David kilborn, John alberici, Matthew Killough
8 August 2019

Are captives cost centres or profit centres?

Panelists at the VCIA conference disagreed on the question of whether a captive should be regarded as cost centres or profit centres within their organisations.

John Alberici, chairman of Alberici Corporation and president of Contractors Casualty Company, its Vermont-based captive, said the captive is a cost centre because maximising returns within the captive is of secondary importance to providing optimal support to the parent organisation.

But David Kilborn, president and chief investment officer at Performa, disagreed, saying he views captives as a profit centre. “You can usually reduce your commercial costs, save premium, make underwriting gains or increase the investment portfolio,” he said. “It is about taking a different perspective.”

Panelists agreed that writing more business through the captive is likely to make it more cost effective, due to the diversification benefits of non-correlated forms of insurance cover. Adding new lines of business can improve captive performance by increasing premiums by more than expected losses, explained Matthew Killough, consulting actuary at Milliman - even if the line being added was relatively high risk.

Generating more premiums via new lines of business can also generate new investment opportunities that may be profitable for the captive, said Kilborn.

“Some policies may be more attractive than they seem at first, because they increase returns of the investor side,” he said. “It doesn't work if you look at the business in silos, you are missing an opportunity if you do not think about the associated benefits of increasing the business in your captive.”

But Killough advised captives think carefully about the risks they insured, giving particular thought to tail risk. Insurance with long tail risk, such as medical cover, requires greater capital to be set against them. “So there is an opportunity cost associated with tying up that capital, which has to be taken into consideration,” said Killough.

Similarly, captives have a fiduciary responsibility to think about the implications of lending money to their parent companies due to the implications for their own balance sheets, said Kilborn. A loan to the parent will be illiquid which may mean the rest of the portfolio has to be in liquid assets, which often generate less returns. “Liquidity comes at a price. As long as the captive is getting paid it can make sense, but that is the conversation that has to be had,” he said.