Industry changes mean the right captive manager is even more critical

Single parent captives continue to be a viable risk management option, even though a pending court case may impose new rules for how they can be set up and run.

“There is a court case that is going to impact a segment of the captive industry, but it’s not the only segment,” says Robert Zedreck, area vice president at Arthur J. Gallagher & Co.

Whether case law or legislative changes, the reasons a company will set up a captive is never going to change — a desire to better control its risk by setting up its own insurance company that isn’t dependent on the market. But like many industries, single parent captives are always evolving, so it’s important to surround yourself with people who know the market.

Smart Business spoke with Zedreck about what’s going on with captives and how some companies are successfully using them.

What changes are you noticing in the captive space?

Fortune 500 companies have been using captive insurance companies for years, but that’s now pushing down to the middle market. Good captive candidates are now companies that have more than $30 million in annual revenue, 100-plus employees or an annual insurance spend of over $300,000.

Not only are captives managing traditional insurance risks, they also are being used to manage enterprise risks. This is any risk a business has on its balance sheet, from the deductibles it takes on its commercial or employee benefits insurance to risks that are uninsurable but have annual expenses, things like litigation, regulatory or legislative changes, accounts receivable or commercial policy exclusions.

There also has been more activity in the employee benefits space where prices are skyrocketing. In a captive arrangement, companies are able to either share risk with other top performers as it relates to their employee benefits programs, or set up a captive to smooth the volatility for years where they have more losses than expected.

Are captives the same as self-insurance?

Companies can be self-insured without having a captive. They just haven’t formalized the process and formed an insurance company. For example, if a business has a rainy day fund for balance sheet risk, a captive helps formalize that process, where the captive team helps identify and quantify those exposures. Again, it’s a licensed insurance company that increases credibility and covers a business for severity in an attempt to smooth earnings.

What are best practices for the most successful captives?

It starts with a feasibility study that holistically looks at your risk management program, in order to identify areas that can be better managed via a captive insurance company. The feasibility study helps determine which captive(s) are appropriate for your risk management goals, whether that means forming your own captive or joining an existing one. Your captive manager will work with you to develop a business plan for the formation and ongoing management of your captive.

It’s critical to have the right team to manage, audit and provide legal and tax opinions on your captive insurance company. The captive manager is the quarterback who coordinates these service providers and helps identify the appropriate risks.

Captives are a long-term approach that needs to be well thought out. You need to work with someone who is going to put a lot of time and effort into a feasibility study. You need to work with credible partners, from the manager to the captive actuary to those performing the legal and tax work and audit opinions.

Even with potential industry changes, this is a viable risk management tool. Many companies are still forming new captives; so if your company faces significant exposures, take some time to explore whether a captive insurance company is a better way to control that process.

Insights Insurance/Risk Management is brought to you by Arthur J. Gallagher & Co.