Introduction

This remark from a real client neatly sums up captive exploration: simple in concept, complex in practice. 

Forming a captive means that your business will own an insurance company, pay for its own losses, and pocket any profit. The “what” makes sense. The “how” is more tricky. 

Forming A Captive: The Home-Building Analogy

Imagine that you purchased a plot of land. You can visualize living in your dream home. But, building it is an intricate dance involving numerous professionals, regulations, and significant financial investment. 

And still, millions of people do it enthusiastically. That’s because the process is predictable and the reward is secure, despite the risks. 

Starting a captive is like building an insurance dream home. Complicated, but predictable and quite rewarding. The result is owning your own insurance–and all its profit. 

Among Fortune 500 companies, 90% own at least one captive. They trust the process and the payoff. Critically, they also have the resources to dedicate an in-house team to the task.  

XN estimates that forming a captive takes 300 to 400 total hours of work, input from 10 distinct expertise, and the coordination of many overlapping work streams. For a mid-market business focused on growth, the investment is daunting. 

Thankfully, there is a realistic path forward. Enter The Captive Manager. 

The Role of Captive Managers

Captive Managers can drastically reduce the workload by providing expertise, coordination, and management services to demystify and streamline the process–like the general contractor that orchestrates the construction of your home.  

Every captive management firm is a little bit different, from the services they offer to their pricing structure. Some specialize in certain types of captives, others in certain industries or lines of coverage. 

The nuanced role of captive managers is incorporated throughout the discussion below. 

Initiating The Process: An Upfront Assessment

The captive journey begins with an upfront assessment, akin to a soil test before building a house. You lay the groundwork with a Captive Manager by discussing your business, insurance needs, and objectives. This is also an opportunity to gauge the manager's approach and align their expertise with your needs.  

The Assessment is a crucial yet non-committal step, often offered as a free consultation.

During the Assessment, you will likely discuss the implications of a few key decisions, including:

• Domicile: Where should you register your captive? The unique rules of a domicile can impact the types of coverages allowed, admin responsibilities, financial requirements, and taxation. 
• Structure: What type of entity should you form? There are many types of captive structures, so choosing the one that matches your goals is important. 
• Policies: Which policies should you include? Your captive policies will have implications on required capital, collateral, fronting, and reinsurance, to name a few.  
• Operations: How will you manage day-to-day operations? Claims handling, investment management, and compliance are examples. Captive managers may provide these services, recommend partners, or incorporate your existing vendors. 

Feasibility Study: Designing Your Insurance Blueprint

Once your assessment is complete, the process to form your captive officially begins with your decision to initiate a Feasibility Study.  

A Feasibility Study is the architectural blueprint of your captive, a data-driven analysis performed by actuaries. Depending on the complexity involved (namely, the types of coverage under consideration), the study can cost between $20,000 and $50,000. It's a significant investment, owed to the extensive time and specialized expertise required to validate the business plan for your insurance company. XN works with its clients to help make feasibility studies more seamless. To learn how, contact us.

Some of the aspects under assessment include: 

• Risk Exposure: Examining historical data and future projections to understand potential losses and the financial implications for your captive.
• Cost and Coverage: How much money you will need to cover the risk you plan to include in the captive.  
• Regulatory Compliance: Ensuring your captive can meet all legal requirements in its chosen domicile.
• Financial Viability: Analyzing the captive's potential for profitability and its capacity to cover claims, including premium calculations and capital requirements.

An Intro to The Study 

The Feasibility Study mirrors the unseen analytical process behind traditional insurance policies, setting costs and coverage based on actuarial science. You are creating an insurance company after all, so this work is necessary to ensure that you are prepared.

Fittingly, the Feasibility Study process is collaborative. Actuaries provide the scientific rigor to validate the intentions you have for your captive. The combination of the two allows your captive to safely meet its goals. 

As such, this stage may require adjusting your expectations. But, like learning upfront that your dream home needs a different type of foundation, it's for the better. Actuaries are not just calculating numbers; they're safeguarding your investment against potential challenges.

Completing the Feasibility Study is not a commitment to build a captive. It is simply part of the required documentation that would eventually be approved by regulators, if and when you proceed. 

Feasibility Study, Phase 1: Collecting The Data 

Actuaries collect your business and insurance information to start their analysis. Most of what is needed can found in the following documents: 

• Financial Statements
• Past Policy Applications 
• Summary of Insurance
• Current Insurance Policies
• Recent Loss Runs 
• Loss Prevention Manuals
• Loss Control Documents
• Future Growth Plans

Feasibility Study, Phase 2: Loss Projection & Premium Analysis 

Once the analysis starts, the first deliverable is often a Loss Projections and Premium Analysis. 

Loss Projection: An estimation of future losses, or Loss Distribution, for the coverages under consideration, factoring in Loss Probability (the likelihood of experiencing a given level of loss). Here is an example of how that might look: 

The Loss Probability determination is used to define your captive’s capacity–the max amount of loss it can support. 

Loss Projections include the full spectrum of anticipatable losses. From that range, actuaries select a Loss Pick, the official estimation of losses that will determine your captive’s Premium. 

