Why Captive Insurance Company Boards Must Be Actuarially Literate

In today's risk environment—marked by hardening markets, emerging exposures, and increasing regulatory scrutiny—having a captive insurance company board that is financially literate is no longer enough. Board members must also possess a foundational understanding of actuarial principles. This doesn't mean every director needs to be an actuary, but boards should collectively have the actuarial literacy necessary to ask the right questions, interpret data, and make informed decisions.

Actuarial analysis is often seen as highly technical or the domain of specialists. While it can certainly be complex, actuarial insights are essential for ensuring a captive's solvency, sustainability, and strategic success. Captives today face challenges from evolving risks such as cyber threats, climate exposures, social inflation, and shifting legal environments. Understanding how these risks impact loss reserves, pricing, and capital adequacy is critical.

Why Actuarial Literacy Matters

Recent failures in the captive and risk retention group (RRG) space have illustrated the consequences when boards lack actuarial awareness or fail to act on their actuary's advice. It's not enough for board members to rely on management or consultants; they must engage with actuarial reports and understand the assumptions and limitations of projections. Clear communication between actuaries and boards is vital to avoid the illusion of understanding where none exists.

How to Build Actuarial Competence on the Board

One of the most effective steps a captive board can take is to engage its appointed actuarial firm to provide tailored education sessions. Many firms offer board-level training on core actuarial concepts, reserve analysis, and risk modeling. It's essential, however, that these sessions are led by actuaries skilled at explaining technical topics in an accessible, engaging manner.

Key concepts that every captive board member should grasp include the following.

Accident Year—Refers to all losses that arise from incidents occurring during a 12-month period, regardless of when those claims are reported or settled.

Example: A vehicle accident occurring in December 2025 is part of accident year 2025, even if the claim is not reported until 2026.

Actuarial Estimate—An estimate of future claim liabilities, typically expressed as an expected value within a reasonable range of potential outcomes.

Example: A captive's actuary might estimate unpaid liabilities at $8 million, with a reasonable range of $7–9 million based on historical loss development.

Adverse Selection—The tendency for higher-risk entities or individuals to seek insurance coverage more often than lower-risk ones, leading to underpricing if not properly accounted for.

Example: A captive insuring only high-hazard contractors without adequate premium adjustment could experience higher-than-expected losses.

Base Rate—The starting price per unit of insurance applied to a specific class of risk or coverage before individual adjustments.

Example: A base rate of $4 per $1,000 of payroll for workers compensation insurance, adjusted for claims history or safety programs.

Calendar Year—Includes all transactions—premiums and losses—that are recorded during a given calendar year, regardless of the policy or accident year.

Example: Calendar year 2025 data could include claim payments for policies issued in 2020, 2021, or 2022.

Credibility—The statistical weight assigned to a set of data in determining rates or reserves, depending on its volume and reliability.

Example: A captive with 10 years of stable loss experience will have more credible data than one with only 2 years of volatile results.

Expected Loss Development—The projected pattern by which claims costs emerge and are paid over time.

Example: A workers compensation claim might begin with medical payments and eventually include disability benefits, developing over several years.

Exposure—A measure of the risk insured, often used as a basis for calculating premium or analyzing loss frequency.

Example: A captive insuring a hospital might measure exposure in terms of occupied beds or annual outpatient visits.

Frequency—The number of claims relative to a unit of exposure.

Example: A fleet of 100 trucks with 5 accidents per year has a frequency of 0.05 accidents per truck annually.

Incurred But Not Yet Reported (IBNR)—Reserves set aside for claims that have occurred but have not yet been reported, as well as expected development on reported claims.

Example: A medical malpractice captive may include IBNR for potential claims arising from recent procedures that have not yet resulted in claims.

Loss Development—The change in estimated cost of a claim from initial report to final settlement.

Example: A claim first estimated at $50,000 might ultimately cost $150,000 due to litigation or complications.

Policy Year—Groups data by all policies issued during a 12-month period and tracks the associated premiums and losses over time.

Example: Policy year 2025 includes all policies issued in 2025 and all claims arising from those policies, regardless of when reported.

Rate—The price charged per unit of exposure for insurance coverage.

Example: $2 per $100 of insured property value.

Risk Margin—An additional reserve to cover the uncertainty in loss estimates and provide a cushion for adverse developments.

Example: A captive may add a 10 percent risk margin to the best estimate of reserves for emerging risks like cyber liability.

Trend Factor—An adjustment applied to account for changes in loss costs over time due to inflation, legal environment changes, or other external factors.

Example: A captive may apply a 5 percent annual trend factor to medical malpractice losses to reflect increasing healthcare costs.

Ultimate Net Loss—The total amount the captive will ultimately pay for a claim, including legal and adjustment costs, but excluding internal overhead.

Example: A liability claim settled for $900,000 plus $100,000 in defense costs results in a $1 million ultimate net loss.

(Definitions adapted from sources including IRMI, Milliman, Pinnacle, and RMS.)

Next Steps

Boards should periodically assess their collective actuarial understanding. One simple approach is to distribute a glossary of key terms and ask members to review or even self-test their knowledge. More formally, boards may wish to embed actuarial literacy as part of their ongoing governance and development processes, including annual training and review of actuarial reports as a standing agenda item.

By strengthening actuarial literacy, captive boards can better fulfill their fiduciary duties, support sound risk management, and help ensure their captive's long-term success.