Having just read the previous paragraph, I am sure you want all your contracts and agreements to be contracts of adhesion, where you have no control.
So, what is the alternative? Captive Insurance.
Captive Insurance provides you with a tremendous amount of Control, as well as some additional responsibilities.
One of the first places most people and organizations would like a little more control is in their premium. As a Captive owner, you cannot directly set the premium, as most states require an actuarial review, often referred to as a feasibility study, to be conducted to determine the premium. However, the premium is based on your behavior or your company’s behavior, not on the actions and missteps of everyone else in the open market looking for the same type of insurance.
A review of your last 3-5 years of claims, along with a deeper understanding of your risk management program, will aid the actuary in determining the real premium for a particular line of coverage. Your control comes in how well you reduce (read as control) your risk. This creates greater premium stability while also decreasing unexpected and ever-growing premium increases. When premium adjustments are necessary, the adjustments should be smaller relative to adjustments with traditional insurance.
You also have control over the lines of coverage you want to put inside the captive. Sure, you can include standard lines of coverage like General and Professional liability. Still, you can also insure hard-to-place risks you have not been able to find coverage in the traditional marketplace. This proactive move starts building up reserves in the event something does happen, and you can also include that particular line of coverage in your reinsurance contract.
Let’s look at an example:
Say you own a large-format printing company that also accepts traditional print jobs. Your internet marketing generates hundreds of orders every day. During the busiest time of the year, your main printing press goes down.
Now, you are unable to complete the jobs that came in today, and it could be several days before the press is back up and running. Thankfully, you have a risk management plan, and you are prepared for just such an event, at least for the jobs that are due three days out. However, the jobs due today and tomorrow are going to be late, which is a problem because of your on-time delivery or its free guarantee.
In our theoretical example, you had the forethought four (4) years ago to establish a captive, and you have been paying equipment breakdown premiums to the captive all this time. This is a great relief, even more so when you remember that your Chief Risk Officer recommends that the captive also establish a loss of reputation line of coverage, just in case you had to make good on your guarantee.
Now, let’s examine what the claims process might look like with a Captive.
You call your Third-Party Administrator to file the claim, who uses the Claims Policy your Captive Board approved when you established the captive, which speaks directly to this circumstance because you knew exactly how it would impact your business if you had a major press go down and you crafted the policy coverage specifically to address this very issue or one significantly similar.
The TPA gathers the details of the claim and applies the Claims Policy the captive board approved to determine how coverage will be applied for both the equipment breakdown and the resulting reputation impact.
The result is that with little additional effort, the claim has been approved. Your company will be reimbursed not only for the total expense of the equipment repair and the cost of the print jobs you had to deliver to the customer at no cost to them due to your guarantee but also for the ad campaign you did highlighting customer testimonials to ensure the rest of your customer base understands that your “delivered on time or its free” guarantee is legit.
Now, let’s look at the same claims process scenario through the real-life lens of the traditional insurance marketplace.
Realistically, you can find both equipment breakdown coverage and loss of reputation coverage in the traditional market. Still, the speed and quality of service you will receive will vary depending on the carrier, which could cause unnecessary delays in recovering your expenses related to the equipment breakdown and a significant amount of time “fighting” to get a legitimate claim paid. The process could very easily go something like this.
You call the “1-800 number” because the agent who sold you the policies really can not help you with a claim, per the carrier’s instructions. When you get in touch with the carrier, you explain the situation, and they may or may not send out an adjuster. The carrier may instead ask you to take pictures, get quotes, and provide a detailed report of the loss for review. This review may take anywhere from six days to six weeks.
After the review, the insurance company agrees that coverage is available for the equipment breakdown but values the claim at only 50% of your actual expenses. They say that their experts determined that the cost of the repairs should not have been as much as the invoices you submitted, so they are only going to pay 50%.
After this determination, the claim is submitted for payment, and you will get a check covering the “agreed” to 50%, minus the 3% deductible. The deductible was supposed to be 5%, but you agreed to pay an additional premium to reduce the deductible because you knew if you had a claim, it could be a significant expense; that is why you initially purchased these specific lines of insurance coverage.
Now, you are only getting 47% of the real cost of your claim. The insurance company also determines there is no coverage available for the reputational damage part of the claim even though you have been paying premiums for this coverage for over five (5) years. The insurance company decided it did not meet their “standard” to be covered.
No Control!
The scenario above is just one of the thousands of scenarios that could play out where a traditional insurance company may undervalue your claim or deny the claim altogether. A captive insurance program provides you the flexibility to create the types of coverage you need to address your specific business needs and gives you greater control over premiums and claims.
An additional advantage of having a captive is the realization of how an effective risk management program can positively impact your overall premiums and claims volume. Controlling your risk can further reduce the likelihood that premiums will need to be adjusted upward on an annual basis to maintain proper reserves.
The traditional insurance market is also subject to the up-and-down cycles of hard and soft insurance markets. During times of a hard market, coverage offered becomes more narrow or limited and premium prices go up. A captive is less susceptible to these fluctuations and offers you, the captive owner, more control over underwriting requirements and claims settlement activities.
Let’s think through that. When you need insurance the most, it is likely to be less affordable, and coverages will have more restrictive guidelines. The underwriting process is likely to be more stringent, further reducing your possibilities of getting the coverage you need at a price you can afford. Two more factors of which you have no control.
With a captive insurance program, you have more “levers to pull” to ensure you get the reliable, effective coverage you need at a price that reflects your real risk, without the worries of what unexpected changes may occur in the future.
Increase Control, Reduce Costs
The Vermont Department of Financial Regulation, which oversees it captive approval process, published the list below to help those thinking about establishing a captive determine how to increase control and reduce costs. Here are the control advantages they listed:
- Coverage tailored to meet your needs
- Reduced operating costs
- Improved cash flow
- Increased coverage and capacity
- Investment income to fund losses
- Direct access to wholesale reinsurance markets
- Funding and underwriting flexibility
- Greater control over claims
- Smaller deductibles for operating units
- Additional negotiating leverage with underwriters
- Incentives for loss control
- Alternatives to the costly practice of trading dollars with underwriters in the working layers of risk.
As you start to weigh the decision to create a Captive, the consideration should include more than just the initial financial costs, which are not generally associated with traditional insurance. Starting a captive is not a short-term move. To see a Return on Investment, you must be willing to give the Captive a minimum of three years, and in most cases, it takes five years for the benefits to truly start to manifest, but when considering the next 20 years in the life of your business, do you want to be paying all that money to a traditional insurance company, or do you want to start positioning your company to be more financially healthy for the long-term.
In the next article, we will discuss Capacity, a captive’s ability to retain risk.
