Our chosen five key pillars of captive corporate governance are as follows.
- Independence
- Accountability
- Fairness
- Responsibility
- Transparency
While each of these five holds weight similar to the others in importance, we believe independence should be the key attribute captive insurers focus on.
Independence
While it is true that most captive domicile regulations require captive insurers and risk retention groups to have an independent director on the board, the question arises as to what constitutes "true" independence. First, many state statutes call for the independent director to have residency within the state. While there are many competent independent directors residing in most captive domiciles, the legislative restriction seems too limiting for several reasons.
One, if there is a large number of captives within the state and a limited number of available directors, the result is an independent director serving on multiple boards. Besides the time commitment to fulfill this role in a meaningful way, there is also a potential for conflicts of interest when directors have access to internal information from multiple captives. Two, in many instances the "independent" director may also serve as the general counsel for the captive or as part of the captive management team. While it is true neither individual is directly related to the entities responsible for forming the captive, can a director truly be construed as "independent" when he or she serves multiple roles?
The NACD says an independent director should meet the relevant standards as defined by a self-regulatory organization (SRO). The following composite definition is drawn from various US and non-US SROs. Most SROs provide additional guidance on what they believe comprises "independence."
Independence
While it is true that most captive domicile regulations require captive insurers and risk retention groups to have an independent director on the board, the question arises as to what constitutes "true" independence. First, many state statutes call for the independent director to have residency within the state. While there are many competent independent directors residing in most captive domiciles, the legislative restriction seems too limiting for several reasons.
One, if there is a large number of captives within the state and a limited number of available directors, the result is an independent director serving on multiple boards. Besides the time commitment to fulfill this role in a meaningful way, there is also a potential for conflicts of interest when directors have access to internal information from multiple captives. Two, in many instances the "independent" director may also serve as the general counsel for the captive or as part of the captive management team. While it is true neither individual is directly related to the entities responsible for forming the captive, can a director truly be construed as "independent" when he or she serves multiple roles?
The NACD says an independent director should meet the relevant standards as defined by a self-regulatory organization (SRO). The following composite definition is drawn from various US and non-US SROs. Most SROs provide additional guidance on what they believe comprises "independence."
Independent Director means a director who has no direct or indirect material relationship with the company other than membership on the Board.
We think the independent director helps ensure that management and the board follow the other four pillars of corporate governance. It is this individual who most likely will ask the truly tough questions.
Accountability
Accountability means having ownership of the strategies and tactics required to attain organizational goals. While accountability can often take on a negative context (i.e., who is to blame if something goes wrong), real accountability should assign both the reward and the risk associated with the attainment of the captive's goals.
For captive insurers, especially those that outsource a significant number of operational functions, a clear delineation of accountability is important. This accountability should be agreed to up front as part of any contract negotiations. Who is ultimately responsible for the decision? The old saying that "success has many fathers, but failure is an orphan" certainly holds true in the context of accountability. Therefore, good corporate governance requires this accountability to be both understood and acknowledged.
For captive insurers, especially those that outsource a significant number of operational functions, a clear delineation of accountability is important. This accountability should be agreed to up front as part of any contract negotiations. Who is ultimately responsible for the decision? The old saying that "success has many fathers, but failure is an orphan" certainly holds true in the context of accountability. Therefore, good corporate governance requires this accountability to be both understood and acknowledged.
Fairness
Fairness means treating all stakeholders reasonably and equitably. For captive insurers, the question of fairness comes into question in many areas including claims handling, pricing, and underwriting. It may even include who is eligible to serve on the board of directors.
Fairness also entails an effective option for addressing perceived or real violations of fairness. For many captive insurers, this redress may include arbitration of any issues that arise between the captive and one of its policyholders. One of the most egregious examples of a breach of fairness, in our minds, is where policyholders are forced to undergo arbitration but the party hearing the appeal is the captive's board of directors. The captive's directors are not disinterested parties in this case and may also be wearing multiple hats representing not only the captive but their own organization as well.
While third-party arbitration certainly may be more expensive, it also is a more equitable alternative than arbitration by the board of directors.
While third-party arbitration certainly may be more expensive, it also is a more equitable alternative than arbitration by the board of directors.
Responsibility
As noted above, accountability entails having ownership for the strategy and tactics of the captive insurer whether as a manager or board member. Responsibility goes hand in hand with accountability. Since both managers and board members are vested with the authority (accountability) for acting on behalf of the captive insurer, they should therefore accept full responsibility for exercising those powers. In the captive, the expression of ideas and implementation of those ideas need to be tempered by preparation so that the actions taken are informed.
Responsibility requires education and awareness of the proposed actions, as well as understanding the consequences of those actions. A "responsible" director will carefully weigh the impact of the proposed actions on all of the various constituents of the captive insurer. This may involve having to make difficult decisions concerning fairness and transparency.
Transparency
This concept, which is now a major part of the corporate vernacular, is a critical component of the five pillars of captive corporate governance. Transparency, such as in the GE article referenced earlier, means management has informed the board there was still a business jet available to the CEO for corporate travel. Transparency in its simplest terms is "having nothing to hide."
However, transparency in a captive insurer is a more delicate balance. Both management and the board need to recognize that while transparency would suggest full disclosure, there are matters—such as in the handling of claims—where this may not serve the captive well. While transparency is to be encouraged, it also must be weighed in the context of both accountability and fairness. Boards and management teams that have a firm understanding of the principles of good governance will be better prepared to make informed choices concerning how much transparency is necessary and/or required.