Construction companies are increasingly prolific users of captive insurance companies, according to Randy Sadler, principal at CIC Services, at a time when a lower US tax rate and deregulation have encouraged a building boom.
CIC Services works with a large number of midsize construction companies that write insurance through their captives. “Construction accounts for around 6.3 percent of US GDP and around 20 percent of our captives are owned by construction companies, up from around 10 percent three years ago,” said Sadler.
“Captives tend to offer coverage at a better price than is available in the commercial market. They also allow them to aggregate their risks and premiums and create a profit centre,” he added.
Sadler noted that conditions have been ripe for construction in the US, at least until COVID hit. “This is likely to continue regardless of the election outcome,” he said. “If the Democrats win they will likely invest in infrastructure and renewable energy projects which will also support growth for construction.”
Construction companies face a number of unique risks that captives can help them with, Sadler said. They can bond subcontractors via their captive, providing insurance coverage in the event that this third party labour does not complete its work. “These things happen on building sites which can cause a significant expense, especially if work was done badly and has to be redone,” said Sadler. “This is a huge risk, especially for midsize companies.”
Construction companies also have long term construction defect exposure, the risk that a project will be signed off by an inspector upon completion but later prove to be defective. They can use captives to write warranties to cover them in the event that they are held liable for such defects at a later date.
The increasing use of captives is also permeating down to large subcontractors, noted Sadler. “They often face as much risk, and similar risks, to the construction companies,” he explained. “They may have multiple crews working on multiple sites at the same time, and face the risk of financial penalties if work is completed late, for example, which can be managed in a captive.”
Using a captive is likely to increase risk management discipline and improve cost controls, noted Sadler. “If as a contractor you have subcontractor default insurance being purchased from the contractor’s captive by all the subs, the risk manager has a very strong incentive to ensure subcontractors are managed properly to avoid the captive paying out claims and draining its insurance profits,” he explained.
Many construction companies are being pushed to look at captives as a solution to the increasing cost of commercial coverage, said Sadler. “Most are ‘blending’ captive cover with commercial cover to gain control and rein in costs,” he added. “They are using their captives to participate in the risk, for example via a higher deductible or having their captive serve as a reinsurer to a carrier. This increases the incentive for the construction company to keep tight control of the risk.”
Sadler observed that the proportion of risk managed via the captives tends to increase as the chief financial officer gets more comfortable with the captive, usually after two or three years of working with it.
“New lines get added, because spreading the fixed costs across more products makes the captive more economical,” he said.
Sadler advised construction companies - especially midsize ones - to think about group captives for some lines, such as workers’ compensation, general liability and auto liability. “We don’t recommend our clients manage these lines in their single parent captives unless their exposure is very large, which they tend not to be for the mid market companies we work with,” he explained.
“We encourage them to write a layer of property and other coverages through their single parent captives, which offer greater flexibility, such as easy access to your capital in the captive if and when they need it.”
Randy Sadler, CIC Services, Construction