News
Try A Little More TLC For Your ART
20 Nov 2007
My most recent experience in the alternative risk transfer (ART) marketplace has been participating in the introduction of a new insurance company targeting captives and specialty programs. During my travels it is surprising to hear so many stories of one-sided negotiations, channel conflict, miscommunication (or no communication!) and unclear decision-making processes. With current predictions that ART will continue to grow, prosper and become more mainstream regardless of market cycles, all parties in the process have a vested interest in enhancing the quality of their interactions and support for each other. Transparency, Long-term planning and Collaboration (TLC), too often overlooked, downplayed or forgotten along the road from conception to construction, form the points of successful and sustainable ART programs. ART stakeholders may find inspiration in the ancient wisdom of Socrates: "The way to gain a good reputation is to endeavor to be what you desire to appear."
Transparency
Transparency at its best means that parties to a captive program know and understand the business models, specific functions and expense allocations of each other. This relatively simple idea of knowing how everyone makes their money can be clouded by the aggregation of expense components into broadly labeled items like "fronting," "acquisition" and "services."
Issuing carriers should be willing to break down the "fronting" expense into the actual charges for providing insurance company paper and related administrative services; specific and aggregate excess charges; and estimates for boards, bureaus and taxes. Without this level of detail, the captive is unable to understand how revising risk retention or unbundling of services can affect expenses and loss funding.
Acquisition expenses should be broken down into retail agent or sub-producer commission, program administrator fees, and any intermediary or consulting fees. This provides the issuing carrier the detail needed to ensure regulatory compliance and proper accounting.
Services can include claim handling, loss control, premium audit and captive management. Full disclosure of the cost of these component parts enables the captive, captive manager, and issuing carrier to evaluate whether or not there is sufficient value for the services provided. This approach invites accountability, prevents one discipline from subsidizing another, and better indicates the potential costs associated with changing a service provider.
Transparency also encompasses the concept of disclosure. Each party should go beyond trumpeting their selling points and provide an honest assessment of their limitations and potential business impediments. For captive owners, this means providing complete and accurate information about their operations, exposure and loss data, financials, and other data necessary for developing an accurate picture of the risks associated with their business.
Issuing carriers should proactively raise the possibility of channel conflict if there is a potential for competition for captive insureds with other programs or divisions in their own company. Channel conflict may arise as carriers pursue market share, or be the inevitable result of multi-faceted organizations whose independently operating entities seek similar opportunities. This is of greatest concern where there is no defined company clearance system. Captive owners should seek to clarify where they stand in the pecking order and understand the company protocol for conflict resolution in the event these overlaps occur.
Transparency not only includes disclosure of information and business practices, but reducing to writing the commitments and obligations of the parties embodied in those practices. Appropriate documentation of captive program terms and conditions in program administration agreements, captive reinsurance contracts and service provider contracts like TPA agreements and captive management agreements creates increased certainty with regard to specific responsibilities, timing and methodology related to collateral posting, captive cessions, loss funding release of profits, among other things. Establishing a common understanding through contract wording is invaluable over the life cycle of any program.
Long-term planning
Captives continue to be formed in the current soft-pricing cycle. This evidences some level of long-term planning as owners invest in the face of what may, in some circumstances, be a more cost-effective near-term option. Forward thinkers embrace the long-term value in the frequently cited benefits of captives: stability, control and ability to drive down cost of risk over time, versus a short-term view as a bandage to treat immediate pricing or coverage concerns.
Long-term planning is rooted in an assessment of a captive’s risk taking tolerance in every line of coverage and a regular review as risk management and surplus needs change over time. The captive owners should clearly define their profit and service objectives at least annually. It is impossible to hit the targets or measure against benchmarks when they are not established.
Once the captive has established expectations, these need to be clearly communicated to, and weighed against, issuing carrier and service provider capabilities and outlook to determine if they can support the long-term vision of the captive. Is ART a major focus and commitment of their operations or a small segment of the company’s overall revenue? Does the company have a solid capital base to support growth? What expertise and resources are allocated to the captive program? Is the infrastructure tailored to servicing the ART market? Can the carrier support modification of captive risk tolerance along the risk continuum by use of quota share participation? Does the carrier have the flexibility to change claim handling entities? Answers to these questions will help define business partnerships, program structures and planning objectives.
Long-term planning also requires an understanding of how capital is deployed in the form of surplus for the captive and collateral posted to the issuing carrier. Professional advisors are well-utilized in these two areas. Actuarial input related to the expected run-off of captive liabilities, especially for longer-tail coverages like workers’ compensation, will help educate a captive owner on issues such as stacking of collateral year over year.
Long-term planning should be a captive Board of Directors annual agenda item and draw on the perspectives of the issuing carrier and service providers to maximize the flow of intelligence from the marketplace and the alternative scenarios it may presage. This provides a natural introduction to the final point of this article – the value of all parties working together.
Collaboration
The full value of Transparency and Long-term planning will not be realized without Collaboration. Collaboration starts with sharing captive program results, trends, opportunities and challenges with the issuing carrier and service providers. The ability to drive down the cost of risk and have each party win in the process is dependent upon having the opportunity to consider key information, benefit from practitioner observations, and brainstorming. Armed with a strong knowledge base, resources can be coordinated and strategically deployed for the greatest positive impact. Importantly, Collaboration also helps minimize miscommunication and the dreaded "surprises" that breed mistrust. These negative experiences can lead to the program moving from one issuing carrier and service provider to the next. All parties should agree on the benchmarks and measurements of captive program success and identify specific intervals for collective evaluation and discussion of these items. Establishing a positive rapport and collaborative spirit early on generates goodwill and a mindset of "we’re in this together." This can provide an atmosphere in which intellectual weight and coordinated response are equal to the challenges in the marketplace.
Conclusion
Ultimately, TLC creates alignment of business partner interests by promoting a shared vision of captive program success. The leaders in organizations that reflect these values should reap the rewards of more informed decision-making, stronger partnerships, fewer surprises and sustained profitability.
Author: Brian First, Executive VP and Chief Marketing Officer, SPARTA Insurance Company
