Captive Insurance Exit Strategy
November 2007
Captives and interest in them continues to
grow. This behooves an examination of what happens when the captive's useful
life is at an end, voluntarily or otherwise.
by Michael
R. Mead
M.R. Mead &
Company, LLC
Prospective captive owners always rightfully ask: How could this captive
fail? How do we wind it up? What is the exit strategy? These are all good questions
which should be carefully examined.
Undercapitalization
As to the first question, it has been my experience that there are two primary
reasons for the failure of a captive. The first may be obvious, and that reason
is undercapitalization. Often prospective captive owners look at the minimum
capital requirements of a domicile and the minimum surplus requirements computed
by an actuary and believe that those amounts are sufficient.
This where usual and customary business life comes into play. Most of us
would agree that seldom do the best-laid plans cost what we project, nor do
they follow the forecasted timeline. When you are building a house and delays
and extra expenses occur, you can cut out the pool; when it is an insurance
company you are building, you can’t cut out the claims or reserves. And it isn’t
your call anyway. The regulators will decide how much more may be needed.
So, planning for the minimum capital and surplus as your maximum invested
is risky. You can be asked to put in more money. You may choose not to do so,
but that brings a different set of issues.
Ownership Issues
The second major reason for failure of a captive is the mis-, mal-, or non-feasance
of ownership. This takes a variety of forms from inattention in operating the
captive to actually raiding the bank accounts. No matter the size of your basic
business, mom and pop or Fortune 500, starting a captive is starting a new line
of business, a new company, and it requires the active involvement of key decision
makers. The captive manager does not and should not be making strategic decisions.
That is the responsibility of the owner.
It may seem preposterous but it has happened that a captive’s owner(s) decides
that the money that they put into the captive is still theirs with no further
obligations and decides to withdraw it for other purposes. Of course, this action
brings them into direct conflict with managers and regulators, fronts, and reinsurers,
but by the time the action is visible, it may be too late to change the course
of events.
Exit Options
Regardless of the route to "The Close," what happens when the decision is
made to close up shop? A salient feature of an insurance company is the fact
that at the moment one policy has been written, the company is alive until all
claimants, actuaries, auditors, and regulators are satisfied that there are
no further obligations. Funding becomes required for the duration unless you
can find a way to transfer the obligation.
There are companies and individuals who will offer to acquire the captive,
and work to close the remaining claims for less than the reserves and pocket
the difference. If you are highly skilled and diligent this can be a lucrative
line of business.
You may ask, why wouldn’t the original owner close down the captive? Why
not make the money oneself? Principally this gets into business models, focus,
and entrepreneurship. If your captive is an important but marginal part of your
business, you may not wish to take the time and energy to perform the work necessary
to close it down, profit or not.
Another situation is mergers and acquisitions. If Company A purchases Company
B, which has a captive, Company A may not view the captive as important and
may not want to devote the time to deal with captive issues. All of which can
open opportunities for an entrepreneur.
Conclusion
Should the decision be made to perform the work necessary to close the captive
yourself, you will need to acquire detailed information on the outstanding claims,
reserves, and funds or security held to cover them. Then it will be necessary
to conduct negotiations with fronting and reinsurance insurers and regulators
to have reserves taken down, claims settled and closed, and funds released.
Once again, in the captive field, it is wise to work with knowledgeable professionals
in every phase. Ending the use of a captive is not so simple as ceasing to do
business with it or funding its operations. There can be an orderly cessation
but it takes planning and thought, as always.
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