Captive insurance offers many potential benefits, including reduced premium expenses, more control over insurance program structure, access to different pools of capital, including reinsurance and ART markets, and additional investment income. But, growing a captive company demands resources. Risk managers need buy-in from senior leadership in order to get the capital necessary to expand, and that means demonstrating ROI in clear and definitive terms. To demonstrate the ROI of captive expansion effectively, risk managers need to do these three things:
Speak the language of the CFO
A CFO needs to see numbers. Risk managers excel in managing budgetary spend usually associated with readily available information such as insurance premium and expected claims, (the technical account),and may not necessarily have available other variables which contribute to the group cost of insurance in terms of profit and loss, but they will need to place their captive plans into a long term financial forecast to make a clear case to their CFO. This means understanding the accounting language and principles that a parent company uses, as well as aligning to the parent reporting standards (e.g. IFRS or GAAP) and translating things like claims, including IBNR treatment and investment income into balance sheet items.
A risk manager will know what amount of premium goes into the captive, and how much goes out in claims. They can calculate the daily expenses, and reasonably project investment growth. Bringing all of that over into a 5- or 10-year financial plan whilst incorporating the capital adequacy and the opportunity cost of capital to the group, is a key requirement to demonstrate how a captive will support the goals and objectives of the primary business long-term. The process defines a captive in terms that are more relatable and clear to the C-suite whilst also leveraging risk transfer markets.
Highlight flexibility in the face of uncertainty
Insurance purchasing decisions are dictated largely by market dynamics, and no risk manager can predict with 100% certainty how markets will shift over time.
As renewal time approaches, a risk manager may be faced with sudden hardening markets and rising rates, or, depending on topical issues, they could experience a significant contraction of cover. The risk manager might not agree with how a market is moving, or believe that a jump in premiums is justified and they are unlikely to be willing to rely wholly on the vagaries of the insurance market.
There are many other ways to tap into risk capital. For example, captives can assume greater risk and access reinsurance markets for the transfer of large and unpredictable risks, and this gives them the ability to adjust retention levels to gain greater control over how they respond to market fluctuations, and how significantly those fluctuations affect overall budgetary spend.
Choosing to retain more risk in the captive versus leaking more premium into the market helps companies weather the ups and downs of market cycles with greater predictability. With greater control over the price of risk that goes into a captive, and clear visibility of the cost of reinsurance, comes greater long term budget stability despite inconsistent responses from the insurance market.
Focus on benefits of loss prevention and data ownership
Risk mitigation and loss prevention are critical to an effective risk financing strategy.
Data plays a key role here. Claims data helps to unveil where a company’s key exposures lie based on historical loss records. In addition, exposure data can supplement claims data and is typically included in actuarial modelling which helps inform the company about key exposures, including location sensitive Nat Cat losses. Data collected through site inspections can highlight opportunities for different mitigation controls. Identifying what loss prevention measures will have the greatest impact on a captive’s bottom line is made possible through the collection of detailed, site-specific, and business-specific data.
In the insurance world, there are always discussions around who owns data and whose duty it is to protect it. Mature captive companies with their own loss engineering survey programs have control over their own data and can more seamlessly put this data into action to positively affect risk profile. This allows for a more holistic view of risk management across the company as a whole and allows for more productive conversations with (re)insurance markets when renewal time rolls around.
The effects of targeted loss prevention efforts flow through the entire risk financing strategy, allowing for more confident decision making around risk transfer and retention, which again helps to control spend and keep the captive budget aligned with the broader financial strategy of the parent company.
Conversations around captive insurance strategies are multi-faceted and complex, but risk managers armed with the right data — financial, risk and otherwise — can paint a picture of how greater control and ownership over the risk financing strategy afforded by a robust captive translates to greater long-term stability for parent companies.