SELF INSURE IF THEY DON’T UNDERWRITE IT
By Melvin J. Howard
In this climate of shaky insurance companies i.e. down grade in their credit ratings as a result of subprime mortgages pouring over into other markets. Not to mention the high cost of premiums if you can find a stable insurance company. Maybe you should self insure with a captive. What is a captive it is a general term a captive could be a finance arm of a manufacturer like GE, IBM, Motorola etc. Or an automotive builder such as GM and Ford credit. But for this purpose I will use the term captive for an insurance company that is established (generally in a tax neutral jurisdiction) which is owned by one or more non-insurance organizations to underwrite the risks of those particular owners. A variant is an 'Agency Captive’, which is owned by independent agents who wish to participate in the underwriting results of the business they produce. A Captive can also be owned by a number of unrelated companies from within a particular industry (a homogeneous Group Captive), by a number of unrelated companies from different industries (a heterogeneous group Captive) or by a trade or industry association (an Association Captive) to insure the risks of the group owners or association. I have used this technique a number of times as well as advising my clients to do so also. It is especially useful for insuring liabilities that some insurance companies will not cover. You also may make a good return on your investment at the same time.
For this proposes I will use the Rent-a-Captive program which I have used on a number of occasions. A Rent-a-Captive is an independently owned and operated insurance company that allows unrelated companies to use or "rent" its capital, surplus and corporate structure to enable those companies to participate in the underwriting results of the risks they insure into the Rent-a-Captive. Companies interested in utilizing a Rent-a-Captive include associations and independent agents. The Rent-a-Captive performs on a "turn-key" basis the same functions and achieves the same goals as a Captive insurance company, but your company ("lessee") does not own, control or capitalize the Rent-a-Captive.
The costs of capitalizing and operating a Captive insurance company (usually on an after tax basis) are typically higher than utilizing a Rent-a-Captive. Operating a Captive also requires more management time than participating in a Rent-a-Captive. Furthermore, programs in a Rent-a-Captive are much easier to exit than a Captive which requires formal liquidation or sale. In summary, participation in a Rent-a-Captive eliminates the substantial organizational requirements and the need to commit funds for capitalization.
Advantages
The advantages of using this program include the following:
i) the ability to participate in underwriting profits as a individual basis;
ii) the ability to purchase insurance related services on an unbundled basis;
iii) the ability to determine levels of risk assumption;
iv) the ability to reduce and control costs;
v) the ability to carry less administrative and legal costs than those passed on by the insurer;
vi) the ability to earn investment income on premiums paid; and
vii) To accumulate investment income on premiums received.
viii) The elimination of the reimbursement agreement between the bank and obligor (SPE).
ix) Tailor made policies for a particular coverage that is unavailable or in this case unacceptable priced in the commercial market
x) no feasibility study
xi) proof of coverage
xii) flexible operating covenants
xiii) easily can be incorporated into the preliminary official statement
Features of Rent-a-Captive
The primary cost reduction factor is the element of risk retention held by your company. Under a Rent-a-Captive structure, your company retains a portion of its own risk at a level mutually acceptable to both Your Company and the Rent-a-Captive. In the event of a loss or in this case default on the principal and interest payments due the note holders Your Company is responsible to pay claims up to that retention level. However, by "self-insuring" to this retained limit, Your Company reduces its premium costs because the cost of obtaining coverage for limits of insurance above the retention is less than purchasing insurance that attaches at the first dollar of loss, i.e. without any retention. These reductions in costs take place over time and are generally not applicable to Your Company.
Risk Management
Risk management, or loss control, plays a major role in the Rent-a-Captive structure and provides a means for further cost reduction for Your Company. Good loss experience is reflected in the rates to participate in the Rent-a-Captive. By employing effective loss control measures at Your Company, we can reduce our insurance exposure thereby potentially increasing underwriting profits available to Your Company and, at the same time, keeping premium costs down. Your company can also benefit from risk management by improving loss control. A reduction in loss costs should result in increased funds available for investment to offset future claims.
Participation in Rent-a-Captives
There is no specific formula for determining who should participate in a rent-a-Captive program. However, the program is generally suitable to organizations having total annual premium costs in excess of $2,000,000, for agents who can direct a book of business in excess of $5,000,000 and for groups or associations having total annual premium costs in excess of $1,500,000.
