There are alternatives to the spiralling costs of traditional insurance, but too few companies realise it. In the right circumstances, a captive can provide a tailored, flexible and more sustainable option that could also result in considerable savings.
Captives are suited to a wide range of companies and not, according to a common perception, just the very largest. For those firms that take risk management seriously and are prepared to meet set-up costs and compliance implications, the self-insurance route can be a highly attractive one.
Most UK companies, however, continue to buy their insurance from external insurers, with their broker attempting to find appropriate and keenly-priced cover – this is easier said than done.
Soaring inflation, the legacy from Covid and the war in Ukraine have all had an impact and the insurance hard market shows no signs of dissipating. Many insurers have tightened up on their policy wordings, with some withdrawing from sectors where losses are deemed too high. The end result is paying more for insurance that is increasingly restrictive, making it harder to claim, and often leaves companies retaining large deductibles in any case. This can be particularly severe in areas like business interruption, professional indemnity and cyber liability.
Captives – what are the benefits?
A captive exists to provide insurance and pay claims – but it is there for the company, rather than taking a pooled approach. If your business is well-run and has an embedded approach to risk management, claims will be controlled and a captive can then produce a surplus (reflecting the quality of your risk compared to the mean) and so over time take on more risk on favourable terms.
Although it requires capitalisation and there are compliance concerns to consider, a captive is not just for the largest organisations. There are a number of variants that are suited to smaller businesses. This includes the protected cell captive, also known as the ‘rent-a-captive’ where groups of companies self-insure and are segregated, but costs are reduced through sharing services provided by an umbrella management organisation.
In the event of a serious incident, companies remain protected from uncontrolled claims costs, because reinsurance is in place. As such, claims paid by the captive are met up to an agreed limit and beyond this by the reinsurer. Captives can also assist with managing larger retentions on classes where during the hard market deductibles may have increased.
At Mactavish, we are well aware that the needs of each company are unique and this needs to be reflected in any captive they set up. There is flexibility – a company may, for example, choose to use a captive for its most challenging risks, such as cyber. If there is affordable insurance available in the traditional market, then this can be purchased to provide protection alongside the captive. If the captive model is seen to work, then the business may seek to transfer more risk.
One key benefit from a captive is that they can encourage far higher standards of risk management, because there is a vested interest in trying to keep claims levels low. Your company has ‘skin in the game’, and if a captive performs well, this should also lead to more favourable reinsurance premiums.
Businesses with a proven track record in managing their risks will be the most suitable candidate to set up a captive and for those new to this option, expert advice should be taken, with guidance on the right captive structure, how to set it up to meet regulatory requirements and on the right reinsurance.
Experience has shown that for many firms, using a captive works in their favour; they have less volatility and the total costs of risk can be much lower than with external insurance, which can help with cashflow.
A considered choice
There needs to be deep knowledge of the risks faced to determine what type of captive is suitable for your needs and what it can cover. A captive does need any business to take ‘ownership’ of its exposures to ensure there is a strong culture of risk management. There needs to be strong governance and like the external market, a captive is also subject to regulation – for example tax authorities may want to ensure it operates a “real” insurer rather than just an internal fund.
That said, businesses can choose what risks to cover and these may typically be those that are harder to place in the mainstream market. As the captive becomes established, companies also benefit from greater understanding of their risk profile, gathering claims data and that can be invaluable for the future. A captive also eliminates much of the uncertainty that can occur when there is a claim, and can ensure that competent managers deal with these in line with agreed principles rather than face ambiguity and an adversarial approach.
With the right attitude and an engaged company board, captives are an effective long-term solution to managing insurance costs and it is no wonder that captive take-up is increasing. So, could one work for your company? Contact us to find out more.
Hard market report 2023
The insurance market is currently going through the longest ‘hard’ phase in history, with prices spiking, cover being withdrawn and dispute rates soaring.
In this report, you will understand the market conditions and main challenges, the role of brokers in helping businesses navigate the hard market and get best practice advice to tackle a hard market.
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