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Maximizing Shareholder Value - Page 2

clearest illustrations of this is by the providing of insurance to third parties. In this reference, we are not referring to competing in the general insurance market place but rather in areas such as warranty products. Let us review a few examples of the way in which this may work.

Scenario 1

As a manufacturer, you may sell or provide an option for customers to take an extended warranty with the actual product that they have purchased. This warranty product is actually provided by an unrelated party who pays a small commission to you as the introducer of the business. Loss ratios in this area are typically 50% to 60%. As manufacturer of the product, you have the best understanding of its design, the components involved and equally, its potential weaknesses. You have perhaps as much control of the warranty risk as you do over the fire risk of the factory in which the item is produced. The captive can be used to act in an insurance or reinsurance capacity in assuming the risk and realize the income and profit currently going to the unrelated third party.

Scenario 2

As a power utility, you provide electricity to residential customers. From time to time, both surges and power outages occur. Damage to electrical appliances may result or alternatively, there may be food spoilage. As in the previous example, a high degree of understanding exists concerning the risk, as does the ability to manage the risk. An insurance product can be designed and retailed to the residential customers with the captive acting as either the insurer or providing reinsurance capacity. This will serve as a new income stream and with appropriate underwriting and rate setting, will potentially provide much profitable business as well as enhancing customer loyalty. The latter may be particularly relevant as the utilities market continues to deregulate.

Scenario 3

Credit life products are offered by many financial institutions, department stores and retailing outlets. These products tend to provide low coverage amounts for death or permanent disability with rates being determined from mortality and morbidity tables. With the level of actuarial certainty that attaches to the use of such tables, loss ratios tend to be low with the insuring company being able to enjoy a significant level of profitable income. The captive can be actively used in a reinsurance capacity to assume the majority of the risk.

In addition, one of the important aspects of this scenario is that of eradicating bad debt provision and debt cancellation. By alleviating this, additional capital resources can be utilized as the need will no longer exist to ‘ring fence’ them for this purpose.

One of the points we have seen as risk advisors is that many companies have traditionally been unable to identify such opportunities. This has largely occurred because the various departments involved in the management and launch of such a product are not communicating in such a way as to realize the maximum value of the potential ideas. However, when one considers that each of these has the potential to introduce significant income, then the need to draw together these departments becomes even more apparent.

Each of these examples has the benefit of a significant amount of control being exercised over the risk or where this is not the case, reliable historical records exist upon which to base the risk assumption e.g. mortality tables. This is a very key area when risks are being considered for a captive and the way in which it may enhance shareholder value.

In addition, each of the above scenarios is also important to captive owners as they serve to introduce unrelated or third party business to the captive. This can have important tax implications for the parent company when looking to insure or reinsure there own risks into the captive and can significantly add to the pure financial value of the overall program.

As an insurance company, a captive can assist the long-term cash flow of the parent company in the settlement of claims. Rather then either leaving the risk as unfunded or purchasing an insurance contract from a third party, regular premiums can be paid to the captive for risks such as workers compensation and general liability. Given the long-term nature of the pay out patterns and often the size of the payment itself, the captive is able to smooth the payment pattern process and assist in the budgeting requirements of the operating divisions.

A captive can also be used in credit arrangements. Rather than being involved on a pure insurance transactional basis, the captive can be used to provide insurance to a banking partner that has purchased the receivables of the parent company. It may then be possible to enter into a securitization deal and maximize the potential benefits in this area. Such credit deals are receiving increasing attention.

As can be seen, a captive can significantly increase the potential for shareholder value if it is utilized in the correct manner. Identifying the correct purpose and structure of the captive are important elements in the overall analysis as is deciding upon the insurance programs. Ultimately, the captive has a great deal of flexibility with which to achieve its goals.

Jonathan Groves ACII, AIRM
Assistant Vice President
Marsh Management Services (Bermuda) Limited