Joining a group captive can be a rewarding decision, but is not one to be entered into lightly, says Brenda Pickering of USA Risk Group in the British Virgin Islands.
One of the basic concepts of insurance is pooling risk. Any large insurance company relies on the distribution of risk or ‘the law of large numbers’ with the aim of having enough individual risks to be able to take in more premium than it pays out in claims. For larger entities such as Fortune 500 companies, the insurance risks within their own organisations are generally substantial and diverse enough to support a wholly-owned captive. These companies have significant financial resources and risk management infrastructure to efficiently manage their own risk.
The British Virgin Islands, one of the world’s leading domiciles for establishment of sophisticated reinsurance vehicles and captive insurance companies—including healthcare captives—is strategically positioned to facilitate many of such companies with the best solution for risk financing. Its commitment to this area has been proved in its innovation to introduce new products for a seamless approach to forming such structures for the healthcare industry using the group captive concept, which takes a similar approach but on a smaller scale.
Many smaller companies may see a captive as a potential benefit for their organizations. However, they lack sufficient risk diversification and/or risk management infrastructure to support a captive on their own. This is where the group captive comes in. When several like-minded organizations can come together to share risk and resources, a captive solution becomes more viable.
For a group captive, the five key elements of a captive—stability of insurance cost, stability of insurance coverage, access to the reinsurance market, focus on risk and loss control, and retention of premiums and the ability to earn underwriting profits and investments—apply.
Stability of insurance cost
This advantage over a single parent captive is that the group captive has the ability to stabilize insurance cost through risk-sharing of all participants therefore minimizing the cost of insurance through pricing and reinsurance.
"Successful group captives typically have highly engaged owners who actively oversee the various aspects of the captive’s operations to ensure optimal performance."
Stability of insurance coverage
This means that the premiums are taken from the participants’ own loss experience, which they have the ability to control.
Access to the reinsurance market
For certain coverages, such as property and group health stop-loss, access to reinsurance markets can be vital. By forming a group, entities can gain buying power that would be unavailable on an individual basis.
Focus on risk and loss control
Companies can share risk management resources such as loss control consultants, data analytics and risk management information systems. The cost for some of these resources would be prohibitive on an individual basis but become cost-efficient when shared between multiple companies.
Retention of premiums and the ability earn underwriting profits and investments
If the group is able to efficiently manage the combined risks, members retain the underwriting profits that would otherwise go to commercial insurance companies.
What type of groups can be formed?
The group captive can take two basic forms: homogenous or heterogeneous. In a homogeneous group, the entities making up the captive come from a similar, if not identical, industry such as nursing homes. While there may be some slight variation within the individual operations, all the group members will share some key characteristics.
Potential benefits of this structure include:
- The ability to apply standard underwriting criteria across the group;
- The ability to apply standard loss control and claim management resources; and
- The familiarity of members with the industry facilitates a focus on ‘best-in-class’ operations.
Potential drawbacks to this structure include:
- A lack of risk diversification;
- An economic downturn could affect all members at once;
- A mass recall or other catastrophic exposure could affect many members;
- Competitors may refuse to cooperate; and
- Insufficient number of qualified companies within the industry.
In the heterogeneous structure, companies from a variety of industries join together to form the group. Unlike the homogeneous group, the members may have little in common, either operationally or in terms of their risk profile.
Potential benefits to this structure include:
- More risk diversification;
- Industry/geographic variety;
- Less exposure to industry-specific risk;
- The ability to draw potential members from a much larger pool of entities; and
- The ability to learn from different industries and adopt new loss control techniques.
Possible drawbacks to this structure include:
- The need to apply a variety of underwriting criteria;
- It may be difficult to efficiently share loss control and claim management solutions due to varying needs of members; and
- Member cohesion may not be as strong.
What type of risk is shared?
The type of risks can vary from group to group. However, the coverages most commonly written through group captives are worker’s compensation, general liability and auto liability. Group captives may write one or all of those coverages.
Additional coverages sometimes written through group captives include auto physical damage, commercial property, and group health stop-loss, which is now becoming more common.
How much risk is assumed?
The amount of risk assumed varies from program to program. Most commonly, group captives assume per claim risk of $250,000 to $500,000. Above that amount, group captives will have reinsurance for catastrophic claims. Most group captives also purchase aggregate coverage, which protects the group in the event of adverse loss frequency.
How is risk shared?
In general, risk in a group captive can be shared either pro-rata or hierarchically.
In a pro-rata structure, risk is shared among the group based on their overall share of the program. For example, if there are 10 members with equal premium, each will have 10 percent of the risk. If there are 10 members but one member has 25 percent of the premium, they will assume 25 percent of the risk. This form of risk-sharing may be the easiest to apply and possibly the most equitable, assuming the premium accurately reflects individual loss experience.
In a hierarchical risk sharing structure, each member assumes a combination of its own risk and that of the group. For example, if the group captive has a $250,000 retention, each individual member may be responsible for the first $100,000 for each claim it incurs and the group shares risk for all claims between $100,000 and $250,000. This structure is often referred to as an ‘A/B fund’ where the ‘A’ fund is the individual retained risk and the ‘B’ fund is the shared layer of risk.
How are group captives owned and governed?
Ownership is generally pro-rata, based on the amount of premium a company contributes to the group. Since risk is usually shared pro-rata, this is the most equitable way to return underwriting profits to the owners. If profits were to be shared evenly, members with lower premiums may receive an inequitable amount of the profits while the higher premium paying members assume more of the underwriting risk.
While ownership may be pro-rata, governance is typically more evenly distributed. Different classes of shares may be issued to account for the amount of premium paid into the group captive, but in most group captives, each member will receive one share of voting stock regardless of overall percentage of ownership. While this may seem unfair, this ensures that all members have an equal say in the operation of the captive and interests remain aligned. Members are fully aware of the structure going in.
In order to ensure the optimal performance of the captive, group members must develop guidelines and procedures for all of the key operational areas. The owners are able to determine the best course of action for the captive by selecting a board to oversee the day-to-day operation of the company. The board’s tasks will include underwriting, loss control, claim management, finance and auditing.
Depending on the size of group, individual committees may be formed to oversee some or all of these areas. These committees are often the backbone of the captive by making financial decisions and investment with the backing of the board of directors to determine the long-term goals of the captive.
Group captives can be a highly effective risk management tool for companies that are interested in participating in a captive, but may either be too small to form their own captive or would like the benefit of more risk distribution and being able to share best practices with other companies. Group captives can be structured in a variety of different ways in terms of who can participate, which risks are covered, how risk is shared and how much risk is assumed.
Participation in a group captive can involve a significant financial commitment and a potential for financial loss. When a company is considering joining a group captive, it needs to take a number of factors into consideration. With the variety of group captive options available, it is essential for potential members to properly evaluate the merits of each program and structure. The prospective member needs to understand the terms of participation and the financial implications should they decide to leave the program. It should review captive financials and know who is participating in the group and how each member is underwritten.
Successful group captives typically have highly engaged owners who actively oversee the various aspects of the captive’s operations to ensure optimal performance. A prospective member should ask to attend a board meeting. Are the members active and engaged? Or do service providers seem to be calling the shots? Joining a group captive can be a rewarding decision, but is not one to be entered into lightly.
Brenda Pickering, ACI at USA Risk Group (BVI), Inc.
Brenda Pickering, USA Risk Group, US