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Captive oversight Boards of captives face some unique responsibilities By Michael J. Moody, MBA, ARM
In the early days of the captive movement (30-plus years ago), serving on a captive insurance company’s board of directors was considered by many to be a “plum.” For the most part, captives’ boards were similar to other corporate boards of directors—the pay was good, involvement was limited, and the benefits and prestige were great. And in the case of the captive, travel to annual meetings at places like Bermuda, the Cayman Islands or Barbados was not too bad either. However, the past five years have changed the landscape dramatically for all board members, whether they serve on corporate, nonprofit or captive insurance company boards. The rash of corporate wrongdoing which began coming to light shortly after the beginning of the new millennium has resulted in much closer scrutiny for all board members and corporate officers. For the past five years, corporate America has had to establish new and more effective strategies to assure transparency. This has resulted in some corporate directors reviewing their involvement in various boards of directors and their continued involvement with them. As a result, there is a shortage of qualified board members for corporations of all types, including captives. Board of Directors 101 The basic responsibilities of all corporate directors are quite similar regardless of the size or type of organization. In essence, the directors have two broad duties to the stakeholders in the company. The first duty is what is known as the “duty of care.” This duty basically revolves around the idea of the “prudent man theory,” and it deals with a simple negligence standard. This standard requires that the director should be involved with the organization and exhibit a level of skill that others would have in a similar circumstance. For the most part, the “duty of care” is quite easy to comply with. However, the second duty, the “duty of trust,” is a lot more specific and onerous in its requirement. The “duty of trust” centers around the concept that a director is serving in a fiduciary capacity and as such is entrusted with the property of others (the stakeholders) and is required to protect those interests. Together, these two basic duties of care and trust form the foundation of a director’s responsibility. The responsibilities of the directors of an organization have increased significantly over the past few years. The advent of the Sarbanes-Oxley Act of 2002 (SOX), as well as actions of various stock exchanges has required directors to take a more active role in the oversight of their companies—a role where each director must be more fully informed, actively involved and come with an independent focus. Current conditions demand a high level of transparency and increased corporate governance that has not been required previously. Obviously, the role of the captive’s board of directors is an extremely important one. And potential directors must realize that it does require a significant commitment to the goals of the captive. Captive specifics While a number of duties are common to all directors, such as the two mentioned above, there also are specific duties peculiar to various types of organizations. And so it is with the differences between serving on the board of a single parent captive and serving on the board of a group captive or risk retention group (RRG). To the extent possible, we will point out these differences. Once the decision to form a captive has been reached and the initial details such as effected coverages and domiciliary selection have been worked out, board selection is typically the next agenda item. One of the first issues that will need to be resolved is the board composition, including both the people to serve and the number of directors. The minimum board size is typically easy to determine since it is usually established by the statutes of the selected domicile. Most domiciles also mandate that at least one director be a resident of the domicile. Frequently this position is given to the captive’s local attorney or an employee of the captive management company. As noted above, the minimum number of directors to serve on the board of a captive is easy—it’s the maximum number of directors that is difficult. Single parent captives frequently limit the number of directors to five. They usually find that this is a very workable number. But group captives usually have pressure to have more than this number. However, there are practical considerations to any board size that must be dealt with as well. One of the most critical is the ability to achieve a quorum at board meetings. Larger boards find it more difficult to have the number of directors needed for a quorum in attendance, and this can reduce the effectiveness of board meetings. An additional consideration is the time and expense associated with attending a board meeting. Once the board of directors is selected, an early challenge for the directors will be consideration of the contracts with the captive’s service providers. In a perfect world, all service contracts would wait until the board can act on them. However, the reality of this situation is that some important contracts, such as the selection of the domiciliary lawyer, captive manager and actuary will need to be completed prior to the final selection of the board. In cases such as this, the full board will frequently be requested to ratify actions taken prior to the captive’s incorporation. Even after the initial approval of providers, one of the most critical areas that directors will be involved in is the evaluation of the performance of the various service providers and subsequent renewal of their service agreements. Board protection Legal protection for the captive’s board of directors can come from several different sources. Typically the first line of defense for a director is the captive’s bylaws. The bylaws usually contain some type of indemnification provisions, which would respond if the captive’s directors should be liable for good faith actions. The captive’s bylaws should spell out the specific situations where indemnification would apply, as long as the director is serving the needs of the captive. While this is the first line of defense, it is rarely sufficient, from a financial standpoint, to alleviate all potential legal problems. In those situations where the captive’s bylaws are not sufficient for adequate protection, directors will frequently look to the additional security provided by a directors and officers (D&O) liability policy. D&O policies provide a broad array of options that are designed to offer coverage for the insured entity as well as the individual officers and directors. While the actual details of the coverage can vary widely from one policy to another, the basic concept is typically the same for any D&O liability policy—to protect the officers and directors for their good faith actions. The availability of D&O coverage in the general insurance marketplace has become challenging. It is even more difficult for captive insurance companies. Single parent captives do have an advantage when it comes to securing D&O coverage. Since single parent captives are usually a subsidiary of an established corporation, the parent normally has its own D&O coverage. That being the case, the captive can frequently negotiate appropriate coverage under the parent’s policy. Unfortunately, the same is not true for group captives or risk retention groups. The general D&O market continues to experience problems and there are few carriers that are interested in this line of coverage at all, fewer still that are willing to write D&O coverage for group captives or risk retentions groups. As a result, directors of group captives and RRGs frequently have to forgo D&O liability coverage. Every corporate entity must have a board of directors to guide and oversee the management of the entity and be stewards for the stakeholders. While the recent emphasis on enhanced corporate governance has resulted in some short-term problems for many boards, the long-term effect will be better oversight and management. Serving on the board of directors of a captive is an important function and while it may require more time and energy than in the past, it is still a rewarding experience. * |
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