Optimizing a captive insurance company’s capital structure is critical in supporting the captive’s long-term success, but there are a number of factors to consider in seeking capital optimization.

Speaking at a recent Strategic Risks Solutions (SRS) webinar titled “Optimizing Captive Capital—The Benefits of Diversification,” Michael O’Malley, managing director at SRS, outlined several factors that can shape a captive’s capital structure.

The overall concept of the risk-based capital approach is to establish a minimum capital requirement based on the types of risks to which the company is exposed”

Derek Bridgeman, Strategic Risk Solutions (Europe) Ltd.

One is the captive’s underlying risk profile, the risks it’s taking, coverage lines, and correlations between coverage lines, he said. Another factor is regulatory or rating agency requirements.

“When you approach a regulator with a business plan, they’re oftentimes going to want the captive to be funded to a certain confidence level,” Mr. O’Malley said. Rating agencies will have their own requirements associated with certain rating levels, he said.

“Another item to consider is the investment portfolio,” Mr. O’Malley said. “Insurance companies are unique in that there is risk on both sides of the balance sheet.”

Fronting partner collateral requirements can also affect captives’ capital requirements. Fronting insurers will typically require collateral to eliminate or reduce credit risk, Mr. O’Malley said.

A traditional approach to captive insurance company capital is to think in terms of different silos, Mr. O’Malley said. Many captive insurance companies take this approach in which capital structures are developed to address each different coverage line in the captive, without considering correlations between the lines.