One of the primary rewards from operating a captive is the
ability to place more emphasis on the risk management process, in order to
stabilize annual budgets, reduce long-term costs, and utilize capital more
effectively. To accomplish these goals, captives rely on experienced service
providers to manage almost all of their operations.
An actuary is one of these indispensable service providers. Simply
put, actuaries can quantify the level of risk, which allows the company to
better manage it. And actuaries provide value throughout a captive’s life
cycle, from formation to dissolution (if applicable). Risk factors change all
the time, so having an actuary review your experience regularly is crucial to
avoiding problems.
Speaking of avoiding problems, we all love the functionality
of the Waze traffic app, which steers us from one location to another in the
most efficient manner possible. At its core, this traffic app helps you figure
out what path to take to avoid unexpected delays, thereby reducing stress
levels. Anyone who has traveled I-95 in Connecticut knows this value
first-hand.
Actuaries essentially function like a Waze app for captives.
They largely provide a means to keep captives on the right path by avoiding
surprises and reducing potential for management stress.
Initially, actuaries are engaged in feasibility processes to
help ensure a company knows what to expect as it sets out on its journey to
create a captive. Where necessary, actuaries utilize data from the local environment
(the industry) to supplement the company's own experience. The main deliverable
of the feasibility study is a five-year pro forma financial model, which
includes a projected income statement and balance sheet of a new captive’s financial
business plan. Actuaries provide these projections on both an expected loss
outcome basis and an adverse loss scenario basis; this is because it is crucial
to understand the potential risks involved, not just what to expect on average.
Both the captive business owner and regulator are key stakeholders for whom the
feasibility study reduces stress levels right from the outset.
Once the journey begins (the captive is formed), actuaries
perform ongoing loss reserving and loss forecasting (budgeting). As the
captive’s losses emerge, the actuary has to gauge how much weight to place on
an individual insured’s experience versus that of the industry when estimating
ultimate losses. This is a delicate balance amidst the “noise” of random variations
in losses. In the end, actuaries hold the keys to how fast the captive can travel
from a loss recognition standpoint.
Periodically, at least every three years, the actuary should
update the pro forma model, adjusting to the conditions of the road map that
was created. This provides a continuous means of reasonableness testing of
underlying assumptions, including loss ratios, loss development patterns, loss
payment (discount) factors, expenses, investment income, taxes, etc.
All of this effort ultimately supports a smooth ride—the
issuance of fairly stated financial statements with adequate funding of loss
reserves. The actuary’s road map and process needs to be transparent enough to
allow another actuary to essentially reproduce the analysis (even though no two
actuaries would use all of the same assumptions or necessarily take the same
route to the destination). During the process, the captive’s actuary needs to
engage in dialogue with the audit firm’s actuary to ensure audit sign-off is
secured; this helps to arrive at your final destination from a financial
reporting standpoint.
As actuaries, we certainly wish our models could be as
straightforward as the Waze traffic app. Even though we face complex questions,
our processes and expertise have proven to be successful in navigating the
risky terrain of running a captive insurance company. In Connecticut, our
tourism branding is “Still Revolutionary.”
In today’s ever advancing age of big data and analytics, using actuaries
to help captives take calculated risks to justify the potential rewards noted
above is still a state-of-the-art approach.
And the Hartford, Connecticut area has the highest number of actuaries
per capita in the United States. Talk about an opportunity. So you may want to
consider the Waze-like advantages of using an actuary to help you navigate a
new route to establishing a captive in Connecticut.
~ Stephen
DiCenso, President
