In a speech in 1962, President John F. Kennedy observed that the Chinese character for crisis was the combination of the brush stroke for "danger" with the brush stroke for "opportunity." While this could describe the financial world in general right now, it is a good summation of the current captive insurance environment.
Investment income is down significantly, removing one big incentive for risk managers to form new captives. And as long as the soft market continues, prices for coverage from traditional insurers may be so attractive that the decision to form a captive becomes more difficult to rationalize.
To again quote President Kennedy, however: "The time to fix the roof is when the sun is shining." In other words, those who understand the primary purposes of forming a captive understand that for several reasons, this period is among the best ever to do so.
o First, one of the main purposes for having a captive insurance company is to be better able to predict and prepare for loss control. Setting aside assets for predicable risks enables management to plan better and not suffer through the volatility in their earnings that may occur from events that can disrupt even the best business plans.
In this regard, the core argument for a captive insurance company remains very much intact.
o Second, during periods of high captive formations, captive management firms–swamped with other formations, feasibility studies and other duties–may not be able to devote as much personalized attention to a captive owner as is now the case.
With all the new types of liabilities being written and new uses for captives that have arisen in recent years, this extra time for planning can yield benefits to the captive owner–benefits that could be overlooked during frenetic periods of new formations.
o Third, the issue of low investment income returns can actually be used as the single greatest argument for a captive formation right now.
In the most myopic view, a captive formation would appear to be less rational than in periods when investment returns were higher. The fact of the matter, however, is that this era of lower investment returns affects all insurers identically–both primary and reinsurance companies–which means that bargain-priced premiums for all insurance are likely to end. The current "soft market" won't last forever!
It is also interesting that throughout history, periods of high returns are followed by periods of low returns, and then the "opportunities" again present themselves for higher returns. These opportunities are only there for those who invest at the bottom in anticipation of the reversal–less so for those who invest at the top of any given market.
It is relevant to compare Western thinking to Asian thinking as part of business planning, both as it relates to the environment for new captive formations and to the investment markets.
In the West, our view of the world and events that unfold are almost exclusively determined by Judeo-Christian/Greco-Roman philosophies–pretty much in a linear fashion. We extrapolate trends infinitely into the future. Thus, while the stock markets were shooting up in parabolic fashion in the 1990s, covers of all the major newsmagazines were screaming about the "bull market."
Conversely, the newsmagazines right now, along with "talking heads" on cable TV, give the idea that the world is teetering on the edge of an apocalypse–that the only investments that should be made are in canned goods and ammunition! (Does anyone remember the doomsayers predicting the end of the world as we know it from Y2K? )
The truth is that the world does not function in a straight, linear fashion. Instead, it tends to evolve in cycles, much as Asian philosophy teaches. Tides change, day turns into night, winter turns to spring, interest rates rise and fall, stock markets have bull and bear periods, and economies have expansions and contractions.
Within this context, the greatest single argument for forming a captive insurer right now is the fact that it may seem to be–counter-intuitively–a bad time to do so!
There is an old adage that "a recession is a terrible thing to waste." In other words, while this may be a once-in-a-generation opportunity for investors and corporate management, we don't recognize it because we are fixated on our "linear thinking" patterns rather than the inevitable reversal ahead.
The recent fiscal and monetary stimulus being provided to the world's economies is certain to stabilize the investment markets and improve opportunities for income for captive insurance companies.
This is NOT the 1930s, as some doomsayers would have us believe. The current environment for lower returns is likely to "harden" the cost of premiums in the traditional insurance markets.
Meanwhile, the attention from the various captive service providers in this market is likely far more personalized than will be the case when there is a flood of new applications.
So the first step in taking advantage of an opportunity is usually to recognize it as an opportunity in the first place.
Risk managers, more familiar than most with the "danger" side of crisis management, may want to consider the "opportunity" side of the coin–especially as it relates to captive formation at the present time.
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