CAPTIVE INSURERS: ALTERNATIVE RISK TRANSFER AT ITS BEST?
Opportunities abound for mid-sized agents and brokers to profit from the captive trend
By Michael J. Moody, MBA, ARM
Several years ago you could set your clock by where the underwriting cycle was in the commercial property and casualty insurance market. Seven years on the dot. Rates would, for the most part, follow this predetermined timetable. If it was year three into the cycle, you knew you had four more years before rates would reach the zenith of the pricing cycle. As a result, the industry rose and fell on the seven-year cycle. Periodically one line of coverage would independently move away from the cycle, but for the most part the seven-year timeframe held.
A perfect example of this independent movement was product liability coverage in the late 1970s, when the market suffered an extremely hard pricing period. The distress in the marketplace was catastrophic, leaving many manufacturers without any coverage as carriers abandoned the market in droves. The short-term result was that most manufacturers could not find any product liability coverage, while those that did paid premiums that sometimes were as high as the limits of liability.
Agents and brokers who wish to move beyond simply selling insurance should seriously consider entering the ART market.
Among the issues that surrounded this situation were several adverse court rulings that held manufacturers legally liable for malfunction of their products. The situation was so bad that Congress was forced to act. To restore some order to the market, Congress passed the Liability Risk Retention Act of 1981, which permits the formation of risk retention groups (RRGs). By the time Congress finally passed the act, the commercial insurance market had begun to soften. Although RRGs were not widely used at this time, insurance experts had their first view of the future of the insurance marketplace and the potential advantages available via alternative risk transfer (ART) mechanisms. The RRG was designed for use by small to mid-sized manufacturers that would purchase coverage as a group. No longer were ART market structures like captives the exclusive domain of the Fortune 500.
Both the captive service providers and the majority of big box brokers were quick to see the opportunity afforded by smaller and mid-sized captives. Middle market agents and brokers soon realized that many ART offerings like captive-related services could allow them to compete effectively with the larger brokers for this important segment of the insurance market. It soon became apparent that some middle market agents and brokers could duplicate the methodology that would allow them to gain and maintain captive business. Thus, while the idea was originally advanced for defensive purposes, they soon discovered a number of advantages to offering these services. Some of these earlier adopters since have moved on to compete successfully for other captive-related services, as well.
Getting involved in new service areas for defensive reasons has worked well for many of the early adopters. Today, however, more middle market agents and brokers are seeing the offensive advantages of moving into the captive segment. As the ART market continues to grow, many believe that ample opportunities still remain. Forward-looking mid-sized agents and brokers will find a multitude of opportunities.
A number of mid-sized agents and brokers have found a variety of ways to take advantage of the current captive marketplace. As the market has grown, however, it now appears that captive usage has just begun to scratch the surface of possibilities. Captive owners and service providers have incorporated innovative approaches to derive greater value from captive ownership. An assortment of new requests has found owners exploring the increased viability of captives.
For instance, much of the early use of captives was driven by casualty-and liability-related problems. For the most part, property coverages were thought to be of limited value in a captive. Most property losses were first-party claims and as such were settled quickly. More recently this view has changed. For example, the National Risk Retention Association has been trying for years to get Congress to expand the scope of a risk retention group to include property coverage.
Groups that have invested the time and effort to form a RRG for liability coverage have observed firsthand the savings available from the use of this structure. Additionally, they have noted that the risk extends much beyond a simple property loss. An obvious exposure that should be covered is business interruption (BI). BI losses have always been thorny issues to settle, and with today’s extended supply chains it is now far more difficult. Frequently, supply chains are located throughout the world and thus require unique coverage, and terms and conditions.
Each of the above-noted risks may require coverage that is designed for a specific need. This is driving corporations to view their captives as part of an integrated risk management approach. Many experts believe this represents one of the most innovative approaches that have been introduced in the past 50 years. The concept is known by many names, the most common one being enterprise captive insurer. In this case the corporation has chosen to have its captive serve as the focal point of its overall risk management program. Movement toward this enterprise approach has accelerated significantly over the past several years, with signs indicating that this trend will continue for the foreseeable future as more and more companies are introduced to this approach.
The question becomes: Where does the mid-sized agent or broker fit into the equation? The past half century has seen significant growth of all ART programs, and captives have been the primary beneficiary of this growth.
During this time, the commercial insurance market has been expanded from ART programs that were used only by Fortune 500 companies to acceptance by the middle market.
Despite all of the recent ART-related activities, the alternative risk transfer market remains relatively unexplored and is still dominated by large corporations. The majority of activity today, however, involves small to middle market accounts, and many industry observers believe this group represents the greatest growth potential.
Agents and brokers who wish to move beyond simply selling insurance should seriously consider entering the ART market. The captive sector has experienced significant changes over several years, and significant opportunities remain. Forward-looking agents and brokers should begin to incorporate captives into their strategic plans.
Michael J. Moody, MBA, ARM, retired as the managing director of Strategic Risk Financing, Inc. (SuRF), a firm that was established to advance the practice of enterprise risk management. As a regular columnist, he continues to actively promote the concept of enterprise risk management by providing current, objective information about the concept, the structures being used, and the players involved.