Beyond price

The appeal of captives can hold up, even in a relentless soft market

By Michael J. Moody, MBA, ARM

Despite all odds, the soft market for commercial insurance continued during the third quarter of 2010. According to recent updates from large, international brokers, lower rates were available, across all major lines of coverage. While there are a number of reasons for this continued decline, two reasons stand out: intense competition and an over abundance of capacity.

With competition at one of its highest levels in recent years and capacity plentiful, buyers are continuing to have the upper hand with regard to pricing. Survey data from RIMS/Advisen suggests that the rate of declines has slowed, however. A sample of the current market indicates that property rates have experienced an average decline of 4%, while general liability had average premium declines of less than 1%. Additionally, workers compensation experienced rate declines in the 1% neighborhood as well, and specialty liability coverages such as D&O liability saw declines in the 4% range. Despite this, RIMS/Advisen indicates, "The soft market is far from over."

Alternative risk funding

Based on the above figures, one would have to question the viability of alternative financing approaches, such as captives, in this market. But despite the overwhelming premium reductions available within the traditional insurance market for the past seven or eight years, interest in captives continues to grow. In prior, prolonged soft insurance markets, the above figures would signal a death knell for captives. Early on in this soft market, many industry observers were predicting a similar fate for captive growth; but such is not the case today.

Captive owners and prospective owners are seeing something besides a short-term pricing advantage. They are beginning to view the captive as a much more valuable asset within their overall risk-financing strategy.

Certainly, not all captive parents are able to see the long-term advantages of captive ownership, so there has been some migration back to the traditional insurance market. Risk retention groups (RRGs) and other group captives have come under increasing pressure to lower rates to compete with traditional insurers; however, it is difficult to follow the lead of larger insurers that can withstand difficult loss conditions, should they occur. As a result, RRGs have been losing some insureds to the traditional market.

Additionally, some single-parent captives have been forced into run-off positions because the owners are in such dire straits that they are in need of additional cash to remain in business. By discontinuing the captive's operation, they can gain access to its capital and surplus. They can also ultimately be able to be released from collateral requirements of frontiers and/or reinsurers. Finally, some captives are disbanded as part of normal merger and acquisition activity. However, overall the captive movement continues despite the current market conditions.

Why a captive?

Most captive owners realize that price is only one of the numerous advantages available to them, and as the captive matures, other more significant advantages become available. One of the ways that captives are continuing to prove their worth is by expanding their scope of coverage. Certainly the vast majority of captives will still provide coverage for traditional coverage areas such as workers compensation, general and professional liability; however, they are also looking at other coverage areas as well.

For example, the use of captives in conjunction with employee benefits has been long envisioned but has experienced a slow start. Even today, only a couple of dozen captive owners have taken advantage of this option, despite an expedited U.S. Department of Labor approval process. Most of the activity to date has been in the area of non-ERISA-related benefits, thus reducing the potential savings available from the larger ERISA-related programs.

However, a major development has occurred that may impact this area in the future. According to a press release from Spring Consulting Group, a Boston-based employee benefits consulting firm, Spring received the first patent for the funding of employee and retiree benefits via a captive. The press release noted that the U.S. Patent and Trademark Office granted a patent entitled "Program for Alternative Funding of Employee and Retiree Benefits."

The patent relates to "a system and method for configuring, optimizing, managing, and tracking alternative funding" for these programs. In developing a program for Energy Insurance Services of Greenville, South Carolina, Spring established a funding process that enables organizations to better manage and stabilize the cost of their employee and retiree benefit costs. Many industry observers believe that this new approach may result in renewed interest in using a captive to fund these important areas.

Long-term, however, captives must ultimately keep pace with the changing landscape of corporate risk management. Today, risk management has been going through massive changes that are driven by assuming a more holistic view. Risk management is rapidly moving beyond the traditional concept of "insurable risks." This expanded view of risks has provided captives with the opportunity to be of further value in the strategic planning process for their corporate parents. In order to keep pace with this increasing view, captives must begin to think beyond the "insurable risks" box. They must move past this artificial barrier and provide protection for additional types of risks.     

In this regard, it is important that mid-sized agents and brokers, as well as some smaller, independent captive managers begin to move their customer base in the direction of enterprise risk management. This is important, because it is now clear that the larger, international brokers/captive managers fully understand the importance of this concept.

As a result, they are actively and aggressively marketing these types of services to commercial accounts of all sizes. There is a growing level of sophistication concerning ERM, and many organizations now see that ERM and captive insurance companies make an ideal pairing. Based on this mutual relationship, many experts estimate that within the next 12 to 24 months, many mid-sized accounts will begin to embrace ERM and look to their captives as a strategic component in this growing aspect of risk management.   

Conclusion

This discussion would appear to apply primarily to Fortune 500-type accounts, but that is not really the case. Over the past few years, it has been the mid-sized accounts that have made up the lion's share of new captive formations. And with the increasing interest in a holistic view of risk management, captives will only grow in importance. By adding additional risks to the captive, even smaller corporations can benefit from the strategic advantages of captives. Certainly, the "big box" brokers/captive managers have already figured this out, and are developing specific marketing plans to attract these types of accounts.

Thus, mid-sized agents and brokers must begin to carefully analyze their existing books of business, as well as prospects, to determine whether or not they could benefit from forming a captive. Today, these types of accounts are coming to realize that captives are the embodiment of the idea that if you can gain control of your risks, it is, long-term, the most cost effective approach to risk financing. Mid-sized agents and brokers would do well to consider business development activities that mirror this movement.