Captive insurance: evolution and outlook

August 2023  |  TALKINGPOINT | RISK MANAGEMENT

Financier Worldwide Magazine

August 2023 Issue

FW discusses the evolution and outlook for captive insurance with Karin Landry, Prabal Lakhanpal and Peter Johnson at Spring Consulting Group, an Alera Group Company.

FW: Could you explain the primary purpose of captive insurance? What are the potential advantages for a parent company of owning a captive insurance company?

Landry: A captive insurance company is a separate entity established to insure or reinsure risks of its parent company or third parties. A captive is a form of self-insurance and a strategic risk management tool that can be leveraged for a wide range of risks, including those related to employee benefits and property and casualty (P&C). It can reduce frictional costs, such as administrative and commission, spread risk, provide investment return – such that profit that would normally go to a commercial insurance carrier can be recouped – and allow for increased customisation and coverage. Over the course of time, captives have broadened to writing more third-party business, further development of cell captives and many more domiciles entering the captive arena.

Lakhanpal: Aside from the savings and investment return and reduction of risk, captive insurance programmes give more control to the parent organisation and allow for faster, more informed decision making. A captive is also able to constantly evolve and helps organisations measure the current state of their programmes versus intended objectives, and to adapt to areas for improvement such as economic and insurance market conditions. Captives can provide a more flexible plan design and better coverage than a commercial insurer can offer, which is especially critical in today’s hard market and, on the employee benefits side, the healthcare cost landscape as well.

Johnson: On the P&C side, advantages remain the same: accelerated cash flow, reduced frictional costs, investment return, reduced overall cost of risk, improved data analytics and customisation. However, we are also looking at lines like cyber, property insurance, commercial automotive, general liability, medical malpractice, workers’ compensation, directors’ and officers’ liability, and more. The cost savings and effective risk management yielded from a captive are especially advantageous given today’s market related to climate risk, ransomware attacks, workplace violence and other difficult trends.

FW: How creative and diverse is the pool of viable candidates for captives? Are certain types of entities more likely to gain maximum benefits?

Johnson: Hospital and healthcare, construction, hospitality, real estate, transportation and retail are some of the most notable industries, which makes sense given their propensity for workers’ compensation, cyber, property, general liability and other liability-associated risks. There are so many solutions to choose from based on size, industry and risk appetite. Furthermore, company loss experience comes into play as well.

Landry: Captives work best for organisations with risk management teams that are finance-driven, have a long-term outlook, are financially sound and have reasonably predictable insurance risk. Savings in captive insurance do not happen overnight, but rather after claims experience has matured and surplus has time to build. Groups looking to move to self-insurance should focus on understanding the financial and qualitative impact of this move. Plan experience, reviewed by actuaries, can help with understanding and outlining the financial implications of potentially taking on some of the risk associated with moving to self-insurance. As has always been the case, captives are available to fund coverages that are unaffordable or unavailable in the commercial marketplace.

Lakhanpal: For employee benefits captives, understanding health trends and claims patterns is essential to developing sound captive programmes that truly cut costs. Organisations dedicated to both cumulating and acting on this data will see the best results. Regarding size, it depends on the type of captive. A single parent captive is best for larger organisations with the upfront capital and resources needed, but group captives, cell captives and risk retention groups are gaining a lot of traction in the smaller to mid-market. There is a spectrum of self-insurance and captive models, and there is a fit for most companies.

FW: How is captive insurance responding to current economic uncertainties, such as inflationary pressures, to meet risk management needs?

Lakhanpal: On the employee benefits side, during times of uncertainty we typically see an increase in disability claims as well as a spike in usage of health insurance. When taken together with the change in exposure units that may result from workforce reduction – such as the layoffs we have been seeing – benefits programmes may start to underperform. Captives allow organisations to be closer to plan data and greater transparency regarding where each dollar goes. In addition, the spread of risk makes claims more predictable and less volatile. These characteristics of captives are extremely important right now.

