It is vitally important that captives, particularly offshore captives, retain the services of a professional management firm in the domicile in which they choose to operate. These domicile managers do more than keep the books; they ensure that the captive's interests are kept at the forefront in all matters, such as finance, accounting, record-keeping, and relationships with regulators and others.
As an essential, even mandatory part of establishing your captive, you will be encouraged or even required to retain the services of a professional management firm in the domicile in which you have chosen to operate your captive. The essential role of the domicile manager is to keep the books, pay bills, record and maintain excess and reinsurance contracts, interface with regulators, and arrange lift tickets and tee times. Actually, that was truer in years past.
The Goal of the Domicile Manager
The exigency of today's financial and regulatory worlds compel the manager to perform more services, at a higher level of professionalism than was expected 10 years ago. In most domiciles, the regulators require, or at least strongly encourage if the legislation does not mandate, that captive owners retain a professional management firm to keep the records and actually manage the captive. The reasons for this are several, but the root is that most domiciles have not funded the regulatory function to such an extent that each and every captive can be observed to the finest detail. Nor should they do so, in my view.
Captives are all about financing and managing their own risks. To do so requires enlightened and efficient regulation. If the regulator is forced to frequently inspect the books and records for every transaction, the entire process will become overburdened and largely pointless. To that end, the regulator needs the services of an independent, professional firm that will be sensitive and responsive to the laws and regulations of the domicile, and the preferences of the regulators.
That goal is in an interesting juxtaposition to the fact that the captive owner selects the domicile manager, and believes that the manager is beholden to his interests. Further, some captive owners believe that, as it is their money, they should be allowed to manage the captive themselves. After all, who knows more about their business than they do? The art of the manager is to operate effectively while serving, perhaps, two masters. In theory, there should be a consistent goal for all parties. In reality, that goal can be often tested.
The Duty of the Domicile Manager
It may defy logic, but cases exist in which an owner does not make decisions in his own best interests, or more particularly in the best interests of the captive. The owner may well believe that the captive, and its money, are his alone to spend, but in fact, as a separate corporation, the captive has a life of its own, and while the ownership may be the same as the owner's structure, the regulators and risk sharing partners expect that the captive will operate in their best interests as well.
It becomes the duty of the manager (and the word duty has been carefully chosen), to protect the assets of the captive, including money, policies, claims reserves, reinsurance and excess insurance contracts and standing in the marketplace. This would include the interests and responsibilities of any outside directors, who may not be current with decisions made by the owner that may compromise or adversely affect their role. This duty is enlarged if the ownership structure involves investors other than the owners of the insureds.
If the owner executes decisions that drain cash to the point of threatening the timely payments of claims, or compromise the integrity of the risk sharing partnership, then the manager must immediately notify the responsible party or the owner, and work toward rectification.
Should the owner fail to respond, and the situation does not improve, the manager has no choice but to notify the regulator, and work with the regulator and the owner to repair any harm done or potentially done. This is often solved with an injection of cash.
Practically, regulators meet at least annually with some of the officers and directors of the captives for which they are responsible. These meetings are intended to further the relationship between the captive, its owners, and the official structure of the domicile which was begun with the licensing process. The domicile manager must manage this process so that all parties feel informed and satisfied. If this is done, as it is in the case of most captives today, then all move forward on their individual tracks to the common goal, a successful captive.
The Power over the Checkbook
The daily duties of the manager should include, in my view, keeping the checkbook, the excess and/or reinsurance contracts, claims records and issuing the policy and endorsements. Many owners hesitate when keeping the checkbook is introduced. The checkbook is, of course, the official record where all relevant transactions occur. Certainly it is possible to set up the checking account in such a way that the manager does not have unlimited access to all of the funds of the captive. The use of impressed or zero balance accounts is widely done.
The point is that a third party whose interests are primarily aligned with the captive's interests should control the actual use of the checkbook, even with restrictions. In practice, there are often two accounts established, one small one for the use by the manager to pay general and ordinary items such as regulatory fees or other operational charges that arise from time to time. It is recommended that a responsible party at the office of the manager be appointed an officer of the captive so that such mundane checking transactions can be handled with a minimum of call upon the time of the captive's principal officers.
Record-Keeping and Other Duties
As the policy is issued, there must be a record of the billing to the insured for payment and of the payment received. Some may be dubious as to the necessity of actually performing this action inasmuch as they see the situation as all one pocket, and the premium transaction as merely bookkeeping. There is a well-known case of a major accounting firm with a captive, which denied a large, public claim, in part because the parent had not transferred the cash owed to the captive. This denial caused considerable tension in an already difficult situation, and lead to the unwinding of a large settlement with a state attorney general. Suffice it to say, the premium must be paid, and all records should reflect that fact.
Some managers will be retained to perform reinsurance and excess duties. It is not a requirement of which I am aware, but merely a service offered by some firms. Whether or not the manager actually places the coverage, he should have copies of the entire transaction, and should review the contracts with the interests of the captive in view. Again, it is possible, and has occurred, that the excess or reinsurance contracts contain language or provisions which conform to the wishes of the parent/insured, but are not in the best interests of the captive.
A case in point would be language referring to coverage that was not included in the application for a license. When the regulator issues the license based on the application that includes the coverage projected to be offered and that is supported by an actuarial study and a business plan, they are not happy to see other coverage slipped in later.
Relationship management cannot be overlooked. There are several players who will interface with the risk sharing partner, the regulator, and the excess insurers or reinsurers. Often a broker performs that function. Frequently another person within that broker performs the function. No matter who performs it, good relations must be maintained, and the manager must, at a minimum, be aware of the current state of those relationships. For that reason, the manager often is the responsible party for the care and feeding of the regulators and the insurer partners.
As in all relationships, those with regulators require a regular and thoughtful effort. It is very helpful to have occasional meetings to be current on proposed regulatory changes, including personnel. This applies as well to the insurer partners. A good domicile manager will know the regulators, their goals and objectives, and the legislative climate within which the regulators must do their jobs. A captive owner does not want to be attending a meeting with serious issues on the table only to learn then that none of his service providers have yet met the regulator or know the regulators wishes and preferences.
While some of this commentary may seem to be in support of additional frictional costs for the captive, I hope that I have made the case for your consideration that all of the players have the common goal of the success of the captive. Reaching that goal is more challenging than in the past, but the rewards are still worth the trip.
The author has an ownership position in three captive management companies, but is not in a captive management position.