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Captive insurance strategy driven by company size

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SCOTTSDALE, Ariz.—Captive facilities meet a wide range of business needs, from helping domestic middle-market companies arrange otherwise unobtainable insurance protection to providing large global entities with greater control over their worldwide benefits risks.

But while captive insurance arrangements can benefit companies across all industries, middle-market and global firms generally differ in their business objectives for captive arrangements, speakers told the Captive Insurance Cos. Assn.'s 2012 International Conference, held March 11-13 in Scottsdale, Ariz.

“You would generally see a large global organization with a risk manager who is in charge of insurance transactions, (and) they are going to be focused on lowering their cost of risk,” said Justin C. Mead, senior vp in Chicago for R&Q Quest Management Services USA L.L.C.

“Whereas in a middle-market company...their focus is not generally cost containment,” Mr. Mead said. “It's either to transfer risk off the company's balance sheet or there are often wealth planning considerations” for the company owners.

Additionally, middle-market companies are often “looking to insure risks that are not presently covered rather than simply lowering the cost of risks that they are purchasing insurance for,” Mr. Mead said. Risks not covered can include those described in insurance policy exclusions.

Considerations for companies weighing captive arrangements include whether to use an onshore or offshore domicile, said Patrick J. Haddad, an attorney with Kerr Russell & Weber P.L.C. in Detroit.

Whether a state maintains legislation that facilitates certain business objectives and insurance regulations that favor forming an appropriate captive structure are key factors to assess when choosing a domestic domicile, Mr. Haddad said.

“From the insured's standpoint, factors to be assessed include capitalization requirements,” Mr. Haddad said. “Typically in the offshore jurisdictions, you will find more flexible capitalization requirements than you will in the onshore jurisdictions, although in appropriate circumstances the regulators are known to work with one relative to the dynamics of a particular situation.”

Captives can function as direct insurers, but most frequently they operate as reinsurers, meaning they reinsure policies provided by an admitted fronting insurer, Mr. Haddad said.

Results from a survey of 120 captive owners released at the CICA conference showed that 54% of the owners use fronting arrangements, while the remainder use their facilities only to write direct insurance policies.

Fronting arrangements may be required, for example, when insuring workers compensation benefits with a captive, because states typically require the coverage to be written by an admitted insurer unless an employer qualifies as a self-insurer, Mr. Haddad said.

Large, global corporations, meanwhile, may use captives to fund employee benefits such as private medical insurance that supplements public health care provided by countries around the globe, said Kathleen Waslov, senior vp for captive consulting and multinational employee benefits in Boston for Willis Group Holdings P.L.C.

“We say "private medical' because, except for the U.S., most other countries have social security systems that provide primary layers of medical financing for their citizens, and employers are coming in above that with supplemental medical, which is known as private medical” coverage, Ms. Waslov said.

Other benefits typically offered to employees around the world include death benefits, retiree plans, disability insurance, accidental death and dismemberment, business travel accident coverage and personal accident insurance, Ms. Waslov said.

“Typically these plans...are financed with insurance,” she said. “But like any other liability, you can finance them through different alternative risk methods, including captives.”

To consider financing employee benefit plan liabilities the way property/casualty liabilities have been financed, evaluate the exposures first, Ms. Waslov said.

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“Benefits departments don't always view their benefit plans as corporate liabilities, and they tend to buy insurance and not track claims trends, and maybe they don't understand really what the cost of risk is,” Ms. Waslov said. “These (benefit) plans do cover losses much like any other corporate liability. There is potential for significant cost, and you see your insurance premiums grow over time and, perhaps, not understand why. Because of that, they should be managed like any other liability.”

A big advantage to using a captive to finance benefit liabilities is gaining control of the assets or cash used to support the owner's liabilities, Ms. Waslov said.

Those assets can be consolidated with other captive assets.

“The larger that asset portfolio, the more leverage you have with investment management techniques and the more alternatives you have in the way you deploy those assets,” Ms. Waslov said.

Control of benefits data also is an advantage for spotting trends. Some global medical benefit captives are launched to recover underwriting margins that previously flowed to insurers, Ms. Waslov said. But “the real value from the benefit captive comes from control of the data, the consolidation, centralization and understanding of the claims data you are able to access.”

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