A mid-sized (over $1B in annual revenue) architecture, engineering, construction and consulting firm was utilizing an industry group captive to underwrite their workers’ compensation, general liability, automobile coverages and subcontractor default risks. The organization requested Spring to help assess whether the group captive solution was still optimal and to help shape their risk management strategy. As part of this review, we assisted them in considering the pros and cons of exiting the group captive program to form their own single parent captive. To support this decision, we helped them understand both the financial implications and qualitative factors they should contemplate and the implications of this change.
Spring began by undertaking a total cost of risk assessment at the line of business level for workers’ compensation, general liability, excess general liability, professional liability, subcontractor default, and medical stop-loss insurance lines. The purpose of the study was to explore the universe of options available to the client and included a high-level review of potential risk structures, retention levels, domicile options and reinsurance/fronting options. In addition, Spring commented on the competitiveness of the existing framework, generating a robust view of the advantages and disadvantages of the different solutions, and provided recommendations as to how best to move forward.
Spring implemented a multi-step approach that included the following:
- The Quantitative Analysis: Creating a total cost of risk comparison between the previous group captive and proposed single parent captive structures for each line to understand program cost savings. The key steps include:
- Analyzing loss and exposure data
- Developing expected claims at various retentions
- Defining operating cost assumptions (other than retained loss)
- Modeling captive company Proforma balance sheet and income statement
- Estimating captive capital requirements
- Obtaining brokerage quotes at the analyzed client retention levels to determine optimal retention level and the anticipated market savings that go with it
- The Qualitative Analysis: Evaluating non-financial factors such as risk distribution, domicile, regulations, administrative requirements and the positives and negatives for each captive solution. The key steps included:
- Evaluating the required structure to meet appropriate insurance tests, like risk shifting and risk distribution
- Evaluating differences between the home state and other potential domiciles
- Conducting a deep dive into the various service provider functions and requirements
- Completing a policy review to outline potential changes to coverage terms with a single parent captive
- Providing a pros and cons analysis for a single parent captive versus the current group captive structure. Some of the benefits of each are as follows:
- A single parent captive model allows additional flexibility in coverage option including medical stop-loss, more control over funding structure and selected services and risk control programs, and the ability to take full advantage of a favorable long-term loss profile
- The original group captive structure offers favorable pricing over commercial markets for certain lines in the near term due to large, self-insured retentions and economies of scale by mixing in the risk of other large insureds with similar risk profiles. It also allows access to certain safety management and other services (if desired)
- Reporting of Results: Preparing and presenting a report highlighting the financial and non-financial differences to enable the client to make a fully-informed decision to either move forward with implementation or stay with the existing captive.
- The Client Decision: After thorough fact finding, analysis and comparisons, and communication with the client, the decision was made to form a Vermont-based single parent captive. To move the process forward, we created an actuarial captive feasibility study, a captive business plan, policy forms and other documents to be submitted to the Vermont regulators. There was initial uncertainty over whether the client would still receive required risk distribution, as there was a change in the third-party risk profile with a single parent captive. However, the accounting and tax team concluded that the new entity, based on the selected coverage structure and underlying insured exposures, still qualifies for risk distribution and can be treated as an insurance company
- Next Steps: Spring began quarterbacking the client through the implementation process once they decided to form their Vermont single parent captive, which involved the following:
- Preparing an actuarial captive feasibility study and worked with the selected captive manager on the application material for submission to the Vermont department of insurance
- Assisting in the selection of service providers for the captive
- Providing ongoing actuarial and consulting services to the parent company and their captive to ensure that they are aware of all possible insurance solutions available and are informed in their insurance choices
In the current challenging market conditions, a captive solution is a powerful tool to have during renewal negotiations. Even if it isn’t implemented immediately, having the captive option available provides a competing solution to traditional carriers. Even for coverages not insured through the captive, the client will have increased bargaining power and may receive better offers from traditional insurers. Most importantly, moving from a group captive to a single parent captive has provided the organization the opportunity to use a captive solution to support other aspects of their business. For instance, by adding medical stop-loss to the captive, they will be able to generate additional savings for the HR teams, allowing increased support for employee wellbeing and resources to implement additional wellness initiatives.
In summary, the client chose the solution that provides them flexibility, over maintaining the status quo of their group captive, and enables the parent company a recoup of profits, particularly as it builds surplus over time, that would otherwise go to the group captive and excess carriers. As the captive matures, the client is also expected to receive captive profits back as dividends and be able to further increase self-insured retentions. We will continue to provide insurance consulting (both captive-related and beyond) to the parent company and lead them through the initial year of single parent captive strategies.
