Crawl, Walk, Then Run: Adding Nontraditional Captive Insurance Coverages

While "set it and forget it" might be smart advice for a kitchen appliance, applying that mindset to a captive insurance company can limit its potential value. Too often, organizations that have wisely established a captive to address a specific risk fail to consider how it could also serve as a practical, cost-efficient tool for managing additional exposures.

Every organization's risk profile evolves over time, as does the insurance market. Additionally, well-structured and carefully managed captives can accumulate surplus. Leveraging the captive—and that surplus—to address other risk management objectives may help reduce overall insurance spend and free up cash for other priorities.

That's why we believe it's essential for captive owners and board members to regularly assess their entire risk portfolio and explore opportunities to incorporate additional risks. We do this through a comprehensive strategic review, using a framework we call the "crawl, walk, run" method. Like infants gaining confidence as they learn to move independently, this approach helps organizations take increasingly confident steps to expand the value of their captives.

The review focuses on aligning the captive strategy more precisely with the organization's overall objectives. It includes the following.

• Verifying that the structure and captive domicile remain optimal for the organization's needs
• Identifying changes that may affect the captive insurer's performance, such as regulatory developments or parent company changes
• Considering retention levels and alternatives, additional lines of coverage, what-if scenarios, domicile considerations, and market trends
• Interpreting and analyzing actuarial, financial, and other key data
• Assessing current vendors and supporting the request for proposal process when needed
• Evaluating risk areas where a captive could enhance protection, reduce the cost of risk, and improve profitability
• Reviewing the captive's effectiveness, surplus position, and opportunities for further utilization

Based on the analysis, we group opportunities for expanded captive utilization into three categories. "Crawl" opportunities are those recommended for the short term—typically 6 to 12 months. "Walk" opportunities are best suited for the next 2 to 3 years, while "run" opportunities focus on longer-term goals.

To build a data-driven, economically efficient 5-year captive strategy using the crawl, walk, run methodology, we focus on the following key questions.

• How much risk currently placed in the insurance markets can the organization safely retain?
• Are total insurance limits appropriate, and are current retention levels adequate?
• Does it make economic sense to assume additional risk, and which layers are best suited for captive placement?

Before identifying specific opportunities to expand captive utilization, we first assess what we refer to as the organization's financial capacity to bear risk. By analyzing captive data alongside the organization's financials, we can determine how much additional risk can be assumed without compromising the company's financial security.

Once we determine how much additional risk the organization can safely assume, we begin analyzing which risks are most economically efficient to retain or transfer into the captive. The first step is modeling the organization's potential for losses and volatility across each line of coverage.

Using historical claims data, exposure information, and industry benchmarks, we run thousands of simulations—varying frequency and severity—to estimate potential losses at different confidence levels. These levels represent the likelihood of different loss scenarios occurring within a given year. For example, we typically equate the mean to a 55 percent confidence level, reflecting the losses an organization can reasonably expect. A 99.9 percent confidence level, by contrast, represents a once-in-1,000-years scenario.

This analysis helps determine whether current insurance limits are appropriate or if the organization is over- or underinsured.

We use those same confidence levels to evaluate whether the organization's current retentions are appropriate or if alternative deductible options should be considered. Additional analyses using actuarial models allow us to simulate how retained risk changes at various retention levels and to calculate optimal pricing for each option. This enables us to identify which configurations present the greatest economic opportunity based on their impact on the total cost of risk.

To evaluate whether the program is appropriately priced, we analyze each insurance layer individually. This allows us to identify the most cost-effective ways to shift additional retention into the captive over the 5-year strategy horizon. In addition to premium rates, the analysis also considers the organization's return on premium investment.

Ultimately, this data-driven approach informs our recommendations for expanding captive utilization—bringing in additional coverages and services in a way that is both economically efficient and aligned with the organization's broader business and growth objectives.

The above information does not constitute advice. Always contact your insurance broker or trusted adviser for insurance-related questions.