- Programme structures have evolved, but remains common captive line
- Helps captives to build reseves and investment income
- Group captives common structure due to predictability of losses
Workers’ compensation is one of the most popular lines for captives to insure in the United States, with its predictability and stability allowing captives to build surplus and write more volatile risks.
As a result of its predictability, group captives are a popular structure to write workers’ compensation as members of the group generally feel secure in risk sharing.
Companies across all industries utilise their captives to write workers’ compensation risk and it is often those firms with the largest number of employees who tend to see the most benefit, whether utilising a group or single parent captive.
Despite its predictability, companies should be careful to implement effective cost control measures as there is still the chance for significant claims to occur.
“The differentiator is not industry-based, but more so employee-based,” Julie Patel, senior vice president and central zone captive consulting leader at Marsh, told Captive Intelligence.
“If they have a large employee count, then workers’ compensation risk could present a viable opportunity and something that they can operationally and financially benefit from.”
Nancy Gray, regional managing director at Aon, said around 50% of clients write property coverage in their captive, and workers’ compensation and general liability are not far behind.
Prabal Lakhanpal, senior vice president at Spring Consulting Group, said workers’ compensation is one of the top two or three most common lines for captives across the US.
Captives are generally not admitted in most US states to write the coverage directly.
“Historically, when captives first started writing workers’ compensation or general liability coverage, we used to have a fronting company licenced in the state and then the coverage was ceded to the captive as reinsurance,” Gray said.
The workers’ compensation policies are now predominantly written as large deductible programmes with a commercial insurer.
“The fronting company, the licensed carrier, will write a policy with maybe a $500,000 deductible or a million-dollar deductible, and then the captive will issue an indemnity policy to the parent company to indemnify them for the workers’ compensation or general liability losses,” Gray said.
“As a result, the captive is not writing a workers’ compensation or general liability policy, they’re writing a financial indemnification policy for these losses.”
Gray said that around 20 years ago, there were much lower deductible layers and retentions have since been driven up.
“It is not uncommon for large organisations to have a $500,000 or $1m deductible on their workers’ compensation or general liability insurance programmes, when historically it used to be $100,000, for instance.”
Lakhanpal said a workers’ compensation claim for client that is in a guaranteed cost programme and has a $500,000 claim on day zero, and the carrier might tell the client they need to hold a $500,000 reserve that will pay out over a 10-year time horizon.
“From a carrier perspective, they are attributing that complete cost of reserve to the client on day zero, which is to say, when the carrier computes the renewal, they’re attributing that as a claims cost, whereas in reality, from a cash flow perspective, they’re only paying out $50,000 of the $500,000 reserve in the first year,” he said.
The remaining $450,000 will then be disbursed over a nine-year period, and the carrier is then going to collect investment income on that reserve.
Lakhanpal added: “Fundamentally, if we think about it from a captive’s perspective, being able to hold on to the reserve, have transparency to how that is leveraged in computing future premiums and the investment income on the reserve is one of the best attributes of worker’s comp in a captive.”
Stability
Over the years, workers’ compensation has proved to be a highly stable and predictable line of business for captives.
“For many years, this stability and predictability were foundational principles of captive utilisation as the focus was on incorporating stable and predictable risks into captives to build up the reserves,” Steve Bauman, global programmes and captives director for the Americas at AXA XL, told Captive Intelligence.
“We’ve had decades of capital and surplus being built up in captives, and that’s provided the groundwork and the building blocks for captives now to take more volatile risks.”
Bauman said it is important for a captive to establish strong partnerships with reputable fronting companies, legal, service providers, and loss control professionals when writing workers’ compensation.
“These partnerships play a significant role in enhancing the effectiveness and overall success of the captive,” he said.
Patel said if a client is looking for a solution where they want to take on more risk, there are various options and lines of coverage they may want to consider.
“Many captive owners want to ensure the captive is not costing them anything additional compared to what they’re currently paying in terms of the total cost,” she said.
“They will look to see if the captive can at least break even or generate some savings, and many times it ends up being a combination of property as well as casualty, including workers’ compensation.”
Mitchell Dane-Henry, senior manager of insurance programmes at Sprouts Farmers Market, recently told Captive Intelligence that the company was looking to form a US domiciled captive so it can more effectively manoeuvre the commercial market.
Sprouts is a supermarket chain headquartered in Phoenix, Arizona. The company employs around 35,000 workers and operates more than 380 stores in 23 states.
“For us, I think a captive makes a lot of sense as much as we’re already spending the money to some extent,” Dane-Henry told Captive Intelligence.
The captive will begin life by writing workers’ compensation, general liability, and medical stop-loss.
“The obvious ones are the workers’ comp and the general liability, but for us to get the diversification that we need to qualify as an insurance company, we need that medical stop loss,” he explained.
Lakhanpal said that medical risk such as stop loss, or property do not have the same long tail risk as workers’ compensation.
“We are helping a lot of organisations think that through from an actuarial perspective to determine what is the sweet spot of funding for each of these lines and the best strategy to determine capital allocation,” he said.
He said that when individuals contemplate setting up captives, usually their greatest concern typically centres on the catastrophic nature of risks associated with any coverage they’re funding in a captive.
“Worker’s compensation because of its long tail assuages those concerns to a great degree from a cash flow perspective,” he added.
Group captives
Bauman said that for many years, workers’ compensation has been the primary coverage in group captives, particularly in the US.
“While this perspective is primarily US-centric, it serves as a significant indicator of the captive market,” Baumann said.
“However, there has been notable growth beyond workers’ compensation into other lines of business in recent years.”
Benz said that from a group captive product perspective, workers’ comp is the most predictable line of cover, so the group captive feels the most comfortable writing that line.
“With all the risk mitigation and loss control techniques we can put in place these days, it just lowers the expectation of a loss. We shouldn’t really be expecting a loss, we should expect zero losses.”
Challenges
Benz said one challenging aspect of workers’ compensation lies in the occurrence of significant nuclear claims which can be extremely unpredictable.
“It’s difficult to anticipate where the next claim of this size will come from,” he said. “These catastrophic claims cannot easily be factored into actuarial calculations.”
He said the captive layer assumes the most predictable portion, characterised by frequency and clear understanding, while the excess layers from the carrier side are more difficult.
Prabal Lakhanpal, senior vice president at Spring Consulting, said that although the US workers’ compensation market is very mature there are a few aspects that should be considered.
“One, if an organisation has not implemented good loss control measures, workers’ compensation can become an expensive coverage very quickly, and the tail associated with that coverage can therefore become a challenge as well,” he said.
“Secondly, workers’ compensation structures in captives can take a variety of forms, based on organisational needs.
“Thirdly, some states in the US are monopolistic in nature, meaning you typically have state funds that an employer must leverage to fund workers’ compensation.”