Recently, Spring Consulting Group conducted a survey of captive insurance company owners and regulators to understand what best practice approaches were in use or contemplated for implementation over the next year. In the survey, 60% of organizations are or have considered using a captive for employee benefits in addition to funding their property and casualty coverages. Companies with premiums greater than $10 million are more likely to use or consider using a captive to fund employee benefits (70%).

During this current economic crisis, companies are even more focused on looking for ways to reduce benefits costs and minimize risks. Many are turning to captives to achieve this, often starting by funding life and disability.

For example, a healthcare organization found that their life insurance premiums were excessive. In order to lower these costs, they funded their $4.0 million life program through a captive, found a commercial insurer fronting arrangement in the market, and as a result, lowered their premiums, eliminated broker fees and generated a $720,000 (17%) cost savings in year 1. This cost saving was expected to be generated each and every year.

We now see the range of benefits considered for captive funding expanding with companies like United Technologies Corporation and Memorial Sloan Kettering Cancer Center who have contemplated using a captive to fund retiree medical, and others now looking at funding pensions in a captive. Considering the 60% of organizations in our survey using or considering using a captive to fund employee benefits, it is clear that there is a significant movement in the industry.

In fact, many companies including YKK Corporation of America (2008), Heinz (2006) and AGL Resources (2005) have expanded their captives to cover employee benefits.

In 2008, Spring conducted a captive feasibility study for a multinational manufacturing company with approximately 8,800 employees. This manufacturing company currently has a Bermuda captive that writes property, workers’ compensation, general liability, auto liability and employer’s liability. Spring provided a detailed evaluation of writing employee benefits (life and disability) including multinational pooling benefits through the captive. Due to the tax complexity and age of this manufacturing company’s captive, Spring explored two structural options: redomestication, or making a 953(d) election and establishing a branch captive in the United States to fund employee benefits. Spring was able to provide estimated financial savings by redomiciling the captive to the United States of $4.6 million in savings over five years.

Once a captive is established, maintaining its operation requires working with service providers to meet regulatory requirements, including establishing a board of directors, creating a business plan and selecting legal auditing and actuarial advisors. As a result, many organizations such as the Captive Insurance Company Association (CICA) have started to create captive best practices guidelines to help captives reach an optimum level of operation and regulatory compliance. CICA, in order to develop the best practices guidelines it released in March 2008, worked with Spring Consulting Group who created a survey designed to research and benchmark captive performance specifically in the areas of business alignment, corporate governance and regulatory compliance. Additionally, Spring was tasked with providing captive owners with an overview of tools and practices employed by survey respondents to increase captive effectiveness.

The research group consisted of captives in various industries, including manufacturing (36%), services (32%) and pharmaceuticals (17%), 11 of which operate multiple captives. These captive decision makers were asked questions related to the three areas of focus from the CICA Captives Best Practices Guidelines. While approaches to business alignment, corporate governance and regulatory compliance vary from one captive to the next, commonalities do exist and can provide guidance.

Respondents’ captives had been in business anywhere from 8 months to more than 35 years, with the average captive in business for 13 years. Captives with premiums greater than $10 million had been in operation longer than those with premiums less than $10 million.

The most commonly established captive was a “Pure captive,” with a limited number operating other captive structures, including group captives, segregated cell captives and RRGs.

The most common captive insured lines of coverage were property (64%), general liability (47%), workers’ compensation (45%) and auto liability (36%). However, 60% of survey participants are considering, or have already implemented, employee benefits through their captive. Captives with premiums greater than $10 million showed more interest in captive benefits financing.

While approaches to business alignment, corporate governance and regulatory compliance vary from one captive to the next, commonalities do exist and can provide excellent guidance.

Most captive owners for example, develop comprehensive business plans to maintain captive efficiency, prefer formal feasibilities and actuarial analyses to less rigorous diagnostics, outsource captive management services and perform annual captive strategy assessments. In fact, 79% of those surveyed identified a carefully developed business plan as the most important tool for effective captive operation. Treasury and risk managers are now working with benefits groups to develop these operational guidelines. A majority of respondents use captive managers to provide domicile services; however, some survey participants use a combination of outsourced and in-house management resources. While 70% of survey respondents evaluate their captive strategy and business plans once a year, all survey respondents review their captive strategy at least once every five years.

The survey also found that more than half of respondents have a captive manager on their board, while about a third have an independent director on their board, signifying the increasingly strategic role captives are playing in assertively managing insurance and employee benefit costs. While captives’ strategic importance is growing, many still lag in the area of benchmarking, with only 45 percent using benchmarks to manage operations

While the range of responsibilities assigned to captive Boards of Directors (BOD) differ substantially across respondents, most common BOD functions include election of officers (49%) and establishment (51%) and/or enforcement (38%) of captive policies and procedures. The vast majority (83%) of BOD members are covered under Directors & Officers insurance and are bound by Conflict of Interest agreements

Forward-thinking investment strategy, adherence to financial protocols and annual audits have been recognized by captive owners as especially useful in ensuring captive efficiency. Third-Party Administrators are used by 43% of those surveyed to manage claims, while 34% rely on in-house resources.

30% of survey participants rely on the Finance, Investment and Budget committees to manage their captive. Other committees used for captive management include Advisory Board, IT, Insurance, Governance and Claims Management

Almost half of the survey participants meet annually with domicile regulators to stay apprised of their captives’ activities.

Compliance with domicile and filing guidelines (98%) and licensure maintenance (89%) are most prominent among core responsibilities of the modern captive manager.

Only 17% of the surveyed captives are rated, and the majority of unrated captives rely on AM Best Captive Guidelines and/or financial ratios to evaluate their captive’s financial strength. Although only a few captives are AM Best-rated, most have devised methods to assess captive financial strength. The most common financial ratios used are reserves-to-surplus ratio (34%), premium-to-surplus ratio (32%) and loss ratio (28%).

Particularly in this economy, companies are increasingly interested in managing risk and developing innovative funding strategies for their employee benefit and property and casualty insurance programs. The findings give us a good baseline for determining how captives are addressing the areas of business alignment, corporate governance and regulatory compliance.

Looking forward, as the captive industry continues to grow and change survey participants expressed a few concerns, including tax regulation (39%) and regulatory compliance between on-shore versus off-shore domiciles (21%). However, more than 25% of respondents do not expect any significant operational barriers or adverse regulatory changes.

It is clear that in the current economic turmoil, maintaining strong regulatory management of captives is essential. For financial officers, the environment also demands that they consider expanding their use of captives to maximize control over their corporate risks. Many of them now see that using captives to drive down the escalating cost of employee benefits is the logical next step in prudent enterprise risk management