< PreviousTHE AM BEST BUSINESS TRILOGY Founded in 1899, AM Best is the world’s first credit rating agency and the only global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. The AM Best Business Trilogy is a three-volume series that tells the story of AM Best, its founder, and the credit rating industry. To purchase your set, scan the QR code or visit www.ambest.com/sales/BRtrilogy A portion of the proceeds from The AM Best Business Trilogy will be donated to the AM Best Foundation, a nonprofit which supports charitable organizations that encourage education and thought leadership in insurance and risk management. As part of AM Best’s sustainability initiatives, these books are printed on stock that contains 30% post-consumer recycled fiber and a clean printing process. T h e A M B e s t B u s i n e s sT r i l o g y The Industry The Company The Man Industry Theeee A History of the Credit Rating Agencies AM B est T h e A M B e s t B u s i n e s s T r i l o g y The Industry The Company The Man AM B est A History of AM Best Company Theeee T h e A M B e s t B u s i n e s s T r i l o g y The Industry The Company The Man AM B est A Biography of Alfred M. Best Man Theeee 21.TRI08A Our Insight, Your Advantage ™ Learn More: sales@ambest.com www.ambest.com • (908) 439-2200View past Issues & Answers sections at www.bestreview.com/issuesanswersarchive.asp Special Advertising Section ISSUES & ANSWERS: Interviewed Inside: Daniel Linton Pinnacle Actuarial Resources Christopher J. Flatt AIG Programs & Captive Solutions Industry experts discuss how to choose a captive manager and the role of actuaries in captive management. CAPTIVES AND DOMICILE SOLUTIONSCommitment Beyond Numbers Beyond transactions pinnacleactuaries.com ReinsurancePricing and Product Management Predictive Analytics Loss Reserving Litigation Support Legislative Costing Enterprise Risk Management Alternative Markets It’s about partnerships and relationships. When you work with Pinnacle, you become a partner. We start by getting to know your organization’s business goals, geographic and industry mixes, risks, and corporate culture. Our consultants provide you with the highest level of professional expertise and service. The result is a true partnership to guide you through available options and help you make better business decisions.SPECIAL ADVERTISING SECTIONSPECIAL ADVERTISING SECTION Issues & Answers Share this edition at www.bestreview.com/issuesanswersarchive.asp. BEST’S REVIEW • AUGUST 202221 Daniel Linton, Senior Consulting Actuary, Pinnacle Actuarial Resources, said that for a captive insurer, discussions regarding capital deployment strategy is the ideal time for the actuary, the captive manager, and the captive owner to engage in productive dialogue about opportunity—and risk. “The types of risks that keep you up at night,” he said. What is the actuary’s role in the formation of a captive? The actuary serves as a trusted adviser—playing a critical role in the formation phase of a captive. First, the actuary needs to be heavily involved in setting the overall structure of the captive —determining what coverages should be considered, as well as how much risk should be retained (i.e., risk tolerance). Ideally, this advisory relationship should be a dialogue between the actuary, the captive manager, and the captive owner to set a solid foundation for how the captive will operate in the coming years. In addition, the actuary will construct an actuarial analysis that will set rates and estimate the expected losses that will flow through the captive in the captive’s first years of operation. Based on sound actuarial understanding of expected losses, the actuary can build a set of pro forma financial statements which will give stakeholders an understanding of the overall feasibility of the proposed structure. Do reinsurance costs and available capital play into that decision? Absolutely. It’s a balancing act between reinsurance costs and how much capital the captive wants to hold. For example, rather than carry a $500,000 per occurrence limit, a captive owner chooses a $250,000 per occurrence limit. The result would be a lower capital requirement because the captive is taking on less risk. On the other hand, it increases your reinsurance costs because you’re buying more reinsurance in the commercial market. It’s a sophisticated balance that will vary from captive to captive based on risk tolerance. What is the actuary’s role as the captive grows up? When the captive grows up, the actuary is going to serve two primary roles. The first is to review incurred claims and present an analysis of estimated outstanding losses (i.e., reserves). That gives captive management an opportunity to understand how actual claim development compares with projections derived from the previous actuarial report. Further these analyses give guidance to management on what they should book as reserves on the balance sheet. What follows is the actuary’s review of the booked reserves and the issuance of the statement of actuarial opinion—a document that must be filed with the insurance department, or other regulatory Actuarially Sound body, where the captive is domiciled. Secondly, the actuary will set the expected losses for the upcoming policy period—similar to the exercise performed during the feasibility phase. During this time, the