Determining Whether a Group Captive Is Right for Your Organization

Group captives give multiple companies the opportunity to band together to insure (or reinsure) specific risks and share any resulting profits. Members of group captives participate in key decisions about their insurance company, including underwriting, loss control, claim management, operations, insurance and reinsurance options, and consulting/management service providers. Each member's premium is based upon their own loss history, with all the operating expenses driven from this foundational element.

Through a group captive, tiers of risk transfer can be established. For example, the captive would be responsible for claims up to a predetermined amount, and the reinsurer would handle anything above the established retained layer up to policy limits. A key advantage of the group structure over a single-parent captive is that the capital, collateral, and operating expense requirements are spread across all members instead of being limited to just one company, and significantly greater buying power may be achieved over time as the group program expands its footprint.

Homogenous group captives are designed for companies in the same industry and sector. In contrast, heterogeneous group captives allow a variety of businesses in different (but often related) industries to band together to manage their risk.

Leaders of family-owned and other privately held middle-market companies typically bring an entrepreneurial attitude to their businesses, and that's exactly what's needed to pursue the advantages of a group captive. Members must be willing to assume (and take responsibility for) risk, invest in their own companies' future, and see the potential for lower costs and higher profits.

Forming a group captive with the appropriate guardrails is not recklessly risky. In fact, both types of group captives have built-in advantages when managing risk, not the least of which is more buying power. In a heterogeneous group captive, member businesses interact with other companies outside their industries, allowing the owners to expand their knowledge and adopt or adapt strategies from the different perspectives of their fellow members.

Homogeneous group captives also offer advantages, primarily because all the members have the same insurance needs and deal with the same business issues. This encourages holistic solutions for those specific situations. On the downside, if there's a significant downturn in the industry segment or a sudden spate of high-profile lawsuits and verdicts, all the members will be impacted.

That said, group captive strategies may not be appropriate for every company desperate to shrink its insurance spend. There are companies whose industries have what captive consultants refer to as vertical loss potential. Put another way, the nature of their business leaves them open to staggering verdicts from class-action lawsuits resulting from sizable, latent loss activity. Companies with a high vertical loss potential are often better off placing those risks in the standard market or in vehicles such as a risk retention group (RRG).

It's also crucial to consider the loss history of all potential members of a group captive. A history of a high frequency and severity of losses can be a red flag. Every business faces catastrophic loss potential that sometimes is not preventable or predictable. That is why you maintain insurance for those times when the worst-case scenario plays out. However, if a potential group captive partner has been involved in an inordinate number of losses, that could suggest that they are not as invested in safety and loss control as the other members. If they are committed to change and are eager to get better, that's one thing, but if they aren't invested in improving their safety programs, they won't be a healthy partner in the captive.

Given the nature of the group captive, it should come as no surprise that the success of the approach depends largely upon the membership and the service partners supporting the operations. Experience teaches us three crucial prerequisites are needed. First, the risks being addressed need a loss experience history that's better than average. Also, a continued commitment to loss control, safety, and claim management forms the foundation of a successful captive. Then, the company must have the financial strength to post a capped and reasonable amount of collateral, either with cash or through a letter of credit. This approach demands leaders who can take the long view, make a long-term commitment, and are a company capable of exceeding market expectations.

Establishing a group captive is a way to take control of what is often one of a company's fastest growing and most frustrating expenses. In essence, it's a way for entrepreneurs to do what they do best—take a fresh look at something that isn't working well and apply transformative ideas to make it better. After participating in the program and experiencing the results firsthand, many business owners say this is one of the smartest business decisions they have ever made for their companies.