To be successful, a captive's management must develop a strategy, execute it, reassess it and then evaluate programme performance, say John Lochner and Thomas Hermes.

Strategic planning is the cornerstone of a successful captive insurance programme. A captive operating without a governing strategy is often misguided in its efforts. To paraphrase Louis Carroll, from Alice in Wonderland, if you do not know where you are going, any road will take you there. But simply having a strategy is no guarantee of success. A poor strategy, even when successfully executed, will doom the captive to failure. As such, developing a well thought-out strategy should be a top priority for prospective and existing captive board members.

Revisiting a captive's strategy, and revising it where appropriate, is also extremely important to a captive's long term usefulness and survival. In many respects, captive board members should view strategic planning as a continuous process. This article explores the strategic planning process for captives. We see this as a continuous, four-step process.

It begins with developing the initial strategy. Next, the strategy must be executed. Periodically, the captive's performance should be measured, relative to whether it is helping the organisation meet its original objective(s). Lastly, the strategy itself must be challenged to ensure it is appropriate for the current and near future environment.

Strategic planning process
The stages in the strategic planning process are:
• Develop the strategy (initial or refined);
• Execute the strategy;
• Reassess the strategy;
• Evaluate programme performance.

Developing the strategy
The initial strategy is typically conceived and largely defined during the captive feasibility study process. This process seeks to:
• Identify the organisation's current perceived needs and future direction, both operationally and from a risk financing perspective;
• Articulate the mission for the chosen risk financing vehicle (i.e., the reason for its formation);
• Detail the possible risk financing alternatives (captive vs. trust, owned vs. rented, single-owner vs. group etc.);
• Outline the pros and cons of each alternative in terms of how it addresses the organisation's needs and will support its future direction;
• Provide recommendations for implementation.

For many captives, the initial strategy focuses on furthering the parent's more immediate business objectives. Typically, these objectives include risk management, managing insurance related costs and enhancing protection of corporate assets. Longer term, many captives' strategies begin to broaden into areas such as insuring business partners, writing more exotic coverages, etc.

Executing the strategy
How one executes a particular captive's strategy will depend on that strategy itself. There is, however, some commonality of approach between captives which we will touch on briefly.

For a start-up captive, executing the newly defined strategy focuses on implementing the new programme. Implementation steps include:

• Defining the captive governance structure, such as board composition and committee structure;
• Drafting the captive's by-laws;
• Assembling the captive's service provider team of actuaries, managers, and legal advisors, among others;
• Drafting the captive coverage agreement;
• Securing (re)insurance services (such as fronting, claims handling) and/or protection as needed.

For existing captives, executing the strategy could require one of two approaches. Where the strategy remains largely unchanged, execution involves “staying the course”. However, where the board modifies the captive's strategy to pursue new or emerging needs, key facets of the programme then need to be reoriented to support the new direction.

Evaluating programme performance
Evaluating a captive's overall performance is a critical element of the strategic planning process. The key issue to explore is: Have the original objectives established for forming the captive been met?

If the organisation's objectives have not been met, the captive programme should be rethought. The captive should be repositioned, or its key elements restructured, to enable it to achieve the original objectives. If this is not a likely outcome, the board should consider closing the captive.

If the organisation's objectives have been met, congratulations are in order on a job well done. However, the programme evaluation should not end just yet. In the spirit of continuous improvement, the board should ask whether the captive could have been even more successful in helping the organisation to meet its objectives. Can subtle improvements make the programme more responsive to member needs or wring out additional costs?

How does the captive's performance compare to internal or external benchmarks? Internal benchmarking could focus on the cost of coverages written in the captive versus those costs historically, pre-captive. External benchmarking could include comparing captive expense ratios, leverage ratios and investment performance to industry results.

The captive performance check-up focuses on past performance, but also provides the foundation from which future strategic directional changes may take place.

Reassessing the strategy
Today's business environment is changing rapidly. Using the healthcare industry as an example: declining reimbursements are causing serious financial pressures, merger and acquisition activity continues, the push to create integrated healthcare systems persists, hospitals are acquiring physician practices, etc. As such, organisations are, therefore, trying to adjust and reposition themselves just as rapidly.

With organisations forced to change rapidly, the potential exists for a mismatch between a captive's objectives and strategies and that of its sponsoring parent. So, what were reasonably sound objectives and strategies for a captive to pursue may no longer be valid or appropriate.

Captive boards need to reassess their organisation's needs and future direction periodically and prioritise its objectives, both operationally and from a risk financing perspective. Once this has been done, board members can develop and, as necessary, refocus the captive's strategy and plans to pursue those objectives.

All too often, organisations assess and retool their captive strategy assuming a relatively static environment. This is dangerous, especially in this very dynamic time. Many different variables can influence the success or failure of a captive. (Re)insurance market conditions, investment returns, tax and regulatory issues, business cycles or other factors affecting financial solvency are but a few examples.

The strategic planning process may include pro forma financial modelling of the captive's expected results under a base case or expected scenario. Such projections may also be run at alternative scenarios, including a pessimistic case. This helps the board understand the downside risks and positions it to manage these risks.

One question often asked is: “How frequently should we evaluate our captive and its strategy?” The answer, ideally, is always. Practically speaking, we suggest the board, working with its strategic advisors, discusses the captive's performance and strategic direction at least annually. We have found that dedicating a set amount of time to discusses strategic issues at one of the captive's board meetings works quite well.

We offer an important warning to the exuberant strategic planner. Do not let the allure of the strategic planning process convince you that change must be made. Change for change's sake is not appropriate. Captives often fail, or perform less well, when their masters begin operating outside of their areas of expertise and/or beyond their organisation's core mission. It is all right to conclude during the strategic planning process that the current strategy is appropriate.Strategic planning is critically important to captives. Without a strategy guiding your captive's daily operations, how will you know if you have arrived, that you have achieved your goals? Or worse yet, how will you know if you are lost, before it is too late? Those captive boards which invest the time to develop a sound strategy and continuously monitor and refine it, as needed, should reap the rewards of a successful captive.

John Lochner and Thomas Hermes are with Tillinghast-Towers Perrin, the global risk management/actuarial consulting firm, in Hartford, Connecticut. Both are experts in captive formation and strategic operation.