Johnson: In the current hard market, we are expecting to see price increases across all lines of business, with an overall average increase of 9.3 percent in rates in 2023. Carriers are tightening underwriting standards and may refuse to underwrite certain risks or business types altogether or force insured retentions up. We have seen this for certain casualty lines like cyber, general liability and excess liability. For property, we are seeing the carriers put more effort into auditing statement of values, so insureds are not in an underinsured situation. This, combined with increases in catastrophic and reinsurance costs, is leading to double digit property increases for many companies. Carriers may also remove manual rate discounts or increase rates altogether while narrowing coverage at the same time. In addition, we will see changes in risk profiles driven by economic changes – examples include commercial auto frequency moved down then up, cyber ransomware on the rise, healthcare workers’ compensation programmes utilised, excess liability and umbrella rates increased substantially. While a captive is not isolated from these circumstances, they do offer protection by going outside the commercial market.

Landry: We are still recovering from the pandemic. Its effects continue to impact decision making and uncertainty remains. As a result, risk management teams are looking to actuaries and consultants to ensure programmes are strategic, maximised and focused on underwriting investment income, leading to an uptick in captive interest. For organisations with good loss history, they are able to minimise the impact of inflation.

FW: For owner-insureds, what are the main risks and disadvantages of using captive insurance? How can these be managed?

Landry: Some organisations shy away from captives because of fear surrounding increased risk, initial costs and fees, and resources needed to maintain the captive. With captives, instead of paying the insurer a fixed premium amount, employers fund a portion of the financial risk associated with the claims of the programme, in exchange for lower overall costs. The incentive to do so relates to the additional risk charge carriers typically add to their fully insured premiums. By taking on this extra risk in a captive, employers recoup these fees and insurance carrier profits and are able to reduce their insurance spending. However, not every organisation has the appropriate risk appetite for this arrangement.

Lakhanpal: The key to captive success is having a team committed to the programme as well as trusted partners that are routinely evaluating possibilities for programme enhancements or adjustments due to market or regulatory shifts. If a proper team is not in place, return on investment on the captive’s implementation may not come to fruition, and compliance issues can arise. In addition, organisations without enough capital or predictable risks may find captive insurance an unfavourable option.

Johnson: If an organisation does not have adequate stop-loss coverage for catastrophic claims, this could become an issue since it would lessen the stability and predictability of the captive programme. Strong underwriting protocols must also be in place.

FW: How important is it for captive insurers to take a data-driven approach to managing risks and costs more effectively, as well as to optimise beneficial strategies?

Johnson: It would be impossible to manage risks and reduce costs without having the necessary data to understand the current state of the programme as well as make financial projections for the future. With accurate data, we can calculate the level of expected loss and allocated loss adjustment expenses at various retentions, which is a key factor in being able to minimise the total cost of risk for a captive programme, while providing insight into the risk versus reward relationship of various programmes.

Landry: Without proper data recording, collection and analysis, captive owners will struggle to develop cost-effective programmes that match the needs of their insureds. With robust and timely data, actuaries can help identify health patterns, chronic conditions, considerations for point solutions and other areas where action can be taken to effect positive change. Captive clients are able to receive key data well in advance of their renewals, giving them time to implement solutions for problem areas before the next plan year.

Lakhanpal: Greater transparency of data is a driving factor in considering a captive, and it is data that should inform the entire process: determining a captive structure, conducting a feasibility study, appointing a captive manager and selecting a domicile. After implementation, it is still all about finding the right solutions based on qualitative and quantitative data points. Captive owners with poor data collection processes are not able to take full advantage of their captive, which can be used as a problem-solving mechanism but only if you know what the problems are. This is true for any strategy an organisation implements; you cannot judge performance or results without metrics in place.

FW: In terms of medical stop-loss issues, what are the upsides of arranging this type of coverage through a captive? Are there any implications for the owner-insured that need to be considered?

Lakhanpal: The biggest concern when considering any self-funded programme relates to the cash flow volatility to the programme being impacted by unexpectedly high claims – be it due to the volume of claims or exposure to a handful of large loss claims. One high cost claimant or a series of unanticipated smaller claims could lead to a higher than expected claims level in a self-insured plan. Stop-loss insurance minimises or eliminates this risk as well as dramatic fluctuations in claim costs over time, creating a level of predictability. A medical stop-loss captive yields increased insight into the actual cost of care, administrative costs and any loaded fees or additional expenses to the plan, allowing for more informed decision making.

