Financial R&R: Are Captives the Next Big Thing in D&O Insurance?
By Alliant Specialty
Many larger companies have considered starting a captive as an alternative to traditional D&O insurance. With the amendment to Delaware Corporation Law (Section 145(g)), captives appear, on the surface, to be a more viable option. But is this really “The Next Big Thing” in D&O? Ron Borys & Ryan Farnsworth, Alliant Financial Institutions, sit down with Matia Marks, Alliant, and explore the possible risks associated with starting a captive to replace traditional D&O.
Welcome to Financial R&R a show dedicated to financial insurance and risk management solutions and trends shaping the market. Today. Here are your host, Ron Borys, and Ryan Farnsworth.
Ron Borys (00:13):
Well, welcome everyone. Thanks for tuning into the latest edition of the Financial R&R. This is Ron Borys and Ryan Farnsworth. And we are here today with one of, our special guests. Who's certainly joined us in the past, Matia Marks, and we want to talk about some of the recent news that came out over the last couple of weeks regarding the use of captives and the ability to run D&O insurance, more of a follow up to podcast our colleagues, Steve Chappelle, and, and Brian Dunphy, and Seth Madnick had put out last week, but with an angle and a focus more on financial institutions, because as we know I've been working with large financial institutions for over 20 years, many have captives already. And obviously to the extent that you already have a captive and ability to potentially run your D&O and in particular, your side, A, your non-indemnifiable loss, a portion of that risk through the captive.
That's, got to be exciting for a lot of risk managers. We certainly know that a lot of large companies have been thinking about starting captives, especially with the market being as hard as it's been over the last couple of years. And I think there's a lot of misunderstanding and misinformation out there regarding captives, Matia and her prior life was a risk manager at a large company that actually had a captive. So, we thought her joining us and, and giving that perspective would be great. So, Matia, thanks for joining us today.
Matia Marks (01:29):
Sure. Happy to be here.
Ryan Farnsworth (01:30):
Yeah. And Ron, you can't say fake news, right? You have to say other ways to describe it because one of the things that we in the insurance world, sometimes we get bored with ourselves sometimes, right? And so, when something like this comes, we feel like we need to think that it might be the next big thing. And, and the reality is as we'll talk about today and continue to evaluate this development in the coming months and years, is that at the end of the day, what we're most focused on is helping our clients find that more rewarding way to manage risk and identify coverage and risk. And how does that affect we transfer off of a company's balance sheet and how does it most effectively protect directors and officers? Because at the end of the day, it's still the same risks that we've been seeking to ensure with the commercial marketplace for years. And what we're always trying to do is find the best way to possibly do that. And we're thrilled to have Matia with us today. I would love to just here Matta's initial thoughts, Matia, we love that you're here with us at Alliant, but what would be some of the things running through your mind as a client if you were still on the risk management side, on the heels of this development?
Matia Marks (02:35):
Yeah, I mean, I can certainly understand the knee-jerk reaction of wanting to do something like this because of the way that the market has been going over the last several years and looking at this as an alternative to placing the risk in the traditional commercial marketplace. But I have to say I feel like it's such a large endeavor to start a captive. There's so much that you need to do, the feasibility study, you know, the regulatory approval, all the things that are required. It's certainly not something that an organization is going to, or in my opinion, at least entertain just for the purpose of doing something like this, because it's just such a huge endeavor and requires a big commitment on the part of the company. And furthermore, it's really not the type of risk that traditionally you would see in a captive in that you don't necessarily have the underwriting expertise to understand, first of all, how you would need to price something like this and how to reserve for claims. And also, it just doesn't have the predictability of the types of risk that you would normally put into it, like a worker's comp where you have high frequency, low severity. I mean, if you have a D&O claim, as we all know defense costs and settlement costs have been growing exponentially over the last several years. So, in my opinion, it's just not something that I would really want to expose my captive to unless I had a really mature captive that had a lot of excess capital to deploy.
Ron Borys (04:04):
Yeah, Matia, listen, I think you hit the nail on the head, from my experience firms that are buying or running insurance through their captives, they're doing it because the market has gotten to a point where they're requiring retentions to be really large. And the captive is less of a risk management tool and more of a risk financing tool. Right? So, to suggest that you know, if you have to take the, the first 10 or 15 or 25 million in retention, you're going to have to pay that anyway as the company. So, why not take that capital, pull it aside, put it into a captive and, and manage it that way. I, think you even the fact that D&O has historically been, a low frequency, high severity type exposure. The understanding is that yes, maybe you're funding your captive with 10 million and that helps, but at the end of the day, you still have to buy reinsurance to some degree, if you want to have some type of, uh, stop loss relative to your capital and exposure.
And then in many cases on top of it, you're looking at reinsurance or the commercial market sitting on top of that program, which again, is going to cost you money in this market. So, you know, again, uh, Ryan, I think the new term today's term is misinformation. I think we've moved away from fake news. Maybe we'll go back to fake news at some point. But I think the going term today is this information. And I think that's what we're here to try to clear up for folks.
Ryan Farnsworth (5:25):
Having information is the key because regardless of what we or Matia said, risk managers and general counsels, and people who handle the D&O insurance are still going to get questions from the board saying, what about captive? The market has been really hurting our balance sheet the last couple of years by having premiums go up retentions, go up, you know, and of course any increase in cost is going to impact that decision-making process. And I think that's one of the great things about being at Alliant. You can go and talk with Seth Madnick and some of our other captive solution experts at Alliant and put the combination of captive expertise with D&O risk advisory services. And what does it mean not just the brokerage side from the insurance market perspective, but talking with our legal and claims team, it was Steve Chappelle with Matia Marks and down the line. And I think, as, as we look at answering clients' questions in the future, we're going to continue to stay focused on hearing what's important to them, but also dealing with the realities of seeking coverage and cost certainty, because, we're, we're also going to talk through the, the upcoming market challenges and, and, and changes that are going to be happening throughout 22’ and 23’, where the reality of having captives as an option should help the competitive forces in the marketplace in what we're already seeing as an improving D&O insurance market in the months to come.