actuary, the captive owner, and the captive manager can discuss other opportunities available to the captive—whether it be introducing new coverages, expanding limits, etc. How important is the actuary’s relationship with the captive manager? It’s very important. I have found that the better the communication between the captive manager and actuary, the better the captive operates. It opens up the lines of communication, providing a conduit to respond to unexpected events quickly and efficiently. A sound relationship allows all parties, ideally including the actuary, captive manager and captive owner, to have meaningful discussions about the results of the actuarial report. That, in turn, provides all with key insights and hopefully agreement into how much capital is necessary to support the operations of the captive. Capital deployment should be an area of strategic opportunity for the captive and should be evaluated and planned for carefully. Daniel Linton Senior Consulting Actuary Pinnacle Actuarial Resources Visit the Issues & Answers section at www.bestreview.com to watch an interview with Daniel Linton. “When it's time to deploy capital, you want to make sure that you're leaving enough economic capital to support the operations of the captive to manage the risks that are already there.”Insure wisely. Recover from setbacks. Partner with AIG. Learn more at www.aig.com/whyaig The information provided is intended for general informational purposes only and should not be solely relied upon for the prevention or mitigation of the risks discussed herein. Insurance products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Such products and services may not be available in all jurisdictions, and coverage is subject to actual policy language. For additional information, please visit our website at www.AIG.com. © American International Group, Inc. All rights reserved.SPECIAL ADVERTISING SECTIONSPECIAL ADVERTISING SECTION Issues & Answers Share this edition at www.bestreview.com/issuesanswersarchive.asp. BEST’S REVIEW • AUGUST 202223 Christopher J. Flatt, President, AIG Programs & Captive Solutions, said the company develops innovative, customized captive programs for clients. Following are excerpts from an interview. What is driving growth in captives? Whenever clients experience things like increasing premium rates, coverage restrictions, or reduced capacity, they look for alternatives and captives are often the option to which they turn. For example, large companies that already own a captive can expand the use of captives by adding new lines of business or adding increased net retentions or limits to their program. We are also seeing more mid-sized companies looking at whether a captive might be right for them, either through the use of cell captive facilities or joining a group captive program. Certainly more challenging lines (e.g., property, cyber, D&O, professional liability) and industries (transportation, health care, construction/energy) are driving a lot of the growth currently, but the interest is widespread. What should a captive consider in selecting a captive manager? Captive Management is all about service, so important considerations for a prospective captive owner include: • The manager’s experience and expertise—review the services they provide, how long have they operated and how many clients they have in their portfolio. • Industry reputation—ask the domicile regulators, captive law firms, auditors, etc. about what they have experienced with the manager. Getting these third-party views is important to choosing the right captive manager. • Staffing levels, tenure, and turnover—people provide the service and low turnover typically leads to higher consistency of service. • Domiciles the manager operates in—it is important to be sure they can operate in the domicile that is right for the client. What should a captive consider when selecting a domicile? • Regulatory Environment—domicile should have a clear regulatory framework while providing a degree of flexibility for the regulator to apply to each situation. • Infrastructure—established domiciles typically have more services available (managers, audit, tax, legal, etc.). • Taxes—captive owners should review both premium tax and federal tax implications with their professional advisers. • Cost—some domiciles can be a bit less expensive than others—but typically the costs are similar. Captive Solutions How is AIG Captive Solutions meeting the needs of its captive clients? AIG Captive Solutions develops innovative, customized captive programs for clients employing AIG’s extensive knowledge and collaborating across our underwriting, claims, credit, legal and actuarial teams. AIG has been in the captive business for over 50 years, and knows that captive clients value expertise, creativity and responsiveness to their needs. We deliver these solutions across three businesses: • Group Captives—provides fronting and excess risk transfer to large member owned captives for primary casualty (i.e., Auto, GL, and WC); • Fronting provides fronted paper for nearly any line of business, admitted and non-admitted paper, and typically reinsured to single parent captives; • Captive Management—provides captive feasibility studies, formation services and ongoing domicile management for captives. Also sponsors and manages protected