Landry: Healthcare costs keep climbing; within the past decade, healthcare costs have risen roughly 80 percent for employees and 60 percent for employers while economic growth remained around 2.5 percent annually. This dynamic has helped start a fundamental change in the healthcare market, and all parties within the healthcare continuum are being asked to handle risk and chase healthcare dollars. As a result, many employers have or are moving to self-funding plans like captives because they allow for greater customisation, more control over risk and potential cost savings. Many of these self-insured programmes are looking at putting medical stop-loss into a captive, offering additional protection from claims volatility.

Johnson: There are two types of stop-loss insurance: aggregate and specific. Aggregate stop-loss offers protection for the risk of catastrophic loss by providing insurance coverage for total group claims over a certain dollar amount. Stop-loss carriers issue policies that pay when the aggregate claims amount exceeds a predetermined percentage of expected claims level. On the other hand, specific stop-loss protects against individual catastrophic claims. For both specific and aggregate stop-loss, all claims exceeding the attachment point are covered by the stop-loss carrier and not the responsibility of the parent company.

FW: What are your predictions for the captive insurance market in the months and years ahead? To what extent are we likely to see an increase in uptake?

Landry: I have seen many developments in captive practices and expect to see more in the years ahead. The coronavirus (COVID-19) pandemic has shown that an old dog can be taught new tricks and the captive sector has always been at the forefront of insurance innovation. We must, and will, continue to adapt to changing regulatory landscapes, the evolving needs of future workforces, and new and emerging risks. As return on investment is becoming a top priority for organisations across the globe, more and more companies will turn to self-insurance and captives to help reduce spend and tailor their programmes.

Lakhanpal: In just the past few years we have seen unprecedented changes in healthcare, regulations and the economy that have caused a ripple effect in the captive space. As we progress through 2023 and a hardened market, I believe captives will continue to be focal points as strategic risk management tools, as we have seen how they help organisations solve seemingly unsolvable problems. From a more overarching perspective, I expect we will see a greater embracing of technology. With artificial intelligence and ChatGPT dominating headlines, only time will tell if and how these or other technologies like blockchain will change the face of risk management.

Johnson: Emerging risks and tricky risks such as cyber and climate are causing a lot of buzz, but have yet to be totally solved for, and I think they will remain top-of-mind. In addition to a continued increase in captive interest, I believe more organisations will be integrating programmes across different lines, so that they have a comprehensive dashboard of programme performance and can be as nimble as the market demands. Integrating P&C and medical stop-loss captive programmes for greater diversification and shifting of risk is an exciting trend that I expect will continue. Although it is hard to identify areas of focus for the future, I can guarantee the industry will keep evolving. Captives are a ‘think outside the box’ strategy, so experts in this space are sure to push the envelope.

With more than 25 years of experience in the insurance, healthcare, risk financing and benefits industries, Karin Landry is an internationally recognised thought leader in this sphere. As managing partner of Spring Consulting Group, she helps clients develop customised, innovative solutions including developing insurance and captive entities, designing new health and life products, evaluating benefits strategies and funding, and creating market entry strategies for companies in the retirement area. She can be contacted on +1 (857) 239 1244 or by email: karin.landry@springgroup.com.

Prabal Lakhanpal is a senior vice president and has been with Spring since 2015. At Spring, he leads many of the firm’s most advanced client projects, with a focus on employee benefits, captive insurance and alternative risk funding. He drives the strategic and innovative thinking processes and serves as the project lead for some of the country’s largest employers. Prior to joining Spring, he worked in various finance and operational roles across the globe. He can be contacted on +1 (857) 239 1250 or by email: prabal.lakhanpal@springgroup.com.

Peter Johnson is chief property and casualty actuary at Spring Consulting Group. He has over 18 years of actuarial experience in reserving, pricing, alternative risk funding, risk optimisation, captive feasibility and reinsurance risk transfer work. This experience includes workers’ compensation, medical professional liability, professional liability, automobile, general liability, cyber liability, mortgage insurance and other enterprise risks. He was recently recognised by Business Insurance as a ‘2019 Breakout Award winner’. He can be contacted on +1 (508) 772 4382 or by email: peter.johnson@springgroup.com.

© Financier Worldwide

THE PANELLISTS

Karin Landry

Prabal Lakhanpal

Peter Johnson

Spring Consulting Group, an Alera Group Company