If you don’t have a captive, get one
After graduating college I went to work for an oil company that provided onshore well stimulation services and owned a number of offshore drilling rigs. The company’s slogan was “If you don’t have an oil well, get one!” It was Texas in the early 1980s, and the principles of supply and demand were fully in place.
“When captives participate in the primary risk layer they earn the opportunity to add new or emerging risks to the parent’s overall programme.”
The current situation in healthcare professional liability insurance may not be as dire as what existed with energy decades ago. Nevertheless, savvy organisations might be advised that “if you don’t have a captive, get one!”.
Healthcare professional liability and medical malpractice (HPL) insurers often argue that the market needs a material adjustment. Because there has been a surplus of available capital for investment, HPL has had a supply problem, at least from the underwriters’ perspective. For more than five years there have been numerous companies around the world willing to offer insurance protection to American healthcare providers, on both a primary and an excess basis, and generally with extremely competitive premium structures.
Yet the days of attractive pricing seem destined to end, at least for the next few years. This is due to a rise in the number of large awards to claimants, and what some call an “alarming increase in the frequency of severity”. This concerns not only verdicts, but also settlements and payouts.
In November a Cook County, Illinois, jury awarded $101 million to the mother of a brain-damaged baby born in 2014. That will result in a $50 million payment, since the parties had entered into a settlement agreement prior to the verdict. Such cases have forced carriers to reassess their underwriting models, and often seek significant premium increases, which has in turn put insurance buyers on the defensive—a position many are unaccustomed to.
How should healthcare organisations respond?
One solution for healthcare companies is to make use of alternative risk-funding mechanisms, such as a captive insurance company. Ideally a sophisticated, far-sighted organisation has already established its own insurance subsidiary, or entered a group arrangement. If not, it should strongly consider forming a captive.
As part of the captive formation process the parent must ensure the captive is closely aligned with the parent—not just organisationally, but philosophically. The captive should set goals and strategic objectives that match with those of the parent. The parent’s philosophy and risk appetite should influence and match the captive’s—if the parent has a low risk tolerance and cannot absorb large deductibles, a captive that retains a significant amount of loss may not be acceptable. This should be outlined in the captive’s business plan.
In this hardening HPL marketplace, carriers are increasing premium rates and proposing more restrictive coverage terms. Provisions in HPL policies that were traditionally offered without additional cost, such as protection for managed care operations or breaches in protecting health information, are now being excluded. The typical healthcare provider-insured has little recourse but to accept these higher premiums and more restrictive terms, except for finding a different insurer offering less onerous terms.
The captive advantage
Companies with a captive have significantly more options. A captive owner in a hardening market can access more markets including, most importantly, the commercial reinsurance market. Access to reinsurance enables a captive to create a participation slip and partner with several reinsurers, allowing it to develop a quota share loss structure. This enables the captive-insured to help establish a pricing structure that various reinsurers can sign up to. It means the healthcare company can set the pricing, rather than react to it.
A captive with a higher risk tolerance can participate in losses at the primary level and/or the excess level. An effective way to address rising premium rates is for the captive to take 100 percent of an active layer of risk and, say, 50 percent of the next layer, with the final layer fully reinsured. This “skin in the game” approach helps drive premiums down by reducing risk transfer expenses and, importantly, helps make a statement to balky underwriters regarding the healthcare organisation’s view of potential liability.
Taking risk in the captive is often more effective in lowering overall costs than simply increasing the insured’s deductible. Captives typically have a more methodical, actuarially sound ability to calculate potential losses.
When captives participate in the primary risk layer they earn the opportunity to add new or emerging risks to the parent’s overall programme. Today’s healthcare organisations are actively expanding operations, forming new ventures, and making physician practice acquisitions. Most commercial carriers in the hardening market are unwilling to add risks without increasing premiums, no matter the size or scope of the new venture. Placing this type of operation in a captive is generally a less costly option.
Placing the coverage in the captive also enhances the parent’s risk management team’s ability to influence the direction and assimilation of these new operations into the parent’s organisational framework.
There are numerous other benefits to healthcare companies creating a captive. It can establish a grant programme, encouraging and funding the development of risk management initiatives that target high-cost liability exposures. Forming a captive often improves the parent’s claims management expertise, where previously the insured simply relied upon the carrier’s staff for claims and litigation services and oversight. Adding internal claims personnel often results in better outcomes and lower overall costs.
Given the unfavourable environment that has recently surfaced, and now seems established in the healthcare professional liability sector, an organisation without access to a captive insurance vehicle would be wise to heed this advice: if you don’t have a captive, get one!
Charles Kolodkin is executive director of enterprise risk and insurance at the Cleveland Clinic. He can be contacted at: kolodkc@ccf.org
