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Captive insurance companies now handling tough risks

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MIAMI—Companies and organizations are looking at their captive insurance structures to address difficult coverages and risks, such as rising medical costs for employee benefits and reputational risks.

Emerging uses of captives for such exposures were highlighted during the 21st annual World Captive Forum, held last week at the Doral Golf Resort & Spa in Miami.

Reputational risks have risen to the forefront after recent scandals at Pennsylvania State University, News Corp. and MF Global Holdings Ltd., among others, panelists said during a session on reputational risks. Several corporations are covering such exposures through their captives, panelists said.

Most reputational risk insurance in the marketplace provides crisis management services and does not indemnify loss of revenue tied to potential reputational damage, experts say.

Henry Good, previously a risk manager at Rohm & Haas Co., a unit of Dow Chemical Co., and now a principal at Global SIRC L.L.C. in Naples, Fla., said he knows of “several companies that have transferred (reputational risk exposures) to the captive.”

The advantage of a captive insurance company is that “you can do whatever you want—you can issue a policy from your captive for whatever you want,” Mr. Good said, noting that capping such coverage at the captive level might be necessary to limit the exposure.

The common denominator linking the companies and organizations was the perception that “nothing could go wrong,” said Jeffrey Triplette, past risk manager at Duke Energy Corp. and now a principal at Triplette Advisors L.L.C. in Oxford, Miss.

“They were all riding the crest very high. Then something happened,” Mr. Triplette said, noting that many variables—from regulatory violations to confidentiality agreements—might expose companies to reputational risks.

“It's all over the board, what might drive that disaster,” he said.

As companies consider writing reputational risks through their captives, there are some regulatory and tax issues to consider, said Bruce Wright, partner in the tax department of law firm Dewey & LeBoeuf L.L.P. in New York.

Quantifying and covering any financial loss resulting from reputational damage may affect tax deductions for premiums paid to the captive if the value is tied to a company's stock price, he said.

Also, moral hazard concerns may arise when trying to insure such exposures, Mr. Wright said.

Panelists weighed different funding mechanisms to write reputational risks through a captive, such as the use of catastrophe bonds and business interruption coverage.

“We don't have all the answers,” Mr. Good said, noting that risk managers need to identify, anticipate and prepare for events that may never happen.

Seating U.S. employee benefits programs within a captive was another innovative use of the captive structure to address rising medical costs, panelists said during a session on managing global medical risks.

Medical and prescription medication costs are rising due to early onset of chronic diseases, lifestyle-related issues such as an increasingly sedentary lifestyle, and the rise of chronic diseases, among others, Bill Fitzpatrick, vp of corporate risk benefits, insurance and risk management in London with Deutsche Post DHL, a unit of Germany-based Deutsche Post A.G., said during the session.

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DHL has had an employee benefits captive program for over 16 years, with e80.9 million ($106.9 million) of gross written premium written through the captive, which includes group life, group disability and group medical coverages.

In a strengths, weaknesses, opportunities and threats—or SWOT—analysis, DHL found that its opportunities and threats were related to employee health and wellness.

One of the advantages of running an employee benefits program through a captive is the collection of defined wellness data, which provides a wealth of information regarding medical claims and exposures, panelists said during the session.

Mr. Fitzpatrick said that DHL, which has 225,000 employees in more than 100 countries, collected the top five diagnoses per country and applied proactive measures to deal with particular exposures.

In line with its corporate strategy, controlling employee benefits costs makes DHL more competitive in the marketplace, Mr. Fitzpatrick said during the session, which was moderated by Kathleen Waslov, senior vp of captive consulting and multinational employee benefits in Boston for Willis Group Holdings P.L.C.

For companies looking to fund employee benefits through their captives to slow down rising medical costs, the process can smooth operations, diversify holdings by adding third-party business, and allow for plan flexibility that the insurance market cannot offer, said Peter Bandarenko, advanced markets sales director in Silver Spring, Md., with Prudential Insurance Co. of America, during a session on fronting and reinsurance.

“Clearly the potential of lower benefits costs is a motivator, along with frictional costs as well,” he said.

“Overarching all of this...is the ability to align corporate goals” by providing governance structure and bringing together the human resource, risk management and finance departments, Mr. Bandarenko said during the session, which was moderated by Mitchell Cole, director in Stamford, Conn., with Towers Watson & Co.

But for prospective captives looking to add employee benefits to their program, important considerations include the regulatory requirements by the Labor Department, a feasibility analysis by a third-party consultant and fees associated with A-rated fronting insurers, he said.

“It clearly continues to become an accepted practice, but not for everyone,” Mr. Bandarenko said, in terms of costs and organizational attitude.

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