Originally published in The Broker, Summer 2009
Mike Johns looks at the use of captives and Protected Cell Companies for insurance and the benefits for both the independent broker and the SME.
The concept of retaining risk through the use of a captive insurance company is not a new one. The original captive dates as far back as 1957, yet many independent brokers are still reluctant to introduce their clients to the concept and have overlooked the advantages such a vehicle could bring both to their client and their broking business.
In 1997, Guernsey introduced Protected Cell legislation which provided a more cost effective way of entering into self insurance. This effectively extended the "captive concept" to the small and medium sized enterprises (SMEs) which previously had been the sole realm of large multi-national companies, such as those appearing on the FTSE100. Whilst the PCC has been incredibly successful, and is now available in most domiciles, many SMEs are unaware of their uses and advantages, primarily because the broker has not recommended their use.
At the recent BIBA conference held in Manchester, there was a clear consensus amongst the brokers that, whilst premium rates are flat across many lines at the moment, the market will harden and rates will increase. Many SMEs are aware that it is impossible to insure every risk and they will have to focus on how best to manage their risks, decide which they wish to insure and whether to increase deductibles or retentions to maintain existing insurance costs. Captives and Protected Cell Companies (PCCs) can provide an alternative to the conventional market. Many independent brokers have now identified this and this was clearly demonstrated by a significant increase in the number of enquiries, particularly with regard to Protected Cells, during the conference.
So what can Captives and PCC's offer the typical larger client of an independent broker?
- An ability to smooth premium costs and the level of insurance coverage over a prolonged period of time, hopefully ignoring the volatility in the premium cycle.
- An ability to properly structure an insurance programme in a vehicle that will maximise underwriting profits. These profits will accrue to the captive owner.
- An ability to write risks that may previously have been considered "uninsurable" due to the conventional insurance market attitude to the risk or pricing structure.
- To reflect premium to the specific risk of the client and not a premium pool of other risks inclusive of administration costs of insurers.
However, it is important to emphasise that the benefits of using a captive or PCC are not restricted to the client. The broker can also enhance their business in the following ways:
Enhancement Of Risk Financing Capabilities
As a captive grows, the broker will become increasingly involved in providing support by way of sourcing and arranging reinsurance for existing and new covers. Where the captive becomes an increasingly dominant feature in the client's group structure, it will inevitably attract the attention of the main board and senior financial personnel. This can also provide a wider opportunity for the broker to promote other service offerings that may previously have been thought to be solely within the capabilities of the client's other professional advisers.
By emphasising their risk financing capabilities the smaller independent broker can elevate their service to that offered by the large international brokers who have their own captive management operations.
Insurance / Reinsurance Commissions
The use of a captive or PCC should not overtly impact the existing commission / fee structure that may exist. Pricing of the programme within the captive or PCC should be comparable to the conventional market including commission structures.
Producer Owned Insurance / Reinsurance Vehicle
Many independent brokers have valuable schemes and underwriting facilities that produce healthy profits for the incumbent insurers. Several brokers have set up their own captive or PCC to capture some of these programmes with appropriate stop-loss protection and become true underwriting operations.
Development Of A Long-Term Relationship
The relationship between the broker and the client is paramount. Brokers are entrusted to advise and assist in the selection of reputable insurance carriers. Whilst most of the time that works as a straight forward broker/client relationship an increasing number of the clients are becoming more sophisticated in their insurance buying and are moving to a more in-depth consideration of their internal and external risk. The establishment of a Captive or PCC Cell will commit the client to a long-term relationship with the Broker and the Captive Manager to develop their organisation's risk management strategy.
Whilst no-one can accurately predict when rates will harden, both SME's and independent brokers should prepare. By establishing an alternative vehicle, now both parties can ideally position themselves to avoid any undue influences of the premium cycle.
Guernsey hosts more captives than any other jurisdiction in Europe and is the fourth largest captive domicile in the world.
40% of the FTSE 100 and 95 of the Global 1500 have captives in Guernsey.
Approximately half of the captives established by UK companies are based in Guernsey, although the Island hosts captives from more than 40 different jurisdictions.
About The Author
Mike Johns ACII is Insurance Executive at Alternative Risk Management in Guernsey.
He has 22 years industry experience, 15 of which have been in the captive sector.
A past President of the Insurance Institute in Guernsey, Mike is currently an Executive Committee member of the Guernsey Insurance Company Management Association (GICMA).
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.