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Association Captives: Renewed Interest in an Old Concept

by John Prescott and Deborah Lambert, Johnson Lambert & Co.

Association captive insurance companies, providing property and liability coverages to association members, have existed since the 1960's. However, in the last ten years, market conditions have not encouraged new formations and some existing association captive programs were disbanded due to lack of demand for the service. The insurance market has changed and associations are experiencing a renewed interest in captive insurance from their memberships.

A captive insurance company is an insurance company owned by an association, its members or both. It is called a "captive" because only a limited population of entities, typically association members, are eligible to participate in the program. Each captive insurance company selects a domicile, a state or offshore country, that has enacted captive insurance laws and regulations. That domicile has primary regulatory jurisdiction over the captive insurance company.

There are various benefits to an association and its membership in forming a captive insurance company. Those benefits include-

• meeting member need for affordable insurance coverage or availability of coverages not otherwise provided by the commercial insurance market,
• source of revenue for the association,
• opportunity to increase association membership

However, the first of these benefits, meeting member needs, is imperative to a successful program. The other benefits alone will not sustain a successful captive insurance program.

During the 1990's the commercial property and casualty insurance market was characterized by intense competition for business among the commercial insurance carriers resulting in the availability of affordable insurance coverage and fairly broad coverage. The decade of the 1990's experienced what is referred to in the insurance industry as a "soft" market. Thus, most associations did not receive demand during that period from their memberships to help solve an insurance problem.

In the beginning of 2001, we began to see a change in the commercial insurance market; this change became dramatic following the September 11 attacks. In many cases, commercial insurance carriers are limiting terms of coverage, either by excluding certain coverages previously offered or by reducing policy limits. In some markets, commercial insurers have withdraw entirely. Additionally, the cost of most coverages has risen significantly. The result is that companies are working harder to find adequate property and casualty insurance coverage and are paying more for the same or less coverage than the entity has historically carried. This is referred to in the insurance industry as a "hard" market.

Members are now looking to their trade and professional associations for assistance in solving their insurance problem. Accordingly, many associations will be evaluating the feasibility of a captive program for the property and casualty risks of their members in the near future. While each potential captive program should be the subject of a unique feasibility study there are certain common characteristics of successful programs that provide benchmarks against which potential programs can be assessed. These benchmarks include the following-

• a need of members,
• critical mass of participation,
• source of initial capitalization,
• realistic loss projections and pricing,
• long-term commitment of participants,
• long-term commitment of association to captive program leadership.

The first of these factors, a need of members, was discussed above. The other benchmarks are discussed briefly below.

In order for an association captive insurance company to be successful it must be of a certain minimum size. Our experience has shown that a minimum gross annual premium volume of $7,000,000 is a good general rule of thumb. This premium volume will need to be supported by capitalization of the captive the amount of which will be dependent on premium volume, nature and amount of risk retained by the captive and laws of the captive domicile. Capital may be provided by the association or by the participants.

Realistic loss projections are necessary to determine program structure and pricing. Such projections need to include worst case scenarios as well as expected scenarios in order to make sure the program structure includes appropriate "safety valves" usually in the form of reinsurance. Our experience has shown that projections prepared during the analysis of captive feasibility are frequently overly optimistic. Accordingly, we recommend that a degree of conservatism be built into the feasibility study. It is better to be surprised by better than expected loss experience and financial results rather than the converse.

Finally, both the captive participants and the association need to be committed to the captive program for the long-term. A captive should not be viewed as a short-term solution to a current insurance crisis. We have found that many successful association captive programs have developed such loyalty through a combination of contractual financial commitments and through the inclusion of superior ancillary services beyond risk financing including risk management programs such as training, engineering studies and active loss mitigation strategies.

In conclusion, we expect to continue to see increased interest in association captive insurance programs for the foreseeable future. When formed for the right reasons captive insurance companies can provide a valuable service to members and at the same time provide an additional source of revenue and or new members for trade and professional associations.

This article is reprinted with permission of the Self Insurer Publishing Corp. and the Palmetto Insurance Journal