There are numerous advantages to captives over traditional commercial insurance. One is the access to underwriting and investment income, and component pricing, which gives the ability to control frictional costs. Another is an enhanced focus on loss prevention and claims handling.
There are numerous advantages to captives over traditional commercial insurance. One is the access to underwriting and investment income, and component pricing, which gives the ability to control frictional costs. Another is an enhanced focus on loss prevention and claims handling.
Others include the ability to provide coverage that may be unavailable or overpriced in the market. Similarly, the use of rating plans that reflect groups’ own good experience, rather than insurers’ pools, and the facility for pooling risks of groups of employers, are advantages of captives over traditional insurance.
However, there are also challenges. The need to dedicate capital for solvency and reinsurance security, the risk of higher claims and tax costs than expected, complexity, and the ‘distraction’ risk are just some of the obstacles that present themselves.
Opportunities in the industry are threefold. Firstly, one must define profiles of target captive owners, for example:
Non-US multinationals with US benefit plans
US state or territory needed
Lower operational costs
Latin American corporations
Proximity
Language.
Promotional efforts must be made around the captive, which can involve marketing and business development, representation at captive events, and involvement in news magazines. Domicile selection is also a vital component, where the following must be taken into consideration:
Capitalisation and surplus requirements
Stability of regulatory environment
Experience in business under consideration
Flexibility in investment choices
Receptiveness of regulatory environment
Tax costs
Qualifies for ERISA benefits (state or territory)
Quality of local infrastructure
Service costs
Availability of expertise
Proximity to directors and corporate HQ.
Reputational risk: a coverage for your captive insurance company?
Reputation risks for companies are an growing concern for risk managers, who are examining their captive structures for relief. After recent scandals at Pennsylvania State University, News Corp and MF Global, major corporations are covering such exposures through their captives.
The CFO, the general counsel and the treasurer of the corporation are called upon to evaluate the proposal to underwrite reputational risk insurance in their captive insurance company. To evaluate this type of decision clearly puts these very capable corporate executive officers into the insurance business. What is their plan of action? The strategy would be to summon the vice president of corporate taxes and the director of risk management to prepare the proposal as respects the writing of reputational risk coverage in their captive insurance company.
Let me offer a suggested plan of action to understand the concept of insurance product development in a traditional insurance company.
Firstly, examine the exposure as we know the following types of corporations will always be interested in this type of coverage:
Sports—remember what the public said about Nike?
Clothing—Ralph Lauren and the Olympics?
Toys—what about Mattel?
Fragrances
Restaurant chains
Food
Beverages.
Secondly, look at the traditional companies, global insurers offering the reputational insurance product, global reinsurers offering the product, and Lloyd’s Syndicates starting to provide the reputational risk. How do they price the product? It tends to be ‘rate on line’ which I observed working at Lloyd’s as an underwriter in 1967. Forty-five years later, Munich Re’s underwriters discuss 1 percent to 2.5 percent rates on line for this coverage.
Just exactly what is covered when we speak of reputational risk coverage? Some underwriters have said that the coverage afforded is a loss of profit or revenue at the corporate level because of the change of consumer perception. What triggers the coverage?
Let’s look at the theoretical structure for your captive insurance company:
Self insured deductible
$1 million
(parent corporation)
Primary layer: captive
$9 million
(50 percent reinsured to new hedge fund-owned reinsurers)
First layer: global insurer
Direct excess of $10 million, excess of $10 million = $20 million
Second layer: Lloyd’s Syndicate
Direct excess of $25 million excess of $20 million = $45 million
Third layer: World’s largest global insurer
Direct excess of $65 million excess of $45 million = $110 million
The underwriting of this coverage has many challenging discussions, which must be considered properly before implementation. Factors to consider would be the risk appetite of the parent corporation, what are considered to be the financial losses, and lastly, who handles the claims of this type of coverage.
