A captive mindset

Business owners take pride in their operations and have a deep understanding of what it takes to successfully get the job done. From logistics to employees and everything in between, they understand the factors necessary to effectively manage an operation. However, for many operators, the cost of insurance is where they feel they have the least amount of control.

If insurance renewal results in consistently rising premiums with no directive on opportunities to lower them, it could be time for an owner to adjust his or her mindset. Reframing the process from simply buying insurance to financing risk can be advantageous when it comes to controlling your insurance costs.

Insurance is a highly cyclical business with many external factors affecting premium levels. From social inflation to swings in the investment market, catastrophic events to litigation funding, highly publicized accidents to large jury verdicts and changes in underwriting appetites, it can be challenging to understand insurance—one of any organization’s top operational costs.

Some of these factors are outside of the owner’s control, such as economic cycles, natural catastrophes, insurance capacity, other poor operators and freak accidents, to name a few. The good news is there are more advanced risk financing options today than ever before and resources to help business owners understand their options.

A number of strategic measures can help mitigate these factors, including:

• frequency of loss—By controlling his or her number of claims, an owner can control overall risk.
• safety culture—The primary goal should be ensuring employees return home safely each day. A strong safety culture focuses on accountability and trust between management and employees.
• fleet maintenance—Sustaining a quality fleet of vehicles that drivers would be proud to operate.
best practices—Invest in best practices so drivers understand how important they are to the operation. One way to do that is by making sure drivers know they’re supported by implementing a driver awards/recognition system.
• strategic hiring—Hiring qualified drivers who will carry the company’s values with them every day is critical.

Now, an owner might still be wondering, “Why does my insurance premium go up every year and how can I impact those costs?” To answer, it is vital to understand the available options when it comes to financing risk.

Transfer the risk

The option most owners are familiar with is transferring risk. This usually is done with a guaranteed-cost, zero-deductible or traditional insurance option, where all risk is transferred to the insurance carrier. The operator pays an insurance premium to an insurance carrier in exchange for transferring all its covered risk for a set premium. With this method, there is no upside and no downside, and the insurance company keeps all the profit. The insurance carrier benefits if claim costs are lower than they are priced for, and the insured has the peace of mind of transferring all risk covered by the policy. This is a good option for those who are risk-averse or new to taking on risk.

Retain the risk

The next option is to retain all, or the majority of, the risk. This is typically done by self-insuring or taking a large deductible. This option has downsides because the owner could be responsible for paying for all claim activity out of pocket, even those large, catastrophic claims. For most operators, this is not a practical option.

Combine those options

The third possibility is a combination of the two above options, allowing owners to achieve the best of both worlds. This option is referred to as alternative risk transfer or captive insurance. These programs allow owners to keep a predictable layer of risk they can control and to transfer away the less predictable or catastrophic risk to the insurance carrier.

While not for everyone, captive insurance is an option that provides new possibilities for the proactive organization: a palatable level of risk that oftentimes includes a defined best- and worst-case scenario, allowing organizations to take advantage of their favorable claims experience.

Captives can be overwhelming, given the several varieties and options, with each requiring careful consideration; but working with an insurance agent could reveal several appealing and previously unconsidered options.

How do captives work?

While all captive programs differ, customarily, the member of a captive program pays a premium and a portion of that is set aside in an investment account that functions similarly to a checking account. As losses occur, funds are then drawn from this account to cover the claim costs up to a known limit or retention. If the participant has fewer losses than expected, part of the premium could be returned, along with any investment income accrued.

On the contrary, if a company’s losses are higher than expected, the participant will pay additional premiums up to a specified maximum.

There are many kinds of captive programs: group and single-parent captives, heterogeneous and homogenous captives and owned and rental captives. While the general concept is consistent, it is important to understand how the captive being considered operates.

For midsized operations, the most common captive approach is to band together in a group with like-minded, safety-conscious companies. This mutually beneficial relationship in which the captive members share in risk and reward helps create alignment with the insurance carrier. This allows the participants to exit the traditional insurance market and help protect themselves from those uncontrollable factors mentioned above.

Driving your outcome

Captives are not for everyone, and as a captive insurance buyer, owners must be willing to have a long-term vision. Insurance companies and agents who are experts in captives can supply the needed information to understand the program. Expect transparency from the agent and insurance carrier and, when exploring a group option, ask for data highlighting past financial performance and speak with current members about their experience.

Risk can be managed to a greater degree than many imagine. However, this requires a holistic approach to risk financing, including vision and support from senior management, a commitment to reducing accidents before they happen and aggressively managing losses that do occur. If an owner has an above-average loss history, strong financials, an appetite for risk and a commitment to safety, a captive can be the preferred solution.

Jennifer Boyd is a marketing specialist at Richfield, Ohio-based National Interstate Insurance. She can be reached at jennifer.boyd@natl.com.