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Captives used creatively help realize broader goals

Captives used creatively help realize broader goals

NEW YORK—More and more U.S.-based firms are discovering their captive insurance company's potential beyond providing a viable alternative means of transferring risk.

Through innovative program structuring, newly developed risk management tools, and cooperation among C-suite executives and managers, many companies are not only able to self-finance numerous liability exposures, they also can use elements of their captive programs to address strategic goals such as customer retention, global expansion and profit generation.

“Captive owners can get very creative, and—it being the alternative risk financing market—you expect them to get very creative,” said David Provost, deputy commissioner in the captive insurance division of the Vermont Department of Banking, Insurance, Securities and Health Care Administration.

He was speaking as part of a panel of captives experts at the Business Insurance Risk Management Summit® in New York.

For example, the practice of electronics makers and other manufacturers using captive programs to insure extended warranty offers is nothing new.

“What is new is the pace at which technology is changing,” said Bruce Abrams, the New York-based director of Chartis Inc.'s international risk management group.

By coupling low-cost product upgrade offers and extended warranties, companies are using that high rate of product turnover in concert with their captive-backed programs to drive greater customer retention.

“They're assessing, from an actuarial standpoint, the proportion of the products that are going to be returned to them, and they're using a captive to remove the volatility,” Mr. Abrams said. “It has the impact of binding the customer to that client, and that's something that CFOs really treasure.”

In order to capitalize on what they called the “advanced benefits” of captive insurance programs, experts said companies should be acutely aware of the financial, cultural and regulatory demands associated with setting up a captive insurance subsidiary.

Most captive domiciles tend to be fairly lenient in their review of new or augmented risk management strategies, experts said. Above all, parent firms seeking to open their own captive insurance company must be able to demonstrate the financial and cultural commitment necessary to sustain an underwriting subsidiary.

In Vermont, Mr. Provost said the state will sometimes revise its statutory framework in cases where a company's proposal for a captive insurance risk transfer plan doesn't meet regulatory requirements.

However, he said, a domicile also must consider its own reputational risk and the wishes of its other captive owners, Mr. Provost said. “What we don't want to do is lower our standards.”


Captive insurance proposals also will need to pass muster with certain federal regulatory agencies, in particular the Internal Revenue Service. Charles J. Lavelle, a partner and federal tax attorney with Bingham Greenebaum Doll L.L.P., said captive programs offer the potential for significant tax savings, but only if they meet a series of IRS requirements (see box).

One key requirement with which Mr. Lavelle said prospective captive owners could struggle is the IRS' rule on demonstrable risk distribution. The agency requires that the total captive premium be shared among several insured entities. Those entities can include parent-owned operating subsidiaries or third-party insured companies, Mr. Lavelle said.

“You don't actually need any unrelated business to participate in the captive,” Mr. Lavelle said. “As long as you've got an insurance subsidiary and enough operating subsidiaries that don't own any stock in the insurer, then you don't need any outside entities sharing the risk.”

Captive owners don't have to use complex structures to make better use of their captives, said William Motherway, executive vp at Tishman Construction Corp. Using a captive conventionally but aggressively, can achieve significant results, he said.

Tishman uses its captive, Vermont-domiciled TRIMCO Insurance Co., to cover terrorism property exposures as well as a wide range of liability risks. The captive produces $2 million to $3 million in annual net proceeds for its parent.

More than anything, Mr. Motherway said, Tishman's success with its captive programs is owed to its culture of self-reliance.

Through TRIMCO, Tishman internalized several operations that otherwise might have required a third-party administrator or consultant for the construction and hotel/real estate companies, including safety management, actuarial and regulatory review, selection of legal counsel and claims management, he said.

Having those capabilities in-house lowers the aggregate cost of managing risk and provides services that are tailored to Tishman's operational standards and priorities, Mr. Motherway said.

“We think that by doing it that way, it's going to get done right,” he said.