Matia Marks (06:53):
Yeah. I'd just like to add to Ryan that certainly one of the goals of having a robust D&O program is to encourage high-quality individuals to join boards. And I'm not sure that having a D&O program run through a captive is necessarily going to accomplish that goal. So, it's something else to keep in mind as well.
Ryan Farnsworth (07:11):
But listen, as we know, and rightfully so, pricing has been a major issue for many clients, right? We saw not financial institution-specific, but, Elon Musk, Tesla, essentially stopped buying D&O insurance. It was big public news, right? And he was going to give a personal indemnity. And of course, if we had the other, the rest of our legal team on the phone, they would tell you why there are tons of reasons why that doesn't necessarily work the same way a Dino insurance policy will work either. But you know I think it's really interesting recently, we came across some literature, apparently there's a market or, a broker out there trying to sell a captive in the solution for specs. And, uh, in looking through the materials, I can see why it might be really attractive to a company that's staring down the barrel of some real expenses, right?
You know, very competitive pricing. And, and one key difference is if you have no losses, the company has the opportunity of a return premium. I mean, that sentence alone is just riddled with misleading information, right? So, what if you have a claim, right, as we know, D&O claims can sometimes take six months, a year, three years, or five years to sort out. So, how do you know if your policy has no losses at the end of the day, you don’t, right? The reinsurance is provided by a carrier with an AM Best rating of A, well that's reassuring, right? I mean, for those of us, who've worked in this business for a long time. Most directors want to see at least an A + or A ++, because again, as you know, Matia as a lawyer, long-duration claims take a long time to settle.
Unfortunately, we've had situations where carriers have not survived the period of a loss. We've had carriers in our time in the business, go into insolvency or receivership or wind down. And at the end of the day, then what happens, right? If you're a director involved in some complex D&O litigation, you basically line up with all the other policyholders that are trying to get their claims paid? I mean, there's, there's a lot of interesting information there. I thought another interesting comment was how do my claims get paid; claims will be handled as any other insurance company handles claims. Okay. That's really reassuring. As we know, most directors go into insurance policies, thinking insurance companies don't want to pay claims. Obviously having a deep claims recovery team, we're really good at getting carriers to respond and pay, but don't get me wrong here.
There are definitely good reasons to consider using a captive in your risk management sort of tool chest of things available to you. But again, this is not something for everybody, this is something that really experienced sophisticated buyers should be considering, and also understand that there are benefits in consideration. And I think that's sort of the goal in these discussions is to make sure that while we’re certainly all in support, and we're just as excited to see this change come about, out of Delaware, it's not something that's going to be there for everybody.
Ron Borys (10:00):
Yeah. The devil is definitely the details, as we've always talked about when it comes to transferring risk to insurance companies. So, having the conversations as Steve Chappelle always says early enough and often, in these processes, when you get a question from the board, when you get an internally about how to handle costs and the D&O risk, what are the implications? There's a lot of literature out there that's walking you through it, but at the end of the day, what's the most important thing doing what's best for your individual organization and your stakeholders? And we're thrilled to have the tools and the resources to be able to do that for our clients and look forward to doing so as this law takes effect and continues to impact board rooms around the country.
Ryans Farnsworth (10:41):
Obviously, there's going to continue to be a lot of dialogue here. Matia, we're really lucky to have you and your perspective, just given the fact that you've done this kind of both on the brokerage side, on the risk management side. I guess what's your sort of parting takeaway here for at listening today if they're looking at this news or being approached with a solution here as a captive in, in lieu of paying D&O insurance premiums, what's kind of the message we can send to folks?
Matia Marks (11:09):
Yeah. I mean, I certainly think that there's a role for captives to play in this space, but it's definitely not a one size fits all solution for every organization. You really need to flush it out, speak with your management, speak with your broker and make sure you really understand what your goals are, what you're trying to accomplish, and whether or not this is a solution for your particular organization.
Ron Borys (11:30):
Yeah. I saw another one that said something about sharing limits, right? Ryan, we know how much directors love to share limits. Some of these pulled captive approaches. It actually is a pool of insurance where multiple publicly traded companies would be sharing limits. I just, I can't believe any director would be on board with that. But like I said, it's an interesting time that we're in right now, our goal here is to try to just provide some clarity. We're certainly seeing a ton of this across a variety of sectors, but captives have been heavily utilized in the financial institution space forever. And you know, we thought it was really important to, to get this out there. So, if anybody's listening in right now, it has any, any questions or, or, or wants to learn more about what we're doing within financial institutions and how we're helping clients find that more reward way to manage risk. Please visit our website at www.alliant.com. That's it for now, we'll wrap this up and look forward to speaking with you all again soon. Thanks.
Alliant note and disclaimer: This document is designed to provide general information and guidance. Please note that prior to implementation your legal counsel should review all details or policy information. Alliant Insurance Services does not provide legal advice or legal opinions. If a legal opinion is needed, please seek the services of your own legal advisor or ask Alliant Insurance Services for a referral. This document is provided on an “as is” basis without any warranty of any kind. Alliant Insurance Services disclaims any liability for any loss or damage from reliance on this document.
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