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Christopher Lajtha of France-based independent risk management resource Adageo explains why a captive insurance company can represent a very effective management tool, notwithstanding the costs of operating it. In the second of three articles he addresses the issues surrounding centralised insurance procurement and strategy.
For our imaginary multinational conglomerate ABC Co, there may be a number of internally and externally motivated reasons for commercial insurance procurement. For example, a non-exhaustive list might include:
- Local regulatory requirements to purchase certain types of insurance, where failure to comply can result in fines and other penalties.
- Local insurance market regulations that dictate that, if commercial insurance is purchased, it must be on an “admitted” basis and where failure to comply can result in fines and other penalties.
- ABC Co’s division and/or business unit managers may not wish to put their operating results (and bonus opportunities) at risk of impairment by events that could reasonably be covered by commercial insurance.
- Joint venture partners may not share the same insurable risk appetite as ABC Co and want their interests, and perhaps even the whole joint venture, appropriately and adequately insured
- Customers in many countries may require ABC Co subsidiaries to procure insurance as part of compliance with their contract terms and conditions
- To the extent that there is any third party project financing or other forms of borrowings, there are likely to be covenants relating to insurance collateral.
- There may be specific instances where a spot purchase of insurance in certain niche areas appears to be a particularly attractive option—especially if access to specialist/expert services are part of the insurance proposition.
- At different moments in the business cycle, and/or in niche areas, certain commercial insurance products (and related specialist services) may have a particular appeal.
- Commercial insurance may be perceived to be a cost-effective form of noncore risk financing—and may be expected/assumed by some of the company’s stakeholders.
- Special interests may require insurance protection (notably directors & officers and pension trustees).
Centralised insurance procurement
Insurance contracts (policies) are conditional guarantees—the broader the initial grant of cover, in general the longer the list of exclusions. There are also important exposure disclosure and claims notification/cooperation conditions to respect.
Unfortunately, insurance contracts are often lengthy, multisection documents that are far from easy to read and understand. The quality of policy construction and drafting of clauses is highly variable—especially when contracts are amended repeatedly by endorsement over time.
For ABC Co, further difficulty arises when multiple insurance contracts are purchased in different countries, languages and subject to different insured limits, coverage terms and conditions and judicial interpretation.
In the absence of any kind of centralised coordination of insurance procurement ABC Co would waste considerable amounts of money and management time making inefficient multiterritory insurance purchases—paying for access to capacity (cost of insurance company capital) far in excess of its realistic needs.
Therefore, in common with many large companies, ABC Co has centralised insurance procurement and insurance management at the parent company level—employing only a small specialist resource internally. There are few, if any, insurance managers in the business divisions and none at the business unit level or below.
Insurance programme design and procurement is undertaken by the corporate insurable risk management team—with appropriate support from external insurance service providers—and subject to approval from the business division chief executives and the group CFO/CEO.
Commercial insurance procurement strategy
ABC Co purchases customised ‘master’ insurance programmes designed to protect the parent company and all its subsidiary and affiliate operations around the world.
Insurance protections are purchased in various blocks/towers from one or more of the larger, more sophisticated commercial insurance companies (master insurers).
These insurers have networks of subsidiary companies and/or strategic alliances with local insurance companies in many, if not all, of the countries where ABC Co operates.
The network insurers issue local insurance policies to ABC Co subsidiaries and affiliates where required and, to the extent permitted, reinsure much or all of the exposure back to the master insurer(s). In this way, ABC Co does not pay repeatedly for insurance capacity that it does not need, while paying careful attention to respecting the plethora of local insurance market regulations. It also exercises control over the quality and quantity of insurance purchased.
Single parent captive
At last, we arrive at the heart of the matter—why a captive insurance company might represent an important management tool for ABC Co.
As we have seen, ABC Co is not the architect of a complex web of national commercial insurance regulations, ostensibly designed to protect insurance buyers against insurance company irresponsibility and/or insolvency but, more often than not, designed to protect local market interests and generate tax revenues for the state or country in question.
In effect, ABC Co is obliged by regulation and/or contract requirement to purchase commercial insurances around the world that, absent such regulation or contract requirement, it would not seek to procure.
Further, in a company with a decentralised management culture and limited edicts from corporate centre, it can be a challenge to prevent business divisions and business units taking the decision to purchase certain insurances. It is almost always the case that the insurable risk appetite of the parent company is materially greater than that of any of its divisions or business units.
In light of all this, ABC Co decides to create a wholly-owned insurance company subsidiary—a single parent captive insurance company dedicated to underwriting only ABC group insurable exposures. This provides a vehicle that not only caters for varying insurable risk appetites but provides a mechanism for insurable risk and premium clawback where such expenditure is largely unavoidable in the first place.
A captive can be used to induce positive and sustainable behavioural changes with respect to interest and investment in loss prevention and loss mitigation initiatives.Of equal importance to the financial recovery of otherwise lost expenditure, a captive can be used to induce positive and sustainable behavioural changes with respect to interest and investment in loss prevention and loss mitigation initiatives.
In part three we will sum up the arguments involved.
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insurance, management, company, commercial, procurement, captive, business, Christopher, Lajtha, Adageo