All For One or One For All
Perhaps the most important decision any risk manager faces when choosing a captive program is whether to select a single-parent or a group captive.
A single-parent captive (SPC) is set up exclusively by an organization to insure against its own risks. The insured owns the captive and is therefore only liable for its own risks.
A group captive, on the other hand, is formed by a group of insureds that band together to share their risks. Each organization is an owner of the captive and thus shares in its profits and losses.
The benefits of a captive from an insurance perspective are obvious — to have greater control over your insurance program and to reduce your insurance costs in the long run.
In its August report, A.M. Best found that captives continued to outperform the commercial sector in most key financial measures.
But before deciding on the right captive, companies must first consider a host of factors including the size of their business, the industry they are in and their risk appetite, and ultimately whether they want to go it alone or be part of a large group, and the advantages and disadvantages each brings.
“The key question you have to ask yourself,” said Dennis Silvia, president of Cedar Consulting, “is whether I can do this on my own or do I need other people to come on board with me?”
The argument in favor of SPCs is a strong one. SPCs have consistently outperformed the commercial insurance market and the overall captive sector over the last few years, according to A.M. Best.
“This focus and discipline on writing coverage where the SPC is only responsible for its parent’s risk, and not mutualizing risks or paying losses for third parties, is another key factor in SPCs outperforming both A.M. Best’s commercial market composite and captive composite,” said the ratings agency.
Such has been the growth of SPCs that between 2010 and 2014, the surplus in U.S.-domiciled SPCs increased by 33 percent, to $9.2 billion, while the amount of dividends paid during that period was a staggering $1.9 billion, said A.M. Best.
An SPC is an attractive option for any company with a highly specialist or unique class of business that doesn’t fit into a group program, or one that doesn’t want to share risk or any of its private financial information with others.
“The type of companies that set up SPCs are typically Fortune 500 multinationals looking to expand their risk management function, who have a loss experience better than the market and/or want access to the reinsurance market,” said David Gibbons, PwC Bermuda’s captive insurance leader.
Advantages of an SPC
One of the key advantages of an SPC is flexibility, with the captive owner in full control of all operational aspects, including lines of coverage and limits, as well as choice of service providers and domicile.
And because there is no risk-sharing, the company has greater control of its risks and doesn’t have to pay someone else’s claims, as in a group situation.
On the flipside, the captive owner is 100 percent responsible for any losses.
“With an SPC you can create your own business plan to define how much risk and the coverage you are going to have, and change that on an annual basis, without the need for agreement with other parties,” said Chad Kunkel, captive services division executive vice president at Artex Risk Solutions.
“And because you are only insuring yourself, you don’t need to worry about any potential losses from sharing with other insureds that may arise in a group situation.”
Another benefit is that any surplus made can then be used to address the client’s immediate needs, such as increasing retentions, insuring new lines of coverage, or reducing future premium requirements.
Added to that, said PwC’s Gibbons, is the faster speed to market of an SPC than a group program because there is only one party making the decisions.
“Group captives, however, need to find other companies with a similar risk appetite and outlook to band together with, to agree on the level of risk they are going to put into the captive, as well as how they are going to share the profits and losses,” he said.
Group captives, on the other hand, appeal more to companies whose premium volumes are not big enough to warrant owning or operating their own SPC.
Similarly, they are likely to suit a company involved in a non-high-risk class of business or that is looking for pre-defined lines of coverage, such as workers’ compensation, general liability and auto liability.
While autonomy is central to SPCs, a key feature of a group captive is the pooling together of resources, enabling smaller to medium-sized companies to join together to share their risks, as well as profits and losses.
“Group captives tend to be formed by medium to small enterprises, like a car dealership, for example, that don’t have the economies of scale or the size of premiums or assets to be a meaningful player in the reinsurance market,” Gibbons said.
“To get that, they need to band together with other entities with similar risks in order to take advantage of the reinsurance market, to achieve lower costs on rates and to build up a big enough portfolio of assets.”
Peter Willitts, vice president of the Bermuda Captive Owners Association, said that because of its structure, it’s key that the guidelines of a group program are established at the outset.
“You have got to make sure that all parties are as committed to risk safety as you are and that they can live up to their financial obligations. Because the last thing you want is somebody to walk out on you after landing you with a big loss,” he said.
“Ultimately, everybody wants cheap insurance and to turn a profit, but at the same time you also need to hold back enough capital for the bad times.”
If you can find the right fit though, Artex’s Kunkel said, joining an established group captive has the advantage of being able to tap into the resources and expertise within that program, which are not necessarily available through an SPC.
“If you fit into the group captive model, long-term I would say it’s the best way to take advantage of the group purchasing, tax deductibility and risk management opportunities that it provides,” he said.
The Case for a Group Captive
Among the most attractive features of a group captive is the ability to spread costs among the various captive owners and thus reduce your own management and administration fees.
“Because all the members are like-minded individuals, everyone is pulling in the same direction — they want to control their losses and to do the right thing from a risk management perspective,” said Nick Hentges, whose company Captive Resources manages 31 group captives worth $1.7 billion in gross written premium.
Added to that, the capital requirements you have to put up are usually lower, Kunkel said.
“Your collateral requirements from an insurance carrier are typically lower in a group captive than they would be on your own because you are part of a group sharing some of that risk,” he said.
“Because all the members are like-minded individuals, everyone is pulling in the same direction — they want to control their losses and to do the right thing from a risk management perspective.” — Nick Hentges, president, Captive Resources
Because of the mass purchasing power of the program, reinsurance and services can also often be obtained at a fraction of the cost of doing so individually.
Group captives also offer ease of entry and a one-stop solution, they are structured to be tax efficient and often only require a nominal fee to join.
In addition, overall claims experience can be predicted with a higher degree of certainty than in an SPC, leading to improved loss forecasting, while there is an increased emphasis on loss control because of the risk-sharing element.
And with adequate capitalization, they allow members to retain higher levels of risk than they would otherwise be able to do on their own.
Disadvantages of groups
One of the biggest challenges of setting up or joining a group program is finding a group of companies with a similar risk appetite because they all have their own agendas, Gibbons said.
Those may include different retention and coverage needs, particularly if they operate in different areas of the country, are of varying sizes and have different ownership structures (publicly owned vs. privately held).
“When you enter into a group captive, you not only have to understand your own loss experience but also that of the other entities in that captive and how you mitigate against such exposure,” Gibbons said.
Sean Rider, managing director at Willis Global Captive Practice, said that in some cases companies don’t feel comfortable sharing other people’s risks.
“The first question I always ask a prospective client is, ‘Do you feel comfortable with taking on other people’s risks?’ ” he said.
“This is because you are entering into an environment where your contribution to the pot is exposed to other people’s activities and their contribution is exposed to yours.”
The distribution of underwriting profits and earnings can also be a bone of contention among members.
Being in a group captive also means it’s harder to change levels of retention and coverage than in an SPC because you have to get agreement from all parties, Kunkel said.
“The main challenges when setting up are data collection, making sure you have the critical mass and being able to take on any claims that may occur on an annual basis,” he said.
Hentges believes the relatively untapped resource of middle market companies means that the possibilities in the group captive space are almost limitless.
“We have about 3,400 clients right now, but we think there are somewhere between 20,000 to 25,000 middle market companies that we can go after, so there’s a tremendous amount of scope for the group concept, regardless of the overall market environment,” he said.