Archive for March, 2008

Ibi est Vox in Sermo

March 31, 2008

In conversation there is power. 

I want to thank everyone who visited the weblog in our inaugural week last week.  The emails and comments were very encouraging  and have convinced me that I need to continue posting about the fundamentals of captive insurance programs. 

Let me invite you to offer your own opinions, questions and additional thoughts to the postings.  I think the current insurance market is reaching rock bottom and now is the time to begin thinking strategically about how captive insurance initiatives can be utilized to the advantage of good risks in a developing hard market environment.  It is this type of collaborative effort that I want to strive for on this blog.

You can reach me by email at Our web-page is and our Bermuda captive management sister company, Cedar Management Limited, has a website at

I look forward to your continued interest. 


Supply and Demand- It’s Impact on Insurance Pricing

March 31, 2008


 Insurance is a supply and demand type of product.  In order to provide insurance coverage the insurance company has to pledge assets to support the losses on that insurance.  Depending on where the insurance company is domiciled there are different standards for how much surplus has to be leveraged to support insurance premiums.  Most US traditional insurers leverage their surplus between 1:1 and 2:1, premiums to surplus.  The limiting factor for overall insurance capacity then is how much surplus is available.  Surplus is contributed to insurance companies by investors, for the large part shareholders of the publicly traded stock insurers.  Shareholders are drawn to a particular investment because there is a good chance of earning a significant return from the investment.  Insurance companies connect these dots and then make decisions on which insurance segments they will deploy their surplus into in order to get the best return on investment.

All this works well for market segments that exhibit stable and profitable results overall.  But what if you are a good player in an otherwise iffy market segment?  In a soft market the differences between good and iffy are not as distinguishable, but in a hard market, where premiums are rising as a result of external pressures, insurers have to start making tough capital deployment decisions.  Remember they can only write insurance premium in an acceptable ratio to their surplus.  Markets that are iffy get the short end of the allocation stick and as a result the reduced capacity for that market makes the prices jump dramatically for that segment.  Think trucking, medical malpractice, tough workers compensation exposures, residential home-builders, product’s liability, coastal property, etc….Remember that we are not talking about all risk in these industries.  Let’s face it some accounts deserve the pricing they get, but there are accounts that represent excellent risk characteristics in every market, regardless of what that market’s averages are, and these are the prime targets for captive insurance involvement.

A captive insurance arrangement in essence creates capacity for its owner-insureds and it often does so in a regulatory environment that supports premium to surplus ratios that far exceed that of traditional insurance companies.  These leverage ratios can be as high as 5:1, making for a very efficient use of corporate capital to support risk transfer needs.

By further connecting underlying captive insurance capacity with reinsurance placements a significant amount of capacity can be created in a market segment that might not have had any reasonably priced capacity available at all.  The best accounts in a market segment can leverage their own investment in loss control and risk management in order to take control of their risk financing costs even in the hardest part of the insurance market cycle.

Riding the Roller Coaster

March 27, 2008

So, how is insurance like a roller coaster?

Coming back to the office from a visit with a client today I drove by Geauga Lake Amusement Park.  Living and working in close proximity of a noisy venue like this one has had its ups and downs (no pun intended).  The park is full of history.  In 1887 it was a popular picnic and fishing spot accessible by trolley from Cleveland.  The old rail station stood on Depot Road around the corner from the office until just a few years ago when it was demolished.  In 1925 the park boasted the largest wooden roller coaster in the world.  In 1927 Johnny Weissmuller (Tarzan) broke the 220 yd world freestyle swimming record in the newly opened Olympic swimming pool.  In the 30’s a dance hall was added where big bands like Guy Lombardo regularly entertained pre-war crowds.  The park closed at the end of last summer and the rides are being sold off and the grounds and the lake are on the auction block.  Not a very glamorous end for an historic landmark.

So what does all this have to do with captives?  The traditional insurance market is subject to pricing cycles.  We are currently experiencing the bottom of the soft market, but any insurance professional who has been around longer than 10 years knows that the hard market is coming.  Insurance buyers might say that the soft markets are good and hard markets are bad, but I would like to suggest that any deviation from the average makes for a difficult environment to plan strategically and manage a business.

Market pricing swings are like the roller coasters at amusement parks (I told you I would make a connection!).  Exciting for some, bearable for others, and if you’re like me they are enough to lose your lunch over.  Who needs that kind of excitement when it comes to running a business?

Traditional insurance cycles are deep because for the most part insurance companies don’t learn from the past.  They chase market prices down hoping to accumulate market share efficiencies and offset undewriting loss with investment income.  The investment market goes south and all of a sudden they are bleeding cash.  These conditions are sometimes compounded by some type of catastrophic loss scenario that really catches them by surprise.  (911, Katrina/Rita/Wilma)  The reaction is to knee jerk prices and we start the upward trend of hard market pricing.

