Companies looking to delve into the world of captive insurance will have to weigh up the pros and cons of different types and structures of captives. Barney Dixon takes a look at the option of group captives in detail
The concept of a captive insurance company has existed for decades, but it wasn’t until the 1950s that Frederic M. Reiss coined the term “captive insurance,” after founding the Steel Insurance Company of America. The term referred to the company writing insurance exclusively for its captive mines. Since then, the industry has grown massively, with captives now covering various lines of business across a number of domiciles and industries. With several different types of captives on offer, group captives have emerged as a good option for small and medium-sized enterprises (SMEs) who don’t have the capital to form their own single-parent captive.
In its Group Captives 101 article series, captive insurance consultant, Captive Resources, says that captive insurance can be defined as “an insurance company owned and controlled by the organisation it insures.” Rather than paying for conventional insurance, a captive owner can retain certain risks often at a lower cost, while transferring others to an insurer. In creating their own insurance company, companies have more control over all aspects of coverage including types of coverage and coverage terms and limits.
There are several different types of captives, but the majority can be categorised by whether they are a single-parent or group captive. According to Captive Resources, a single-parent captive is “owned by one, typically large, organisation or parent, and insures the risks of the parent and its affiliates,” while a group captive is a “captive insurance company owned and controlled by a collection of organisations.”
“The differences between the two go well beyond the number of owners, as there are several ways to structure and operate both single-parent and group captives.”
Captive Resources highlights two principal ownership structures for group captives: “Owned,” where the policyholders are the owners of the captive insurance company, and “Rented,” a licensed insurer owned by an outside organisation that provides the functions of a captive for a fee.
Why should a company opt for a group captive?
Single-parent captives are typically run by large organisations that can afford to retain large risks independently. A group captive may be the more salient option for SMEs looking to insure their risks via a captive insurance company.
By grouping up with similar companies in a group captive, SMEs can avoid traditional commercial insurers and reap the benefits of a captive insurance company, without requiring the capital of a larger, single-parent owner.
Captive Resources, for example, offers companies “more control over their insurance programmes, the resources to make their workplaces safer, and the ability to lower their total cost of risk,” via the member-owned captives that it supports.
Captive Resources works with over 40 group captives leveraging its member-owned model and offers extensive guidance for companies looking to pursue a member-owned group captive.
Captive Resources says that its member-owned group captive model “works well for organisations of varying sizes and from an array of industries,” but concedes that its “not for every company.”
“The companies that find the most success in our model share common attributes — both in terms of their analytical approach to insurance and their business profiles,” the consultancy adds.
For example, companies should be “safety-conscious,” “accountable,” and “entrepreneurial.”
Captive Resources explains: “The group captives we work with recruit safety-conscious companies committed to continuous improvement, and we provide extensive resources to support their efforts. Successful members regularly attend risk management workshops, undergo risk control assessments (RCAs), and implement the latest methods and systems to make their companies safer.”
“Successful members aspire to the mantra ‘what you put in, is what you get out’ and share many entrepreneurial qualities — they’re motivated, forward-thinking, assertive, innovative, and embrace the risk-reward trade-off.”
Captive Resources says it works with companies from a wide range of industries. The majority of these members hail from sectors such as manufacturing, distribution, construction, transportation, temporary employment agencies, retail, food and beverage, hospitality, health care services, agri-business, and oil and gas well operations.
While this is not representative of all group captives, Captive Resources represents a large market share in group captives and can be seen as a representative sample of the way many group captives for the middle market operate.
Structuring a group captive
Group captives can be structured in a few ways, but the two main ownership structures are the aforementioned “Owned” and “Rented” structures. In Captive Resources’ member-owned model, group captives are structured as reinsurance companies.
These companies utilise “A-rated, licensed carriers for policy issuance/fronting and the A/B Fund model we pioneered in the mid-1980s,” according to the company.
“The captives reinsure frequency losses typically up to $100,000 to $150,000 in the A Fund, and up to another $350,000 to $500,000 in the B Fund, and obtain excess cover for larger, catastrophic losses for a total limit up to $1m to $2m.”
“The captives are owned solely and equally by the members; outside parties such as service providers or insurance brokers do not and cannot hold ownership positions. Each member has one seat on the Board of Directors.”
According to Captive Resources, the owned structure offers members “more control over and transparency into their insurance programmes, thanks to a unique loss-funding formula and programme structure.”
Minimising risk and reducing costs
Captive insurance companies of all stripes can help to minimise risk and reduce costs, with different structures offering different ways of doing so. Again using Captive Resource’s group captive model as an example, there are several mechanisms within this model to help members control their risk and reduce costs. Captive Resources outlines four key mechanisms, starting with premiums based on performance.
According to the consultancy, traditional insurers typically base premium on industry averages and state rates, leading to pricing that doesn’t reflect a company’s individual loss experience.
But the member-owned group captives advised by Captive Resources use a company’s most recent five-year loss history to determine premium, helping to better indicate the company’s loss experience.
The next mechanism it highlights is the ownership structure of its group captives, which it says reduces overheads costs.
“Commercial insurers spend significant sums on marketing and acquisition, commissions, administration, and other items that do not directly involve insurance coverages—expenses that are passed along to insureds. By contrast, group captives minimise operational costs by unbundling services and reducing overhead.”
Captive Resources says that these captives can provide “enhanced profit potential,” so when member companies increase safety and reduce losses, the captive can return their unused loss funds, along with investment income, to the members in the forms of dividends. Members also earn investment income on capital and cash collateral.
The fourth and final mechanism outlined by the consultancy is improved risk control and safety. It says: “The captives we work with devote a significant portion of every premium dollar to loss prevention to help members improve their risk control methods and better understand the factors that commonly lead to losses.”
“As a result, a wealth of resources is available to individual member companies to support their continuous improvement.”
With many options to choose from, companies looking to delve into the world of captive insurance will have to weigh up the pros and cons of different types and structures of captives. For SMEs, group captives may be the clear option due to their many benefits over traditional commercial insurers and low capital requirements.
As companies of all stripes look to minimise risk and reduce costs, it is clear that the captive insurance industry and, more specifically, group captives, will continue to become a valuable option in the insurance landscape.
