Improving insurer purchasing power
In addition to reducing cost of capital, bundling the organisation’s risk through one entity may improve its purchasing power. The organisation can retain more risk than the sum of its individual subsidiaries without endangering its overall financial position. Increased retention positively impacts the organisation’s attitude to claims prevention and shows the market that management is committed to and confident of its risk management practice. It also avoids the expense of taking too much risk as is possible in a decentralised approach.
Cycle management and independence
The ability to retain more risk provides the organisation with greater independence from capacity available in the insurance market. Through the captive, the organisation can choose to retain more or less risk depending on market cycles. With a good program in place, the captive can accumulate substantial shareholder equity, which further increases the organisation’s capacity to retain risk.
Funding of non-insurable risks
The parent can protect its subsidiaries for risks that the insurance market is not willing to accept or that are too expensive to buy by incubating the risk in the captive as premium and loss information is developed over time in the captive, the parent is better positioned to approach the insurance or reinsurance market place for protection.
Control over claims settlement
Brand and reputation is highly crucial for many companies, especially those in the consumer goods and services sectors. Through a captive, the organisation may exert significantly more influence over how a claim is handled.
Setting of claims reserve
The risk management team is in a position to set reserves for the captive’s insurance liabilities. This involves substantial professional judgment as the reserves can be more or less conservative, reflecting the organisation’s attitude to risk.
Formal mechanism of risk retention
The captive’s premium and loss data are centralised. This provides a formal measure of the organisation’s overall risk management performance. Where appropriate and desirable, the organisation can turn its risk management department into a profit centre.
Appropriate funding of risk retention
The captive also provides feedback on the effectiveness of the organisation’s risk financing strategy. As the organisation acquires more experience, it can adjust the captive’s retention limits and use of available capital.
Corporate governance considerations
The captive structure creates a strong governance environment to manage risk across the organisation by centralising the collection of risk data in a regulated environment and promoting better risk management behaviours.
Creation of an additional revenue stream
Captives primarily insure the risk of its parent, however, there are many examples of captives that have expanded beyond their parent’s risk to provide insurance solutions to other parties. These strategies can be extremely successful when an insurance product is linked to the company’s overall marketing strategy to benefit core revenue lines (by creating differentiation in the marketplace) as well as earning profits from insurance products.
Contact Aon today to discuss how a captive can help your business.