Advice for firms considering a captive

How to choose the right service providers

If you are a mid-sized business interested in an alternative risk transfer product, choose your service providers carefully. Dealing with those who are inexperienced in the captives market can result in delays and mistakes, which defeats the purpose of controlling loss costs and could end up costing you money. By selecting insurers, captive consultants and brokers with financial stability, service consistency and a strong commitment to this market, you can help ensure the long-term success of your captive.

When captive insurance programs first became popular in the mid-1980s their cost and complexity made them useful for only the biggest, most sophisticated corporations. Since then, by joining group captive facilities many smaller businesses have caught up with the huge multinationals in their use of more creative insurance solutions..

Unlike a single-parent captive that insures its own risks, a group captive is composed of multiple companies with a similar desire to share assets and liabilities of a jointly owned captive company. While the process of setting up a group captive is straightforward, very few are self-insured due to the legal and financial complexity of conducting business in the United States. Commercial insurance companies licensed to issue policies act as fronting carriers for the captive to overcome these issues.

A variation on this theme is the segregated portfolio company (SPC), which segregates the assets and liabilities of each captive cell. The assets of each individual cell are protected from underwriting losses within the other cells.

SPCs can potentially mitigate start-up costs and administrative burdens, making them attractive to middle-market businesses. Given the increase in domiciles with SPC legislation, the trend of smaller companies moving to group captives is likely to continue.

However, group captives can be risky from a liability standpoint if the fronting carrier administering the captive doesn’t understand the long-term commitment required to make it work. Finding an experienced and financially stable insurer that offers a full range of coverages and services to customize your program is essential to helping captive owners get the most from their investment.

Beware the pitfalls
The fundamental idea of a captive is a direct correlation between cost and losses — as losses decline, the cost of the program lessens. While this is a simple concept, things can go wrong — in many cases, because of missteps by the fronting carrier.

For example, often the fronting carrier’s financial handling of the premium lags expectations, resulting in lost investment income for the captive. One reason for the cession delay could be failure to execute workable reinsurance agreements with the captive. Fronting carriers with experience in the group captive business have processes in place to expedite premium cessions and execute agreements.

By knowing what is involved in running a captive — and working with an insurer that can coordinate all areas of account management to align with your long-term business strategy — you can minimize these risks and get the most out of your captive arrangement.

It is also important to consider the financial security and business commitment of the fronting carrier before you engage in a relationship. A successful captive operation hinges on many hidden operational aspects involving money transactions. Captive owners should choose insurers that understand what is involved in these processes and will be there to administer claims payment on behalf of the captive until the policy year is closed out.

Over the years, many insurers have gotten in and out of the captives business — often leaving their captives high and dry. For example, working with a carrier in runoff can delay claims payment and slow down collateral return to the captive.

In addition, having to move a captive because of a fronting carrier’s change of appetite distracts from the captive’s mission of reducing losses and minimizing the cost of risk. By working with a committed fronting carrier from the start, you are adding to the captive’s stability and keeping everyone focused on its overall goal.

Choosing an experienced insurer
An essential first step to exploring a captive is to have a high-quality business plan, including future growth goals, upfront capital commitments and a designated captive leadership team to oversee the process.

In turn, insurers dealing with captives must have the experience, breadth of capability, long-term view, underwriting support and backroom capabilities to handle this unique business. They should also have experience with niche captives, which is essential for proper underwriting of the risk.

The insurer should be able to offer a wide range of capabilities, including fronting, risk transfer and reinsurance, dedicated claims handling, access to rent-a-captives, customized loss control services and access to consulting services.

The most effective approach to administering a captive is to use dedicated, integrated teams that go beyond simply offering risk transfer insurance mechanisms. These teams should include experienced professionals and specialists in all areas — underwriting, claims, marketing, risk engineering, actuarial, finance, policy issuance and regulatory compliance — and be supported by state-of-the-art technology.

A captive is a long-term investment designed to control losses through better management and solid claims administration.

Over time, you can achieve these goals by selecting an insurer with experience, stability and staying power that can face the future with you and your captive.

Lynn Cordes is president of Commercial Markets Alternative Solutions for Zurich North America Commercial.

Topics Carriers