Business owners are in the driver’s seat. For years, it has been the owner’s sound decision-making that has developed their business into the force that it is today—profitable, resilient, competitive, progressive, and operational...
Business owners are in the driver’s seat. For years, it has been the owner’s sound decision-making that has developed their business into the force that it is today—profitable, resilient, competitive, progressive, and operational. But as anyone worth their salt can attest to, there is no such thing as relying on forward momentum when risks are involved.
Natural disasters, security or data breaches, loss of key employees, equipment breakdown, international risks and other perils can aggravate the proverbial squeaky wheels and loose bolts of the operations. Vulnerabilities exist that may lead to sometimes predictable, sometimes unforeseeable losses.
This is the narrative that every business owner laments over, as evaluating risk mitigation strategies becomes one of the primary responsibilities bestowed upon them. Risk mitigation’s role in the business environment is essential to the survival of the company, focusing primarily on the reduction of the extent or even likelihood of a risk.
The tedious work of putting risks into perspective takes priority among the big make-or-break business decisions, such as securing capital, recruiting and employee retention, research and development, production, and the implementation of effective growth strategies.
In general, business owners assume a significant and active role within their company in efforts to protect the assets and investments. In risk mitigation, it is the assumption or acceptance of a particular risk, avoidance of that risk, implementing actions to minimise the impact of that risk, and the monitoring of environmental changes that may affect a business that have become part of the vernacular.
What is the reasoning behind the vital work of risk mitigation? Without the existence of sound decisions and continuous monitoring, the threat of business interruption or the complete failure of a business can become a palpable reality. However, what happens when one cannot effectively reduce the extent or likelihood of a risk within the company?
Enter captive insurance, a hybrid plan that essentially combines risk transfer and financing, once simply a novel approach to handling hazard risk, has evolved into an effective tool to reduce the overall cost of risk for a company.
Captive insurance is an alternative risk planning strategy that streamlines the risk management process by adding tailored coverages or filling in coverage gaps left by commercial insurance policies. The unique coverages written under the captive paired with conventional policies helps insurers mitigate the business and operational risks that often lead to dire financial repercussions. Think Blue Bell ice cream and its need to lay off—so as to survive—more than 1,400 employees due to a deadly listeria outbreak. Blue Bell voluntarily recalled all of its frozen desserts in April after the US Centers for Disease Control and Prevention linked its ice cream to the outbreak that resulted in three deaths and additional illnesses in several states.
Business owners should look to their trusted advisors, such as certified public accountants (CPAs) or financial advisors, for strategic planning that is sound and efficient. Discussing all facets of the business can help them determine whether a complete risk transfer is the most appropriate course of action or if the addition of captive planning could be an alternative (given the completion of a detailed feasibility study).
Without this guidance, clients are unaware of the options, which may lead to the exposure of being underinsured or ultimately purchase coverages that don’t fully address their specific risks. Moreover, the high costs of some coverage may prompt insureds to drop ‘unnecessary’ coverage over time, leading to financial vulnerabilities if the exposure occurs while uninsured.
Comprehensive risk coverage is no longer an option. Assessing risks and mitigating the potential effects requires a commitment from everyone involved in the business planning—forming a captive insurance company has become a viable option for clients. Captive insurance not only gives owners a plan of action for risk coverage for important operational components (such as the supply chain), but it also affords them the types of benefits that strengthen the organisations over time.
The strength of captives: protecting the supply chain
Businesses integral to the supply chain are essentially domino pieces, lined up in perfect form, ready to do their part. If one of those dominoes falls, the rest of this formation becomes vulnerable. Whether one provides services or products, the supply chain is critical to the health of every middle market business. As a result, risk mitigation and comprehensive coverage should be appropriated throughout to prevent or fund potential losses. The formation of a captive insurance company is one option to combat the risks that are created throughout the supply chain.
The types of coverages that can be underwritten by a captive become especially important for the supply chain, as the tailored, broader coverages could fund special or ‘non-standard’ risks. An example of these coverages could include the loss of a major supplier because of a tsunami in Japan or floods in Thailand—both of which have affected US businesses in the last three years or so—so that the insured is protected against ensuing business interruption or extra expense while the insured establishes a suitable replacement to resume normal business operations.
Trade disruption coverage, which provides business interruption and extra expense coverage, insures against an event or incident that causes an adverse impact on the insured’s supply chain. These risks can include treacherous events, such as war, embargo, tariff spikes or trade restrictions. Companies that conduct business globally, working with suppliers overseas or have operations in multiple countries would benefit from coverages such as political risk, kidnapping or trade disruption. For example, Exxon’s large exploration activity in the Russian Artic was disrupted by government imposed trade sanctions, stranding billions of dollars.
