As captives continue to grow in popularity with small and mid-size companies—as outlined by a recent captive benchmarking study carried out by Marsh—deciding whether to self-insure, establish a captive or stick with the commercial markets is becoming an increasingly important decision for an ever-growing swathe of businesses.
Captive International spoke to industry experts about finding the perfect insurance mix.
Michael Mead, president of M.R. Mead & Co and the Missouri Captive Insurance Association, gave Captive International some simple advice: look for value. “Basically business owners must look at their claims and loss history,” he said. “Are their losses manageable? Can many of them be prevented or eliminated? Are they a drain on the company’s balance sheet? If the claims and losses are manageable and the company has good financial resources to manage their own risk then looking at a captive is a good idea. There is no need to swap dollars with the insurance company when they can keep their own money.”
But according to Arthur Koritzinksy, managing director of Marsh’s Captive Solutions Group, it’s rarely an either/or decision. “It’s a partnership,” he said. “The commercial market is providing for catastrophe losses as well as providing services for captives in terms of claims handling and loss control, engineering and making sure they have the certificates of insurance that [a captive] needs to meet its contractual requirements.”
Les Boughner, executive vice president at Willis Captive & Consulting Practice, agrees. “I don’t see a conflict. It’s more of a partnership if it’s done right.” The real decision, according to Boughner, is whether to go totally self-insured or set up a hybrid. But, as he explained: “it’s usually a hybrid. A company is fully insured, they’re in the commercial markets, and they find they’re getting very poor value so they decide to improve the value. Generally that means taking an increased retention or an increased deductible to generate savings on the insurance piece which would cover the desired risk profile. The captive effectively gives you an insurance wrapper in a very cost-effective manner.”
When it comes to establishing a captive versus relying on self-insurance—the payment of claims out of company coffers if and as they occur— Mead has a pretty clear idea of why a captive is often the better option. He said, “The three major strengths of a captive are control, control, control. You are able to control your risk dollars and obtain the coverage that you need, which may not be otherwise available in the marketplace. You can see the costs unbundled and decide for yourself which service providers to hire and fire.”
According to Koritzinksy, the process of establishing a separate entity can be a useful way to make sure a company’s attention is as focused on its risks as it should be. Incomings and outgoings are generally scrutinised more when they’re going through a captive and serious thought is given to how claims might be reduced or managed. “It forces a client to self-insure with a highly disciplined approach,” he said. “You’re forming a separate corporation; there will be annual meetings and generally there are representatives from senior management on the board of a captive. So it’s much more disciplined approach than an, ‘okay, we’re self-insured, we’ll pay the claim when it occurs’ type of philosophy.”
But all of this discipline takes time and money, a reality that Koritzinsky acknowledges might turn some companies off the captive insurance concept. “There will be some extra costs involved because of the audit, actuarial work, management, license fees and such. And there may be less flexibility to adjust loss reserves. A captive has a very narrow path on how to create loss reserves and the infrastructure that manages those losses.”
According to Mead, that extra burden in terms of time and resources is actually a necessary and positive element of a captive. “Owning a captive takes some time, and it should. It’s a new line of business, to which one must pay attention.”
And, according to Boughner, well worth it when it comes to finding the best insurance mix. As he told Captive International, “It’s about trying to find a balance between the most effective use of the captive and the most effective use of the commercial market. A captive lets you do that.”
But there are, of course, areas in which the commercial markets will always have the upper hand. As Mead explained: “commercial carriers will usually have a stronger balance sheet and can handle large limits and exposures better. Lines of coverage with more of a certainty of frequent or large losses are better insured in the commercial market.”
And once a company does decide to go for a captive, it’s important not to get too complacent. As Bougher warned: “One of the weaknesses we see quite a bit with captives is that companies will go into a captive structure with a certain strategy and they maintain that strategy. A captive is a financial tool. It should follow a dynamic strategy."
insurance, captive insurance, commercial markets, captive management