Originally published in Captive & ART Review Guernsey Supplement, May 2007
Could independent brokers be missing out on wider business opportunities in the small and midsize enterprises (SME) community by not getting involved with captives? Charles Allen, of Heritage Insurance Management (formerly Prism Insurance Management) a member of the Heritage Group, thinks that not enough is being done to apprise brokers of the potential benefits of introducing captive insurance concepts to their larger clients – which is where the independent manager steps in.
The ideal candidate for the evolution from captive-shy to captive-friendly is a broker who doesn’t have within their organisation the ability to offer a captive management arm to theirs clients, or the knowledge and/or will to do so. The ideal partner to effect this change in attitude is, in Allen’s view, an independent captive manager with no ties to a broker, insurer or other service provider, who is therefore in a position to offer that service to the broker on a no-conflict basis.
"There’s one particular quotation from Charles Darwin that we often use when we talk to brokers about the role of the independent captive manager and captives in general," says Allen: "It is not the strongest of the species that survives, nor the most intelligent. It is the one that is most adaptable to change."
In other words, it is the broker who can move with the times and make sure that they’re always offering the newest and best technology in insurance terms. "Adaptation to change, in our view, is accepting the fact that self-insurance is a very useful tool, for many businesses," says Allen. "It fulfils a number of objectives. It allows them to write policies that perhaps they find it quite difficult to place in the open/retail market, thereby accessing the reinsurance markets behind some form of captive retention or other involvement. It also allows them to look at wordings and the extent to which certain types of coverage are excluded in the market."
Allen is concerned with middle-tier and smaller brokers who could be persuaded to offer captives or cells in protected cell companies (PCCs) to their clients. His argument is that brokers, at the point of renewal with a client, should be in the position of offering the widest possible selection of alternatives and innovative ideas to their clients. Many brokers, in his view (and especially the smaller ones) will have a few ‘star performers’ – star clients in their portfolio – who are essentially very high fee-earning or commission-earning clients for the brokers.
"They are at risk from the larger brokers – Marsh, Willis, Aon – or those brokers, shall we say, who have their own captive management offering and have experience at doing that sort of structuring," he says. "They need to have that in their armoury, whether they use it or not."
The issue at stake in persuading brokers of the value of captive business is the apparent difficulty of convincing them that they are not going to lose their carefully nourished brokerage by allowing clients to choose self-insurance. The introduction of a captive manager into the relationship with the broker and client implies a dilution of control, but Allen refutes this. "The loss of brokerage is usually minimal, and is often more than compensated for by reinsurance-placing opportunities and new policies not previously placed by that broker," he says.
There is also scope, once the captive has been started, to examine the risk management strategy of the company as a whole. Brokers will, of necessity, become closely involved in that process because the reason the examination process is going ahead is precisely that the broker has introduced a new form of risk transfer and financial enterprise to that client in the first place.
And this is where the relationship really starts to bear fruit for both parties. In examining the risk management strategy of a client, the broker comes across other policies – perhaps held by other brokers, or policies that haven’t even been placed yet – and they pick up more business from that client, which is either placed into the captive or direct into the market.
As Allen explains: "There’s other business within that client that the broker didn’t previously see, which he is now being made privy to because he’s providing more than just an annual renewal service on a certain number of policies."
But why should brokers be wary of captives in the first place? Allen believes there is sometimes a natural resistance within the broking community to third parties getting involved with their client on the placing side.
"There’s a great deal of trepidation about the relationship being shared," he says. "They’ve got the relationship, they’ve spent a lot of money on securing the client and making sure that client receives excellent service – and when another service provider comes on the scene, there is a perception that it could dilute the relationship they have worked hard to secure."
It would seem that middle-tier brokers might have something to learn about captives and their potential advantages. However, Allen says that as long as they do at least find out what captives are and how they operate, then it doesn’t really matter if they then sit on that information, as long as it’s at their disposal when confronted by a client who wants details of this option.
"The broker needs to be clued up on that. If the client’s heard of it and the broker hasn’t, then that’s the wrong way round," he says. "It’s the broker who should be saying to the client: ‘this is another way of transferring risk, and we can assist you in tackling this process’. I would have thought that’s a very good opportunity for a broker to shine in front of their client, even if it doesn’t happen."
Case study success
Heritage’s approach to getting brokers on board the captive ship is to make presentations to about six to 10 smaller brokers each year, giving them case study examples to illustrate what can be achieved. Its success rate has been to secure new captive or cell business from several of those brokers targeted for each year. Allen points out that the ones that take it no further often come back to the material a year or two later when the subject arises with a client – and then the issue can be addressed again, when the timing is perhaps better for both parties.
Heritage currently manages 35 fully formed captive subsidiaries of parents and 10 PCCs, within which there are about 80 cells. Allen attributes the popularity of the PCC structure to the ease of start-up: compliance and regulatory aspects are effectively already implicit in the structure of the PCC; cell-management agreements look after the relationship between the cell owner and the PCC; and overall the process is quicker and cheaper than setting up a wholly owned subsidiary.
An additional plus is that, as a first step into captive insurance, the PCC cell can, if successful, be easily translated into a fully blown captive. Clients can form their own subsidiary, and simply novate the policies from the PCC cell into the captive.
A PCC or cell is also an extremely good way for a broker to dip their toe into captive business. From a broker’s point of view, it doesn’t make much difference if it’s a cell or a captive and it’s often quicker to start up a cell for a client.
"One of the most important things is that, if it’s a captive or a cell, you want the person who is deciding to go down this road to buy into the strategy," says Allen. "The only way they really buy into the strategy is if they put capital on the line."
As far as incorporated cell companies (ICCs) are concerned, Heritage see potential additional benefits in these structures. Nick Heys, Heritage’s new business director, lists the advantages of ICCs as follows:
- They offer clear ownership distinction between the ICC and the individual cells;
- They offer quick and easy access to special purpose vehicles (SPVs);
- They have the ability to provide intercellular transactions: one cell transacting with another as a separate legal entity;
- There are possible combinations of cell transactions such as: short-term versus long-term business; residual value SPVs that sit alongside the asset – the SPV in one cell, the asset owned in another cell;
- ICCs are very much more focused on a structured insurance basis as opposed to what would be considered a more traditional captive insurance/reinsurance basis.
"The basic underlying advantage, in our view, of setting up or getting a client involved in a captive or PCC arrangement is that it creates a much longer-term relationship with that client", says Allen. Additional to this – and critical in Allen’s view – is that, in setting up a captive or cell, a broker can get much closer to the senior management of their client – especially the larger ones.
"You often get the financial director sitting on the board of the captive – and very interested in the results of the venture," explains Allen. "You get very senior people, main board players, starting to take an interest in the result of this new subsidiary that they are running. The broker then has a better potential level of business from that client than he had before."
In short, by not engaging with the captive industry, brokers are potentially denying themselves the opportunity to grow and evolve the relationship with their key clients, and face the potential risk of the larger players successfully attacking their best business.
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