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Hugh's Views from the SRS Symposium, May 2011
What the Industry Could Learn From Captives

Over the years I have had the occasion to point out how the larger commercial insurance systems and programs have followed the initiatives of captives. They were specific examples, such as wording of coverage by BICL, a banking group captive for professional liability, and the now-common XL liability language (XL started out as a group captive). The connection of underwriting, engineering, and reinsurance, originally spearheaded by the Factory Mutual system, was advanced much further by the Reiss Group’s interlinked programs. And the rating and progressive adjustments applied by captives have been copied by insurers, too.

At the SRS symposium I was able to revisit some of the more general lessons that captives -- if they are to be considered insurance companies -- have learned and applied  that could be learned by “the industry” if they chose to do so. That I use the conditional and implied future – they could learn from captives -- indicates they haven’t yet been bothered to do so.

The first lesson is Financial Measures that Matter (FMTM). Captive owners have long understood that return on capital, and shareholder value expressed in terms of constant positive bottom lines, are not the right FMTM. Captive owners consider their captives to be an adjunct to their self-insurance and risk financing strategies. They are only rarely measured in the same terms as operating subsidiaries or projects. Why this is so is simple to understand. “You want me to show a nice annual profit? A high return on capital? No problem – I’ll just charge everybody more premiums. I don’t really need that extra profit, but can generate it if you require it. Is that what you want?” No, it’s not.  The financial measure that matters is actually the overall improvement for the owners or businesses in the captive program – see my last point.

Captives are quick to react: When underwriting situations develop, or losses arise, or when the business is blocked by supply chain interruption, the captive’s managers can adjust rapidly, not waiting for the end of the policy year. Rates can be changed mid-term, insureds can be “corrected,” or their values reduced, and the claims that begin to surface can be addressed long before the commercial insurers would have been able to start asking for meaningful changes. The simple adjustment of accruals for premiums due, which can be changed from month to month as the risk or underwriting situation changes is what captives could do, and often practice.

And captive owners make a point of bringing together their insureds, encouraging communication of best practices, and sharing of problem-solving. This collegiality is a hallmark of captives, and often keeps them together when soft markets bring competition challenging their pricing.  It is the secret to insured loyalty, as a few large insureds have tried to emulate with their advisory boards and their client conclaves.  And it often results in specialized services being developed for captive members or insureds, services that arise from the sense of collegiality whose costs are rapidly perceived as much less than the value added.

The most obvious lesson is the characteristic of captive owners, managers, and everyone involved with them in claims at all levels. This is the real reason captives flourish in both good times and bad. At the SRS Symposium, example after example brought this out. 

This attention to the insured’s risks and underwriting situation, as well as the insistence on reducing and eliminating claims actually results in captive owners being able to demonstrate that their own business model has been enhanced by using their captives. I never tire of citing programs where the captive has allowed extension of trade credit risks, the underwriting of special guarantees, or the cooperation with client projects that have added to the owners’ top lines – before there is any mention of premiums or losses.

Of course readers all know the decades-old slogan that I have been using -- that Captive business is the best business. This still holds, and is the envy of the commercial insurers – even though the total captive business is less than 10% of worldwide insurance business. The fronting companies have a view of it, although they won’t openly admit it, and the reinsurers and Lloyds syndicates certainly have picked up on it.

Well, just like direct democracy working well in Switzerland and not so well in California, maybe it’s a question of size. Closely-controlled captives can run “better” than the big multiline multi-million dollar commercial insurers. This is as it should be for the specialized insurers that captives are.

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Hugh Rosenbaum, one of captive.com's friends and valued contributors, is a freelance consultant. Hugh can be reached by telephone at +4420 8883 6729 or by e-mail at hughro2@yahoo.com. Learn how you can spend a day with Hugh!

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