VALUE OF THIRD-PARTY BUSINESS OVERLOOKED BY CAPTIVES: PANEL

TUCSON, Ariz.-Captive insurer owners have more options for writing third-party business than they may realize, and the coverage could do more than help them obtain a tax deduction for their own premiums.

The coverage also could generate profits while adding value to the captives' relationships with their parent companies' employees, suppliers and customers, according to a panel of captive owners speaking at the 24th Annual Captive Insurance Cos. Assn. conference, held in Tucson, Ariz., March 16-19.

Third-party business has become a hot topic to captive owners over the past two years. Like last year's Clinton administration budget proposal, this year's budget plan would require captives to write at least 50% of their business for third parties before their parent companies could take tax deductions on the premiums they pay the facilities for coverage. The current third-party business threshold to obtain favorable tax treatment is 30%.

The mention of third-party business can conjure images of past captive insolvencies that were triggered largely by someone else's losses.

But, captive owners should not picture all third-party business as a financial danger, according to panel moderator Ronald D. Ryan, president of group benefits broker Evergreen Benefits Inc. of Stamford, Conn. "It's unfortunate to paint all third-party business with the same brush."

Based on CSX Corp.'s experience, successful third-party business programs should have several common features, said Richard H. Hamilton, president and general manager of CSX Insurance Co., the Vermont captive for the Richmond, Va.-based surface transportation company:

"Most important to CSX and myself is that we have control of the exposures or the program terms," Mr. Hamilton said.

The captive's parent should have "good knowledge" of the underwriting issues and trends associated with the third-party business.

The outside business must offer a good profit opportunity for the captive.

The outside business must increase risk shifting and distribution and improve customer, contractor and community relationships.

Four main sources of third-party business have helped the CSX captive rack up a "seven-figure" profit over the past 10 years while also burnishing the company's image, according to Mr. Hamilton.

The captive has been reinsuring fronted coverage for contractors since 1988. One example is force account coverage, which is comparable to owners, landlord and tenants coverage. It protects contractors when they are working on, for example, CSX railroad tracks that cross a third party's property.

Since 1991, the captive has been participating in a group home and automobile insurance program with Metropolitan Property & Casualty Insurance Co. of Warwick, R.I. Metropolitan writes "discounted" homeowners coverage for CSX employees, and CSX Insurance reinsures a portion of this business on a quota-share basis.

In addition, in an effort to ease any tensions created when CSX began requiring employees to use personal vehicles for company business, the captive-again offering reinsurance support-and Metropolitan have teamed up to offer inexpensive auto coverage to CSX employees. The program covers about 700 vehicles, Mr. Hamilton said.

Another source of third-party business is reinsuring the fronted coverage of benefits for 5,000 international employees of a containership subsidiary.

CSX Insurance also participates in pooling arrangements with rail industry association captives, including Railroad Insurance Assn. Ltd. and Transportation & Railroads Assn. Co. Ltd., both of Bermuda.

A supplemental employee life insurance program has helped the Bermuda-based captive of Burlington Industries Inc. of Greensboro, N.C., generate a tremendous amount of third-party business, said Gerald McCabe, director of risk management for Burlington and a vp of its captive, Insuratex Ltd.

The textile, apparel and home furnishings manufacturer provides its employees with a free life insurance benefit that is equal to their annual salary.

Then, through an Insuratex program with Provident Life & Accident Insurance Co. of America of Chattanooga, Tenn., Burlington employees can purchase additional coverage of up to three times their annual salary.

Term and universal life plans are available, and employees can borrow up to 50% or $50,000, whichever is less, of their death benefit. Another attractive feature for employees is that the coverage is portable, Mr. McCabe said.

Insuratex writes a 50% quota-share reinsurance program for Provident.

As a result of the life insurance program, which has been profitable, the percentage of Burlington business in the captive has dropped to 51% from 100%, according to Mr. McCabe.

And, in January, Insuratex began participating in a new reinsurance pooling arrangement designed to generate significantly more third-party business for the pool's participating captives.

Seven companies-including Bur-lington, highly diversified FMR Corp. of Boston, electrical equipment manufacturer Hubbell Inc. of Orange, Calif., and Tyson Foods Inc. of Springdale, Ark.-participate in the Green Island Reinsurance Pool, which is managed by Johnson & Higgins (Bermuda) Ltd.

Under the arrangement, the captive participants cede the first $100,000 of their primary general liability, auto liability and workers compensation losses to the pool.

Pool losses are combined and then allocated to pool members. The allocation percentage equals the ratio of a captive's premium to all of the premiums paid into the pool.

A participant's pool losses are limited to two times the premium it has paid. Losses beyond that are kicked back to the pool participant that incurred them.

And, a "batch clause" protects participants from a sequence of related events by limiting the number of times those events could trigger coverage.

Each captive's premium, determined by Milliman & Robertson Inc. in Boston and paid in four installments, is equal to its parent company's expected losses during the one-year policy period.

The captives, though, do not have to commit any capital to the pooling arrangement, because it is not an entity.

Besides the third-party business the pool generates for its participants, the arrangement also is designed to reduce claims variability with minimal frictional costs.

The Certified Grocers of California, a grocers cooperative, also runs a captive insurer that writes third-party business. The captive, Springfield Insurance Co. of Covina, Calif., currently writes workers compensation coverage for co-op members, and it plans to begin writing more casualty coverage for members later this year, said Joe Ney, president of Grocers & Merchants Insurance Service in Covina.

Still, Mr. Ney sounded a note of caution to risk managers who are contemplating writing third-party business through their companies' captives.

He reeled off a list of potential sources of captive business: a captive's owners; related entities; related customers, like owners of a co-op; niches within your industry; and totally unrelated risks.

"The potential risk to your career goes up very fast as you go down that list," Mr. Ney said. "If you make a bad decision there, your involvement with third-party risk could be very short."