Is a group captive right for your organisation?
Sarah Williams (pictured right) and Lukas Gengarella (pictured left) of Hylant Global Captive Solutions look at how a group captive can come into being, thanks to an exchange of information.
A group of successful business owners shared breakfast nearly every Monday morning. Friends since their high school days, the group had taken different paths before running successful businesses in their home town. Some of them had formed trucking companies engaged primarily in delivering goods across the country, some owned manufacturing facilities and others had formed retail and distribution businesses.
The breakfasts weren’t just an opportunity to talk about old times. The group shared a strong sense of mutual respect and turned to each other for advice or sympathy on the never-ending issues associated with operating a business. Insurance was a common source of subject matter and frustration.
This morning, liability coverage provided fodder for conversation. One of the owner’s insurance agents had just told him what renewing his company’s policy would cost. The group exchanged stories about their own renewals and the experiences they had heard from other business owners in town. One of the owners, Rex Blomquist, offered a suggestion: the group should start their own insurance company.
Once everyone stopped laughing, Rex said he was completely serious—that he knew another trucking company owner who teamed up with several others to create something called a captive insurer.
Rex described what’s known as a group captive, in which multiple companies band together to insure (or reinsure) specific risks and share any resulting profits. The example with the group of trucking companies is what’s known as a homogeneous group captive, in which all the members are from the same industry.
If the group decided to form their own insurance company (and to invite other business owners to participate), they would create what is known as a heterogeneous group captive, which is a captive structure where the membership consists of different types of businesses.
Either way, members of group captives participate in key decisions about their insurance company, including underwriting, loss control, operations, insurance and reinsurance options, and risk management service providers. Each member’s premium is based upon its own loss history, with all the operating expenses shared by the group.
A key advantage of the group structure over a single parent captive is that the capital, collateral and operating expenses requirements are spread across all members instead of being limited to just one company.
“Captives reward their owners for better-than-expected performance through lower premiums and/or dividend payments.” Sarah Williams
Liability issues
Like most other owners they knew, the group had lost sleep over liability issues. They had heard about the astronomical verdicts awarded by juries. Through a group captive, they could establish tiers of risk transfer. For example, the captive would be responsible for claims up to a predetermined amount, and the reinsurer would handle anything above the established retained layer up to policy limits.
All of the owners took pride in hiring good people and improving processes. Taking on the first tier of liability through their group captive insurance programme would incentivise them to find ways to reduce losses while protecting them from larger, more unpredictable claims. If losses in a given year were lower than anticipated, their future premiums would likely go down, and over time they could decide to issue dividends.
The owners brought an entrepreneurial attitude to their businesses; creating a group captive was further evidence of that. Their willingness to assume (and take responsibility for) risk, invest in their own companies’ futures and see the potential for lower costs and higher profits made the group captive a logical strategy. Their attitude is typical of family-owned and other privately held middle-market companies.
Forming a group captive with the appropriate guardrails is not recklessly risky. In fact, both types of group captives have built-in advantages when it comes to managing risk, not the least of which is more buying power. In a heterogeneous group captive, member businesses interact with other companies outside their industries, allowing the owners to expand their knowledge and adopt or adapt strategies from the different perspectives of their fellow members. Biannual board meetings and quarterly risk control workshops provide regular opportunities to exchange information and ideas.
Homogeneous group captives also offer advantages, primarily because all the members have the same insurance needs and deal with the same business issues. That encourages holistic solutions to address specific needs and goals. On the downside, if there’s a significant downturn in that industry segment, such as a sudden spate of high-profile lawsuits and verdicts, all the members are likely to be impacted.
“The success of the approach depends largely upon the membership and the service partners supporting the operations. Lukas Gengarella
Better together
The best way to illustrate the financial advantages offered through a group captive is to compare the structure with traditional insurance policies. Companies pay premiums to their insurance carrier so that the insurer will fund any losses during the year. But if the amount of premium paid exceeds what the carrier paid out in losses, the carrier gets to pocket the difference as profit.
If the company’s loss control efforts are effective, these benefit the carrier’s bottom line. In comparison, captives reward their owners for better-than-expected performance through lower premiums and/or dividend payments. Over time, a well-run captive can become a profit centre for its members.
It is not unusual for companies establishing group captives for a particular type of coverage, such as workers’ compensation, to subsequently extend the concept into other lines of risk, such as general liability or commercial auto. There are also group captives that support employee benefits. As companies better understand how to secure the greatest benefit from the captive insurance structure, they recognise the opportunities to make additional moves.
That said, group captive strategies may not be appropriate for every company keen to shrink its insurance spend. There are companies whose industries have what captive consultants refer to as “vertical loss potential”. Put another way, the nature of their business leaves them open to staggering verdicts from class-action lawsuits resulting from sizable, latent loss activity. Companies with a high vertical loss potential are often better off placing those risks in the standard market or in a vehicle such as a risk retention group.
Loss history
It’s crucial to consider the loss history of all potential members of a group captive and each member’s commitment to managing its risk. High frequency of claims can lead to larger, more severe claims, so appropriate guardrails must be put in place to ensure the long-term success of the group captive model. Some of these guardrails include results-driven loss control and claim management practices, sound actuarial modelling and reliance on credible historical data.
Every business faces catastrophic loss potential that, at times, is not preventable or predictable. That is why you maintain insurance for those times when the worst-case scenario plays out. Engaging with partner companies who are committed to change and are eager to get better elevates the outcomes for everyone.
Not that long ago, most businesses learned about group captives only if their risk consultants raised the idea. Now companies which are wearying of constant premium increases have heard they have other options. Carriers are noticing, too, with some traditional insurance carriers dipping their toes into the captive consulting and management arena.
If a carrier isn’t already involved with captives through fronting and reinsurance, it will likely lose significant business to them in the foreseeable future. Companies are learning that options such as group captives allow them to take control of the insurance process while reducing expenses.
Many business owners say this is one of the smartest business decisions they have ever made for their companies.
Given the nature of the group captive, it should come as no surprise that the success of the approach depends largely upon the membership and the service partners supporting the operations. Experience teaches us that three crucial prerequisites are needed. First, the risks being addressed need a loss experience history that’s better than average. Also, a continued commitment to loss control, safety and claim management forms the foundation of a successful captive.
Then, the company must have the financial strength to post a capped and reasonable amount of collateral, either with cash or through a letter of credit. This approach demands leaders who are capable of taking the long view and are willing to make a long-term commitment, and that they are a company capable of exceeding market expectations.
For this group of business owners, establishing a group captive (and inviting other business owners they respect to become members) is a way to take control of what has been one of their fastest-growing and most frustrating expenses. As they continue to grow their businesses through smart strategies and choices, having a captive allows them to bring similar oversight to their efforts to manage the inherent risks their companies face.
In essence, it’s a way for entrepreneurs to do what they do best—take a fresh look at something that isn’t working well and apply transformative ideas to make it better. After being in the programme and experiencing the results first hand, many business owners say this is one of the smartest business decisions they have ever made for their companies.
Sarah Williams is director of group captives at Hylant Global Captive Solutions. She can be contacted at: sarah.williams@hylant.com
Lukas Gengarella is senior group captive manager at Hylant Global Captive Solutions. He can be contacted at: lukas.gengarella@hylant.com
Click here to read Captive International's US Focus 2024 publication.
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