Insurance consultant advises captives to focus on growth

You say captives can and should do more for their owners. What do you mean?
Too many owners fail to appreciate the enormous potential of their captives. Whether it was created to provide bespoke insurance coverage or to retain the premiums that had previously been paid to commercial insurers, the captive’s function rarely evolves as it matures. That is a shame, because many captives could be doing so much more for their owners.

Captives that use a third party captive manager are rarely managed with a view to growing the business. Rather, they remain in maintenance mode. Third party captive managers simplify the process for companies that want a captive but do not want the hassle of managing it themselves, and they generally do a good job of it. But they do not have an incentive to grow the business or create innovative new products.

I sit on boards of traditional insurers and captive insurance companies, so I know both groups well. A captive is an insurance company, and should be managed like one. It should hire people with insurance experience, people who are not affiliated with the captive owner and will not see the captive as essentially a division of the owner business, but as an insurance company in its own right.

Like any insurance company or a company in any other business for that matter the captive should always be looking at opportunities to deliver growth.

Might this create a divergence of interests between the owner and the captive?
The interests of the owner and the captive will not always be perfectly aligned. If the captive has surplus money on its balance sheet, the owner is most likely to want it to pay the money back as a dividend, whereas the captive might want to invest it back into the business. If the captive board is full of people affiliated with the owner that is likely what it will do.

Instead, the captive should be thinking about how it can use that money to grow. It could use it to acquire a small reinsurance company for its investment portfolio.

The same issue arises when parent companies ask their chief financial officers (CFOs) to run their captives. CFOs are very busy people who are unlikely to have much time to dedicate to the captive, or attend board meetings, if they are also managing the finances of the parent company. Ideally, running the captive should be a full-time job, done by someone with no other distractions.

Captives that are run on a part-time basis by the CFOs of their owners, and managed by an independent third party captive manager, can be thought of as “maintained captives”. There is nothing wrong with that if that is what the captive owner wants. But owners should recognise that this is a missed opportunity, because a captive that is managed with a view to growth can deliver much more for its parent.

What kinds of products could captives design that would benefit their owners?
One commercial real estate company was unable to get insurance from the commercial market to cover the risk of its properties being vacant and not generating rental income. This kind of coverage has never been available in the US commercial market, although it does exist elsewhere, for example in the UK and Australia.

As with other lines commercial insurers neglect, the calculation is that the work required: analysing details of tenants and default rates across different locations and business types, is not worth it for the potential level of demand.

The solution was for the commercial real estate company to create a captive, using its own proprietary data about tenants and default rates to accurately price the risk. It may seem like a daunting task, but the captive actually has some considerable advantages over the larger commercial insurers.

Do captives need to be quite large to contemplate this?
Being smaller makes a captive more nimble, and quicker to take decisions, meaning the product can be developed faster. It has an intimate understanding of the business it is looking to insure. And it has proven demand, and does not need to worry about whether it will be able to convince brokers to sell the policies it creates.

On the other hand, some big captives have very considerable resources. A company such as Coca-Cola’s captive probably has more surplus cash than many commercial insurance companies. As such, it has the resources to compete with such insurers on equal terms, developing new products and potentially selling insurance into the market.

Developing and launching new products is an expensive business: realistically it will need to generate around $10 to $15 million in premiums to have the resources to do it. It requires hiring actuarial firms to study all the data that is available within the organisation and ideally from elsewhere too. It will require hiring a law firm to design the coverage and the policy wording, and teams of IT people to ensure the policies can be booked properly.

It is therefore probably not feasible for smaller or relatively youthful captives: older captives tend to be in a better position to innovate and develop new products, having taken in more premiums and had time to optimise their investment portfolios.

Is there still a limit on the captive’s growth potential?
The captive’s priority will be to create coverage perfectly suited to its owner’s needs, but in doing so it will create products that its owner’s competitors and industry peers may also need. For example there are plenty of commercial real estate companies that face the risk of empty properties not generating rental income, which many will want to insure. The coverage can be sold to trade associations, and to other companies in the market, fuelling growth for the captive.

By thinking like this, successful captives can grow and begin to resemble the larger commercial insurers they were set up to bypass. The Internal Revenue Service won’t be able to pick on captives, and question whether they are really insurance companies, if they behave in this way.

It comes down to the management style. The captives that seize these opportunities will not be the ones managed by third party captive managers that manage another 275 captives, and overseen by the CFOs of their owners.

They will be the ones that think of their businesses just like any other insurance company, with a responsibility to find new opportunities to grow, and that bring in dedicated teams with insurance experience to help achieve that.

Andy Barile is the founder of Andrew Barile Consulting. He can be contacted at:  abarile@abarileconsult.com