Michael Corbett, Nate Reznicek and Robert Walling explore whether additional captive manager licensing would raise standards or simply impose regulatory burden.

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There continues to be rancorous debate regarding the need and potential value of captive man­ager licensing and credentialing, as well as debate regarding pos­sible approaches to credentialing captive managers. This article will try to provide a systematic examination of the pros and cons of three different approaches to licensing captive managers – maintain the status quo, pursue an National Association of Insurance Commissioners (NAIC)-based licensing model, or utilizing a credential­ing organization such as the ICCIE. We will not advocate any of these approaches or take a position of advocacy. However, we do suggest that the captive management industry will be better served if they take a position before one is taken for them.

Why does this matter?

It is instructive to consider the scope of work performed by captive managers. Captive managers are responsible for creating a captive insurance company’s financial statements. They regularly interface with all the captive’s other licensed professionals as well as the captive’s regulatory domicile.

Most captive managers provide coverage advice, draft policy and reinsurance agree­ments, negotiate claim settlements and adjudicate claims for transactions that are typically in the hundreds of thousands of dollars or more. If a captive manager was a lawyer drafting policies, a claims adjuster handling claims, a reinsurance interme­diary designing the reinsurance, or an insurance agent advising on insurance program design, that manager would be required to be licensed.

It seems counterintuitive that one would need to obtain and maintain a license to sell/service commercial insurance through the standard market, but is somehow exempt when the insurer/reinsurer is owned by an affiliate of the insured(s). How can it be that one’s cosmetologist (assuming one had one) has more stringent licensing and continuing education (CE) require­ments than one’s captive manager?

An iron fist in a velvet glove?

In most US captive domiciles, captive man­agers, actuaries providing loss reserve opinions and certified public accountants serving as captive auditors must apply to be accepted onto approved lists in order to provide services to captives. These approved lists are similar to, but far less rigorous than, a state’s licensing of insurance agents, healthcare providers, lawyers, accounting professionals and other professionals.

When asking captive regulators about the current approach to regulating cap­tive managers, one common theme is that regulation starts with the captive. The response from one domicile indicated they try to avoid difficulties by not licensing problem captives, including those with captive managers they are uncomfortable with, in the first place.

The regulation of the captive and captive managers continues as the captive oper­ates. One regulator noted that the ongoing regulation of captives provides valuable information about service providers. They said: “The [captive financial] exam process is revealing a range in the quality of work that is enlightening. We have worked with several service providers who have pro­vided less-than-satisfactory work product by actively communicating our expecta­tions of them to improve their work.”

Another regulator added: “For already licensed managers, we review their com­pliance during exams.” Again, it begins with captive regulation, but naturally leads to proactive service provider regulation.

The current approach can be quite effective in managing specific captives and captive manager situations. Advocates of the status quo also point to the success the current approach has had in regulating captive managers.

They also note that some of the worst offences in recent years have been com­mitted by individuals who were not captive managers and would not have been affected by changes in captive manager licensing. Proponents of the status quo also note the substantial level of communication that exists between captive regulators today.

However, the current approach fails to provide: 1) more formal communication and coordination between domiciles; and 2) due process, appeals and a process for rein­statement for a disciplined captive manager. At a high level, it also lacks transparency to all parties involved, including other regula­tors, captive owners and the public.

Another notable problem that exists in some domiciles is regulators lack the stat­utory authority to remove a captive man­ager from the domicile’s approved list. In other words, once a captive manager was added, it is difficult to remove them.

In recent years, some regulators have made the subtle but important change of removing the word “approved” from the service provider list to remove any sug­gestion that they are approved or recom­mended by the regulators.

As a result, expanded regulatory over­sight and stricter licensing of captive service providers are real possibilities. One regu­lator provided some interesting perspec­tive on where captive manager regulation could be headed. They said: “Because of the IRS’s [Internal Revenue Service] posi­tion that many managers of 831(b) cap­tives are promoters, I am hearing discus­sion about managers (being required to) become licensed producers/agents. This would allow states the authority to take action against managers under the existing producer licensing laws.”

Characteristics of effective captive manager licensing

What characteristics would be necessary for an effective approach to captive man­ager licensing? First, any captive manager licensing approach should have broad applicability, ideally at least all US captive domiciles to avoid captive managers simply changing domiciles. In addition, the approach needs to provide due process, that is give some organization the authority to investigate conduct, discipline captive managers, and provide both appeals and reinstatement processes.

There are two potentially successful approaches to developing a licensing pro­cess for captive managers: the establish­ment of a credentialling body, and the use of an NAIC model law. We will examine both alternatives.

Option 1: Credentialling body with disciplinary authority

The first viable approach to licensing cap­tive managers involves the establishment of a credentialing organization with both the ability to provide a professional designation and also the authority to have a disciplinary process. One such example is the Casualty Actuarial Society (CAS), which provides cre­dentialling for property-casualty actuaries in the US. It also has the authority, in part­nership with the Actuarial Board for Coun­selling and Discipline (ABCD), to discipline actuaries in violation of actuarial standards.

Importantly, the ABCD and CAS not only have the authority to discipline actuaries, but also undertake formal investigation, appeals and reinstatement processes.

The American Institute of Certified Public Accountants (CPAs) has similar credentialling and disciplinary author­ity for CPAs. The mandatory nature of these designations for certain profes­sional activities helps ensure that all say appointed actuaries are subject to the CAS disciplinary process.

