Reeling in smaller players

Risk & Insurance, August, 2004 by Bonnie McGeer

For some industries, alternative risk mechanisms are becoming less of an option to traditional insurance and more like the only choice. As this shift takes place, Main Street executives who once stressed about the transition are feeling more comfortable and confident, talking up the benefits that experts believe will make these once-obscure transactions even more commonplace.

A captive insurance company--once the domain of only large national and multinational businesses, is becoming popular with the middle market and smaller companies as overall activity in alternative risk transfer is on the rise, industry watchers say. Jim Auden, a senior director in the insurance group at Fitch Ratings in Chicago, says significant rate increases on traditional insurance coaxed many companies toward the alternative market over the past few years. "You see companies, even if they're keeping traditional insurance, they're raising their retentions--the point where the insurance kicks in," Auden says.

Neal Enriquez, a vice president and executive underwriter in risk management at Chubb Commercial Insurance, has been working with alternative risk mechanisms for the past 13 years. He says Chubb's business in that area grew 36 percent in 2002 and another 21 percent in 2003.

The trend appears to be continuing even as the hard market begins to abate.

"Since the onset of the hard market, post-Sept. 11, there was a tremendous increase in premium rates for property and liability. Companies were scrambling to reduce premiums by retaining more risk--in other words, self-insuring. So we saw a tremendous increase in inquiries about alternative risk," Enriquez says. "We're still seeing that--even though the hard market surge is somewhat leveling. We haven't seen any sudden about-face."

He says Chubb generally targets companies in food service, hospitality and light manufacturing, so those are the industries where it is seeing the most activity in alternative risk.

PLEASE, S.I.R., GIVE ME MORE

For companies looking at alternative risk transfer mechanisms, Michael Murphy, president of Risk Cap, a Denver-based consulting firm that designs, implements and manages captives, says a self-insured retention, or S.I.R., program offers a relatively simple way to get into the alternative market.

The technique, whereby the self-insured entity retains claims management control, is becoming pervasive. "It is the largest segment of the alternative market--two or three times larger than the U.S. captive industry," he says.

But to get started, a company must go through a state application and permit process to become a "qualified self-insured." The option is used largely for workers' comp, and companies need to have a concentration of employees in a certain state to make it worthwhile. Some states require companies employ a minimum of 300 to 500 employees, Murphy also says.

A more complex route is forming a captive. There are numerous variations on that option, with the size of a company being a factor, Murphy says.

The single-parent captive requires some heft, but unlike an S.I.R. program, often allows a company the benefit of a tax deduction for the premiums it pays. A group captive accommodates multiple policyholders; an example would be 10 hospitals coming together to self-insure for medical malpractice.

Although a captive can entail large start-up costs, prohibitive insurance premium hikes are making this option more attractive to smaller firms.

"Many people felt, prior to Sept. 11, the whole single-parent captive market was saturated," Murphy says. "But suddenly, midsize accounts paying $60,000 a year in premiums were looking at renewals of twice that. It was a surprise to many of us how massive the effect was on the alternative risk market. There was a huge wave in an area that we would have thought was already saturated."

CAPTIVE CONSIDERATIONS

By owning a captive insurance company, a business can obtain insurance coverage for virtually any risk. If claims are low, it also retains the money set aside as reserves, plus any investment income.

But Chubb's Enriquez cautions that companies need to be interested in more than an immediate cash benefit to go the captive route.

Enriquez says for a company with a deductible of $100,000, a cost analysis comparing the option of retaining the first $100,000 versus setting up a captive, shows that taking the large deductible is more economical--based on dollars. "However, one thing we can't quantify is the long-term benefit of having your own insurance company," he says. "Over time, the surplus earned in that captive can be used for their property program or for lines that are difficult to place."

For those intimidated by the single-parent captive, Enriquez pitches the rent-a-captive option. "It's a good way of introducing them to the concept without them having to invest a lot of money," he says. "You can be in a couple of years and, if you don't like it, it's easy to unwind. If you like it, you can continue, or form your own captive."