Kodda /
7 January 2019Analysis

Captives’ central role in the construction industry

Risky business

Risk is plentiful in the construction industry. More obvious and inherent dangers involve heavy equipment operation, movement of large volumes of raw materials, climbing, lifting and the use of heavy tools. Add to these the mix of project owners, suppliers, contractors, sub-contractors, transporters and remediation specialists, all of whom face myriad standards for project design and engineering, human safety, environmental concerns and union demands, and you begin to see the complexity of managing risk in this industry.

Successful construction companies understand these risks and structure their operations to minimise exposure to them. Unfortunately, with the way commercial insurance works, they often pay higher commercial insurance premiums to compensate for insured construction-related companies that do not pay as much attention to risk management.

Commercial insurers operating in the construction space must price their coverage to make a profit on their overall portfolio of construction risk, often resulting in higher insurance premiums or complete lack of availability for coverage.

Rewarding risk controls

As a result, many risk-aware construction firms with strong safety and operating performance records use captive insurance companies to self-fund appropriate layers of risk. These companies understand that strong risk controls combined with assuming a portion of risk often result in their “capturing” underwriting profits otherwise lost to commercial insurers.

Self-funding for potential losses based on individual performance can result in lower overall insurance expense. This occurs when reserves for retained risk layers in the captive are actuarially based on the parent’s strong individual performance versus a commercially insured portfolio.

Moving commercial insurers further away from risk results in lower cost of commercial risk transfer because they are less likely to have to pay claims.

Tax advantages

With the correct fact pattern, many captive owners can deduct premiums paid to their wholly-owned captive against current taxable income. While captives recognise premium income, they may be able to offset it with currently deductible loss reserves, reducing or eliminating their federal income tax liabilities.

Additionally, many states do not tax the net income of qualified captive insurance companies. Taken together, these factors are often relevant in high tax locations.

Varied risks appropriate

Typical risks insured in construction industry captives include:

  • Workers’ compensation
  • Owner-controlled insurance programmes (OCIPs)
  • Contractor-controlled insurance programmes (CCIPs)
  • Construction defect and rework
  • Product warranty
  • General liability
  • Property
  • Cyber
  • Terrorism

Part of the solution

Despite the multiple advantages of using a captive-centric approach, construction firms typically are best served when captive insurance is part of a total risk-financing solution.

Each construction entity should evaluate its risk profile and loss history to determine the appropriate balance of captive insurance funding and commercial risk transfer.

JLT’s brokerage services work in tandem with its captive insurance group to ensure that proper balance. Our companies’ collaborative approach offers an array of risk-financing solutions designed specifically for construction-related risks.