Richard Latham outlines the importance of adequate software systems for captive management.

In order to assess the technology needs of a captive insurer, it is first necessary to define what a captive insurance company really is. In its simplest form, a captive is a wholly-owned subsidiary company of a corporation, established to underwrite some of that corporation's risks, including risks originated from sister companies within that group. In that sense, using a captive can be viewed as a form of self-insurance, although legally this is not the case. A captive is a properly established insurance company with its own articles of association, and its own board of directors. It also has regulatory obligations, which will vary according to the domicile in which it is established. Some captives expand to write third-party business, which will arise from outside the parent corporation. Captives can be either self-managed, or run by a captive manager (which will be established to manage a number of captives).

Captive insurance companies have been a feature of the insurance landscape for over 30 years. They were originally established in Bermuda, but have spread to nearly 50 domiciles worldwide. According to some recent reports, they and allied `alternative risk transfer' mechanisms (a euphemism for any non-conventional insurance), account for one third of the property and casualty business written worldwide. Captives have become particularly important since September 11 and the onset of the current hard market, where traditional re/insurance has become increasingly expensive, or unavailable in certain areas. However, software companies have often ignored this market, arguably to their detriment.

Like all other insurance companies, a captive will have basic systems requirements:

  • underwriting - risks, premiums and claims;

  • reinsurance - inwards and outwards;

  • enquiries and reporting;

  • accounting; and

  • risk management, loss control and communication.

    Software and advanced future-proof technology can assist in these areas.

    Underwriting

    It is important to realise that each captive is different. Consequently, a captive manager needs to employ a software system capable of handling the range of captives under its management. In addition, the captive manager might run a rent-a-captive or cell programme, both of which bring their own sets of challenges. This means that software systems need to be flexible enough to cope with a high degree of variety, as well as capable of dealing with any other alternative risk transfer vehicle that might come along in the future.

    In terms of underwriting, risks need to be entered and recorded, and linked with claims and reinsurance that attach to them. Often, there is a need to record quotations, before they are confirmed as firm orders. Documents such as cover notes, invoices and policies will need to be produced, and letters of credit recorded. Mid-term changes and renewals need to be issued.

    The recording of claims is especially important. Captives often have low retentions and the linking with reinsurance is also important to record. Regulation is increasingly difficult to ignore. All manner of reports will have to be run, including triangulation reports, and the captive will need to record movements in reserves and IBNRs (incurred but not reported). Indeed, for UK-owned captives, since 2000 there has been a statutory definition of a claim reserve, which may vary from the actual, and both of these will have to be recorded.

    There are insurance company systems that will meet these requirements, many of them well established. Broking systems have also been adapted, and would be able to record the underwriting and claims requirements, maybe with some adaptation. Document management and production systems will be needed to generate documents.

    Reinsurance

    Because of local regulatory requirements in numerous territories, a captive frequently acts as a reinsurer to a locally admitted carrier, which `fronts' the risk by writing the initial insurance business of the organisation, and then ceding it to the captive. Therefore, captives often act as reinsurers as well as insurers, and must be able to handle inwards reinsurance (reinsurance assumed). Most underwriting systems will handle this.

    Nowadays, captives must meet increasingly strict regulatory capital and solvency requirements, but, compared to conventional insurers, they often lack net capacity. Outwards reinsurance (reinsurance ceded) is therefore vital, and the system must be able to record the different types of reinsurance that might apply, be it quota share or excess of loss treaty, or facultative. Stop loss programmes are also common. The proportion of the risk, or insurance programme, which is retained within a captive, and what is ceded to reinsurance, can be measured by the use of sophisticated stochastic risk modelling programmes.

    Enquiries and reports

    Modern systems are able to enquire and report at all levels and at high speed, and consequently management increasingly expects instantaneous information. There is no doubt that quick and accurate information helps sound decision-making and hence contributes to a successful business. But at the same time, this means that this ability to enquire and report at short notice is vitally important.

    Any information contained within the system should be available for reports. The reporting package should be sophisticated enough to sort and to determine the relative importance of information. It must also be able to drill down to individual transactions and claims. Finally, it must be able to integrate with Excel, and packages such as Business Objects, so that management reports can be produced.

    A captive reports to its parent and separately to its board of directors, the latter often being made up of local experts. Information is as important to these two constituencies as it is to the management of any insurer - sometimes more so.

    In addition, as part of their regulatory approach, all domiciles demand regular returns. These vary in content and frequency but the principle remains the same, and the ability to set up reports which can be produced quickly at short notice remains enormously important. Examples of what may be required from these returns include:

  • premium split by classes of business;

  • schedule of maximum retentions net of reinsurance per policy per year, showing policy limits and estimated maximum losses;

  • summary of reinsurance business ceded outwards by class and by method of placement, including the threshold, any one loss and in the aggregate, showing the basis of premium and commission received, and specifying any reinsurers writing over a certain pre-defined amount;

  • claims analysis, reported, paid, outstanding and IBNR by class of business, and by year of origin, showing expected trends. Claims over a percentage of net assets will often need to be shown individually;

  • details of any letters of credit or guarantees showing the beneficiary, who issued it, and how much;

  • material changes projected beyond financial year ends, focussing on policy limits and retentions, and reinsurance programmes; and

  • solvency margin calculations. This often is made up of minimum capital, plus fixed percentages of net premium.

    It all adds up to quite a challenge!

    Accounting

    Accounting systems are essential to any captive and must include the ability to record all insurance transactions. It must also include a general ledger package to record all non-insurance transactions. Many captives keep multiple bank accounts in multiple currencies, and Euro compliance is crucial if any business is being done in that currency. The captive may also wish to record results in different currencies. Finally there is the beginnings of carrying out financial transactions down the internet, and secure electronic trading systems are now available to cater for this.

    As the captive forms an integral part of its parent company's balance sheet, its performance is of vital importance. Risk management and loss control processes are therefore essential, and to measure these, captives, or their parents' risk management departments, need risk management information systems (RMIS). These systems record everything from physical protections to surveys to claims history. Furthermore, stochastic modelling tools can determine what part of an insurance programme is placed in the system, and what is insured elsewhere - or not insured as the case may be. Finally, much of this information can now be imported directly into a captive's own underwriting system.

    By Richard Latham

    Richard Latham is vice-president at software boutique The Alphabet Group.