The third-party captive frontier

Mike Posko (pictured), from Old Republic, examines the key qualities a parent should consider when choosing the right fronting carrier.

Owning a captive insurance company has been an alternative risk financing strategy for many decades.  Historically, financially strong parent companies committed to maintaining an exemplary risk management and loss control programme have capitalised on the tactical and financial benefits captive programmes provide. 

A captive may provide greater access to the reinsurance market and create opportunities for a more efficient risk-financing structure. Financially, a captive provides the parent the opportunity to reduce the total cost of their risk management programme. The captive enables the parent to obtain coverage that is either unavailable or too expensive, given the parent’s exposure.  

Beyond these advantages, some parent companies might pursue additional options to maximise the benefits of their captive. One significant way to expand a captive’s use is by writing third-party business. This generally involves a captive assuming risks associated with unaffiliated entities, including customers, vendors, tenants and other parties connected to the parent’s operations, products or services.

Most commonly, a parent can use its captive to provide coverage to third parties to solve a business problem. There are several benefits to the captive and the parent in implementing this strategy.

“A fronting carrier (can) provide rated paper and a more arms-length counterparty to the transaction with the third party.”

In some cases, it can build stronger business connections between the parent and its supporting business. When the parent’s captive provides insurance to third-party vendors who are having difficulty finding affordable insurance solutions, it does so to stabilise their insurance programmes, creating greater ease of doing business and a more stable financial situation for the vendors. Additionally, this generates trust between the parent and the vendor and can lead to a deeper, long-term partnership.  

Another effective strategy is to offer coverage to support the parent’s product or end users of the parent’s services, thereby deepening satisfaction and goodwill between the parent and their customers. This is most frequently used when the captive provides warranties to the buyer of a retail product, or with tenant legal liability programmes.

When a third-party program is successfully implemented, this strategy can also generate underwriting profit for the captive. The path to a successful third-party programme lies in the data. The parent must understand their business and the unaffiliated vendor’s business better than the traditional insurance market does.  

Comprehensive actuarial data, combined with a strong loss control and enterprise risk management strategy, are foundational to that understanding. The parent must also have excellent financial strength. As with all captive programs, undertaking third-party captive business requires a plan for long-term sustainability to achieve stable, consistent pricing.  However, the parent/captive must be sufficiently financially strong to weather unforeseen severity losses to ensure prosperity over time. 

To provide these third-party benefits, the parent company and captive will frequently partner with a fronting carrier to provide rated paper and a more arms-length counterparty to the transaction with the third party. There are several key qualities a parent should consider when choosing the right fronting carrier.  

The fronting carrier should have high-quality paper, a strong track record of service excellence and exemplary knowledge of the regulatory environment. The carrier communicates and coordinates with other captive service partners; therefore, historical experience in programme design and implementing a third-party programme is critical, as is an understanding of the parent’s objectives.  

For sophisticated programmes, it might be beneficial to select an unbundled fronting carrier.  This provides the parent and captive with maximum flexibility in selecting a claims administrator and risk control service provider best suited to handling the programme’s claims profile. 

In addition to providing flexibility, programme construction knowledge and coverage and compliance expertise, the fronting carrier may collect premiums, pay premium taxes and assessments, service provider fees and provide informed access to the reinsurance market. As the fronting carrier is ultimately responsible for paying the claims of the policy, regardless of the captive’s ability to do so, the financial strength of the fronting carrier is critical.  

Writing third-party business through a parent’s captive can be a valuable tool for providing the parent with greater tactical, financial and operational flexibility over their loss control and risk management programmes, as well as for building trust and confidence with unaffiliated business partners and customers alike. Identifying and collaborating with the correct partners that listen and understand is the pathway to achieving a parent’s ultimate objectives, solving business problems, and expanding its captive usage. 

Mike Posko is the AVP – account executive at Old Republic Risk Management. He can be reached at mposko@orrm.com 

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