A True ROI model for Insurance: If you are willing to bet on yourself, you can win big!

Date Posted: March 22, 2015

Posted In: Ideas, White Papers,

by Chris O’Hagan
JD Kutter Insurance Associates

Construction Group Captive programs are entering the conversation more and more in the Midwest. These alternative risk financing vehicles have been around for decades but are just now gaining momentum with middle-market contractors in the St. Louis Metro and outstate Missouri regions. The reason is simple: These captives offer construction business owners increased control over one of their largest business expenses – Insurance. Specifically the casualty lines of insurance (Workers’ Compensation, General Liability and Auto Liability/Physical Damage), which comprise the bulk of a contractor’s overall premium expense. Losses in these coverage lines are the most predictable and controllable which tend to make them the most profitable for the insurance carrier.

A Group Captive turns the standard insurance market model on its head. Instead of trading dollars with the insurer (a game the contractor will never win in the long run), the contractor, along with other members of the captive, becomes the insurer and essentially bets on itself.

GROUP CAPTIVE DEFINED – A group of companies that comes together to form their own insurance company.

In the Construction Group Captive model the contractor joins a best-in-class group of its peers who are seeking greater transparency and increased control over the insurance process. The goals of the Group Captive are simple:

Fund for expected losses. This minimizes risk sharing across captive members, which is necessary for the captive to qualify as an insurance vehicle (and lets the contractor write off its premium as a business expense)
Let the contractor drive his success or failure in the captive. No member wants its success to be disproportionately impacted by another members’ claim activity.

Premiums are developed by actuarially predicting expected losses (the loss fund) and grossing up fixed expenses such as reinsurance costs, claims management costs, etc. These fixed expenses are unbundled (unlike in the standard insurance market) with the contractor knowing where every dollar of his premium is spent. Insurance is fronted with an A-rated standard market carrier, as is the reinsurance – so no-one ever need know the contractor is even in a Group Captive unless he wants them to know.

The captive retains a specific layer of risk per occurrence – usually $250,000 to $350,000 depending on the captive. Losses are paid out of the contractor’s loss fund up to the amount of the captive retention – any loss above that retention is paid by the captive reinsurer. If the contractor keeps its losses below the amount in the loss fund, it keeps the remaining underwriting profit plus investment income.

Members purchase one share of stock to become a shareholder. Each shareholder gets one seat on the board and one vote. In sound Construction Group Captives, the board of directors control all decisions including who administers claims (is it the carrier or a third-party-administrator?), the captive retention, who qualifies for membership, the captive growth and investment strategy, the captive fronting carrier and reinsurer, where the captive is domiciled (is it onshore or offshore), who administers the captive and most importantly, how much profit is distributed to the members.

This is a long-term strategic play. A contractor should not “dip its toe” in group captive waters. Most captives operate on a four-year accounting cycle, which allows losses to develop properly. This means that a contractor won’t reap the rewards of its success until the end of its fourth year in the captive. But once the contractor begins receiving profit distributions, it begins to truly understand the advantage that comes with being a captive member.

The upside benefits of Group Captive membership are very attractive to the right construction ownership/management team:

Ability to drive your success and capture underwriting profits and investment income normally reaped by the insurance carrier
Greater control over a large business expense
Increased spotlight on risk management that offers a bona fide ROI for controlling losses
Increased transparency and control by unbundling professional partners
Increased claims control (The TPA is working for you)
Best-in-class peer sharing with like-minded contractors
Stabilizes insurance pricing over time, offering the member a long-term competitive advantage

There is risk associated with being in a Group Captive as well:

Members must be willing to share risk with other members of the captive. In the right Group Captive model, risk sharing averages around five-percent, leaving the member responsible for 95% of their success in the captive.
Members face increased accountability to other members for managing losses
Good Group Captives are designed to sustain severity losses but not a high frequency of losses. No member wants to reward another member for sloppy loss performance. As such, members can be assessed additional premium for poor loss performance. This amount is capped and is transparent to the contractor at the onset of each policy year.
Some collateral is required to secure a portion of the loss fund.

Construction Group Captives are not for everyone… and not all Group Captives are created equal. The decision to join a captive requires a strategic leap-of-faith, the willingness to bet on yourself, and the desire to finally take control over this large business expense.

Ideal captive candidates spend a minimum of $250,000 across the casualty lines of coverage, are entrepreneurial, desire more control, have a commitment to loss control and safety and are financially strong.

As with many alternative risk financing vehicles, there is as much misinformation about captives as there is sound information in the marketplace. Please contact Chris O’Hagan (chris@jdkutter.com) or Brenda Mainer (brenda@jdkutter.com) from JD Kutter Insurance Associates via email or at (314) 657-2959 if you are interested in discussing how a Construction Group Captive might fit into your long-term risk management strategy.