Courtney Claflin, executive director, University of California
Establishing a captive may seem like a heavy lift for educational establishments with no experience of, or interest in, running an insurance company, but the cost savings can be quite substantial, says Courtney Claflin of the University of California.
The University of California (UC) system consists of 10 universities, five academic medical centres, 280,000 employees and more than $37 billion of annual revenues. Like many large organisations, the university formed a captive programme to finance its risks more efficiently, create direct access to additional reinsurance markets and provide coverages that are either commercially unavailable or too expensive to procure.
“If the savings generated from a captive can pay for a new dorm room, it has been worthwhile for the university as a whole.”
Additionally, the captive platform helps provide customised insurance programmes to its faculty, staff, employees and students, delivering long-term value from coverage and financial standpoints.
Captives generally insure traditional hazard exposures. Most educational institutions assume relatively high retentions (deductibles) and then purchase excess insurance or reinsurance for claims exceeding those retentions. Transferring actuarially determined, expected losses to a captive via premiums means the university earns interest income until claims are paid out.
The captive’s investment portfolio is likely to have the flexibility to be more entrepreneurial than that of its parent. This drives a positive investment income return relative to traditional banking programmes or trust programmes. In most cases, this will add up to significant new money for organisations looking for new sources of revenue.
The captive can also access excess coverage via the reinsurance markets, which are not available to non-insurance organisations. It is analogous to a person buying products from the wholesale market, rather than retail.
Captive reinsurers are much more amenable to negotiating terms and conditions that address the company’s specific risk profile than traditional commercial markets. As a university system, UC’s risk profile is unique and robust, and negotiating enhanced terms and conditions with reinsurers is a significant advantage.
As an insurance company, the captive can participate alongside reinsurance companies in quota share arrangements and provide layers of coverage inside its reinsurance towers. This reduces premiums and endears the captive to reinsurers, which ultimately helps the parent institution’s standing in the market.
Finally, owning a captive increases the owner’s ability to access additional capacity (limits). This allows UC to insure its unique risk profile as an educational institution.
What risks should be placed in the captive?
Any risk with a retention, or deductible, can be placed through a captive. Currently UC places more than 50 different risks and risk-financing arrangements through its captive programme, including workers’ compensation, cyber, general liability, employment practices, and auto.
Some risks are perceived to be too risky for a captive. This is a misconception. In fact, the captive is simply financing the same retentions that existed prior to this arrangement. The captive then uses its status as an insurance company to secure more favourable reinsurance protection, in excess of its retentions.
UC also places risks into its captives that are commercially unavailable, which were previously technically self-insured on the university’s balance sheet. The captive formalises the arrangement with an insurance policy which can be priced, with claim results then monitored, enabling UC to better manage its risk going forward.
Once a captive owner establishes its governance protocol and develops its operational policies and procedures, it can start getting creative. The captive can take an underwriting position on the insurance that the owner is already purchasing.
For example, most institutions provide health insurance for their employees. Most institutions are also to some extent self-funded in this space, meaning they self-insure to a certain limit per claim and buy stop loss reinsurance for claims exceeding their retentions.
Captives can purchase stop loss reinsurance wholesale, which saves money, and can then provide an excess layer of coverage prior to reinsurance attachment points, which lowers the cost even further. UC captives executed this transaction on its employee and student health plans, to great financial success.
These are just two examples of what can be called enterprise risk-financing (ERF), where dollars can be retained within an organisation, rather than funnelling them into the bank accounts of insurance companies. UC currently executes multiple ERF arrangements that drive significant savings back into the university system.
Worth the effort?
Some may dismiss such savings as rounding errors, a term usually used to imply an amount so small it is not worth the effort involved. But UC takes a different view. As we are an educational institution that is always on the lookout for new revenue streams, it is important to understand that the savings gleaned from these captive risk-financing arrangements add up. Not every saving is a financial home run, but in aggregate they make a considerable difference.
A captive owner can take considerable pride that its board of directors cares about $10,000 of savings. UC’s reference is that a new finished dorm room is worth about $10,000 in construction costs. If the savings generated from a captive can pay for a new dorm room, it has been worthwhile for the university as a whole.
Educational institutions have an excellent opportunity in the captive insurance industry, regardless of the institution’s size or the scope of its operations. The captives industry is well served with professionals that can help institutions determine whether a captive is the right choice. From single parent captives to educational institution group captives, there may be an opportunity to take advantage of more efficient risk-financing arrangements that were once considered to be the preserve of only the largest institutions.
Courtney Claflin is executive director of captive programmes at the University of California. He can be contacted at: firstname.lastname@example.org
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