Risk Management for Captive Insurance Managers.
Captive insurance at its best complements risk management but what do Insurance Managers do to manage their own risk.
IRS Notice 2016-66 requires additional reporting to the IRS for certain captives and their key service providers. Many in the industry should fully understand the specifics of the requirements so we will not cover those. However, whilst Albion does not provide any tax advice whatsoever we do think it is important to think about the consequences of these reporting requirements.
Just think about the information the IRS now has on all 831(b) captives. Ironically, the IRS will now have available to it, probably, the most detailed statistical exposure and loss data for the captive insurance industry. The IRS can quite easily, if it so chooses, establish :-
Overall loss rations by line of risk
Loss ratios by individual captives
Loss ratios by insurance managers
Loss ratios by actuarial provider
Why the focus on loss ratios? Over many years personal discussion with many insurance managers has provided anecdotal evidence that manager look to provide significant return to their clients via low loss ratios.
In the short-term low loss ratios may be reasonable for some of the captives just like the possibility of hitting the craps table and throwing a hard 8 when the point is 8. Long term, the likelihood that everyone is throwing a hard 8 on demand might give the impression that the dice are loaded and the house is likely to react.
What of this statistical improbability of the industry having a low loss ratio, what are the implications? In short, premiums maybe overstated. This may be applicable for a line of risk such as some of the more esoteric included within captive programs. It may also be the premiums appear overstated for organizations as a whole. Where the premiums are seemingly overstated in a systemic manner there may be a suggestion that there is something amiss within a pooling structure or an Insurance Manager or with an actuarial firm. The upshot of a systemic issue may be a promotor audit.
The consequences of a promotor audit, besides the fines and threats of imprisonment, will include hours of sleepless nights, major disruption to the business, hundreds of thousands of dollars in legal fees and the loss of clients and prospective clients.
Many Insurance Managers who do not rely on strong external benchmarking with defined underwriting and claims standard operating practices in line with commercial practices might find that their future clouded.
So what should be done?
Getting back to risk management, how many insurance managers or captives have truly considered the implications of the data being supplied to the IRS? How many have identified the risks now being faced? How many have truly evaluated that risk? If they have evaluated the risk what risk control measures have been put in place?
One option is to engage an independent firm to carry out a review of operations and operating procedures. Having a new set of eyes on the business can highlight areas that may need improvement. It may also mean that the manager or captive is able to rely on a second opinion of good practice should issues arise.
One way to mitigate the ongoing investigation into a promotor audit may be to demonstrate that the manager is moving towards best practice. Those that can identify, evaluate and control matters are likely to be those that survive these dark times.
With many years of experience both within the captive and commercial insurance sectors Albion can provide an independent and confidential review of operations. We can assist with operational systems and procedures to ensure best practice is met. We can work on a one-off basis or continue to provide ongoing captive consulting.
Contact Albion to see how we can help you manage your risk.
Albion Risk Consulting, S.A.
23rd May 2017