Why is a captive a different situation?  The largest single component for insurance pricing, about 60% of the total depending on retention, is the loss funding element.  The loss funding is determined by considering the account’s specific loss history for the past five years or so and applying standard trending and development factors.  The remaining costs are for administrative services and there is little variability in them other than for wage inflation.  Notice that we haven’t said anything about competitive market pressures yet!  If you read yesterday’s post you know that above average risks are best suited for a captive mechanism.  Their loss history already affords a “discount” price so without compromising loss funding we have a competitive product that is prepared to pay losses at the historic levels.  Thus we end up with a very stable pricing platform that may have dips and curves but more like the ones in kiddy land than the ones on the Big Dipper.  If the account happens to have a bad year it’s impact is mitigated by the other 4 years in the loss analysis.

Wait a minute you say!  Doesn’t a captive have to buy reinsurance, and isn’t reinsurance subject to the wild gyrations of the rest of the insurance market?  Well, yes.  But lets look at the math.  Let’s assume a $1M liability limit and the captive retains the first $250K per occurrence.  Depending on the line of business the reinsurance cost for $750 XS $250 might be 15% of premium.  A 50% increase in a 15% line item only changes the overall pricing by a factor of 7.5%.   Even a 50% increase is pretty unrealistic since this is a reinsurer that you have a longstanding relationship with and who has probably done very well on your risk.

While the market lows may not be as low as the traditional market, the highs won’t be either.  The pricing swings are modulated and through a captive you can offer your clients a much more predictable environment to run their business in.

Do That Voodoo That You Do So Well

March 26, 2008

There are many reasons why an insured might consider being involved in a captive insurance program.  Over the next few days I’ll try to unpack those reasons in a way that makes sense.  Today I want to address the potential premium advantages of a captive.

I think one of the most frustrating things about captive insurance is that it is so misunderstood.  There is a sense of smoke and mirror magic about how a captive might solve the risk financing ills of an insured and often captives come out of the agent’s bag of tricks as a means of reducing premium for loss-distressed clients.  Let’s try to debunk some of the mystery around who should be involved in these kinds of insurance programs in today’s post.

In any insurance product offering, captive or traditional, there are several elements to cost that are standard.  There is a cost associated with paying claimants for loss and the costs associated with adjusting those claims.  There is a cost to the administrative work associated with the underwriting and issuance of policies and to the maintenance of compliance and regulatory issues associated with licensing in the various states.  There are premium taxes, boards, bureaus and assigned risk charges levied on the policy’s premiums.  While the litany of frictional costs on an insurance program are standard, the percentage that each of these items consume is relative.

Assuming that a traditional insurer has made his frictional cost as efficient as possible the one cost that has a sense of uncertainty is the costs associated with the payment to claimants for damages they sustain through the fault of insureds.  Actuarial work is either Voodoo or science depending on who you talk to, but it is an insurer’s best method for determining the correct price to charge for the loss cost element of a policy.  Actuaries pour over loss data and determine statistically, based on a specific set of circumstances, what the correct costs per exposure unit should be for risk in a particular market.  The “Theory of Large Numbers” is the basis of actuarial accuracy.  It says that the more data you pour into the analysis the more accurate the results will be for the insurance company taking risk on those results.  Herein lies the good news for captive insurance!


The Dart Board Theory

If insurance companies price their products based on pooling a large database of losses in a particular industry then their pricing is an “average” for that industry.  If you are an average risk then you are paying the right amount of premium based on the risk you present.  If you are below average then you are getting a deal and if you are above average, you are paying more than you should be.  Obviously insurance companies mitigate this inequity by offering credits and debits off of the standard price for accounts with certain attributes.  These adjustments are most prevalent when there is a lot of competitive pressure either because of a soft insurance market or a lot of demand on the part of insurance companies for the type of risk being considered.    If your client is in a market segment that is not highly sought after by insurance companies they can often be left behind in the pricing rush.

Back to our dartboard.  Imagine a horizontal line across the center of the board.  Any darts above the line are above average and any darts below the line below average.  The problem here is that the pricing for all the darts is essentially the same within +/- 20%.  The over-pricing for the really good accounts is being used to offset the under-pricing for the not-so-good accounts.  From the insurance company’s perspective the result is good, on average just what they expected, and the actuarial staff will probably get a great bonus.  The insured’s perspective depends on where they fall on the dartboard.  Poor risk management is rewarded and good risk management is punished.

So, what have learned about the best clients for a captive program?  They are the ones that are consistently good performers, above average from a risk management perspective and typically involved in activity that the insurance market does not actively compete for.  Think trucking, medical malpractice, residential construction etc…. Now, here is where agents get it wrong.  Not ALL companies in these industries should be involved in alternative risk structures, only those who have earned their chops from a risk management perspective.  Certainly no client with a history of poor loss control and risk management results should consider an alternative risk structure until they have fixed their problems and seen positive result trends.

