Seasoned owners look to expand range of coverages in captives

Increased benefits business seen as key area for potential growth

Posted On: Mar. 02, 2008 6:00 AM CST
Dave Lenckus
gloria Gonzalez

Many owners of long-established captives have grown comfortable with expanding the risk profiles of their captives, pulling third-party risks such as employee benefits into their facilities as well as retaining much more of their own risk.

The evolution of those older captives is something every owner of a new captive or one that has been around only a couple of years should study—and then set aside for a few years, captive owners and consultants agree. Captive owners should first become comfortable with their rate-setting abilities and the capital structure of their facilities before expanding into areas that are advantageous but financially dicey if not managed properly.

Writing benefits business has attracted many owners of captives with a solid record of retaining risk, because writing enough of that third-party business enables a captive owner to deduct the cost of its premiums for its own risk. In addition, that coverage—typically long-term disability and group life insurance—is a nonvolatile risk, experts say.

"We're seeing, certainly, an increase in the interest level and a large increase of captives writing benefits," said Michael Cormier, a managing director in the Captive Solutions Group unit of Marsh Inc. of New York.

For example, Vermont-domiciled captive Three Rivers Insurance Co. has assumed tax-advantageous third-party business by reinsuring benefits—including group life and personal lines coverages—for the domestic and international employees of parent company Pittsburgh-based Alcoa Inc.

The captive, which Alcoa formed in 1983 to assume business from an older Bermuda-based captive that eventually closed, originally wrote windstorm insurance for Alcoa facilities located in areas where commercial coverage was expensive or unavailable, said John Wilson, president of Three Rivers in Burlington, Vt. The captive also covers general liability, workers compensation and management liability risks for Alcoa.

Many captive owners, though, have found opportunity for third-party business beyond long-term disability and group life insurance.

For example, New York-based Verizon Communications Inc. can take tax deductions on the premiums it pays its main captive to cover several of the company's property, casualty, crime and patent risks because of the amount of nonbenefits third-party business the facility writes.

The captive, Vermont-domiciled Exchange Indemnity Co., writes non-Verizon risk that Sheila Small, Verizon's assistant treasurer-risk management and insurance, describes as "related third-party business" because of the familiarity and comfort that Verizon has with the risk.

Exchange Indemnity, which opened in 1995, reinsures a portion of the cell phone insurance that Verizon offers customers; it reinsures part of a package of personal lines insurance that the company offers its own employees; and it writes an owner-controlled insurance program that covers the general liability and workers comp risks of construction contractors who work on Verizon's building maintenance and remodeling projects.

Third-party business accounts for around 70% of the captive's premium volume, Ms. Small said.

Boeing Co. of Chicago has funneled significantly more risk into its two captives over the past 10 years as the company has become more comfortable with retaining risk and as the commercial insurance market has moved through various cycles, said Mark Meyerhoff, senior director-risk management and insurance. Boeing formed its Bermuda-domiciled Astro Ltd. captive in 1969 and its Vermont-domiciled Astro II captive in 1984.

Among the risks the captives cover are aviation product liability, insurance deductible buydowns for its commercially placed property and directors and officers liability insurance, workers comp and the terrorism coverage that is backstopped by the federal government. In addition, Astro Ltd. has assumed third-party risk by participating in the Green Island Reinsurance Pool. About 20 employers pool their workers comp risks through the pool, which is managed in Bermuda by Marsh Management Services (Bermuda) Ltd.

Alcoa's Three Rivers captive also is involved in a property/casualty and marine pooling arrangement with Cayman Islands-based United Insurance Co.

Captive owners also are beginning to look at benefits business beyond long-term disability and group life insurance and are considering funding post-retirement medical benefits, said Nancy Gray, the Burlington, Vt.-based executive director-North America of Aon Insurance Managers USA Inc., a subsidiary of Aon Corp.

No captive has received approval to cover those benefits, "but we're working on a couple and expect them to go before the (Department of Labor) in the next couple months," she said.

Under those arrangements, companies that finance retiree health care through a tax-exempt voluntary employees' beneficiary association would pay a premium to the captive to assume some of the retiree health care risk. The advantage for captive owners is that a facility would be able to apply the premium to its capital structure. Any capital contributed to a VEBA is locked into that trust.

Meanwhile, captives that traditionally covered general liability and professional liability risk for health care-related entities are expanding into other types of liability as well as property coverage.

After more than a decade in operation, Harvard Medical Institutions began providing directors and officers liability coverage for the boards of directors and senior executives of its member organizations in the early 1990s. Its captive—Controlled Risk Insurance Co. Ltd.—was the first captive formed by a health care organization in the Cayman Islands when it was created in 1976. It was established to cover the general liability and professional liability risks for the physicians and hospitals in the organizations, said Jack McCarthy, president of the CRICO/Risk Management Foundation in Cambridge, Mass.

When coverage through the captive was expanded, "I think it was to get more flexibility of coverage terms, and I suspect there was a hard market for D&O in those days so it made more sense to bring it into the captive," Mr. McCarthy said.

Recent insurance market cycles, though, mainly have affected its reinsurance retentions, Mr. McCarthy said. Several years ago, Harvard Medical decided to retain more of its risks due to significant increases in reinsurance premium pricing despite its good claims experience. It created a "swing plan" deal with Hannover Re that achieves a lower premium for the captive based on its experience. In a "swing plan arrangement," a captive pays a reinsurer a lower premium based on its good loss history, but the captive will pay a higher price if losses surpass a certain threshold.

Below-market rates

"We had a run of six or seven years where we paid a lot less than market rates for reinsurance as a result of taking more of the risk into the captive," Mr. McCarthy said.

Some longtime captive owners, though, have maintained their risk profile because they have found that the commercial insurance market can sufficiently handle the exposures they have not retained. In 1984, Carle Risk Management Co. established a Cayman Islands captive to cover general liability and professional liability for its physicians, hospital, clinics and related health care businesses. The organization has chosen not to add other risks such as auto, workers comp and D&O liability, said Laurence J. Fallon, vp and chief risk/quality officer for the Urbana, Ill.-based organization.

"We've not added any additional risksÖbecause we've been able to get favorable terms in the commercial market," he said. "We've just kind of kept it status quo."

Longtime captive owners advise companies with new or younger captives to proceed cautiously when taking on new risks.

Getting too aggressive with third-party business right away, for example, could lead to early and large financial troubles for the captive if the facility was not created with a capital structure that accurately anticipated losses, Boeing's Mr. Meyerhoff said.

"Most risk managers are not underwriters, so you want to be careful about what you elect to write," because the captive's fortunes ultimately impact the parent company's financial condition, he said.

Writing employee benefits is a good plan, but it can be time consuming, and arranging payroll deductions to cover employees' premiums is not always easy, said Verizon's Ms. Small. Running a captive properly takes time and resources, she said, noting that Verizon commits a full-time employee to its captive in Vermont.

"People say it doesn't take time, it doesn't take a lot of work" to run a captive, Ms. Small said. "I don't think I agree with that."