The mid-1980s were not easy times for many agents and brokers. Markets were changing — or disappearing. Agents and brokers spent much time trying to find adequate coverage at relatively reasonable prices. But they weren’t always successful.
Most property/casualty insurance clients faced dramatic premium increases. Some counted themselves fortunate to get any coverage at all. The industry saw a higher-than-normal number of carrier insolvencies. And more businesses found their way into alternative markets, with many setting up captive insurers.
It was during this time that some independent agents and brokers came together to devise a way to take better control of our own destiny and insulate ourselves from market volatility. Together, we formed an agents’ errors and omissions coverage captive to serve our own needs. Since then, many of us — our agency included — have helped clients form their own captives. Our agency, for instance, manages several captives focusing on professional liability for hospitals.
Through these activities, we’ve identified several elements that help contribute to creating a successful captive and managing it profitably over time.
1. Long-term focus
Perhaps the most significant success factor is to bring together a group that has a long-term reason for wanting to do this. For our agents’ E&O captive, it was to gain control of our destiny over the long run and to let us benefit from our collective efforts to better manage our operations. Captives that sprout up simply to avoid impending premium jumps or to address cyclical market tightening generally don’t succeed.
When we formed this captive, we thought far into the future. For instance, we knew exactly what our coverage form needed to be over time. We wanted to ensure a high level of consistent, predictable protection. When you exist at the mercy of market conditions and the in-and-out nature of some carriers, you run the risk of inadequate coverage — often when you need protection the most. As a group, we understood the risks we presented, and were comfortable that we could jointly protect against losses we might encounter and could manage our risks in such a way to minimize those potential losses.
2. Effective risk management
The second key success factor involves having a risk management program that responds to exposures you’re looking to insure. When we created our agents’ E&O captive, we believed we had an effective way to control our exposure to loss. As it turned out, we were right. We’ve done a good job in keeping losses to a minimum. That’s because we agreed up front to spend a lot of time concentrating on potential losses, which can represent anywhere from 60 percent to 70 percent (or more) of the premium dollars.
A risk management program can be driven internally — insureds working with each other using staff loss prevention and risk management professionals. Or it can be driven by outside consultants.
Whether you’re talking about road contractors or hospitals or agents and brokers, every organization has in-house expertise. And you want to use it. You need to bring members together to share best practices. It’s in everyone’s mutual best interest to understand trends and effective ways to address them.
Don’t neglect the use of outside resources in your quest for good risk management. As a group, a captive offers a benefit of scale that makes tapping the best consultants easier and more cost effective. Within our agents’ E&O captive, we use consultants to go into our insureds’ offices and conduct reviews or audits. What they learn they are able to share with all.
3. Adequate capitalization
Too many captives run afoul by under-funding the start-up. Losses will occur. And when they do, they affect cash flow and reserves. That has an impact on your reinsurance program. Inadequate capitalization combined with ineffective risk management may lead a reinsurer to exit the program or increase premiums so much that the captive’s insureds may be unwilling to pay.
Now losses won’t always follow the predictable pattern actuaries expect. Things will vary from the projection. Over 20 years, we’ve seen a couple of years that didn’t go according to plan within our agents’ E&O captive. But we were very fortunate. We started with enough capital to begin with, and had very favorable loss experience in the first few years. So we very quickly accumulated additional capital.
Perhaps the best thing to do when starting a captive is to charge more premium than you actually need. If your insureds understand the program and are committed to it long-term, extra premium won’t upset them. They recognize that you’re simply preparing for adverse deviation when it does happen. And, of course, if losses don’t materialize, excess capital can go back to the insureds as a dividend or return of premium.
4. Insured involvement
Another key to captive success involved keeping your insureds, who are part of the captive, involved in the process. This will help keep them committed to the program and reinforce the captive’s long-term focus.
We’ve found several strategies useful in this regard. First, we publish quarterly reports of captive activity and performance. Now, our agents’ E&O captive leverages a registered security as part of our funding, so SEC rules require us to publish reports and audited statements. But even in the absence of such requirements, regular communication and sharing is a good idea.
At our E&O captive, and in the other captives with which our agency works, we regularly tell insureds what’s happening. If we achieve good loss experience, we share that. If it’s poor, we do the same. It’s important to be forthright not only with your results, but also with your plans. Making sure insureds are up-to-speed on the future helps guarantee buy in and commitment.
We also hold an annual meeting, where designated quality managers from each of our agencies and brokerages come together. They review results and work together to form and strengthen strategies to bolster performance. We also bring our board of directors together each year for an in-person meeting. And beyond that, we have three regional meetings each year for insureds where we detail our accomplishments and lay out our plans for the future. This is a relatively new addition, and the extra layer of meetings has been very well received.
5. Strong partners
Finally, it’s important for captives to find and use the best possible partners. This includes reinsurers, who must be viewed as long-term players who’ll go through the ups and downs of adverse loss experience with you. Also, employ good actuaries who understand the program and can give good advice. Tap good lawyers who understand the insureds’ business and alternative risk mechanisms, and who will keep the captive and its insureds up to speed on law changes, because laws will change.
Within our agents’ E&O captive, we’ve used consulting partners who work with our insureds to identify what is and is not working within their own operations. The consultant captures and shares what is going well — good risk management strategies, for instance — and shares them as best practices with other partners. When problems are identified — for example, something people might be doing to create exposure to loss but which may not have occurred to them — the consultants apply their own expertise or elicit ideas from other members.
Albert R. “Skip” Counselman, CPCU (email@example.com) is president and CEO of Riggs, Counselman, Michaels & Downes, an Assurex Global Partner based in Baltimore. He is vice president and director of Professional Agencies Reinsurance Ltd., an agents’ E&O captive facility developed through the cooperative efforts of Assurex Global, The Council of Insurance Agents & Brokers and Fireman’s Fund.
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