The evolution of a physician-owned captive

The Cooperative of American Physicians Insurance Company, domiciled in Hawaii in 2002, has proved its worth as a a long-term, stable alternative to the commercial marketplace. Sarah Pacini, CEO of the Cooperative of American Physicians, and Jason Flaxbeard, executive managing director of Beecher Carlson, outline its evolution.

Within the insurance industry, certain criteria are required to effect a hardening market turn. These include a material decline in capacity, a tightening reinsurance market, a prolonged period of underwriting losses and the industry’s renewed underwriting discipline.

Captives have expanded within a hard market framework since the industry’s inception. Healthcare captives more so, following the lack of underwriting capacity in the 1980s through the mid-2000s. The rise and expansion of captives and risk retention groups has led to a period of competition within the industry, rising capacity and a focus on underwriting results and safety. Although born in a hard market, this focus on risk management, reduction in costs and control over losses (lessons learned from losses defined program structure) is what gave rise to the Cooperative of American Physicians Insurance Company (CAPIC).

CAPIC was domiciled in Hawaii in 2002 as a wholly-owned captive insurance subsidiary of the Cooperative of American Physicians (CAP). Throughout the years leading up to the formation of our captive, we found the reinsurance industry struggling to understand the uniqueness of our risk financing model for medical professional liability (MPL), which often led to fluctuations in offered reinsurance terms. We determined that by forming a captive we could leverage its capacity, flexibility, and creativity to achieve the organization’s immediate and strategic needs.

Initially, CAPIC’s business was limited to providing the Mutual Protection Trust (MPT) with excess of loss, aggregate excess of loss reinsurance, and systematic coverages. As CAPIC’s capital position strengthened over time, additional coverages and benefits were designed and added to support the relationship between CAPIC and CAP and MPT.

“Good underwriting leads to capital growth and captives and RRGs use this capital to their members’ advantage.”

The benefits to the organization and its members have been significant. The captive continues to perform profitably through disciplined underwriting, creative risk financing solutions, expanded and enhanced coverages, and exceptional claim and risk management services to its insureds. The addition of the assumed MPL reinsurance business allows CAPIC to diversify its premium composition, grow the business in a measured manner, support the medical community, and remain supportive of the strategic initiatives of its affiliated companies.

With this as a guide, below is a listing as to why so many healthcare organizations maintain captives:

1. Healthcare companies have used captives to evidence coverage through an entity that (a) is regulated; (b) is audited; and (c) allows excess insurers evidence that the liabilities retained by the company are properly stated. As a result, the investment recovery can be significant as the captive holds funds until losses are settled, investing them along the way. 
2. Captives have the ability to manuscript coverage ahead of what is commercially available. This has allowed healthcare organizations to cover risks they may have otherwise self-insured. 
3. Hospital senior management is sophisticated and appreciates the ability to understand and be more involved in claims payment and management decisions, investment decisions, risk management strategies and education. In many healthcare companies, risk management training is paid for by the captive, defining protocols based on loss data received. 
4. For some entities, having access to a captive has allowed access to an expanded selection of re/insurance companies for the risk and better structure for a particular risk (eg, stop-loss corridors). 
5. CFOs may like budgets but they love cost certainty. What a captive does for healthcare organizations is smooth the cost of insurance over years. A properly structured program allows funds to be built up and allocated to the different units in a hospital. What CFOs don’t like is pulling resources from a capital project following a material medical professional loss. This cost can be borne by a captive while smoothing the access to cash over a number of years. 
6. Perhaps the most material aspect of captives in a fully online world would be the access to data and its use to improve patient safety. When a hospital funds its own insurance program through a captive, it must be cheaper than the risk transfer market, offer better coverage and handle claims in a manner that improves decision making. Many CFOs tell me that when the funds come from the company pot rather than from a different capital source, including the insurance market, the pain is greater and the lesson is learned much quicker.

