In a looming insurance rate crisis, captives offer a potential source of affordable insurance for motor carriers who often face the prospect of paying much higher premiums for any insurance at all. A captive is an insurance company that is formed for the specific purpose of insuring its owner, Ron Lawson, executive vice-president of Great West Risk Management, told the annual meeting of the Refrigerated Division of the Truckload Carriers Association. The meeting was held in Sonoma, California, July 11 to 13, 2001.
An insurance captive is not self-insurance, Lawson said. It is an insurance company with all the underwriting requirements found in other insurance firms. A captive assumes risk for its clients in return for specified premiums. Unlike self-insurance, the owner or owners of captives must pay premiums, he said.
Captive insurance companies must follow strict financial guidelines and have standards for membership. To qualify as a captive, the insurance company must have a board of directors, officers, and legal counsel, Lawson said. They must operate according to their own by-laws and be incorporated. Other requirements are investment advisors, banking relationships, and the ability to acquire reinsurance. A captive usually requires about $100,000 in start-up capital. Cash is not required for the entire sum; a letter of credit will usually suffice. To function as an insurance company, a captive must look, taste, and smell like any other insurance firm.
Insulation from Market Cycles
Motor carriers have been showing interest in captive insurance, because these firms provide some degree of insulation against the fluctuation of premium prices that result from insurance market cycles, Lawson said. In addition, captives can be set up to provide flexible program design and coverage for nontraditional exposure. Owning part of an insurance captive is attractive, because the captive not only provides a source of insurance, it also has the potential to realize a profit on its operation and to generate investment income, he said.
Insurance captives take several forms, Lawson said. For instance, a single owner captive insures only its owner; although, it can insure its owner's subsidiaries. Group captives can be owned by multiple, unrelated organizations. The owners of these joint venture captives share operating control. Association captives are similar to group captives in ownership, but they are formed to insure companies all in the same or similar industries. Captives can be formed within the insurance industry as well when one or more insurance brokers set up a captive to cover high quality risks. These agency captives provide control of the coverage to the owners, and they generate a profit.
Third party captives, known as rent-a-captives, also exist. These are licensed offshore organizations owned by third parties. Use of rent-a-captives is available for a fee. Evidence of ownership comes in the form of stock. An advantage of rent-a-captives is insurance availability without administrative and start-up costs, Lawson said.
The location of insurance captives is a matter of convenience and local laws, Lawson said. For instance, Bermuda is home to the largest number of captives with a population of nearly 1,100 companies. The Cayman Islands are the second largest captive domicile with more than 500. In the US, Vermont is home to more than 360 captives, Lawson said.
Look at Alternatives
Before a motor carrier or group of carriers jumps into captive operation, it should do a feasibility study to determine whether a captive is the best alternative, Lawson said. Comparisons should be made to conventional insurance, self-insurance, or other insurance with large deductible options. If a captive offers the best alternative, the owners must go through all the steps of setting up a company including by-laws and incorporation along with a board and officers.
A group of carriers can benefit from a captive, because it offers long-term control and reduced expenses, Lawson said. Captives also provide access to broader coverage than conventional insurance programs along with the ability to reach reinsurance markets. The owners benefit, because their premiums are an investment in the captive. In addition, owners can be involved in solving problems faced by the captive.
However, attractive as captives may be, things can go wrong, Lawson said. The company can experience a catastrophic loss or a large number of losses. A catastrophic loss hinders the captive's ability to acquire specific reinsurance while a large number of losses impacts aggregate reinsurance. In the worst case, the captive company may simply go broke, he said.
For motor carriers to make captive insurance work, they must be committed to long-term, stable risk transfer programs and accept that they will have to pay administrative expenses and losses, Lawson said. They must understand that profit and investment income come only in return for risk assumption. While the income from captives is attractive, the expenses associated with captives are usually no lower than those for traditional insurance. Insurance captives are a long-term solution, not a quick fix for insurance rates or availability. Profits come from performance, not up-front negotiations about rates. The key to success with an insurance captive is to believe the actuarial numbers, he said.
