I have to offer my apologies if you are a regular visitor to my blog. I haven’t been able to post in the last few weeks because frankly I have been so busy with my work with clients. I don’t offer this as an excuse, and it certainly isn’t a complaint, but I think it is interesting to note that in spite of a soft market, captive insurance initiatives continue to be front and center in the minds of commercial insurance buyers.
I think there are two reasons why the soft market hasn’t put a damper on new captive insurance program development. First, I think there are several very compelling reasons to use captive insurance mechanisms to manage risk financing that are not cost-related. Second, I think the current generation of risk management professionals remembers what a hard market looked like and they know that insurance is cyclical. Let’s investigate these two factors separately.
Too often captive insurance mechanisms are marketed on the basis of reducing premium or as a tax play. OK, sometimes they can do either or both, but those two advantages are typically short-lived. Cost related advantages are real, but they are not the only, or the best, reasons to use a captive insurance mechanism. The market swings soft and all of a sudden traditional insurance prices beat captive insurance prices in the short run or the IRS catches up with a tax loop hole and closes it up tighter than spandex on an overweight body. If an insurance client is purchasing their insurance on a year-to-year tactical basis then they will live and die by the pricing sword. What most professional insurance buyers have come to realize is that over a ten year horizon they will end up paying for their own frequency layer losses, a share of the severity losses and the expenses associated with policy and claims administration. The real question for them is how do they want to pay for it. Alternative risk mechanisms typically offer much more stable pricing over the course of a typical insurance market cycle. Relationships are personal with reinsurance support so a company is less likely to be subject to being the “baby tossed out with the bath water” if they are in a tough risk segment but are a better than average player. You know what I mean, the industry knee jerks on trucking companies for instance and all of a sudden decides that they don’t want to write them, any of them, and the pricing jumps for those few insurance companies that continue to write the risk. Sometimes specific coverage or specialized forms are available nowhere else but in a captive setting (think abuse and molestation for religious or social service organizations).
The cyclical nature of the insurance industry makes for a very compelling strategic reason to be involved in an alternative risk mechanism. Rather than being subjected to roller coaster pricing, captive participants see a more stable pricing base. Are the lows as low? No, but niether are the highs as high. This makes for a better financial planning environment.
In my opinion many insurance companies run their businesses by looking in the rear view mirror. Its not surprising. They price their current business by watching their historic losses, they invest long into the future for maximum potential return. The problem is that losses happen in the here and now and insurance companies often get caught holding the dirty end of the stick between historic loss performance and future investment performance being worse than projected. Once they see themselves heading for the ditch they have to react quickly and this more than often ends up as knee jerk pricing and market service decisions. At the end of the day the insurance buyer ends up paying the price.
I think the experience of the risk management community coupled with the availability of captive insurance initiatives to the middle market insurance buyer is driving the current rush to control costs through alternative risk mechanisms. Knowing that behind every soft market is a looming hard market, risk managers are positioning themselves to avoid the next hard cycle. Considering that there is a development period of between 6 and 12 months for programs like this, now is the time to consider an alternative to the traditional marketplace, and that is exactly why I am so busy today.