cell captive facilities in Bermuda and Vermont. To learn more about AIG Captive Solutions, you can visit https://www.aig.com/business/why-aig/captive-solutions. Christopher J. Flatt President & CEO Glatfelter Insurance Group President, AIG Programs & Captive Solutions “Captive management is all about service.”24BEST’S REVIEW • AUGUST 2022 Captives Protected Cell Structures Fuel Captive Growth A hardening insurance market is among the factors resulting in more captives, nearly 20% of which are protected cells. by Anthony Bellano T he number of new protected cell captives has been on the upswing across the United States in the past few years as the overall captive sector also has seen an increase in captive formations. The growth in the captive formations has been fueled by a hardening insurance market while cell captives have become increasingly popular because they are a simpler, cheaper option for companies to enter the market, and can lead to bigger things. Some 18% of new captives formed over the past two years industrywide were protected cells, compared with just 8% three years ago, Marsh Captive Solutions Managing Director Michael Serricchio said. “Cells are really great, especially for middle-market, medium-size corporates,” Serricchio said. Anthony Bellano is an associate editor. He can be reached at anthony.bellano@ambest.com. CAPTIVE DOMICILE: Burlington, Vermont, will host the 37th annual Vermont Captive Insurance Association Conference from Aug. 8-11.Captives 25BEST’S REVIEW • AUGUST 2022 Excluding Bermuda and the Cayman Islands, cell activity was concentrated in four domiciles, all in the U.S.—North Carolina, Vermont, Tennessee, and Delaware—according to a report from Strategic Risk Solutions, which provides captive management and advisory services. North Carolina saw the biggest growth, with the addition of 157 new cells and the loss of 29 existing ones, bringing the state’s total to 667, according to the report. Vermont added 100 new cells and lost 10 existing ones, which brought its total to 485 protected cells. In Delaware, 45 new cells were added, but 104 existing cells were lost, resulting in a total of 466. Tennessee welcomed 65 new cells while at the same time losing 35, for a total of 341 protected cells, the report said. A protected cell company, also known as a sponsored cell or segregated account company, is an insurance company that offers the benefits of a single-parent captive without the need, and associated time and expense, to create a separate legal insurance entity, according to Marsh. Hardening markets present opportunities for new structures, according to Best’s Market Segment Report: Captives’ Flexibility and Control Enable Them to Outperform Commercial Peers . The cell structure is being more broadly developed under various names such as Segregated Account Key Points Growth Spurt: Some 18% of new captives formed over the past two years were protected cells, compared with just 8% three years ago, according to Marsh. Protected Cell Leaders: Excluding Bermuda and the Cayman Islands, cell activity was concentrated in four domiciles, all in the U.S.: North Carolina, Vermont, Tennessee, and Delaware. State Legislation: Delaware recently approved the use of captives by corporations to cover directors, officers, employees and other indemnifiable people, while Vermont clarified rules surrounding parametric contracts.Captives 26BEST’S REVIEW • AUGUST 2022 Company, Segregated Portfolio Company, Protected Cells or Incorporated Cells, according to the report. “For owners of small to medium-sized enterprises across a wide variety of industries and businesses, cell companies may provide general business protection. Some captive managers and professional insurance management teams offer a platform or access to a risk pool under a tightly written policy with a broad menu of coverages, ranging from active shooter to small-airplane coverage, all of which are covered under the same risk pool despite the variety of claims. No financial support is commingled. They are ‘only’ required to share losses under the terms of the pool and, in most cases, provide ongoing proof of financial wherewithal and viability, as well as collateral,” the report said. Cell captives can be used as a steppingstone for employers who may want to move into a single-parent captive in the future, said Chelsea Carter, Artex Risk Solutions business development- account executive. “For example, employers may face timing restrictions or coverage placement challenges that require an expedited entry into alternative risk solutions,” Carter said. “Cell captives provide employers with a quick and easy solution to finance their risk but can also be easily transitioned into a single-parent captive when the time is more appropriate.” Captive formations of all types have been growing since late 2020 as the economy began to recover and a hard insurance market persisted. In 2020 and 2021, Serricchio said Marsh formed about 200 new captives, which grew what he called an “astonishing” $3.4 billion in premium. Nick Hentges, co-CEO of Captive Resources, a consultant to member-owned group captive insurance companies, said the company added more than 1,000 new members during the pandemic, including more than 500 new captives in 2021. Vermont insurance regulators licensed 45 new captive insurance companies