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1 How to Download Your VCIA 2013 App vcia vcia2013 Scan Your QR Code While using a barcode scanner, point your devices camera at QR code Download the App Plug in our Username: vcia And Password: vcia2013 View App To get QR Code Scanner, download one from the apps store on your device Another way to download our app is to start from step two. Go to your devices app store and search: VCIA 2013 Annual Conference

2 Captive Governance: Ensuring a Successful Launch and Steady Course Mary Dewey, Director Of Risk Management & Safety at the University of Vermont William Lytton, Executive Vice President & Chief Legal Officer of Tyco International Ltd. (retired) Kevin Moriarty, Esq. Lori White, Vice President, Senior Account Manager of Marsh Captive Advisory Group August 13, VCIA All Rights Reserved

3 Agenda Governance Legal Compliance Requirements General Governance Issues Governing Board Recruiting and training Operations Retention Role of Committees Officers Equity Holders Third-Party Service Providers Risk Retention Groups Special Considerations 2

4 Governance Legal Compliance Requirements 3

5 Governance Legal Compliance Requirements Domicile statutes authorizing the organization and operation of a captive insurance company/risk retention group In most states (including VT), a captive can be organized as: Stock or nonprofit corporation Limited liability company Reciprocal insurer/mutual insurer Protected cell company (sponsored captive) 4

6 Governance Legal Compliance Requirements Type of Entity Participants/equity holders Governing Board Officers / Others Stock corporation Shareholders Board of Directors President, secretary and any other officers needed Nonprofit corporation Members Board of Directors President, secretary and any other officers needed Limited Liability Co. Members Board of Managers President, secretary and any other officers needed Mutual Insurer Policyholders Board of Directors President, secretary and any other officers needed Reciprocal Insurer Subscribers Subscribers Advisory Committee President, secretary and any other officers needed; Also role of attorney-in-fact Protected Cell Depends on type of entity, stock corp, etc. Note special issues re separately incorporated cells 5

7 Governance Legal Compliance Requirements All captives must have a governing board, with primary responsibility for operations of the captive, including compliance with all applicable laws Board must have at least 3 members, one of whom is a Vermont resident RRGs will have to include qualified independent directors on their governing boards per pending RRG governance rules Reciprocals must have at least 2/3 of board members that are representatives of subscribers 6

8 Governance Legal Compliance Requirements Captives are governed by the domicile captive statute (in Vermont, title 8, chapters 141 and 142 of the Vt. Statutes), and by the law applicable to the form of captive, i.e., a captive formed as an LLC is also subject to the LLC law (in Vermont, title 11 chapter 21 of the Vt. Statutes) If the laws conflict, the captive law controls 7

9 Governance Legal Compliance Requirements Other key governance mandatory statutory provisions: Board meeting in Vermont annually Requirement to comply with conflict of interest provisions of Vt. Ins. Regulation 81-2 Retention of an approved captive insurance management company Annual actuarial review by approved actuary Annual audit by approved independent auditors 8

10 General Governance Issues 9

11 General Governance Issues Captive participants are generally equity holders, with rights to elect governing board All captives with more than one equity holder should have an agreement that binds the captive and each equity holder, e.g. corporate shareholder agreement; LLC operating agreement, and that addresses: Conditions for participation, including capital contribution, rights to operating distributions, repurchase of the equity interest if the equity holder leaves the program, and distribution of assets on dissolution Operation of the captive 10

12 General Governance Issues Governing board is ultimately responsible for all of the captive s insurance and related operations: Compliance with all relevant state and federal laws Understanding the captive s insurance program and approving operational changes Understanding the captive s financial position Oversight of captive s officers and service providers 11

13 Governing Board 12

14 Governing Board Duties Potential issues: 3-member board; governance rules/bylaws allow a 1/3 quorum consistent with VT law What if the captive manager is one of the members? Informal agreement not to hold meetings of 1 director? Breaking ties in board votes Should manager/vt attorney on the board be in this position? 13

15 Governing Board Duties Independence Knowledgeable Not a rubber stamp of management Active as opposed to somnolent Adds value to management and stakeholders by their presence and involvement not merely management checking the box 14

16 Governing Board Duties Fiduciary Duty i. Act in the best interests of another not yourself ii. Usually implies a more conservative approach with less risk taking than might otherwise be acceptable Duty of Loyalty i. Act in the best interests of the company and its stakeholders ii. Fair process (approval by non-interested directors) or else burden on directors to show entire fairness. No conflicts of interest of self-dealing Duty of Care i. Pay attention and ask questions ii. Business Judgment Rule significant deference to the decision of a board where they were diligent but made a poor decision 15

17 Board Composition Will depend on nature of captive program: a group of otherwise unrelated businesses ( single parent captive ) a captive owned and operated for a group of affiliated businesses ( group captive ) For single parent captive, board membership will be determined at parent company level. Usually board members or senior officers of the parent/affiliate will serve on the captive board For group captive, board membership will depend a variety of factors: Capital investment by captive participant (i.e., controlling shareholder in terms of stock ownership of the captive) Experience with insurance and financial/investment matters Size of board Role of board committees advisory only or authorized to act on behalf of the board? 16

18 Board Composition Recruiting board members Vermont resident board member (conflicts of interest) Education of board members Level of participation expected of board members (e.g., number of meetings annually) Size of board; consideration of split votes; tiebreakers (captive manager, VT attorney) 17

19 Committees Check the governing statute (LLCs, corp, etc.) for restrictions on committee powers and requirements regarding membership Generally, board can delegate its powers to a committee (but see statutes) Consideration of independent participants (e.g., for audit committee) Single-parent versus group captive 18