By assuming risk where there is a relatively high frequency of low severity loss potential a good risk is able to leverage their investment in risk management and loss control to reduce the cost of risk financing by a factor equal to the amount that they are better than the industry average price.

The Battle of Frog Pond

March 25, 2008



When I was in grade school my father was transferred to eastern Connecticut from Texas.  Besides all the normal “new kid” on the block stuff, I also had to deal with my Texas y’all standing out against the background of “pawkin the caw”.  I had heard some pretty tall tales while living in Texas, but I was quickly indoctrinated to Yankee humor when I was told the story of the Battle of Frog Pond.  Bear with me, this actually has an insurance lesson in the story…….

The summer leading up to the fateful night in June of 1754 had been filled with terrifying stories of the French and Indian War.  Stories of atrocities committed by both sides in the battle and then reprisals by the other spread like a disease carried by the travelers on the Boston Post Road that passed through Windham Center.  The settlements in eastern Connecticut were pretty spread out and essentially stood alone from a defense perspective.   A local attorney, Col. Eliphalet Dyer, had just raised a militia to join General Putnam in fighting the French and Indians at Crown Point, leaving Windham Center defended mostly by old farmers and shopkeepers.

In the early hours on that fateful day in June the townsfolk were awakened by a unholy noise coming from just over the eastern ridge of the town.  Some literally ran into the streets naked and fell to the faces in the town square praying for forgiveness because they thought it was surely the end of the world.  Others gathered muskets and powder and made their way in the moonless night to the ridge east of the square, ready to defend the town against the onslaught of whatever the dawn would reveal.  Lining the ridge the makeshift militia prepared for battle in the pitch blackness of the early morning.  In town lanterns burned while women tore strips of cloth for bandages and boiled water for wound dressing, all along praying that if the end came for them and their children at the hands of savages that it would come quickly.

As the morning sun began to rise over the Connecticut foothills to the east all attention was focused to the sloping ground that led to Col Dyers farm, but instead of seeing hordes of savages ready to attack, the defenders of Windham Center witnessed instead the carnage of thousands of bullfrogs.  Their carcasses lied belly up in the mud that surrounded the place where the pond and stream had been at the bottom of the hill.  As it turns out, a draught had been effecting the area for some weeks, but with the flurry of activity surrounding the militia muster and the absence of Dye from his farm, no one noticed that the pond was slowly drying up.  On that night something snapped in the frog community as they battled for the last bit of water and that was the sound that the townsfolk heard.  Not ones to be cheated from a good victory, the locals decided to call it the Battle of Frog Pond and to this day a monument stands at the side of Rt 14 as it passes by Frog Pond commemorating the battle.  In fact the Windham County symbol is the frog and the sheriff’s patrol cars are adorned with a giant bullfrog symbol.  The picture above shows one of the frog statues that guard the entrance to the bridge over the river that passes through the county’s seat of Willimantic.

Now, where is the insurance lesson in all this?  You can take pride in your preparation to fight the battle even though you may not be called on to fire your musket.  Understanding about captive insurance initiatives and their proper application to particular insurance needs may be more than half the battle won when trying to protect your book of business from being poached by the big global agencies.   The water is drying up in the insurance pond and agencies, like the frogs in our story, are fighting over the remaining client base.  Agency education is key to anticipating the need for a sophisticated captive insurance program and offering that option to your clients long before someone rides in and offers that service to your client first.

Cedar can help you evaluate your clients potential for alternative risk financing.  When we work with agents we never try to replace the agent in his relationship with the client.  We consider ourselves to be adjuncts and work to serve the client on your behalf.  Let me suggest that you check out our website for more information or send us an email if you would like to discuss a particular client’s situation.

You can reach me at

Hello world!

March 24, 2008

 Having sampled the blog scene across the Internet I really didn’t find much that had to do with Captive Insurance or alternative risk transfer topics.  I don’t really thing that is too surprising.   We are, after all, talking about insurance and this isn’t something the general public gets too excited about until they have to write a check for their own coverage.  Nothing sends folks scurrying away at a cocktail party like telling them you work in offshore insurance.  

What I am hoping to create with this blog is a place where agents, brokers, corporate risk managers and business owners can air out questions, comments and concerns over their cost of financing risk, finding coverages and putting together insurance programs that solve problems, not create new ones.

This will never be a bully pulpit where I alone can render comment and opinion, but I welcome comments and opinions from all.  I don’t think you get to the heart of the matter without approaching the destination from different directions.

I look forward to a lively and helpful discussion in  the days and weeks to come.