The Three-Legged Stool

A three-legged stool is a wonder of physics. It is more stable than a four-legged stool and can sit stably on an uneven surface, as the ends of the three legs are always in the same geometric plane.

Most stools have legs that are angled slightly outward. This creates friction in three opposing directions, which adds to the stability. A well-designed three-legged stool also positions each of the legs equidistant from each of the other two legs, creating a 'perfect triangle'.

The stool will become increasingly less stable if one leg is pulled closer to another, as it changes the weight distribution and the inherent balance and tension amongst the legs that created the stability.

In many ways a group captive is similar to a three-legged stool. There are three principle entities in the structure: the employers, the stop loss company, and the group captive itself. Each one of these 'legs' has a contractual relationship with the other two legs, as shown in the following diagram:

Pareto believes that each of the legs in this relationship needs to be independent and have a competent entity representing its interests. The employers are represented by their brokers/consultants and the stop loss carrier is typically quite adept at looking out for its own interests. The piece that is often over looked is the group captive itself. This leads to "Lyall's Fundamental Observation":

"The most important leg of a three-legged stool is the one that's missing."

We have seen many group captives set up where either the broker or the stop loss carrier is responsible for setting up and managing the group captive. To us, this equates to pulling one of the stool's three legs closer to another. At a minimum, it decreases the stability and if pulled far enough, the stool topples over.

There are three contracts that make up the group captive program. If any of these contracts is not negotiated at arm's length, the structure is weakened. It is difficult to have an arm's length transaction if the same entity is negotiating two sides of an agreement.

We have seen programs where the captive is owned and controlled by the stop loss carrier. This means that the stop loss carrier is negotiating both sides of the reinsurance agreement, which is a conflict of interest as every dollar not ceded to the captive is an extra dollar of premium for the stop loss carrier. These programs are often set up to maximize the returns for the carrier on the backs of the group captive. An independent manager can ensure competitive terms initially and in future years, creating a more stable program.

We have also seen programs where the captive is ostensibly independent but is actually controlled by the broker (there is only one broker permitted and the broker chose and can remove the manager). This puts the broker in a very tough position and potentially exposes them to a conflict of interest claim. At some point, they will need to make a decision in favor of the group captive that is to the detriment of one of their clients, to whom they have legal and fiduciary responsibilities.

Pareto Captive Services is an independent company, not owned or controlled by any stop loss carrier or broker. This independence allows us to focus our efforts purely to the benefit of the group captive, creating long-term stability and maximizing performance.