Captive Insurance Opens Risk Planning Techniques to Mid-Market Businesses

Risk Planning Decades ago, the largest U.S. companies came to realize the benefits of a captive insurance program with the result that there are now as many as 10,000 captive insurers in place worldwide – with the majority affiliated with American businesses.

The reasons are obvious:

Acme Manufacturing is a closely-held, Midwest business, generally offering a one-year warranty on its products, which can be supplemented with a multi-year extended service. This service contract can be structured as an insurance arrangement wherein a captive insurer backs-up or assumes Acme’s financial obligations in exchange for a premium. This is preferable to Acme simply deferring the tax deduction for repair expenses until such are actually incurred in future years while recognizing (and paying taxes on) the service contract income immediately. In some instances, investment income can build-up on a tax-advantaged basis to help fund future losses.

Federal Industrial Cooling, LLC provides industrial cooling equipment and services to commercial and industrial customers. It relies on its experienced HVAC engineers/salesmen, who are often graduate engineers, to interface with architects and mechanical engineers who design projects. Its COO and CFO are also critical members of the executive management. The loss of any of the engineering/sales staff or executive management would significantly impact Federal. While key man policies insuring against death are widely available in the marketplace, polices that insure against disability or simply a person’s retirement or just plain quitting – whether or not joining a competitor -- are difficult to come by. Its captive can insure these risks.

Enviro Services, Ltd. has developed at great expense certain processes used in containing and cleaning up industrial waste. It wishes to insure these non-patentable processes against competitors’ pilferage. Its captive insures the integrity and exclusivity of these processes against devaluation caused by the misappropriation of these processes by competitors.

Plastic Surgery Associates, LLP unknowingly self-insures serious exposures, including change in reimbursement rates, the costs of CMS and insurance company audits, the risk of delisting by an insurer, malpractice deductibles, employment practices (e.g., claims of sexual harassment, racial discrimination), accounts receivables exposure and disability. While the physician-owned business insures against professional liability, these other, more likely and significant exposures have not been covered with insurance. The client found that owning its own captive insurer helps control the rising cost of risk and provides added insurance protection by filling the holes and exclusions in its conventional coverages, while providing a more stable level of income for its owners.

Practically speaking in none of these situations is insurance available from a conventional carrier to cover these company specific risks, at least not at the level of a reasonable premium for a mid market company.

Already, tens of thousands of businesses – representing industries ranging from medical services to manufacturing, fabrication to distribution, finance and construction – now participate in some type of alternative risk planning program, whether it be a group captive, a cell captive, a single parent captive insurance arrangement or some other form of alternative risk financing to better insure risks of its parent company.

These companies do not necessarily cancel their conventional liability or property or auto and truck coverages. Rather, these businesses supplement their conventional coverages with tailored policies that pick up where conventional carriers fall short.

For years the largest U.S. companies have realized the benefits of alternative risk financing and captive planning. Principal among the reasons is the ability to customize coverages to the insureds' needs rather than simply relying on "standard" conventional policies riddled with restrictive exclusions.

Insureds have found that the vexatious claims submission processes of conventional property & casualty carriers, especially when faced with substantial commercial claims, often are more cost effectively handled through captive insurance arrangements.

Additionally, traditional carriers pay out only a portion of premiums received for actual losses, with marketing costs, regulatory expenses, executive compensation, commissions, investment losses, and litigation with insureds absorbing a disproportionately high amount of the actual premium dollars. A well-designed and implemented captive arrangement can recoup these dollars for the insured.

Thus, it is not surprising that captive insurance as an alternative risk management strategy have long been used by most Fortune 1000 corporations.

The last decade has seen an increasing demand for more targeted and cost effective insurance coverages which quickly leads to captive insurance and other alterative risk financing techniques. To meet this demand, Capstone Associated has, for over a decade,  been translating sophisticated alternative risk financing techniques used by large corporations into techniques feasible for use by the middle-market, privately-held company and its principal owners.

Outsourced providers, such as Capstone Associated, with legal, regulatory, actuarial, risk management, statutory accounting, claims management and policy manuscripting skills have reduced the complexity of captive planning for the privately-held, middle-market business.

More Confidence in Claims Payments

One of the factors that continue to fuel the growth of captive insurers among middle market companies is the conventional carriers’ recalcitrance in responding to claims. Conventional property and casualty insurers have a well-deserved reputation for not paying claims.

Yet businesses naively depend on these same carriers for protection when they are sued. Middle market companies are looking for more certainty from their insurance company when filing claims. It is commonplace for many conventional insurers -- especially on larger commercial claims -- to deny bona fide claims as part of the ‘negotiation process’, especially when facing a significant loss.

As a result, businesses have to sue their insurance companies to recover unpaid claims or face declaratory judgment actions where in a classic role reversal, the insured can be liable for the insurer’s legal fees. The certainty of payment from a captive is, for many, a better alternative.

Commercial insurers often tend to rely on policy exclusions, which create uncertainty among an insured regarding whether the claim will be paid. In contrast, policies issued by captive insurers can be custom-designed to more clearly delineate coverage and to eliminate ‘holes’ in conventional insurers’ policies. As well, a captive can provide cost-effective coverages not readily available in the conventional markets. In some cases, the captive’s policies specifically take over when the conventional carrier denies coverage on the underlying policy.

A captive can take various forms. It may provide primary coverages. Or it may just insure the policies’ exclusions. Often the client keeps most of its conventional insurance in place, using the captive to cover the expectation gap where the items exposures that were thought covered are not covered by the conventional carriers.

Our middle market clients throughout the whole of the U.S. are desirous of protecting their significant businesses with comprehensive and tailored insurance coverages. If the conventional markets are not providing the needed coverages, they are provided by the captives.

The segment of the market where Capstone concentrates its efforts, being captives for the closely-held, non-public companies with substantial operations, are the largest growing segment of alternative risk planning. Our clients’ captives, generally speaking, retain appropriate risks written through their captive, and insuring other risks through the conventional markets. It is not surprising, therefore, that it is estimated that as much as half of the total property & casualty market in the U.S. is written through some kind of captive or alternative risk planning arrangement.


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