20 Types of Committees Executive committee Audit committee Claims Underwriting Investments Risk/Loss Control 19

21 Liability Statutory limits on directors and officers liability D&O insurance for insurance operations Captive obligation to indemnify officers and directors 20

22 Board Activities Board exercises its powers as a group, not as individual directors (unless specific authorization to an individual is made by the board) Dual roles: directors that are also officers or employees of service providers The activist director Vermont examinations interviews with board members 21

23 Operating Benefits & Challenges BENEFITS Underwriting profits go to shareholders, not commercial insurer In everyone s best interest to control losses, manage exposures Provides opportunity for group purchases/group buying power from commercial market (for coverages outside the captive arrangement) Pooling of minds to develop best risk management and claims management practices Retention level adaptability Coverage adaptability CHALLENGES Assessments shared; investment returns subject to market conditions Each shareholder may not have the same level of dedication to loss control, thus affecting the bottom line for all Some may opt not to participate in group purchase Not all shareholders will necessarily implement best practices to the same extent Differing opinions on retention levels with a group > importance of actuarial analysis Whether to broaden coverage or restrict coverage- are insurance partners willing to broaden coverage? Is board willing to expand coverage to address one or two shareholder concerns? 22

24 Operating Benefits & Challenges (cont d) BENEFITS Ability to set shared guidelines on admission of new shareholders. When to grow or not to? Those with good claims experience pay less premiums Active participation allows all members to have a role in setting the direction of the captive; allows for good blend of experience Opportunity for all members to participate CHALLENGES When do too many shareholders make shared governance problematic? More difficult to operate, get things done? Some may be more diligent than others in documenting losses paid within retention. This can be problematic if all losses within SIR and outside are taken into consideration for the premium calculation model There will always be differing levels of participation and parent companies commitment to the role of the captive affects this. Participatory management comes at a cost (time and money) Some members may try to dominate 23

25 Orientation of Shareholders A Best Practice for on-boarding new members Intro History Mission/Goals/Strategy Organizational Structure/Functions Company structure Management Style Broker s role/captive Mgmt. role Officers & Directors How to become involved The flow of meetings Meeting conduct & protocols Committee Roles & Responsibilities 24

26 Orientation of Shareholders A Best Practice for on-boarding new members Operations Issues Insurance coverage summary and program structure Premium allocation methodologies Group Purchase opportunities (outside of captive/rrg) Risk Control Issues Committee responsibilities Best Practices Lessons from Losses Claims Management issues Committee responsibilities Claim Handling procedures Claims Handling Guidelines Outside Coverage Counsel 25

27 Orientation of Shareholders A Best Practice for on-boarding new members Finance Issues Committee responsibilities Actuarial studies Financial Reporting Capitalization Equity Allocation Dividends & Assessments Investment policy Admissions Process for new Shareholders/subscribers Committee Responsibilities Company philosophy on admitting new members Process & Procedures Member Resources & Aids Website? Claim Databases Listserve 26

28 Committee Roles/Responsibilities Executive advisory body to the board Operations oversight of reinsurance and insurance operations; monitor emerging exposures and whether to insure Finance review and provide guidance to the Subscribers Committee and the Executive Committee concerning actuarial results; Prepare/review financial statements; Develop equity allocations model; Dividends and Assessment calculations; appoint independent auditors Investments develop investment policy and invest assets in accordance with policy; appoint outside investment manager; monitor investment performance Risk Control risk identification and mitigation; Lessons from Losses ; development of best practices to mitigate the risks insured 27

29 Committee Roles/Responsibilities Claims Claims review; Assess coverage availability under insurance policy terms; Reserve analysis & setting; develop claims handling guidelines and reporting requirements; directing work of TPA Finance Actuarial reports; Financial statements; Equity allocations model; Dividends and Assessment calculations Admissions Achieving controlled growth through the admission of quality entities ; Establishes criteria for admission; screens applicants for admission 28

30 RRGs Special Issues Model Audit Rule (audit committee) Applies to VT RRGs Insurance Holding Company Act Applies to Vermont RRGs; requires filing of annual registration statement (unless exempted) Governance Rules Will come into effect in

31 Hypothetical 1 XYZ RRG is a Vermont RRG formed by unrelated manufacturing companies Company A participates and receives GL coverage from the RRG Company A has a claim, and there is an issue as to whether the RRG policy covers the claim 30

32 Hypothetical 1 Issues for consideration: Is there a fronting insurer? What role does it play in coverage determinations? Is there reinsurance? May introduce reinsurance coverage issue; consideration of ongoing relationship with reinsurer(s) Fairness to other RRG members: would the coverage decision create a potentially bad precedent? 31

33 Hypothetical 1 Issues for consideration (cont.): What, if any, board involvement should there be in the coverage determination? If there is a claims committee, does its charter include coverage issues and a process for dealing with them? What if the insured making the claim is a majority shareholder and/or a member of the board and/or claims committee? Should a claim ever be approved when not covered, as an ex gratia payment? 32

34 Hypothetical 2 Captive manager ABC has been retained by XYZ RRG to provide management services, pursuant to a written management agreement Jim is an ABC employee with primary responsibility for the XYZ account His team has identified a number of large claims that have been paid without appropriate documentation Jim brings this to the attention of Andrea, who is not an ABC employee and is the XYX Treasurer Andrea listens, agrees to follow up but doesn t 33

35 Hypothetical 2 Issues for consideration: What are the potential risks of this situation to the RRG and its operations? What should Andrea do? Does this rise to the board level? What if Jim is a board member? 34

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