Captives: a competitive advantage in any market cycle


Brian First

Captives: a competitive advantage in any market cycle

Brian First outlines the captive’s edge in managing through the cycle.

“Time is on my side, yes it is…”

The words to the song recorded and performed by the Rolling Stones since the mid-1960s did not refer to the captive insurance industry—but they might have. Much like the song and the Stones, the captive industry endures and enjoys critical international success across a diverse and loyal following. This popularity can be easily explained. Captives and similar alternative risk transfer structures have proven to be resilient and effective solutions that provide a competitive advantage to their owners and insured members in any market cycle.

When SPARTA Insurance Company was established in 2007 in the face of a soft insurance market and uncertain economic environment, we knew that a good idea, like a good song, is timeless, and that innovations brought to the market through captive insurance gave our clients the opportunity to create unique and long-lasting benefits irrespective of market timing.

Captive benefits

Captive owners and industry experts frequently cite these key benefits of a captive insurance programme: control, coverage, flexibility, stability and financial rewards. In our cyclical commercial insurance industry, these benefits may be realised differently depending on whether the market is ‘hard’ or ‘soft’ in the categories of pricing, capacity and coverage.

Historically, captives have been created in reaction to real or perceived restrictions imposed by the traditional insurance industry related to the cost or availability of insurance. The original captive pioneers and the thousands of captive owners following in their footsteps have since realised that captives can be much more than a defensive tool. Today, captives are used by large and midsized companies, franchises and trade associations as an essential component of a comprehensive risk management and financial planning strategy.

Hard market benefits

In a hard market, insureds may find that the law of supply and demand works to their disadvantage. Once plentiful, the insurance company offerings, options and coverage extensions constrict, or become available only at rates that do not make economic sense for the buyer. By assuming all or a portion of their insurance risk, or by sharing risk with other captive members, insureds supplement or totally supplant what the traditional market is willing to provide at a price actuarially determined to be sufficient for their specific risk profile.

In this way, the captive option allows owner insureds to use the flexibility afforded by alternative risk transfer to insulate themselves against harsh market conditions. This may be achieved by retaining a higher limit of risk on each insured loss and adding more lines of coverage to the captive programme, leaving less of the insurance purchase to be affected by the cyclical traditional market forces.

Control, stability and predictable cost of risk are hard market benefits for captive insureds that can be realised as competitive advantages in their everyday business. These advantages can manifest as lower overhead costs due to reduced insurance premiums or by meeting the coverage specifications required on a certificate of insurance necessary to secure a new contract or customer.

There are many success stories in the captive industry about insureds that turned challenge into opportunity by forming a captive during the hard market and subsequently enjoyed the fruits of their labour. What is interesting to note is that once the ‘crisis’ has passed, very few captives declare victory and go dormant or into run-off. Rather, they seek to build on their initial success and look beyond the original reasons for formation to realise the benefits of captives across any market cycle.

Soft market benefits

Soft markets are characterised by intense competition between insurance companies, resulting in ample capacity and coverage at lower rates. How does the captive owner react in this environment? The first thing to realise is that captives are also insurance companies, although more narrowly focused. The same marketforces that have generated a healthy insurance market going into the soft cycle have likely benefitted the captive. This is an excellent opportunity for captives to strategically position themselves for the future, operating from a position of strength.

With financial benefits in the form of retained earnings generated by positive underwriting and investment results, captives can evaluate whether their increased surplus warrants retaining more risk per loss event. More risk may mean more volatility, but it also may produce more reward. This may be a good time to explore the feasibility of adding other lines of coverage to the captive programme and to establish a track record of favourable results before the next inevitable market shift. Another benefit in a soft market is that the captive loss fund as a percentage of total premium may be enhanced by less costly specific and aggregate reinsurance purchased from fronting companies or reinsurers. This is also a good time to conduct a thorough review of all service providers and confirm that the captive is generating strong value from these expenditures.

In all of these instances, the cautionary words of advice are to remain moderate and data-driven when making these decisions. Too much optimism or becoming overly aggressive can lead to becoming a soft market statistic.

No time like the present

Many insurance industry commentators believe we are in the trough of the soft cycle and will bounce along the bottom until there is a significant event or series of events that severely impairs the industry’s surplus. This inflection point in the cycle presents an opportunity for proactive insureds to get out in front of the crowd that will hustle to explore captive options once the market effectively turns and rates begin to rise.

The captive industry is not immune from the basic economic tenet that the least desirable time to buy is when there is a crush of demand and it becomes a sellers’ market. Reserving a seat at the table and thoughtfully implementing a captive strategy are much preferred to urgently waiting in line trying to secure fronting carriers, reinsurers and captive providers.

Getting the band together

A captive insurance programme requires a talented ensemble to deliver long-term success. Obviously, the philosophical and financial commitment of its owners to the captive is paramount. It is important that these leaders in their own industries identify fronting carriers, reinsurers and captive service providers that demonstrate captive expertise. The right partners will specialise in servicing captive clients with an infrastructure to match, answer questions with transparency, proudly provide references, and have a history of executing and successfully shepherding captives through market cycles. As the song goes: “You’re searching for good times. But just wait and see. You’ll come running back. You’ll come running back…”

Brian First is the executive vice president and chief marketing officer of SPA RTA Insurance Company. He can be contacted at:

Captive International