CAPIC’s life

So, back then to CAPIC and its evolution within the above structure. In 2013, management made a strategic decision to re-license CAPIC as a class 4 sponsored captive with access segregated cells. This action was part of a larger initiative by its parent company, CAP, to broaden its medical professional liability offering to large physician groups and hospitals, both in California and in other states.

In conjunction with CAPIC’s relicensing, CAP formed CAPAssurance, a risk purchasing group (RPG), a non-profit, unincorporated association established to allow large physician groups, hospitals, and healthcare facilities to access medical professional liability insurance products through an agreement with a national A+ rated insurance company. Under the agreements, certain risk management, claims administration, and other policy services are provided to the insurance carrier by CAP. The agreement with the insurance carrier included a quota-share reinsurance agreement with CAPIC relating solely to business written through CAPAssurance.

What is important in the above is the evolution of the captive vehicle to take advantage of different structures to access premium, help members and develop solutions. RPGs and risk retention groups (RRGs) were created in the 1986 Liability Risk Retention Act to allow groups access to insurance paper through developing a homogeneous platform. By creating these vehicles, purchasing power is increased. Also, being an insurance vehicle, these entities can purchase reinsurance. There is conventional wisdom that reinsurance is often cheaper than insurance as it attracts less regulation. But for healthcare RRGs and RPGs, the access to the reinsurance market in any form was vital during the 1990s and beyond. Having a capital partner willing to provide support was all important when the medical malpractice market was hard.

The choice of Hawaii for CAPIC is also interesting. The Cayman Islands have been the traditional domicile for healthcare entities since the first hospital captive was originally domiciled there. The Cayman Islands Monetary Authority has significant experience and a history of stability and effective regulation that is not over-reaching. It offers a jurisdiction that doesn’t tax premiums and that, for not-for-profit entities, allows an element of tax certainty.

Hawaii, on the other hand, being proximate to California, offers a strong onshore presence coupled with a good relationship with the California Division of Insurance. The Hawaii premium tax is also favorable, with reinsurance premiums remaining untaxed. Coupled with a regulator that offers expertise in the management, regulation and operation of captives and Hawaii paints an excellent picture.

Being in the US, there are also expansion opportunities should CAPIC ever look to expand into, eg, benefit coverages for members.

For an entity such as CAP, the captive has offered a stable member premium, achieved outside the hard/soft market cycle as captive premiums are set solely on member experience rather than a carrier’s need to charge premium for lines that are performing poorly. What is of concern to captive, however, is a soft market where risk transfer markets are able to use their greater capital base to attract customers out of the alternative market. This has happened over the past few years as reinsurance capital has provided the healthcare industry with ample capacity.

Working together

Captives and RRGs must therefore work to keep their customer base in this portion of the market cycle. They do this in a number of ways:

1. Member experience is paramount. RRGs and entities such as CAPIC have the data and resources to assist members whether that be from a training perspective or from a risk management process/procedure perspective.
2. Claim handling is vital in the healthcare. Being a part of a membership organization allows doctors to receive specialized, focused and personal treatment. Members are more than just numbers.
3. Even in a soft market, members can be rewarded for periods of low losses. Good underwriting leads to capital growth and captives and RRGs use this capital to their members’ advantage, whether that be through the understanding that hard markets will return and premiums remain stable, access to other physicians for peer-to-peer discussions or a policy form that is tailored for specific risks and outcomes.

In conclusion, what part of the market cycle are we in now and are captives relevant?

We don’t yet have a material decline in insurer capacity, reinsurance markets are not tightening, we are in an underwriting period of stability as combined ratios hover around the 100 percent mark and the industry is beginning to renew underwriting discipline.

So, in short, we are currently in a soft market with the horizon looking fairly (famous last words) benign. In this landscape, CAPIC and other captives still excel. Good leadership, membership focus and a reliance on good data to drive insurance decisions, including the access to reinsurers, remains as important as ever.
Captives are not just a hard market tactic. They are much bigger than that. They are a risk management tool designed to offer membership a long term, stable alternative to the commercial marketplace. CAPIC is evidence of this commitment.