The Coverage Tower - With a Profusion of Service Provider Contracts and Policy Documents, Sometimes Captive Perils Sit Alongside the Rewards

Author:Mr Joshua Gold
Profession:Anderson Kill & Olick, P.C.

"The Coverage Tower," Originally published in Captive Review (November 2009).

For just about every risk manager these days, captive insurance is an option that is being considered if not already utilised. But with the options offered by captive structures come risks that many of those selling captive insurance products and services rarely broach with customers until a problem is at hand.

The problems can vary, ranging from fronting insurance companies over-reserving claims to captive manager conflicts of interest to regulators seizing collateral accounts of captive insurance companies when fronting insurance companies go belly-up. While none of these risks can ever be entirely eliminated, there are steps policyholders and their captive insurance companies can take to mitigate these perils.

Observing business formalities

Having the captive operate more like a traditional insurance company may minimise certain problems later under certain captive scenarios. Some policyholders, for instance, use captives to fill lines or layers (or pieces of layers) of coverage where underwriting capacity is either scarce or cost-prohibitive.

When this happens, policyholders would be wise to have their captive insurance companies duly prepare and deliver insurance policies, even where the primary or lead underwriter has yet to accomplish this task. Some insurance companies and insurance markets are notoriously poor at delivering (accurate) insurance policies in a timely fashion.

Policyholders who have captives participating in a tower of coverage at an excess layer should not wait around for the primary to prepare and deliver the policy. If the primary fails to deliver the policy in a timely manner and an insurance claim hits, the captive is put in an awkward position of figuring out the final terms of coverage after the claim. Some insurance companies, both below and above the captive's position in the tower, may try to exploit this situation to the policyholder's detriment.

Not only would it seem advisable to observe formalities by actually preparing captive insurance policies, it also makes sense to handle and pay claims in the ordinary course (even when the net effect is to transfer money between related entities) under a delineated procedure whereby the captive receives and settles claims from the policyholder.

Such niceties not only help support the notion of a separate legal entity, but it may also be necessary to actually have the physical transfer of money to deal...

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