in 2021, the fourth- highest year of growth in the 40-year history of the state’s captive sector, state officials said earlier this year. The growth in captives brought the total to 620 licensed captives—589 active and 31 dormant captives—31 more than it had at the end of 2020. The department added its largest one-year total in 2003, when it licensed more than 70 new captives. Vermont’s 52 sponsored cell captives host nearly 500 cells and separate accounts, in addition to the licensed captive companies. “They are growing as fast as the overall captive market,” David Provost, deputy commissioner of captive insurance for the State of Vermont Department of Financial Regulation—Captive Insurance Division, said of protected cells. “They’re a great solution for all kinds of businesses. They’re often touted as ideal for smaller businesses due to the lower cost and ease of entry and exit, but I’ve seen some very large companies form cells for simplicity and ease of management as well.” The intent of the law in Vermont is to allow a cell to do pretty much anything a stand-alone captive can do, and regulation of the cells is balanced to the risk retained, Provost said. The number of captives worldwide totals a reported 6,027 captives, up from 4,951 in 2006, although the market suffered a 2.5% decline from 2015 to 2020, according to a report from Strategic Risk Solutions. “They’re a great solution for all kinds of businesses. They’re often touted as ideal for smaller businesses due to the lower cost and ease of entry and exit, but I’ve seen some very large companies form cells for simplicity and ease of management as well.” David Provost State of Vermont Department of Financial Regulation—Captive Insurance Division27BEST’S REVIEW • AUGUST 2022 The AM Best report said the number of U.S. domestic captives declined marginally from 3,182 in 2019 to 3,107 in 2020, a 2.4% decrease. AM Best attributed the decline to increased scrutiny by the Internal Revenue Service regarding 831(b) captives and the rise in economic uncertainty from the pandemic during the first half of 2020 which likely resulted in a small number of captive closures as well as a reduced number of new formations. “As economic activity and confidence resumed, and the hardening insurance market persisted, the flexible, adaptable, and innovative solutions that captives afford their owners continued to prevail,” AM Best said. “As a result, there was an increase in captive applications in late 2020 and early 2021, with a growing interest in captive cells as a more expeditious and efficient solution in a challenging market,” the report said. “Cells effectively borrow a third party insurance management and licensing platform to address certain risk transfers more quickly, with smaller amounts of capital investment, and gain professional oversight so they don’t have to take their eyes off the primary business that they are insuring. Further, these are easier to close (or go dormant) when a hard market softens or when a business sponsoring a cell closes or sells. They are also able to restart should a market turn again or should another business need arise if they have left their capital in the cell, which many do for a period of time since distribution is a taxable event,” the report said. AM Best rates more than 200 global captive insurers in a variety of jurisdictions, according to the report. “The COVID-19 pandemic disrupted supply chains and put enormous financial pressure on nearly all industries and companies worldwide,” according to a Marsh report, which said captives experienced record growth in virtually every area. The number of automotive captives, for instance, grew 28% from 2019 to 2020, the most of any industry, according to the Marsh report Global growth affirms captives’ value in solving business challenges . “We’re seeing the growth within new and existing captives be tied more to the expansion of how employers will use their captive insurance vehicles and fund for different types of insurance,” Artex’s Carter said. “That could be using the captive to fund for increased retentions on their primary lines of coverage, the ability for the captive to participate in a quota share arrangement higher up the insurance tower, or even looking to have their captive access reinsurance markets directly.” The pandemic gave insurers the chance to reevaluate how they do things, Jonathan Habart, director of captive insurance, Tennessee Department of Commerce & Insurance, previously told AM Best TV. As a result, a number of new types of captives are emerging, such as cannabis captives and pandemic coverage through their business interruption policies. For many companies, time is of the essence right now because of the financial strains related to the global health pandemic, geopolitical issues and other factors. The pandemic equaled the hard market, which equaled captive growth, and “that’s why I think we saw so much of it,” Serricchio said. “I think the reason folks, regulators, actuaries, brokers, and state insurance departments were able to take on that growth is because they were “It was kind of an interesting perfect storm for captive growth because the industry was not traveling all over the world and regulators were able to deal with huge volumes of new captive applications.” Michael Serricchio Marsh Captive SolutionsNext >