Captives Can Be a Solid Risk Financing Play for Construction Companies

October 21, 2020 |

Like businesses in other industries, many construction industry companies can benefit from the captive insurance option, particularly in the current hardening market, according to one captive expert.

Speaking this week at the International Risk Management Institute, Inc. (IRMI), Construction Risk Virtual Conference (CRC), Anne Marie Towle, senior vice president—Global Captive Solutions at Hylant, outlined some of the benefits captive insurance solutions could offer construction industry businesses and explained some of the details of captives.

Among the captive concepts she highlighted in her presentation, titled "So You Want a Captive? Better Take a Seat," Ms. Towle emphasized the importance of a company understanding its risk appetite before moving into a captive. But, for those who understand how much risk they're willing to take on, the captive insurance approach can provide both insurance program and financial control, she said.

Risk tolerance is different for every organization, Ms. Towle said, and can be measured in a variety of ways, such as a percentage of retained earnings, EBITDA (earnings before interest, taxes, depreciation, and amortization), net cash flow, or unique industry or organization key performance indicators. How a business decides to calculate its risk tolerance is important as it moves toward developing a captive structure, she said.

"From a financial and strategic perspective, it's balancing that aspect of being comfortable with retaining risk and laying off that portion of the risk that's more catastrophic," Ms. Towle said.

A captive is essentially "a licensed regulated form of self-insurance. You utilize a captive to finance risk," Ms. Towle said. "If claims are not paid out, you have control of the underwriting profits." Those profits can be returned to the captive's parent company or can be used to take on additional risks.

In the current market, "a captive has the ability to step in and you can now retain more of the risk that you might be forced to retain in the wider commercial marketplace," Ms. Towle said. "We're seeing a lot of renewed interest in exploring a captive, joining a group captive." With a captive, companies with good loss experience can leverage that experience to their benefit, she said.

Ms. Towle noted that there are several types of captive options. Among them are group captives, in which like-minded businesses get together to share risk. In considering a group captive, a company should take into account the group size and its history, as well as the insurer associated with the group and the cost of doing business with the group, she said.

Another option is a single-parent captive, Ms. Towle said, noting that a single-parent captive is one established by an entity in a domicile and incorporated into the entity's risk management program. "The ability to take on the risk and have various programs in the captive is very beneficial to many organizations," Ms. Towle said. "These become extremely valuable tools as risk managers evaluate what is my total cost of risk."

A captive insurance company can be a very valuable tool in the construction industry for addressing third-party risks, Ms. Towle said. "Many of you in the construction industry have some of the typical construction risks," she said. "You have the ability to capture some of those controlled insurance programs and profitability."

For construction industry companies, insurance coverage in the captive could include workers compensation, owner-controlled insurance programs, contractor-controlled insurance programs, construction defect and rework, product warranty, general liability, property, cyber risk, and terrorism, Ms. Towle said.

"Employee benefits is another area, particularly related to the employee cost and the employer cost of medical benefits," she said.

The captive can bring several benefits to a construction company, Ms. Towle said. They include the following.

  • Control: "Having a captive concept allows you to design the program as you see fit," Ms. Towle said. The captive owner can set its own retentions for various coverages and purchase reinsurance if desired.
  • Capacity: Access to reinsurance can potentially provide the captive owner access to greater capacity than it might be able to obtain in the traditional market.
  • Cost: Owning a captive can provide the parent company added leverage in the traditional market. "Many organizations out there within the traditional insurance market really want to partner with organizations who are willing to retain their own risk," said Ms. Towle. In talking with captive owners, "this is the biggest aspect that many organizations focus on—having the control but being able to manage the true cost of risk," she said.
  • Coverage: "Being able to manuscript your own policy form is very important," Ms. Towle said. "Let's fill those gaps, let's be smart, let's set money aside so we'll be able to pay those claims if some adverse event does happen."

Ms. Towle said the ability to customize a captive for an organization's specific risk financing needs is particularly important. Once the captive is created, the parent company should make it a central component of any insurance buying decisions, she said.

It's also important that new captive owners are conservative in funding the captive and setting premiums, Ms. Towle said, to be sure there are adequate funds to pay any claims. Communication—both internally and with external partners—is also essential, she said. Captive owners should feel comfortable asking questions of external partners, she said.

In addition, "the captive needs to evolve and change just like your operations do," Ms. Towle said. If, for example, a construction company is looking to make acquisitions, it must align those activities with the captive insurance program because the acquisitions mean taking on more risk.

October 21, 2020