Recap on captives: Helping customers brace for a hard market

When clients come to you for solutions, be prepared by exploring options now, especially in alternative risk coverages.

Several conditions are converging to shift the market from soft to hard. In 2008, the industry was buffeted once more by catastrophic losses--by some accounts even worse than 2005, the year of Hurricane Katrina. This exacerbated the problems associated with the diminished revenues resulting from the lower premiums insurers offered in the soft market.

Add to those woes the most devastating economic slowdown in nearly a century, which has diminished investment opportunities and, in some cases, devastated returns on investment. This has reduced insurers' surplus, which impairs their abilities to write new business.

Not enough? The poorly performing capital markets have curtailed reinsurance options. Add it all together and insurance companies find themselves in treacherous financial straits, at least from their perspective. Will the market harden? No doubt--in fact, you can bank on it...if you find a bank that's still in business.

Historically, companies have taken several different approaches to surviving a hard market. A lot of companies have assumed a greater share of the risk by accepting larger deductibles. Many have expanded and intensified their in-house risk reduction and management programs. Others have opted to self-insure. And still others have taken alternative approaches to risk, especially with captive insurance programs.

While captive programs have traditionally been the domain of the largest companies with the resources to establish and fund their own, the perception that small and midsize companies can't pursue the captive option is no longer accurate. Over the past few years, smaller companies have found their way to the alternative risk marketplace by banding together to form group or multi-owner programs. At the same time and in line with their clients' needs, more insurance agencies have seen the value in forming their own captives to offer customers more and better choices beyond traditional insurance.

Getting a grip on captives
Captive structures can be broken down into the following categories:

o Single-parent captive insurer. The traditional single-owner approach is taken by large, often multinational, companies--the parent--to consolidate their insurance programs. It results in consistent pricing and coverage for all of the company's operations around the world and unbundled claims and loss control services.

o Group captive. Generally the most appropriate for middle-market companies or larger accounts, the members of group or multi-owner captives are shareholders of the captive insurance company, and often tied together as an industry group. When structured correctly, group captives can provide cost advantages and offer control over claims and loss control services.

o Association captives. Generally used for a group of homogeneous businesses with a trade association owner, these usually are formed to stabilize insurance costs for association members.

o Agency captives. In case, the captive is owned and funded by an agent, who in turn benefits from an exclusive insurance program and profits from the program's good loss experience. The captive's members benefit by having access to good insurance coverage and more effective claims and loss control services.

o Rent-a-captive. This company "rents" its capital, surplus and legal capacity to the insured party who wants the benefits of a captive without actually participating in ownership or management. The participants avoid having to invest the capital normally required to form a captive making entry and exit easier.

Captives allow organizations to create their own internal insurance companies, resulting not only in lower costs, but also in increased synergies and improved risk management outcomes. Like traditional insurance, captives respond to multi-coverage and multi-state programs, but members of group captives avoid commercial insurers' overhead expenses and receive back any underwriting profits and investment income.

Captives offer the advantage of stable or lower insurance premiums, which are based on the group's loss experience rather than the industry as a whole. By participating in a group captive, employers are better prepared for hard market cycles.

Are captives right for your customers?
For your clients, the advantages of captives fall into two categories: financial benefits and greater control. The financial benefits include improved cash flow, shared underwriting profits, return-on-investment income, potential tax benefits, reduced program expenses and reduced claim costs.

Captives offer increased stability through insurance market cycles, more influence over coverage terms and conditions, direct access to reinsurance markets, loss-sensitive versus class-sensitive underwriting, and greater control over claims and loss control services.

The greatest appeal to most businesses is the ability to drive down loss costs and to reap the benefits of good loss experience. Captives appeal to those who are tired of paying higher premiums because of other businesses in their industry having unfavorable loss experience. They also want some control over the claims and loss control services that directly affect the loss experience.

Are captives right for you?
In turbulent and uncertain times, offering alternative risk programs in the form of captives delivers some clear-cut advantages, not the least of which is being able to respond quickly with practical solutions to your clients' hard market challenges. This not only allows you to offer a higher level of service to your clients, but also has the potential to improve your profitability.

The captive solution is also a way to create a competitive edge by offering unique services and capabilities in the open market. But that may not be enough in a hard market. Many of your larger competitors may already have captives. If you're not offering this alternative to your clients, someone else surely will.

Rick Stasi is responsible for overall operations of alternative risk programs for Avizent, a national risk management provider. Avizent provides claims management, medical managed care, self-insured groups, alternative risk financing and RMIS software. Stasi can be reached at rstasi@avizentrisk.com.