By contrast, an organization like the International Center for Captive Insurance Education (ICCIE) has developed a rigor­ous education and credentialing process, but lacks both the regulatory mandate (ie. you are not required to be an associate in captive insurance, ACI, to be a captive manager) and also the authority to disci­pline ACIs. But what if they did have this?

As noted, the first approach to a formal licensing process for captive managers follows the approach used by CPAs and actuaries. Consider if an organization with a credentialing program, such as ICCIE or the institutes, added a disciplinary pro­cess that gave them the authority to inves­tigate alleged violations of a code of ethics and professional standards, and due pro­cess for investigation, discipline, appeals and reinstatement. Captive regulators could require that every captive application name a credentialed captive manager (for instance, an ACI at the captive manager) who would have responsibility for the con­duct of the captive manager relative to that captive insurance company.

Another approach would be to impose a level of credentialling at the captive man­ager level. Consider ICCIE’s approach to listing ICCIE-trained organizations, where:

• At least 20% of the captive profession­als in the organization must hold the ACI in good standing; and
• At least 30% of the company’s captive professionals must be ACIs, Certificate in Captive Insurance (CCI) holders, or currently enrolled in either the ACI or CCI program.

Could captive regulators require captive managers to be ICCIE-trained organizations? Does that create a barrier to entry for smaller organizations? Does it create salary inflation for ACIs?

The biggest advantage of the creden­tialing association approach is taking advantage of the existing credentialing processes, such as the ACI designation. The biggest challenge is the need for captive regulators to require an ACI, or similar credential, on the captive application and recognize the credentialing body’s author­ity to discipline members.

Option 2: NAIC model law/ regulatory approach

In 2005, the NAIC developed the Producer Licensing Model Act, which “governs the qualifications and procedures for the licensing of insurance producers”. There are many aspects of this model act that could either be expanded to include cap­tive managers or imitated in a standalone model act for captive managers to provide regulators with guidance on captive man­ager licensing. For example, section 3 states that “a person shall not sell, solicit or nego­tiate insurance in this state for any class or classes of insurance unless the person is licensed for that line of authority in accord­ance with this act”. Language such as this could be easily expanded or imitated.

The Producer Licensing Act requires passing a written examination (general and line specific), a written application, a background check, licensing fees and other requirements. It also contains specific criteria for license denial, non-re­newal or revocation. The authority to do these things is conveyed to the insurance commissioner in the licensing domicile.

In short, captive management could almost be added to the Producer Licens­ing Act as a separate “Line of Authority” in section 7 and the act could be very easily expanded to include captive managers.

So, the Producer Licensing Model Act has already been adopted in all states, which simplifies expanding it to apply to captive managers. It also has the advantage of insurance commissioners already hav­ing substantial regulatory authority over similar professionals.

Perspectives on captive manager licensing

It is worth contemplating how all the dif­ferent stakeholders in captive insurance might react to the addition of some form of captive manager licensing.

• Captive managers: Their reaction would definitely be a “mixed bag”. It is wholly conceivable that some manag­ers may view licensing as “raising the bar” and good for their, and the indus­try’s, reputation. Others might view it as unnecessary, bureaucratic red tape that is contrary to the captive industry’s well-known advantages of speed to market and ease of doing business. For this cohort, it may be said that, generally, there is tepid interest in changing the status quo. Would that change if several of the promoter cases or other litigation turns out badly? Or if more captive managers are sued for negligence by their captive owners, thereby publicly tarnishing the reputation of captive managers?
• Captive regulators: Again, we may assume that there would be a fair amount of support for the status quo. With regulators, there is often a perva­sive attitude of “we’ll catch any problems during the exam process”. However, prior examples of known bad actors changing domiciles and engaging in questionable legal activities with new auditors, actuaries and regulators sug­gests that more transparency would benefit captive regulators.
• Non-captive insurance regulators: A number of domiciles that do not have captive legislation are openly anti-cap­tive. Adding captive manager licensing, particularly an approach following the NAIC producer licensing model law route, would be viewed as a positive.
• Complementary service providers: Actuaries and auditors, especially those in smaller organizations, may not cur­rently know the reputation of their new or prospective clients. That condi­tion puts them at risk of engaging with potentially problematic individuals and organizations, and repeating mistakes of the past. More transparency would most certainly help this condition.
• The IRS: While not directly a stake­holder, the US tax agency has been pro­active in pursuing captive managers that they view as promoters. Maybe some form of licensing would provide a venue for more self-regulation.
• Captive owners: They are, by far, the most important stakeholders in this discussion. They deserve transparency. That is, they have a right to know if a captive manager has been disciplined by any domicile or, just as crucially, their licensing organization. Captive owners would never retain an actuary or auditor who was not a CPA or FCAS/ACAS. So, why would they hire a captive manager that wasn’t qualified?

The ongoing interactions between captive regulators and their service providers are an important conduit to foster the captive industry’s continuous improvement and uphold its reputation. Captive industry members have a vested interest in maintaining high standards for service providers and raising the bar as best practices evolve.

Captive manager licensing may be an approach that encourages consist­ently high-quality service to the captive owners, insureds and regulators and strengthen the captive insurance indus­try’s reputation. For better or worse, this sometimes improvement requires raising the bar. Questions remain whether addi­tional captive manager licensing would truly raise the bar and provide more pro­tection or simply impose regulatory bur­den and cost.

(Published on Captive Review)