit
Most of its assets tied up in collateral
Taking little notice of Solvency II Uses standard model
Contrary to popular belief, there are many more mature captives than startups, but startups get all the attention.
Most captives are offshore, which sometimes means onshore captives are erroneously considered in the same light as offshore captives.
Most captives are domiciled in jurisdictions with ‘favourable’ regulations. Some captives, however, accept local commercial insurance regulation, eg, those in Switzerland and some in Luxembourg.
There are more reinsurance-writing captives, but they suffer from the demands of fronting companies.
Among risk managers, this is the big differentiator. It also has a lot to do with how much capital the captive has.
While most captives are run by contract managers, owners of the larger ones often perform some or all the management functions in-house.
Higher risk-taking implies more free capital. Most captives don’t take much, or enough, risk. See also ‘Buys a lot of reinsurance’ below.
Gross cession captives have more reinsurance to place than net cession captives. But fronters are pushing net cession these days.
Most captives’ business plans—lines written, retentions, reinsurance—are modified frequently. For this reason nothing is so misleading as a time-series comparison of all captives or of one captive to another, over time.
Open cell is the standard rent-a-captive modus operandi. It is going out of fashion, though. Promoters of cells nowadays are pushing closed cells.
Most don’t.
Only a few do, but owners of those that do are among the most advanced of today’s captive owners.
Writing long-tail business is a sign of long-term commitment. Most European-owned captives started out writing property only.
Writing employee business, especially if written directly (as, for instance, with high deductible buy-back programmes) is another indication of long-term commitment.
Risk managers who do this are carrying on the ‘do-it-yourself’ tradition of the captive pioneers, but may not be getting the best deal.
This is a key differentiator among captive practitioners.
The risk manager is the best link to the shareholders’ interests, even if they have their own risk- financing agenda.
High profits may be a sign of a successful captive to risk managers and to finance directors, but they are more often a sign that members are being overcharged. See similar comment under combined ratio, below.
Most captives don’t, especially if run close to break-even. This differentiator is used by some investment managers as the threshold for their involvement.
Both tie up assets in lower-yielding instruments. Letters of credit are by far the most common, though.
Captives used to have considerable free assets; these days those that still do are in a better position than those that don’t.
As of 2012 EU-based captives will all be affected. Solvency II will have a major effect on their capital, retention and annual costs. In partially equivalent Bermuda, some captives may also be affected.
Both are expensive, but internal models often justify lower total capital.
36 CICA | Forty years of captive leadership
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