Further, hazard risks that stem from severe weather, causing damage to properties, equipment, vehicles, and more, are a threat to all businesses. Weather-related business interruption insurance would provide funding to cover business interruption losses and the extra expenses resulting from catastrophic events such as earthquake, tsunami, flood, hurricane, windstorm, tornado, or snow/hail storm. One of the main features of this type of coverage is that claims do not require a direct physical loss to the insureds’ property.
Special risks, industry viewpoints
For some businesses, the added costs of specialised risk coverages become too much of a gamble, especially if there’s been no history of claims or claim triggers. As the biggest advocate for the business’s success, choosing the right risk mitigation strategy is paramount.
Special risk coverage may or may not be available in the conventional markets. Typically, insureds are left to bite the bullet and pay higher premiums for coverages needed to cover their high-risk operations.
Industries such as manufacturing, construction, chemical transport, shipping, wholesale/retail, and agriculture inherently possess risks that could result in irreparable financial, operational, and even reputational damage. Companies that rely on or actively engage in the transport of materials, domestically or internationally, can opt for special cargo/transit coverages. This protects the insured against loss or damage to property in transit in owned or leased vehicles, common carriers or goods shipped by freight forwarders.
Other risks such as the repercussions from regulatory changes should also be taken into account. These coverages protect the insured against compliance expenses and the resulting business interruption from various regulatory changes that would adversely impact the insured’s normal business operations. These coverages would also address any changes in regulatory authority and/or enforcement policies of existing regulations.
In focus: workers’ compensation coverages
Workers’ compensation insurance is a highly regulated component of the insurance industry, providing workers with medical and indemnity benefits for the treatment of work-related injuries and illnesses. Workers’ compensation coverage also provides income, birth, and burial benefits. In general, workers’ compensation coverage is commonly understood as a cost of doing business—a requirement in risk mitigation, especially for those working in high-risk industries.
Tailored risk coverages under a captive allow for business owners to underwrite workers’ compensation coverage distinctively designed for their industry. By forming a captive insurance company, businesses can supplement their commercial workers’ compensation insurance—the premiums paid to the captive insurer can cover reimbursement of large deductibles collected by their commercial insurer. Additionally, the premiums paid to the captive can be done on a tax-deductible basis under controlled loss conditions.
By way of example, here is how coverage for workers’ compensation can be established:
ABC Company expects to pay $3.5 million± combined for its workers’ compensation and Longshore and Harbor Workers’ Compensation Act policies.
To reduce its insurance costs, the company is soliciting quotes for a workers’ compensation policy with a higher deductible of $500,000. ABC is prepared to pay the projected workers’ compensation deductibles and cover those deductible losses, above a per claim threshold, through a captive insurance arrangement.
Loss experience for this line of coverage has been exceptionally good with a weighted average developed loss ratio of under 20 percent since 2012. This is partly due to the fact that premiums are calculated for a hazardous industry, although ABC has a loss control programme that is well documented and professionally managed, which has kept losses well below the average. To be sure, a catastrophic loss could occur at any time, or an unusually large number of claims could create high aggregate losses within a policy year.
Through pricing quotations from the commercial insurance market and additional loss analysis, the appropriate deductible level is determined and the ABC retention and stop-loss protection is set. In the example, the company’s conventional workers’ compensation coverage works in tandem with those provided by the captive. That is why the combination of a large deductible plan and a captive insurance programme provides a significant benefit for middle-market organisations.
Heading off labour disputes
Most organisations do a good job in adhering to labour laws and guidelines. However, there will always be some level of risk if the business is involved in a large operation—relationships with employees, vendors, suppliers and so on can create vulnerabilities. Labour disputes can ensue, leading to costly litigation in court. As such, business owners must consider any unforeseen situations that could call their business into question. Regarding labour disputes, captive insurers can provide potential gaps in coverage excluded by employment practices liability insurance.
Other risks: third-party exposures
For any business offering a line of credit (Net 30, Net 60), including those in private healthcare or retail organisations, collection rate insurance coverages protect the insured against an unexpected drop in its collections rate of at least two percentage points for services and/or products billed, where the drop in collections rate may be due to a variety of reasons outside the control of the insured party.
This brings us to third-party liability issues. Product tampering or the alleged or threatened wrongful alteration or contamination of the insured’s products by any person, including employees, poses both legal and reputational risks for businesses operating in the retail sector (other industries could be affected by this as well). Product impairment coverage could fund losses stemming from these product risks. It can also address product extortion, which is the act of extorting money from the insured by threatening to commit product tampering on insured’s products.
In general, risk mitigation and alternative risk planning strategies that include the execution of a well-executed captive insurance arrangement offers organisations the security needed to evolve, despite any losses resulting from unforeseen events. Ultimately, risk mitigation and alternative risk management strategies equate to smart decision-making. Choosing a reputable captive management company that offers the insurance, tax, and legal expertise needed to maintain the captive according to regulatory guidelines is paramount. No one can foresee the future—but everyone can prepare for it.