Under a typical rent-a-Captive program, an insured or agent obtains primary insurance coverage from a direct insurer. The primary insurer will then cede, or transfer, to the rent-a-Captive a portion of the primary insurance coverage in an amount equal to the limit that the insured wishes to retain itself. The net premium received by the rent-a- Captive from the primary insurer for the risk transferred is tracked in a "separate account" maintained by the rent-a-Captive on behalf of the insured. Each entity in the rent-a Captive Program purchases an account certificate (the "Certificate") for a specified sum ("Purchase Price"). Then Your Company provides contingent capital to the Captive to cover the difference between the loss fund ceded to the Rent-a-Captive and the aggregate limit it assumes. The contingent capital, together with the net ceded premium, is invested primarily in cash equivalents and other low risk investments, as permitted by which ever jurisdictional law and is available to satisfy any claims against the insured within its retained limit.
Costs of Participation
Under a typical rent-a-Captive program, an insured or agent obtains primary insurance coverage from a direct insurer. The primary insurer will then cede, or transfer, to the rent-a-Captive a portion of the primary insurance coverage in an amount equal to the limit that the insured wishes to retain itself. The net premium received by the rent-a- Captive from the primary insurer for the risk transferred is tracked in a "separate account" maintained by the rent-a-Captive on behalf of the insured. Each entity in the rent-a Captive Program purchases an account certificate (the "Certificate") for a specified sum ("Purchase Price"). Then Your Company provides contingent capital to the Captive to cover the difference between the loss fund ceded to the Rent-a-Captive and the aggregate limit it assumes. The contingent capital, together with the net ceded premium, is invested primarily in cash equivalents and other low risk investments, as permitted by which ever jurisdictional law and is available to satisfy any claims against the insured within its retained limit.
Costs of Participation
The basic costs to a rent-a-Captive program are:
i.) Fronting fees charged by the insurance carrier to cover policy issuance, taxes and other related costs;
ii) Fees charged by the Rent-a-Captive to access and manage the facility;
iii) Fees for providing letters of credit to the insurance carrier and to cover any contingent capital;
iv) Costs of any excess reinsurance required to limit the your company’s exposure; v) Costs of contingent capital.
i.) Fronting fees charged by the insurance carrier to cover policy issuance, taxes and other related costs;
ii) Fees charged by the Rent-a-Captive to access and manage the facility;
iii) Fees for providing letters of credit to the insurance carrier and to cover any contingent capital;
iv) Costs of any excess reinsurance required to limit the your company’s exposure; v) Costs of contingent capital.
Distributions to Your Company
In the event your company’s cell produces a profit (i.e. premiums plus investment income exceed losses and program expenses), distributions to Your Company are made pursuant to an Accountholder Agreement entered into between your company(s) and the rent-a-Captive. Your company is entitled to a portion of the undistributed underwriting profit and investment income earned, to be paid at specific intervals as set forth in the Accountholder Agreement. Timing for distribution payments is typically agreed in advance between Your Company and the rent-a-Captive, and the first such payment is not expected to be made prior to 24 months following the effective date of the Agreement.
Settlement of Claims
Settlement of Claims
In the event of a claim, payment is made to the claimant by the primary insurance carrier or by a third party administrator ("TPA"). The rent-a-Captive reimburses the primary insurance carrier or the TPA up to the amount of loss retained by your company using the funds held in your company’s cell. If claims exceed the premiums (net of expenses) received into your company’s cell, the rent-a-Captive can use the contingency contributions (or the letter of credit) provided by your company to satisfy the claim or it may seek a contribution from Your Company.
Losses
Losses
If Your Company’s liability for losses exceeds the premiums received (net of expenses), it is possible that Your company would lose its initial contribution, i.e, pay more than the standard premium for the policy, as well as the contingent funds provided. The rent-a-Captive makes no representation that an account will be profitable, nor does it guarantee the Your company’s initial contribution or any returns thereon.
Retention of Risk by Rent-a-Captive
Retention of Risk by Rent-a-Captive
Under a rent-a-Captive Program, the risk is shared between your company and the primary insurance carrier.
In summary the insurance company will issue a policy in which Your Company takes a sizeable deductible and the rent captive issues a policy directly to Your Company for the deductible layer with a combination of premium and collateral. The policy will be funded on a annual basis to guarantee the timely payments of principal and interest. The policy can be for a multiple of years. In this day and age you must become creative and aggressive in how you manage your potential liabilities. I hope I have given you some food for thought.
In summary the insurance company will issue a policy in which Your Company takes a sizeable deductible and the rent captive issues a policy directly to Your Company for the deductible layer with a combination of premium and collateral. The policy will be funded on a annual basis to guarantee the timely payments of principal and interest. The policy can be for a multiple of years. In this day and age you must become creative and aggressive in how you manage your potential liabilities. I hope I have given you some food for thought.
