Self-Insurance Lifeboat Saves Buyers In Hard Market

In the current environment of worldwide corporate misdeeds and failures, such inflammatory statements could lead the reader to conclude that in the alternative market, captives could result in a downfall like an Enron or a WorldCom.

To a captive owner, these are disturbing allegations, even though it is reasonably clear in the Anderson case that such comments are unfounded. Any difficulties experienced by the captive were more a result of Andersons overall improper practices and subsequent losses incurred as result of litigation. The declination seems to have been based on Andersons failure to pay its premium, or fund the captive.

Carl Modecki, president of the Captive Insurance Companies Association, pointed out that a commercial carrier in a similar circumstance would merely have cancelled the policy. Notwithstanding the Anderson situation, however, the question of whether there is any substance to Mr. Watsons remark is worthy of thought.

The truth is that a captive is no better or worse than the parent company.

The popularity of alternative risk-transfer, including captives and risk retention groups, cannot be denied. According to Oldwick, N.J.-based A.M. Best, the number of active captives since 1981 has jumped from 1,089 to more than 4,700 in 2001–a growth rate of about 400 percent. RRGs have seen similar growth–from about 43,337 insureds in 1990 to more that 174,000 in 2001.

A.M. Best estimates that the alternative market now represents more than 35 percent of the commercial market, and will comprise nearly 50 percent by 2003. Captive premium growth continues to outpace the commercial insurance sector in all major markets.

Risk managers have long sought solutions for market instability, price swings, fronting problems and coverages for difficult risks that commercial markets could not or would not address. Captives, risk retention groups and alternative risk-transfer are more likely the necessary and natural outgrowth of this demand.

Although not immune to financial foul play, captives are no more susceptible or prone to misuse than any other enterprise. In fact, they have proven to be quite successful in accomplishing their ends. Captives and RRGs are typically set up by parent companies in a single industry. Not surprisingly, captives and RRGs are potentially subject to the same problems as their parent in the event of inappropriate or inadequate managerial or board discipline in operating the company at large.

The small number of captive owners in the same type of business, however, allows meaningful comparisons and traceable accountability. Success or failure of the captive can be attributed to the way its parent company is operated rather than any inherit problem or conflict with captives.

Alternative risk-transfer strategies also can fail, as exhibited by the difficulties with Andersons captive. However, one implication of Mr. Watsons statement is that commercial carriers are more reliable or more stable than captives–that is, they make better business decisions with respect to financing risk. History does not bear this out.

The number of vanished and banished companies from the property-casualty market is extraordinary. Instability caused by companies withdrawing, often on short notice, has been a driving force in the growth of captives and risk retention groups. It certainly was in Sutter Healths case.

Sutter Health has what would be considered by any outside observer to be a very successful captive program. The captive, domiciled in Hawaii, was formed in 1991 originally for professional and general liability, but has since been expanded to cover many more types of risks. The stability, flexibility and added value is quantifiable on many fronts, not the least of which is financial. (See the accompanying graph.)

The captive's success has allowed us to invest in loss prevention by funding quality initiatives, safety programs and incentive activities to reduce risk rather than just transfer the risk, which usually only delays the cost.

One offshoot of captives or RRGs is that more attention can be paid to addressing exposures to risk so coverage becomes a matter of quality as well as cost. This has been a big part of our success.

A testimony to the feasibility of captives is the fact that A.M. Best has begun to rate captives, and in May published a rating methodology for single-parent captive companies.

Although ratings are not a certainty of success, they do provide an indication of discipline with respect to the operation of the organization. Like insurers, captive insurance companies can, and do receive "A" ratings. Ratings reflect a company's capitalization, underwriting capabilities, discipline, reinsurance programs, and management structure.

As with most companies, captives are regulated in all notable domiciles by competent professionals who have spent years studying risk, financing, and regulation of insurance companies. Captives and RRGs in these domiciles must meet capital and operating standards prior to commencing coverage.

Further, captive strategies often include the participation of a risk-sharing partner–a fronting carrier, often a recognized commercial insurer–that offers fronting and reinsurance, underwriting expertise, and claims management services. These risk-sharing partners thoroughly examine such captives and RRGs prior to agreeing to participate.

Based on headlines of late, captive and RRG regulatory functions appear to be superior to many other regulatory processes. Requirements for operating a viable captive operation are not different from any other business discipline. Ignoring them, however, could leave the captive, or the parent, at a high risk for failure.

Alternative risk-transfer, including captives and risk retention groups, is a natural and important part of the evolution of risk management. Certain U.S. research suggests that insurance only covers approximately 20 percent of a typical company's risk exposures.

Captives have been developed to deal with a companys portfolio of risk. They provide a stable, flexible, inclusive risk-financing product, as opposed to the traditional monoline, single-year, fixed-premium programs.

The emphasis of late on holistic-enterprise-integrated-global-omnipresent risk management has evolved the risk management role well beyond the purchase of insurance to the strategic treatment of risk, including risk financing.

Alternative risk-transfer represents an option for risk managers to better address the spectrum of risk inherent in an industry, and its consequent costs, with some stability. Risk management, as a strategic objective with a measurable return on investment, will continue to drive interest in ART, including captives and risk retention groups.

Rather than the potential time bomb Mr. Watson reported, alternative risk-transfer–particularly captives and risk retention groups–are no more prone to abuse than any other business. In the event management decides to take unnecessary or inappropriate risk with its operations, including its captive, severe consequences may result–but the fact remains that the business of being a captive is not the real problem.

Michael B. Evans is chairman of the Captive Insurance Companies Association and president and CEO of Sutter Insurance Services Corp. in Sacramento, Calif.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 16, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.