WHAT CAPTIVE INSURANCE COMPANY BOARDS OF THE FUTURE MIGHT LOOK LIKE John J. O'Brien JD CLU CPCU "More Fit and More Proper “ How has the small island of Bermuda managed to play such a large role in the world captive risk and insurance industry and carry it off with such a high degree of integrity? Some might conclude that surely there must be in place in Bermuda a highly funded and expansive regulatory body employing highly trained government employees from many disciplines. The reality is quite different. On their first visit to Bermuda, many American risk managers exploring the feasibility of a captive solution have found it hard to believe the insurance regulator works from a small office and with only a handful of staff. These Americans have learned that the Bermuda regulatory body from its inception has relied heavily upon the private captive insurance infrastructure as a vehicle for self regulation. Within the Bermuda infrastructure one finds at work significant numbers of knowledgeable risk professionals and a community of professional service providers for captives who are committed to best governance practices and the belief that boards of directors and management participation at every level be provided by “fit and proper” individuals. The Vermont captive industry patterned itself after Bermuda and met with success. Across the US, many states are rushing to grab their “piece of the captive pie” by passing captive domicile enabling legislation. This rapid growth in domiciles and the increased focus and demand for enhanced corporate governance requires us to take a serious look at the standards of regulation and self governance of this rapidly emerging industry in the U.S.. Perhaps there are some important lessons and guidance that mature and experienced domiciles can provide. Peering into the future and being forward thinking is a good thing. Fortunes can be made and tragedies avoided through intelligent planning. Also management has played an important active role by looking back and assessing the past performance and accomplishments of the entity they manage. Enhanced governance principals have brought not only stewardship responsibilities to management and boards, but also the responsibility of ensuring the survival of the entity into the future. Captive insurance company boards of directors are not exempt from this change in management perspective. Governance is becoming a popular topic and advocates are attempting to understand the likely make up or composition of future captive boards of directors. In some situations advocates are considering or mandating more independent directors in captive boards. What is driving this movement? Here are some of the facts being considered: More than 55% of commercially insured risks are now insured in alternative vehicles with continued growth expected. 60% of the U.S. states have passed some form of enabling legislation to facilitate the local establishment of captive insurance entities. c. Governance failures of public companies experienced over the past ten years including Enron and Lehman Brothers have led to calls for increased oversight – both federal and at the state level -- for financial and corporate entities, including insurance companies. One of the key pillars or best practices relates to the make-up or composition of boards of directors, along with recommendations or mandates for independent directors. d. There is clearly an evolution of corporate governance practices, and consideration is now being given to extending the regulatory requirements, considered to be best practice, to the governance of corporate subsidiaries, including captive insurance companies. e. Specifically, these governance concepts under consideration for captive insurance company management and governance resemble the processes that is applied and utilized in public, corporate companies. While the outcome of the debate and the imposition of regulatory requirements regarding governance is unclear, we can reasonable expect a higher standard of good governance and board responsibility in the regulation of insurance companies in general and extending to the regulation and governance of captive insurance companies specifically. In the regulatory and governance arena worldwide there are many organizations and players at work. A common theme emerging is the “fit and proper persons" criteria for management professionals, service providers and board of directors, as well. The term "fit" is said to apply to an individual’s education, training and experience while the term "proper" refers simply to the person's character. The intent is to ensure and demonstrate responsible behavior by all parties of commerce. After Enron, federal regulation, like Sarbanes Oxley, have required public companies to have independent directors. These concepts can be seen migrating to the governance of captive insurance companies. In the area of captive insurance companies, the future trend will likely define a fit board of director member not only as one with background and experience in measuring solvency (accounting) but also to have a working understanding of enterprise risk management and the actuarial sciences. Clearly, an independent director with such a background would be an asset to a captive because captive boards wrestle with issues surrounding enterprise risk management on a recurring basis. For example, when the captive board sets the confidence level for its reserves, it is being done by experienced insurance professionals who know what they are doing and the importance of their handling the job appropriately. Captives typically are part of a larger corporate family and risks exposure to the total enterprise should always be at the forefront. Captive boards and officers are usually part of a larger enterprise risk management team. Having the captive board members be fit and proper individuals is a good overall risk management approach and provides confidence to whole corporate organization. The current trends in corporate governance appear to becoming a reality in the EU with planned implementation of Solvency II. The current view is that captives will be required to have fit independent board members who can no longer hide and no longer delegate and to be considered fit to be capable of understanding enterprise risk management and actuarial reserving and the goal of establishing prescribed statistical confidence levels. Laying aside for a moment the issues of whether U.S. captives will eventually be required to meet such high standards as required by Solvency 11, no one should take issue with the belief that having a captive insurance company board member or members with enterprise risk management and actuarial science background would add value to the captive. The insurance professionals who built the Bermuda "self- governing” industry, were trained and seasoned insurance professionals. They understood risk and insurance and were concerned that all who were involved did so with the highest legitimacy. Bermudian insurance professionals learned from the start of their careers that they had kjoined a unique industry where their actions towards others are governed by the standard of utmost good faith. Insurance products are sold because they were suitable to the needs of the customer. Insurance claims are paid because the company is in the business of paying claims and a first or third party is counting on the company for this payment during their time of need. This model provides a template for our industry. Captive board members are called upon to serve others in an industry where lack of integrity of any kind is to be avoided. We are fiduciaries who are pledged to always follow the high road. We should expect the "fit" insurance professional who would qualify to serve on a board to also a "proper "person. Corporate America arguably has lost its way in sustaining a highly ethical culture and as a result it is suffering the consequences of increasing regulatory oversight directed particularly at the makeup, operation and responsibilities of corporate boards. Looking forward we can reasonably see governance standards and regulations extending to the boards of captive insurance companies. There are many fit and proper candidates who understand and embrace the increased responsibility and are anxious to make a lasting contribution in exchange for the opportunity to practice their trade with like minded insurance professionals. The captive insurance industry should give high priority to having more fit and more proper independent directors on captive boards without regulatory intervention. Good governance after all is good business. Enterprise risk management is the wave of the future. Does it not make sense for our industry to be proactive and get underway today enlisting more fit and more proper independent directors who understand enterprise risk management?