Captives require customized insurance policy program underwriting to design and price the coverage correctly in accordance with acceptable industry standards. Many captive managers may not be doing sufficiently thorough risk assessment and underwriting to have your captive program withstand close scrutiny.
Why is this important?
First department of insurance regulators who license and supervise captive insurance companies want to make sure a licensed captive has enough capital, surplus and reserves to remain solvent and pay claims. If anything, they want insurance companies to set premiums high.
- For commercial insurance companies insurance policy premium rates are regulated to make sure they are not too high, to assure fairness to consumers. This is not a concern with captives since only related or affiliated parties can buy insurance from a captive.
- The consumer protection function typically of high importance to commercial insurance regulators is really non-existent in most captive contexts; this is why it is easier for a company to qualify for a captive insurance license than a commercial insurance license.
Second, if your operating business wants to be able to deduct against income the premiums it pays your captive, for insured US companies the premiums have to be reasonable business expenses under the Internal Revenue Code (IRC section 162 in particular).
Third, if you want your captive to benefit by the special accounting and tax rules afforded insurance companies under tax codes like those in the US, it must meet be an insurance company for tax purposes. Income tax examiners look to the many factors in making this determination but, competent and proper underwriting so the policy coverages selected make sense, and the pricing of those policies is reasonable, weigh very high on their audit checklist.
Preliminary Assessments – Underwriting Component
Our preliminary assessment service contains a significant risk assessment and underwriting component. This valuable service is often performed free for qualifying prospective clients who complete our confidential client questionnaire (more on this below). It helps determine if a captive is viable in your situation and the pros, cons and costs of you forming one.
Click here to review some of the types of insurance policies we consider when doing a preliminary risk assessment and captive underwriting design review. Suitability and pricing of policies of course is always case specific, and once a decision is made to perform a formal feasibility study or to form a captive, detailed underwriting is then required.
Importance of Underwriting
We cannot over-stress the critical importance of competent underwriting in designing a solid captive program. Nor over-emphasize how important this step is to having your captive meet the rapidly increasing regulatory and tax examiner standards.
Policy selection and pricing should consider all available data, and is a multi-step process. The process starts by client disclosures in the form of completing client underwriting questionnaires.
These client questionnaire disclosures provide data needed to complete a preliminary assessment. More specific detailed questionnaires may follow to fine tune and rate/price specific policies.
Underwriting practices in the captive industry are evolving rapidly, becoming more detailed with increasing case specific precision, a very positive and needed trend. Captive specific underwriting “engines” did not really exist a few short years ago. Policy selection and pricing techniques were fairly simple and primitive.
You would be well advised today to spend a lot of time on the captive underwriting process and document in detail the facts gathered and considered and the rational for associated decisions.
If you decide to form a captive, whether or not we have internally completed a risk assessment and underwriting design, we generally require engagement of an independent 3rd party underwriter/actuary to review and if possible improve our captive design work before proceeding with formation of your captive.
Costs for Underwriting and Actuarial Services
Underwriting and actuarial services for a simple captive can cost as little as $4,000, but typically are higher depending on the quality of the work. Spending $10,000 or more for the initial underwriting and actuary could prove well worth the expense, and depending on the complexity of your proposed captive program, substantially higher fees may be associated with the underwriting, actuarial and feasibility study steps.
Ideally captive underwriting analysis would involve the proposed insured companies’ commercial broker, but this is not always the case largely due to some combination of a lack of captive expertise among most commercial brokers and significant conflicts of interest from effectively designed captive programs often resulting in declining commissions on commercial insurance products.
Once up and running, for US taxpayer owned captives insuring US risks, we usually recommend an independent underwriting and actuarial review annually irrespective of the regulatory domicile’s requirements. We believe such annual underwriting and actuarial reviews conform to best practice standards.
What is an insurance underwriter?
Insurance underwriters evaluate risk exposures and decide whether to provide insurance and under what terms. They evaluate insurance applications and determine coverage amounts and premiums. Using an independent underwriter is important to decide policy coverage terms and conditions and set fair and adequate premium levels.
What is an insurance actuary?
Insurance actuaries go beyond underwriting functions. Actuaries mathematically evaluate the probability of events and quantify the contingent outcomes in order to minimize the impacts of financial losses associated with uncertain undesirable events. Actuarial reports are used to determine loss reserves associated with captive insurance programs, and they compute various loss ratios used by regulating department of insurance staff members to evaluate and monitor the solvency of licensed captives.
Learn more about insurance underwriting by clicking here.