The Case for Centralized In-House Loss Control with Captive Insurance

This article outlines some of the potential advantages of embedding centralized loss control within a captive and how, in some cases, doing so can reduce an organization's cost of risk. It then outlines some specific methodologies utilized in support of my company's captive. Some specific examples are used to illustrate the points in the article.

As background, I am part of the risk management group for an industrial conglomerate that is comprised of a number of disparate types of businesses (e.g., chemicals, mining, steel, security products, marine products, waste disposal, electric and water utilities) in different countries and operating environments. To the extent it makes sense, we normalize safety and health and property protection/preservation policies, strategies, initiatives, and legal compliance templates across business units so that all sectors of the organization are working within a common enterprise risk management (ERM) framework and toward common goals

General Advantages of In-House Loss Control

How can embedding loss control services into a captive drive superior results for an organization? Let's start with some background on the mechanics, as follows.

• Greater control over your destiny: utilizing experienced and qualified internal resources on a proactive basis allows you to focus on issues and solutions that are relevant to your specific business operations and your stakeholders (such as your reinsurance partners).
• Results in greater alignment between the goals of the business and those of the captive.
• A positive loss control story, supported by a track record of tangible results, can be a powerful tool in a captive's discussions with insurance rating agencies, such as A.M. Best (for those captives that seek an initial rating or seek a rating upgrade). Once a captive achieves a certain rating, it may negate the necessity for fronting and related costs/administrative tasks (issuing insurer costs, letters of credit, cut-throughs, etc.). This can result in a meaningful and measurable reduction in the cost of risk.
• As a follow-on to the point above, ERM presentations to financial rating agencies such as S&P and Moody's can be a factor in the parent organization receiving an improved credit rating. Higher ratings can result in a lower cost of capital for the organization.
• In-house resources have greater, more in-depth knowledge of operational issues and may identify risks that would not be noticed by third-party loss control professionals. Additionally, operating units will typically feel more comfortable working with, and be more open toward, a fellow team member who they know and whose consultation they trust.
• In-house expertise can be augmented as appropriate, by third-party experts in a particular area or discipline, as controlled and directed by in-house loss control. Careful selection and management of third-party consultants serve to control costs, standardize processes, and support credibility throughout the organization.
• For captives that earn a profit, some of those profits can be reinvested to support integrated loss control programs and improvements for the benefit of their insureds. This helps to ensure ongoing viability and predictability, which makes it easier for the captive to assume greater capacity and attract third-party business.
• Detailed knowledge of operations allows the captive and any related insurance/reinsurance brokers to craft superior marketing materials that accentuate the positive aspects of the risk and the organization's risk management initiatives and capabilities. A high-quality submission supported by tangible/actuarial data will be a differentiator. The best-managed/presented risks will get the best deals in terms of pricing and terms/conditions. Reinsurers prefer to partner with successful organizations.
• A centralized program allows the captive to see all loss control recommendations, audit reports, and engineering reports across the entire spectrum of covered entities. A holistic examination of such documents is a significant factor in the early identification of positive, or negative, developments. This allows you to capitalize on positive trends and take early corrective actions to manage any negative trends. Effective management of same helps to control costs and reduce exposures.
• An in-depth understanding of an organization’s US terrorism profile, and insuring Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) risk through the captive, allows the captive to appropriately access the partial funding of eligible losses by means of the federal loss-sharing/copayment provision of the Act. This could significantly lower the cost of risk related to any covered TRIPRA events.

Less Obvious/Delayed Advantages of In-House Loss Control

There are also advantages that may not manifest themselves until a loss occurs. For example, assume that the captive's insured entities are considered to be "tough classes" of business. Further assume that the insured's manuscripted policies are broader than what would be available in the commercial market to address such risks. Thus, claims that may not be covered under "commercially available" policies are likely covered under the captive's policies. When businesses are able to contractually transfer all or part of such claims, rather than retain them, it will lower the cost of risk for the organization (in terms of ultimate dollar loss and related overhead costs and time).

A captive can benefit its insureds through active claims management and the selection of efficient and effective third-party service providers that understand the business. An example would be engaging the services of a forensic accountant to assist in the calculations needed to support a business interruption claim. Large captives may have in-house claims capabilities.

Confidence in the captive's data and loss control programs adds to the comfort level when the captive is considering the assumption of risk. The captive may wish to use its flexibility to take on risk or additional risk, where there is a lack of reinsurance capacity, to manage unique business risks, or to fill gaps in hard markets.

Some Examples from Our Organization

One of the roles of centralized loss control is to ensure that best practices, knowledge, and resources are shared across business units for the benefit of the entire organization. Toward this end, we conduct what we call "Loss Control Summit Meetings." The intent of these meetings is to bring environmental, health and safety, plant management, legal, finance, supply chain, and other relevant stakeholders from multiple facilities to a single location in order to share best practices and information on successes and losses/lessons learned, network, and solve problems. As part of the meeting, all attendees visit a company plant in order to learn more about its operations and offer opinions on environmental, health, and safety (EH&S) issues. We have hundreds of years of experience in the room at these meetings and, as a team, there is no problem that we have not solved or cannot solve. Another positive that comes from these meetings is the sharing of information relative to spare parts and equipment/machinery. A sister company may have spares that would be useful to multiple business units. Knowledge of this, as well as coordinated spares sharing agreements, can have a positive impact on the cost of risk.

Part of effective captive management is (1) being creative and (2) knowing when it makes sense to utilize the captive for one-off risks related to insured entities. As an example, one of our sister organizations needed an appeal bond. The entity needing the bond had been part of our group for many years, and we had strong knowledge of the company's management, operations, and financial assets. Accordingly, we felt comfortable with the risk and decided to write the appeal bond through the captive if it was feasible. We went through the process of ensuring that we could write this type of bond under applicable law and obtained consent from both the court and the regulator. Typically, all or a portion of an appeal bond's face amount must be supported by cash or a letter of credit (LOC). When the principal's bank (the insured entity is known as the principal in a bond transaction) issues an LOC, it ties up some of its credit resulting in an opportunity cost. In this particular transaction, the principal provided indemnity agreements, in favor of the captive, as is typical in commercial surety transactions. So, what is different here? The captive worked with the principal to quickly and efficiently set up a collateral trust agreement supported by company treasury stock. When the appeal was concluded, the bond and stock were released. The financial mechanism used to support the bond lowered the cost of risk for our sister company, and our captive realized additional income with little expense. The transaction resulted in both top- and bottom-line improvements for the captive.

It is important to provide underwriters/reinsurers with an overall impression as to how risk is identified and managed holistically throughout the organization. Sometimes this means going off script with underwriters. When speaking with property reinsurers, our team may spend as much as 15 percent of our presentation time discussing liability issues. For example, we might talk about training initiatives, improvements in injury rates over time, and the methods we use to ensure that contracts are properly vetted and negotiated to protect the people, property, cash flow, and reputation of the organization. This type of "off topic" information has been very well received over the years and seems to result in superior offers from markets as respects price, terms and conditions, and level of participation. 

Our claims management is centralized. As a result, we see all claims, losses, and near misses for all business units in all countries. This helps identify trends that may not be noticed when only examining metrics regionally or locally or only for a particular business unit. Seeing all the data allows for more effective utilization of the power of statistics. In other words, more data points facilitate more credible predictions and increased confidence in the setting of reserves. Accurate reserving, and the reduced volatility resulting from same, allows for more efficient deployment of capital.