The Current State of ‘Employer vs. Insurance RFPs
Employers today often find themselves undertaking a Request for Proposal (RFP). RFPs are an important tool that allow for greater insight into the market. RFPs are used as a mechanism by employers to test the market competitiveness of their insurance programs and collect market intelligence regarding new offerings. The bidding process aids accountability and provides market information on emerging risk management techniques, regulatory changes and recent trends. However, RFPs are a time consuming and an arduous task that require inputs from multiple stakeholders, who often have competing priorities.
Captive insurance companies provide an alternate solution for employers who are looking to escape the rut of undertaking an RFP every few years. Captives provide greater transparency and control to employers over their insurance programs and eliminate the often costly and time-consuming need to bid programs to ensure competitiveness. Captives allow organizations to have a clear understanding of their experience and thereby eliminate the arbitrariness of rate hikes by the incumbent carriers. An RFP can also be an expensive exercise both in terms of tangible and intangible resources. In monetary terms, there are the fees for advisors/brokers/consultants. Additionally, time and effort required by your team are also important factors to consider while evaluating the true cost of an RFP.
A bidding exercise is often seen as an opportunity to hit reset on an existing plan and evaluate if the program continues to meet the everchanging needs of an organization. In a dynamic and ever-changing business environment, waiting for an opportunity to bid the program to reevaluate its effectiveness and appropriateness for the organization can result in repairable loss. Businesses need to be able to constantly evolve and change to meet the needs of the market or risk losing its competitive edge.
Captives provide a clear line of sight to the working of the program, thereby allowing for customization in an almost real time basis. A captive framework leads to additional reports and information which further facilitate tweaks and adjustments that benefit an organizations insurance program.
A captive insurance company allows a company to gain true transparency and control of not only their loss exposure, but also the expense structure required to support their programs. This transparency promotes a sense of partnership between the employer and the insurance carrier. Employers with captives have often commented on the change in the relationship dynamic between the two entities, viewing the carrier as a partner than as a market option can have long term benefits.
Organizations that use captives are able to ascertain the need for a change or adjustment in rates without input from the market. Captives rid insurance transactions of opaqueness and thereby results in an open and honest conversations among all stakeholders – insurance carriers, brokers and internal organizational stakeholders.
An integral part of most insurance arrangements is the broker. Broker arrangements can, at times, create a degree of obscurity. Since brokers are usually commissions-based, decreasing premiums or making changes may sometimes not be in the broker’s best interest. This could potentially add another degree of complication and difficulty to the decision-making process. In a captive setting commissions paid to brokers are clearly visible. This clarity of fees generally leads to a clearly defined scope of work for the broker/consultant/advisor. Allowing employers to derive more value from their service providers.
Many organizations may feel pressure compelled to bid frequently, to continually create competitive pressures and achieve better rates. This approach can create an abrasive relationship between the organization, the broker and the insurance carriers. Insurance carriers are looking for long term partners and often may choose to not bid aggressively in cases involving organizations who have a reputation of constantly looking to bid, as this can be disruptive for all parties involved.
Spring recently undertook an analysis for an organization whose incumbent broker initially quoted a 25% rate increase on the employee benefit program. When threatened with the possibility of an RFP, the incumbent carrier revised their quote to reflect a 10% increase in premium. The organization was disillusioned with the insurance carrier and decided to undertake an RFP – which resulted in an alternate carrier quoting a net decrease in premiums of about 15% along with a multi-year rate guarantee.
While a 15% rate reduction is a seemingly positive result, the process and effort required to get there was expensive, time consuming and left the HR team feeling beholden to the wishes of the insurance carriers and the broker.
The employer requested Spring undertake an independent review of the information presented to them by their broker and insurance carriers. Spring’s analysis revealed that the organization had a much better loss experience than indicated in the rates provided. The organization is currently considering its options for the upcoming year, including potentially utilizing a captive to underwrite their employee benefit risks .This exercise could have been avoided if the employer was using a captive to insure its risks. At the time of the initial rate increase (of 10%)the employer along with their broker would have been able to quickly ascertain that the rate hike was unnecessary and could have been addressed with a quick discussion with the insurance carrier. Which could have saved the organization valuable time, effort and cost of disruption.
To conclude, companies that are financially sound and have a reasonably predictable insurance risk, are ideal candidates to evaluate the possibility of using a captive. If you are an employer looking for a long-term solutions should consider a captive. Captives provide the benefits of an RFP without disrupting a company’s day to day activities. It also helps bridge the gap of obscurity and trust between your company and your insurance carriers.
To see if a captive solution is right for your company, a captive feasibility study is the logical first step. The study identifies the organization’s goals and objectives, reviews the current state of programs, analyzes the data, and then estimates potential captive savings for each line of coverage. The study determines the most effective program design for the organization, including potential advantages or disadvantages of this alternate funding mechanism.