By Benjamin L. Gould, Esq.
When forming a captive, one of the first questions that a parent company will be asked is how it will structure its board of directors. (In the case of a captive organized as a limited liability company, the analogous body is the board of managers, while a captive organized as a reciprocal has a subscribers advisory committee, but the requirements and considerations are the same as for captives that are formed as corporations.) This question will need to be resolved before the license application is submitted to the Missouri Department of Insurance for approval.
The board of directors is a critical component for a captive’s success. The board is charged with decision-making over broad matters of policy, strategy, and governance with the best interests of the captive’s owner(s) in mind, along with appointing officers and management to handle day-to-day operational matters. The board is responsible for ensuring the continued financial health of the captive and making sure that the captive is compliant with legal requirements and ethical principles.
In order for a captive’s board to comply with Missouri law, the requirements are relatively minimal. All that is needed is a board with at least three members, one of whom is a Missouri resident, whose “character, reputation, financial responsibility, insurance experience, and business qualifications” will allow the captive to promote the general good of the state. The board must hold at least one meeting per year in Missouri, and the quorum for that board meeting can be set as low as one-third (subject to a minimum of two individuals). However, there are many ways to structure a board within the confines of these statutory requirements. There is no single ideal solution, and what makes sense for one captive might not be optimal for another. The following are considerations for captive owners to entertain when structuring their boards:
Number of Directors – When determining the number of directors to sit on a captive’s board, a captive owner must strike a balance. The board must be large enough to ensure that there are individuals who, taken as a whole, possess all of the desirable attributes for oversight of the captive, but if the board is too large, assembling all of the directors for meetings can become unwieldy. For a pure captive with a straightforward insurance program, the minimum of three might be adequate. For a group captive with larger and more diffuse membership, the board might need to be much larger in order to ensure that all of the members’ various interests are represented. While less-than-unanimous votes are extremely rare in the captive world, setting the board at an odd number of directors will ensure that someone can always be able to break a tie if everyone votes.
Quorum Requirement – While most other business entities are required to have a majority of their boards present to constitute a quorum, captives benefit from a provision allowing that quorum requirement to be set as low as one-third. Setting the quorum requirement as low as possible will lessen the burden of assembling directors for meetings, but it will allow the captive’s business to be validly carried out by a minority of the board. A captive owner will need to determine its tolerance for allowing such potential minority rule to take place. In addition, if a captive has directors who are elected by different classes of members, it is certainly possible to institute a requirement that one or more directors elected by each of those different classes be present in order to form a quorum.
Staffing the Board – Again, there is no one-size-fits-all combination to staff a captive’s board, but most successful pure captives tend to include, at a minimum, representatives from the parent company’s risk management and finance departments, along with the resident director. It is also common for captive boards to include members of the parent company’s in-house counsel unit, treasury department, or executive team. For privately-held parent companies, the ultimate owner (or his/her designee) often sits on the captive board. If a captive owner operates in multiple business sectors, or has substantial international operations, it is often advisable to include directors who have familiarity with those matters. Smaller group captives typically require each of its members to provide a nominee to the board, while the boards of larger group captives are often structured to ensure they include representatives of each of the captive’s various different constituencies.
A director must be able to devote sufficient attention to the captive’s affairs in order to discharge the legal duty of care; if the director is unable to make this commitment, he or she would be well-advised to step aside in favor of someone else who can. For this reason, it is often advisable that a captive’s board not just be the same as (or a subset of) the parent company’s board, but instead include individuals who are closer to the parent company’s day-to-day risk management operations. Finally, note that all captive directors are equals whose votes count the same, even if one is the subordinate of another within the parent company’s organizational structure.
Resident Director – Back when captives were the domain of small, out-of-the-way jurisdictions, the resident director requirement was a proxy to ensure that a captive’s board included somebody with significant industry experience who is at arms’-length from the parent company – usually a representative from the captive management firm or the captive’s legal counsel. With the proliferation of domiciles and many more parent companies forming captives in their home state, the resident director requirement can often be met by an employee of the parent company. Although it might not necessary to fulfill a statutory requirement, a captive owner should consider whether it might still be desirable to include the perspective of a detached industry expert on its board. (As a counterpoint, note that a captive board will receive the same professional advice from a captive manager or attorney regardless of whether that person actually sits on the board.)
Independent Directors – There is no requirement for a captive board to include any “truly-independent” directors, i.e. individuals with no connection to the parent company or its service providers other than membership on the board. With most captive directors being employees of the parent company, it is relatively easy to ensure that the directors’ interests are aligned with those of the shareholder(s). However, some captive owners might find it desirable to appoint a truly-independent director in order to flesh out the talents of the board, and parent companies that are subject to heightened scrutiny by the public or regulators might consider the use of a truly-independent director in order to demonstrate exemplary governance practices. A truly-independent director can receive compensation from the captive for his/her services without compromising that director’s independence; in fact, truly-independent directors of for-profit captives will typically expect compensation, which can be significant, as consideration for their service.
Regulatory Oversight – Newly-forming captives must include biographical affidavits for their initial directors in their license application, while directors who are elected to the board of existing captives must file biographical affidavits with the regulator within 30 days after their election. These biographical affidavits are the mechanism by which the regulator ensures that a captive’s board, taken as a whole, possesses the adequate “character, reputation, financial responsibility, insurance experience, and business qualifications” required by statute. While it is extremely rare for a regulator to object to a director (after all, the parent company is typically in the best position to determine its own destiny), a regulator may occasionally offer gentle suggestions for a parent company to fill a perceived talent gap on the board.
The final piece of advice on this subject is that nothing is permanent. If a particular structure for a captive board isn’t working, it is very straightforward for the sole shareholder of a pure captive to replace directors or elect new directors at anytime. Even where it is necessary to amend a captive’s articles of incorporation or bylaws to make these changes, it is relatively easy for the captive to do so. At worst, captive owners need only wait for the next regularly-scheduled shareholder meeting, which occurs at least annually, to make any changes. As a result, captive owners are urged to regularly evaluate their board structure and make adjustments – or even engage in outright experimentation – to find a structure that works best for them.
Benjamin L. Gould, Esq. is a director with the Burlington, Vermont-based law firm of Paul Frank + Collins P.C. He is admitted to practice in Missouri and represents a number of captive insurance companies domiciled in Missouri, along with Vermont and several other states.
