FAQs – Alternative Risk Financing
What is an Alternative Risk Financing Program?
Alternative risk financing programs include self-insurance programs and captive insurance companies, including risk retention groups.
What is the value of an Actuary to Clients with an Alternative Risk Financing Program?
The actuary’s role is to help ensure the financial stability of the program. Actuaries assist with designing products, pricing coverages, and ensuring that reserves and capital levels are adequate and reasonable.
How do I know if an Alternative Risk Financing program is right for me?
If you are finding that traditional insurance is unaffordable or difficult to obtain then you should explore alternative risk financing programs. As a general guideline, if you are paying approximately one million dollars or more in premiums per year, then a captive should be cost effective for you. A Captive Feasibility Study performed by an actuary will assist you with evaluating the potential benefits and costs associated with this type of program.
What is a Self-Insurance Program?
Self insurance is an alternative risk financing method whereby an eligible risk is retained by a company and funds are formally reserved to cover future losses. The amount reserved is calculated using actuarial and insurance information and, similar to an insurance premium, should be adequate to cover projected future losses. Organizations can gain more control over the cost of risk by retaining a share of their loss exposure. In addition, they may be able to improve coverages and limits, enhance claims management and loss control, and gain cash flow advantages. All states regulate workers compensation self-insurance programs.
What is a Captive Insurance Company?
The following provides a brief summary of the more common forms of captive insurance programs.
Single Parent or “Pure” Captive: Pure captives typically have a single owner for which insurance coverage is provided. In some cases they may also insure controlled unaffiliated business. They are usually monitored by a risk manager or a financial officer at the parent company. Most are managed by a captive insurance management company located within the jurisdiction of domicile.
Risk Retention Groups: A risk retention group is a group captive formed under the requirements of the Liability Risk Retention Act of 1986. A risk retention group needs only to be licensed in one state in order to be eligible to write liability insurance in all fifty states. Risk retention groups are not allowed to write property insurance, personal lines insurance, or workers’ compensation insurance.
Association Captives: Association captives are formed by established associations to provide insurance coverage for members. Ownership rests with the association or individual members. The captive may only insure members of the association, and typically the association must have been in existence for at least one year prior to the formation of the captive. Organizations may employ a financial expert at the association level with prime management responsibility, or this function may be outsourced to a captive management company, broker, or consultant.
Industrial Insured Captives: Industrial insured captives are owned by companies within the same industry that join together to address a specific insurance need. These captives may insure only the risks of the industry group members and their affiliated companies. A board of directors is typically appointed to whom the captive management company reports.
Agency Captives: Agency captives are owned by agents or groups of agents and allow them to share in the underwriting results of the captive. These captives promote long-term relationships between brokers or intermediaries and their clients by allowing them to share a common interest in the financial success of the captive.
Rent-a-Captives: A rent-a-captive insures the risks of its members and returns underwriting profit and investment income. These facilities “rent” their surplus to entities who wish to participate in an alternative risk financing program without committing the capital to form a captive of their own.
Sponsored Captives or Segregated/Protected Cells: Protected cell companies (PCCs) are similar to rent-a-captives with one important difference. PCCs allow participants to shield their capital and surplus from other participants in separate, protected cells.
How difficult is it to form a Captive?
The key to the ease with which a captive can be formed is the availability of qualified service providers and the level of regulatory oversight. The captive can be domiciled on-shore in a United States jurisdiction or off-shore in locales such as the Caribbean. In the case of United States jurisdictions, the regulatory body within the state of domicile takes the lead in approving new programs and monitoring ongoing operations.
What are the minimum Capitalization requirements for a Captive?
Capitalization requirements will vary based upon such criteria as the volume of business, the policy limits, the coverages written, and the choice of domicile. An actuary will assist you with determining what the capitalization requirements will be by performing a Captive Feasibility Study. Letters of Credit may be used to help participants meet the minimum capitalization requirements.
What are some examples of On-Shore Captive Domiciles?
Currently the major players in the United States are Vermont, Hawaii, and South Carolina. However, there has been rapid growth in recent years in Arizona, Delaware, the District of Columbia, Montana, Nevada, and Utah. Some examples of states with recently enacted or expanded captive legislation include Georgia, Kentucky, Missouri, Michigan, and Connecticut.
What are some examples of Off-Shore Captive Domiciles?
Currently the two largest off-shore domiciles in terms of the number of captives are Bermuda and the Cayman Islands. Other off-shore domiciles include the British Virgin Islands, the Isle of Guernsey, Anguilla, the Bahamas, Barbados, Turks and Caicos, Isle of Man, and Nevis.
What are the Advantages and Benefits of an Alternative Risk Financing program?
The advantages and benefits of creating a captive include affordability, availability, stability, coverage flexibility, direct access to reinsurance, claims handling control, underwriting control, sharing in underwriting results, and improved cash flow benefits.
Affordability: The high cost of medical professional liability insurance is an example of the problem encountered by purchasers of traditional commercial insurance. By forming their own insurance company and setting rates based upon their own relatively favorable experience, medical professionals can reap the benefits of lower premiums. Also, there are often expense savings associated with captives that may be result in lower premiums than would be available in the traditional market.
Availability: Forming a captive is a proactive approach to eliminating the recurring problem of coverage unavailability. Control of coverage terms and conditions passes from the hands of traditional commercial insurers to the owners of the captive program.
Stability: An alternative risk transfer program will facilitate tighter control over insurance costs. Premiums will be based upon the actual underwriting experience of the program, which will shield participants from the volatility of price swings common to the traditional commercial insurance market.
Coverage: A captive can tailor insurance contracts to specifically provide the protection needed by its participants. For example, at inception “nose” coverage for unfunded tails under previous commercial contracts can be provided. Gaps in coverage for prior primary and excess insurance contracts can be covered in the captive with proper adjustments in premiums.
Reinsurance: Captive insurance companies have direct access to the reinsurance marketplace. Alternative risk financing programs can be employed to cushion the impact of underwriting cycles in the reinsurance market. Retentions can be increased or decreased as needed as the reinsurance market hardens or softens.
Claims Handling: Alternative risk financing programs allow significant control over the claims settlement process. Policies and procedures can be established to provide guidelines to be followed by claims administrators. Further, since claims experience will be directly reflected in underwriting results and consequently premiums, there is increased incentive for participants to focus on loss prevention and control.
Underwriting Control: A major advantage of ownership of an alternative risk financing program is the ability to generate management information useful for underwriting control. Monitoring results is the key to maximizing the program’s value to the parent and assessing future premium requirements.
Underwriting Results: Under traditional guaranteed cost insurance, commercial carriers are entitled to the underwriting profits resulting from favorable loss experience. Under an alternative risk financing program, underwriting profits remain in the program and provide additional funding for future claims.
Improved Cash Flow Benefits: The ability to generate investment income from unearned premiums received is an important advantage of an alternative risk financing program. In the event that premiums are paid in advance and losses are paid out over an extended period of time, significant cash flow benefits may be accrued.