How forming a captive insurance company can help businesses control costs Featured

8:00pm EDT September 25, 2010

Consumer spending, the lifeblood of the retail industry, is depressed in today’s business climate. Job growth is anemic, and revenue projections are difficult, at best.

As a result, many retailers are seeking to control cost and increase revenue, and one way to achieve those goals is by creating a captive insurance company, says Len Churnetski, regional practice leader of Aon Risk Services’ retail division.

“Historically, companies purchased insurance and paid a premium,” Churnetski says. “Many insurance buyers have asked, ‘Was that a cost-efficient use of our capital? Should we have kept that risk for our own account?’ Instead of putting it on their books as an ongoing business expense, a company could have a formal captive insurance program underwrite that risk that it decided to keep for its own account.”

Smart Business spoke with Churnetski and Kevin J. Pastoor, managing director, Aon Risk Solutions, about how captive insurance companies can help retailers, as well as those in other industries, control costs.

What is a captive insurance company?

There are two types of captive insurance companies. The first one is a single-parent captive insurance company. This is a closely held insurance company that is owned by a single entity whose insurance business is primarily supplied and controlled by its owner. It exists primarily to underwrite the risk of its parent and its affiliated companies. That single-parent captive may or may not elect to underwrite the risks of its customers, suppliers, employees and/or unrelated entities.

The other type is a group captive insurance company, which is organized on the basis of multi-ownership or multi-insured in the captive, all different entities. They might have a similar risk, for example, they might be a homogenous group of companies, perhaps all in the same field, and they want to pool their risk together in the form of a captive insurance company to underwrite that particular risk within their group.

Why would a retailer want to form a captive insurance company?

Major retailers know they are going to have a lot of workers’ compensation claims, property claims and customer slip and falls on their premises. They realize that is a part of their cost and to a certain degree they should retain some of that risk for their own account and just pay those losses. In many cases, retailers keep some of that risk for their own account in the form of a deductible or self insurance, but they all purchase some type of insurance above that to protect them from catastrophic losses. A captive insurance company can be an excellent mechanism for keeping some of that risk below what is deemed catastrophic.

How can retailers determine if this is the right decision for them?

The biggest way is through the feasibility process. There is a soft insurance market right now, which means prices are depressed for the risk. Prices have been decreasing for the last five or six years, but as we’ve seen in the past, a hard market will arrive in the near future. Through the feasibility process, we look at the potential domicile (official residence) of a captive insurance company, the potential lines of business that may be written by this captive company, the amount of capital and surplus that would be required, and the local taxation and reporting requirements of the places you may consider.

Next, we look back at what has happened to you in the past. See how you used corporate capital to purchase insurance to hedge your risk. Do an as-if study: If you had a Captive Insurance Company (CIC) in place to write those risks — the ones you did keep for your own account or the ones you might have transferred to the professional insurance marketplace — see if it would have been a cost- and tax-efficient way to fund those risks in the past.

Then you will have a track record. You can say ‘Here’s what our results would have been if we had a captive insurance company.’ That’s the best test to see if it would benefit your organization. Then you can project that track record into the future.

What are some pitfalls to avoid when creating a captive insurance company?

Make certain you have everybody on board in your own organization who would potentially be weighing in on the decision process. Make them part of the due diligence team. That way, once you begin the process, you don’t find someone in your own organization obstructing forward progress because they weren’t involved in the decision process. The due diligence team can involve tax, finance and legal experts within your own organization. Get everyone on board to look at the issues with a team approach.

When analyzing this, it’s helpful to choose a partner who has the depth of experience to answer your questions such as, ‘What are the best domiciles for my company’s particular needs?’ and ‘Who has expertise on the captive creation side and experience putting some of these programs together for other retailers?’

What’s the next step?

Once you go through the feasibility process, you devise a plan of operations for the captive insurance company, depending on which domicile you determine to be the optimal choice. Then you select a staff to manage and administer the captive, including outside accountants and attorneys. In the domiciles that have enabling legislation for CICs, there has developed quite a large cottage industry of the professionals needed to manage these companies. Running a company can be done on a very cost-efficient basis. Once you’ve selected the people to help you manage the company, you obtain a license to operate in that domicile and make the necessary capital contributions required of the insurance company. Then, you may enter into a reinsurance agreement, in which your captive insurance company purchases insurance to protect itself.

Len Churnetski is regional practice leader, retail division, Aon Risk Solutions. Reach him at (212) 441-1401 or Kevin J. Pastoor is managing director, Aon Risk Solutions. Reach him at (248) 936-5346 or

The 2010 Aon Retail Symposium is scheduled for Oct. 19-21 in Chicago. The agenda will consist of a dynamic mix of clients, insurers and Aon presenters collaborating in breakout sessions, and retailer-only self-moderated discussion forums. For more information on this topic and the 2010 Aon Retail Symposium, please contact Len Churnetski at (212) 441-1401.