The loss pick is typically conservative enough to protect the captive against unforeseen circumstances and pass the scrutiny of regulators.  Each actuary firm applies their own standard to selecting a loss pick, with calculations to support their reasoning. 

Premium Analysis: This is the total amount you need to fund the captive, with extenuating context like regulatory concerns. It typically contains a Pricing Summary, with various Retention Level scenarios. 

This information adds clarity when determining the financial cost of retaining the desired amount of risk. 

The premium analysis will incorporate regulatory considerations into the report, like capital and collateral requirements. Each domicile will have different rules based on the lines of coverage, policy limits, loss projections, required collateral, and fronting circumstances.*

*During the course of the Feasibility Study, a Captive Manager will work to develop a cost estimate for elements like reinsurance. These estimates (and eventually, the actual amounts once finalized) can be provided to the actuaries to incorporate into their financial projections that come in Phase 3. For more information on these processes and how they are used, visit our blog posts on Fronting and ReInsurance.

Below is an example of a Pricing Summary, which presents two options for how much risk will be retained by the captive, also called the Retention Level: 

The Pricing Summary allows you to:  

• Develop an outline of cost allocation.
• Identify the ideal policy types, structures, and scenarios that are feasible based on your stated risk appetite and retained earnings goals year over year
• Demonstrate adequate structure and funding to state regulators 

Note: Multiple methods may be used to determine a reasonable premium amount, and oftentimes additional methods are provided by the actuaries, allowing you (and regulators) to review the reasonableness of the premium level suggested by the report.

Feasibility Study, Phase 3: The Financial Pro Forma

Once the initial analysis is complete, the actuaries develop a financial model to simulate your captive performance, often 5 years into the future, with expected and adverse scenarios. It will also indicate the elasticity of the cost allocations developed in the Pricing Summary.

The Pro Forma will include:

• Income Statement, including growth rates and retained earnings
• Balance Sheet
• Cash Flow Statement

An example report is provided below to demonstrate the elements of a captive Pro Forma:

Income Statement

Balance Sheet

Cash Flow Statement

The Final Step: The Business Plan

Following the Feasibility Study, the focus shifts to finalizing a Captive Business Plan. 

This document packages the Feasibility Study with an explanation of your captive's strategic direction, management framework, and operational readiness.. It's the definitive guide that regulators review to approve your captive, highlighting its preparedness for success and compliance.

Some captive managers will prepare the business plan for you, and present it for review. 

Most Captive Business Plans will include the following sections: 

• Executive Summary: Offers a concise glimpse into the captive's purpose, goals, and strategic direction. This allows regulators to quickly assess its intentions, alignment with the parent company’s risk management, and potential impact on the market.

• Company Introduction & Strategy: The foundational story and strategic vision of a captive help regulators assess its viability and alignment with industry best practices. It also helps convey the seriousness, preparedness, and long-term commitment of the organization towards maintaining the captive. Regulators prefer a focus that extends beyond financial expediency to enhance risk management and insurance efficacy.

• Captive Goals: Precise goals enable regulators to measure the captive's aims against industry standards and regulatory expectations. Well-defined objectives underscore the captive's role in enhancing market stability and fulfilling the parent company's insurance requirements.

• Market Dynamics: An insight into the captive's market position and competition is vital. It assists in evaluating market viability, risk management adequacy, and the potential to influence the insurance ecosystem positively, all while serving its target audience effectively.

• Leadership Team: Highlights the expertise and structure of the managing team to ensure that the captive is secure in the hands of knowledgeable professionals, committed to upholding high standards of regulatory compliance and ethical business practices. 

• Target Audience & Risks: Understanding whom the captive aims to insure and the risks involved is crucial for assessing underwriting strategies, risk pooling mechanisms, and product suitability. This ensures the captive's offerings are precisely tailored to meet client needs and market demands. 

• Coverage Lines: Scrutiny of coverage lines helps evaluate the captive's risk exposure and its capability to provide adequate coverage. This analysis is essential for ensuring the captive meets claim obligations and complies with insurance regulations, contributing to market resilience.

• Capitalization Plan: A well-documented capital plan is crucial for assessing the captive's financial robustness and solvency. This scrutiny confirms the captive's preparedness to cover potential losses, uphold its underwriting commitments, and to survive adverse market conditions.

• Service Providers: Assessing the captive's choice of service providers gauges its operational preparedness and commitment to industry standards. This evaluation ensures the captive is backed by professionals enhancing its compliance, stability, and success.

Making It Official: State Approval

At the conclusion of the process, your state’s Department of Insurance will issue a license officially authorizing your captive to provide insurance to your parent company.  Congratulations are in order—you now own your own insurance company!

Elevating The Process: XN Captive

The path to owning a captive is a significant undertaking that blends complexity with opportunity. 

XN Captive streamlines the captive journey, making it accessible, manageable, and optimized for mid-market companies. Our platform provides powerful tools for planning, real-time monitoring, and in-depth analysis, all designed to maximize your captive's potential.

To discover how XN Captive can transform your captive strategy, visit our Services page. 

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