The Benefits Of Forming A Captive Are Great – IF – You Set It Up And Manage It Correctly
The use of captives as an alternative means for managing risk is growing rapidly (read a nice overview of captives at the Captive Counsel Law Group). Changes in laws, increasing tax benefits and control over assets makes the formation of captives easier and more attractive for many companies. There are many complex issues that need to be addressed when forming and managing a captive which is why many companies will turn to captive management organizations, such the Towner Management Group, for insight and expertise.
One of the great benefits of forming a captive is the ability to manage and control claims directly. Some of the benefits of directly managing claims include:
- Control over decisions on how claims should be defended and when to settle or take a matter to trial
- The ability to direct the financial benefits of good claims handling to the captive’s (and company’s) bottom line
- Using internal specialized knowledge of your industry to better understand and manage exposures and lower claim costs
- Ability to rapidly address claims issues, reduces future losses, and directs claims knowledge to improve overall risk management
Controlling costs, making decisions on what claims should be settled, and using specific industry expertise can all help to lower costs, but only if the claims are managed correctly.
Failing to handle claims properly can result in increased expenses, greater losses and higher costs paid for reinsurance and excess coverage.
Claims Considerations for Captives
If a captive seems like the best way to manage your risks it is still important to consider how claims will be managed.
While it may seem like a good idea to self manage claims there is a lot to consider prior to making this decision. An assessment must be undertaken to ensure claims will be handled effectively while protecting corporate assets. Managing a claim requires a certain skill, and claim tracking systems and procedures need to be in compliance with a variety of regulations. As a captive you become the insurer and must handle claims in a good faith expeditious manner. Controls must be put in place and policies must be developed so the entire organization can benefit from the captive entity.
Tom Stokes, Managing Principal at Towner Management, and I recently discussed how captive managers handle claims. Tom has found that many captive owners “solve” the claims management problem by continuing to use their current insurance provider. As he noted,
“in these cases, the original carrier either picks up after a deductible to the captive, or acts as reinsurer. The problem with this solution is that risk managers may not approve of the way that the insurer handles their claims and then feel that they still don’t have enough control.”
Since control is one of the primary benefits, utilizing this method for handling claims can negate the desired results. Another problem can arise when an excess carrier or reinsurer is put in an adverse position with the captive owner and a conflict can arise. There is always a risk that an excess carrier settles claims on behalf of a captive for higher amounts to avoid claims reaching their layer.
Being aware of all the issues is critical before making a decision on how to manage claims, so when forming a captive, look at the following steps:
Step 1 – Determine what type of claims will be part of the captive
Understanding the nature of the claims to be handled in the captive is critical to knowing what type of operation should be put in place. How many claims do you anticipate getting? Are you prepared to staff and build an internal claims department? Are the claims specialized requiring advanced skill not available in the current organization? Are there extensive regulatory reporting issues like in workers’ compensation that need to be addressed? Answer the basic questions about what type of claims will be managed and then move on to step 2.
Step 2 – Consider how you want to handle claims
There are many ways to handle claims, but keep in mind that claims handing requires specific procedures and skilled handlers to be in place. Don’t think that your legal department or risk management staff can be converted into a claims department without additional training – the skills and requirements are different. If claims are to be handled in-house, it is especially important to establish controls and have systems to track and manage losses.
Another way to handle claims is by retaining a Third Party Administrator (TPA) to oversee and manage your files. There are many specialized firms that are well qualified to handle a variety of claims. Regardless, even if a TPA is retained, establishing expectations and monitoring their activity through regular auditing is critical to getting the most from their services.
A shared claims management arrangement, with association members or in the context of a group captive, is a great way to get the benefits of claims control while sharing costs for systems and staff. Pooling resources will have the benefit of specialized claims skills and decrease costs further.
For an interesting discussion of TPA management versus self-managed or a carrier model read Kathy Kukor’s article Trending Away From Self-Administration, Carriers in Risk and Insurance.
Step 3 – Establish a program to handle or monitor claims
If you are going to self-manage claims or handle them in-house then it will be important to set up your organization correctly (see me post on self-managing claims). Understand that files will need to be reserved, costs will need to be controlled, and all will need to be tracked using some kind of electronic system. It will be important to understand any reporting requirements for the types of claims you are handling, and make sure your system can provide the correct reports. Controls must also be put in place to prevent fraud and ensure company assets are not wasted.
At a minimum, a claims organization needs to develop or implement:
- A claims system to track claims, make and record transactions, and provide metrics to measure and report claims performance (see my post on creating a claims system)
- A consistent reserve philosophy for better financial planning and understanding of current exposures
- Authorities and controls over payments and reserves to minimize fraud risks
- Claim handling best practice guidelines (see my post on drafting claims guidelines)
- Management programs over vendors to reduce expenses and enforce compliance with the captive’s wishes
If you decide to outsource claims to a Third Party Administrator, don’t forget that they are spending your company assets while acting on your behalf. The best way to make sure they are spending money according to the wishes of the captive is to monitor them closely through regular claim file audits.
A lot of thought has probably gone into the decision to form a captive and the best way to ensure success, and take advantage of the claims benefits, is to plan correctly and be prepared in advance.
