The group captive has become an increasingly prominent structure in the self-insurance arena. In Cayman, as at 30 June 2014, group captives represented 17% of the overall market, with 130 such structures licensed on island. Once established, these group captives continue to grow in terms of numbers of members, premiums and assets. That these group structures should have become such a prominent and growing component of the captive market is not surprising. They provide an ideal mechanism for enabling like-minded organisations from similar industry sectors, or various industry sectors but with similar insurance requirements, to join forces in a single structure and take collective advantage of the many benefits this provides.
A group strategy
An organisation’s suitability for owning a captive is often gauged by the magnitude of their current insurance expense, with growth prospects also influencing the decision. A group captive represents an opportunity for an organisation that is not on its own large enough to self-insure to obtain the benefits of captive ownership. In addition, by including a risk-sharing mechanism, the self-insurance layer offered by the captive program can be higher than any one member would contemplate self-insuring.
The group captive model lends itself to multiple lines of business, and as such, examples of the structure can be found in most market sectors, from transport and manufacturing to healthcare and agri-business. Essentially, the group template can be applied to any industry that has low to medium severity exposure, and to individual organisations whose annual insurance expense is in the range $200,000 to $2,000,000. That represents a significant catchment area, offering plenty of growth opportunities for existing group captives and start-up group captives.
The structure is most effective when it represents a group of ‘best-in-class’ organisations with a strong focus on risk management. Bodies such as trade associations and affiliate groups often provide fertile spawning ground for group captives. However, no group captive can ever get off the ground without an advocate. This may be one of the future members, or a broker or consultant; a person who recognises a group of like or diversified business organisations who could benefit from self-insuring through a group captive model.
Meeting the challenges
The first challenge when attempting to establish a group captive is to clearly demonstrate the longer-term, strategic, value potential of participation. For organisations that have minimal experience of self-insurance, insurance purchasing decisions are based on pricing, and the horizon is short-term. However, dissatisfaction with pricing in the short-term is not sufficient motivation for captive ownership. Dissatisfaction with pricing volatility and insurance availability over the longer-term is sufficient motivation – a true desire for stability in a significant business expense.
Such dissatisfaction usually stems, not only from the cyclical nature of the commercial insurance market, but from non-recognition by insurance carriers of an organisation’s successful risk management, loss prevention measures and good loss experience. As mentioned, good risk management and a clear focus on loss prevention measures are key credentials for group captive participation, and the risk-sharing mechanism then fosters an ongoing commitment to continuous risk mitigation within the group. In a captive, good loss experience has a direct, transparent effect on premium funding, and the group captive creates its own benchmark for acceptable operations in terms of risk.
Depending on their respective premium size, a critical mass for establishing a group captive program may be as few as five initial members. The speed at which the membership grows will be influenced by a range of factors, but in many instances recommendations from existing members prove the main draw for new members. It is important to acknowledge that the role of the members is a proactive one – they represent not only the captive’s insureds, but its shareholders and directors, and their willingness to direct the captive’s operations and strategy is crucial. As membership grows, the interaction between the members will heavily influence the dynamics of the captive.
The failure of a group captive is a relatively uncommon occurrence, but when it does happen, often the reasons can be traced back to a lack of necessary controls and adequate discipline. Success relies on discipline in a number of areas:
Reinsurance – reinsurance must be in place to adequately cap the captive’s overall exposure.
Membership credentials – such credentials must not only ensure that members meet the necessary underwriting criteria and demonstrate good risk management, but also that they are suitable as an investor, being able to invest a modest amount of capital (typically in the range $20,000-$35,000 per member) and provide the level of collateral (typically cash or letter of credit) required to secure the member’s obligations under the risk-sharing arrangement.
Risk-sharing rules – these must be strictly applied. In general, members are experience rated for the first “frequency risk layer” and where initial premiums for that layer are inadequate they are obliged to pay a certain level of premium assessments. They are also experience rated for a second “severity risk layer” where any premium under-funding is resolved by risk-sharing among members. The members’ obligations for premium assessments must be secured and this security must be drawn on by the captive if premium assessments are not collected.
Distribution of profits – the distribution must be carried out in a prudent fashion, typically only from the profits of closed policy years.
Member termination rules – these rules should be absolutely clear in the terms of the shareholders’ agreement, to ensure that remaining members are not exposed to ongoing liabilities attaching to any departing member.
A growing market
Current market conditions are conducive to group captive growth, particularly given the fact that Workers’ Compensation rates are starting to rise in some US states as well as in certain industries. This development is sparking an increase in group captive membership enquiries, while new group captives continue to be formed, with Cayman at the forefront of this growth.
The benefits of a well-structured group captive, built around a proactive, risk-focused membership base, go far beyond that of simply offering a stable source of insurance and stable premiums. It provides a mechanism for entrepreneurial organisations to take control of a significant business expense and turn it into a revenue producing asset, while simultaneously offering the benefits of being part of a collective and providing the associated economies of scale coupled with the opportunity to explore best practices with like-minded organisations.