Captive Insurance Assets and Investment Policies

Two pages open on a printed and bound annual investment report with a black and silver pen sitting on top

March 13, 2017 |

Two pages open on a printed and bound annual investment report with a black and silver pen sitting on top

Congratulations; you have just been asked to serve as a board member for a captive insurance company or a risk retention group. While you may well be an expert in your chosen profession, serving as a board member for an insurance company, even a captive insurer or RRG, requires you to exercise your fiduciary responsibility to insure the captive is financially sound. The following article, fourth in the series, is intended to provide new board members with a basic grounding in captive insurance assets and the development of an investment policy to guide the investment of those assets. (See the first article in the series, "Key Concepts for New Captive Board Members"; the second, "Basics of Loss Development Triangles"; and the third, “Insurance Pricing.”)

Obviously, the investment fundamentals discussed below are only a starting point, and, like all good directors, you should seek to continue your education in insurance as you grow into your role.

Captive Insurance Assets

While many directors focus on the liability side of the captive insurer's balance sheet, the asset side is of equal or greater importance. Captive insurance assets, predominantly in the investment portfolio, provide a substantial portion of the free cash flow necessary to meet the claims obligations of the company. The portfolio also serves as a ready source of liquidity when losses are higher than anticipated and can be used to make claims payments prior to the receipt of reinsurance recoveries. 

Most captive domiciles have a regulation regarding the fiduciary obligations of the board of directors that can be summarized as "the board of directors shall adopt a written plan (investment policy) for acquiring and holding investments and for engaging in investment practices and adopting procedures that specify guidelines as to the quality, maturity and diversification of investments." While the board may be able to delegate some of its authority to external investment managers and consultants, the board cannot delegate its fiduciary obligation. Therefore, the board should pay particular attention to the development and annual review of an investment policy.

While all investment policies will differ, they should contain at least four important components. These are as follows.

  • Goals, objectives, and investment constraints
  • Responsibilities and assignments
  • Asset allocations—ranges and targets
  • Monitoring and review

The investment policy defines the nature and purpose of the captive insurer's investment portfolio. The policy should detail the long-term objectives of the captive insurance assets and the investment structure that will be employed to meet these objectives. We will examine each of these four components in turn.

Investment Goals and Objectives

The goals and objectives of the investment portfolio may vary over time and will be dependent on the financial health and strength of the captive. Stated objectives may include whether the portfolio should be managed for yield or total return, whether capital preservation or capital growth is more important, and the extent to which cash flow stability should be maintained. For example, a new or start-up captive might have an investment objective that reads as follows.

The primary investment objective of the portfolio is preservation of capital while the secondary investment objective is investment income. The portfolio will be managed to prefer yield over total return recognizing that liquidity and cash flow are of primary importance.

On the other hand, a more mature captive might have an investment objective more like the following.

The primary investment objective of the portfolio is growth of capital with a secondary objective being total return. Volatility in cash flows is acceptable within certain specified parameters.

What will determine the investment goals within your own captive's investment policy will be driven by the risk tolerance of the captive and the board. Risk tolerance should be considered in conjunction with the risk from business operations. Investment risk should be minimized when the risk from business operations is high due to the start-up nature of the captive, the volatility and nature of the risks being insured, and the captive's capital position. As the captive matures, gains a better handle on its risk from operations, and increases its surplus position, an increase in investment risk may well be warranted. It is the board's role to make these decisions.

Responsibilities and Assignments

The second major function of the investment policy is to affirm the board's responsibilities. As stated previously, the board has the ultimate responsibility for the captive's assets. While it can delegate authority for some aspects of the investment portfolio, it cannot delegate this fiduciary role. Therefore, the board responsibilities include the following.

  • Authorization of the investment policy and annual review
  • Establishment and annual review of risk tolerance
  • Establishment and annual review of asset allocations
  • Monitoring of the investment policy, investment results, and transactions

Additionally, the investment policy may assign other responsibilities to third parties. Other firms that the board may wish to delegate authority to and establish responsibilities for include captive managers, investment managers, investment consultants (they are different from managers), and custodian banks.

Asset Allocations—Ranges and Targets

More than any other factor, the asset allocation decision determines the risk and rewards of the investment portfolio, and the investment policy should address this issue as well. Since the investing function is closely integrated with the business function of the captive insurer, asset allocation cannot be made without reference to a risk tolerance assessment. Most captive domiciles have regulations governing the allowable assets that a captive can invest in. Boards will need to craft their asset allocation policy around these regulations and within the risk tolerances agreed upon.

Asset allocation is one area where a board may seek to delegate responsibility either to an investment manager or investment consultant. However, the board should require and approve an asset allocation matrix, which sets forth the approved asset classes and risk attributes. The asset allocation matrix should also establish both approved ranges within these asset classes as well as targets.


Almost all captive domiciles require the board to perform some type of monitoring of the investment process and results. This may include the approval of all securities purchased and sold within the portfolio. Even without the regulatory component, the dynamics of the insurance and capital markets require flexibility and adaptability, making it essential to monitor the process. Six factors that should be monitored are the following.

  • Effectiveness of the investment policy
  • Adherence to stated investment objectives
  • Compliance with insurance regulations concerning the portfolio
  • Compliance with approved asset allocation ranges
  • Performance of the portfolio/manager against stated benchmarks
  • Compliance with all accounting rules

Another article in this series will explore the ongoing debate concerning active versus passive management of investment portfolios.

March 13, 2017