NEW IMPETUS FOR GROUP CAPTIVES
ASAE establishes protected cell captive for members
By Michael J. Moody, MBA, ARM
The captive insurance movement continues to grow despite a precedent-setting soft insurance market. As figures from various captive domiciles attest, captive formations over the past four or five years are on pace to challenge hard market formations. There are several reasons for this continued increase. Captives are beginning to become part of some organizations' overall strategic risk-financing programs, and many buyers are just fed up with being at the mercy of the insurance industry. However, the number one reason for the increasing usage of captives has been the involvement of mid-sized organizations in the alternative risk transfer (ART) market, most of which are turning to ART for one of the reasons mentioned earlier.
While involvement in the captive movement by middle market accounts can occur through single-parent captives, more frequently this occurs via one of a variety of group captive options.
Several options available
Currently, one of the most frequently used group captive options is the risk retention group (RRG). RRGs legislation that allows groups of companies with similar risks to band together to provide various forms of liability coverage. While RRGs have gained significant following in recent years, they are typically reserved for larger accounts with significant premium volume.
One option available to groups of mid-sized accounts is the "rent-a-captive" (RAC). Rent-a-captives are frequently used to accommodate mid-sized accounts that may not be large enough to participate in a traditional captive formation. In essence, the RAC concept is pretty basic. It is based on an approach that incorporates an unrelated, third-party organization that forms a captive for the express purpose of "renting" space in the captive to outside risks. Frequently, the RACs are established by brokers, insurance/reinsurance companies or other insurance-related service providers. By "renting" part of the existing captive, mid-sized organizations can gain some of the advantages associated with full captive ownership without the financial outlay and time required for normal captive formations. Initially, interest was high for the RAC concept when it was introduced; however, several shortcomings have become apparent.
One of the shortcomings surrounded the expense factors that were necessary to make the RAC feasible. These expense factors were typically in the 40% to 50% range and occasionally put the cost of RAC utilization out of the reach of small accounts, when compared to other available risk-financing options (e.g. the traditional insurance market). However, the most critical shortcoming was a feature that allowed the individual cells to be responsible for any shortfall that other cell owners might incur. It left all "renters" exposed to the losses of any other cell renter. The legal theory that this situation is based on is known as "joint and severable liability."
Recently, a newer approach for the group captive option has been introduced and is known as a "protected cell captive" (PCC). These captives were originally introduced in the offshore captive domicile of Guernsey in 1997. The concept was quickly picked up by both the Cayman Islands and Bermuda shortly thereafter. U.S. domiciles began passing similar legislation that allowed PCCs over the past few years. Today, most of the major U.S. domiciles have enacted regulatory features that allow for the formation and operation of PCCs.
The PCC concept was originally designed to resolve the structural inefficiencies connected with the RAC approach—namely the joint and severable liability issues. Thus, in theory, the PCC is a hybrid rent-a-captive. As one regulator puts it, "It's a statutory means to legally isolate assets and liabilities of an insurance corporation." As a result, by using a protected cell approach for the rent-a-captive, the assets of other "renters" are secure.
Operationally, the PCC consists of two main elements. The first element is the facility itself, or as it is referred to, the "core." Similar to the RAC approach, the core is typically owned and funded by a third party. The second element of the PCC is an unlimited number of unrelated cells. PCCs offer their owners and renters maximum flexibility so as to design a captive facility that is based on the unique requirements of the parties involved. For the most part, the innovation that has been incorporated into the PCCs has yet to be fully realized, due in large part to the continuing soft property and casualty insurance marketplace.
Help from an unlikely source
Despite the current market conditions, interest in both the rent-a-captive and protected cell captives continues to remain high. And while larger accounts enjoy favorable pricing, some of the smaller, middle market accounts are not able to see similar savings. Additionally, many of the middle market accounts have grown in sophistication and realize that a group captive approach may be the only solution for their long-term risk-financing needs. A number of these groups are looking to their associations for help in developing a long-term strategy to address these needs. However, most smaller associations do not have the expertise or time needed to deal with these issues.
Historically, association-sponsored insurance programs have been very popular with association members. As a value-added service, these programs appeal to association executive directors as a way of attracting new members. Additionally, most sponsored programs have also proven to be a welcome source of non-dues revenue for the association. As a result, many associations, regardless of size, have established some type of sponsored insurance programs for their members.
Recently, the American Society of Association Executives (ASAE) developed its own protected cell captive for two of its own property/casualty insurance programs. Associations, nonprofits, and other organizations may also utilize the ASAE facility for their programs. ASAE is a membership organization that represents more than 22,000 association executives and third-party service providers from all types of industry segments.
ASAE established a captive insurance company, The ASAE Insurance Company, a number of years ago; but according to Dixie L. Arthur, president of ASAE Business Services, Inc., they "put it on the shelf in 2000." She is quick to point out, however, "We did not kill it, just shelved it for a while." Several years later, ASAE began to explore ways to utilize the captive, and "in 2003 we redomiciled it in the District of Columbia," and converted it to a protected cell captive. Arthur notes that a key consideration was "to find a way to better serve our members." And while ASAE Insurance Company is 100% owned and funded by ASAE, the individual cells will be owned by the associations and nonprofits.
Associations and nonprofit organizations have access to the captive and thus to the protected cell arrangement. ASAE believes that, in the future, access to the captive will provide a competitive advantage to those associations that avail themselves of cell ownership. In designing the program, ASAE has utilized the services of captive consultant and manager Beecher Carlson. In addition to the normal feasibility and management of ASAE Captive Insurance Company, Beecher Carlson is also available to assist associations in determining if the PCC is a viable approach for an endorsed program.
While there are a number of features of interest with regard to ASAE Insurance Company, there is one that is certain to attract the attention of agents and brokers. That feature has to do with the continued involvement of the broker of record on an existing sponsored program. ASAE realizes that, generally, the broker of record owns the renewal of the business and they do not wish to force a change in this relationship. In fact, they have designed the program to maintain continuity of this relationship. For example, Arthur states, "We certainly would work with agents/brokers/consultants that act as the broker of record on sponsored programs." To take this issue one step further, she indicates that ASAE Insurance Company has been established to allow the agents/brokers/consultants of the sponsored programs to become additionally incentivized by offering them an ownership stake in the captive.
Many mid-sized agents and brokers have established relationships and developed sponsored insurance programs with association clients. Many of these programs have been an important part of the agency's annual revenues. However, many agents/brokers are concerned about how to maintain a continuing role with these programs, particularly with additional pressure coming from specialty middle market units of "Big Box" brokers. Many of these mid-sized agent/brokers also realize that their association program may benefit from a captive insurance approach but fear that they may no longer be needed should the relationship change.
However, the establishment of the ASAE Insurance Company can provide a method where the broker of record can now establish a long-term partnership with both the national ASAE organization as well as the local association. By investing in the captive, the broker of record can enhance its relationship as the association moves forward with a more sophisticated approach to risk financing. This ability to actively partner with the local association via the capitalization of the cell will result in a more stable, long-term relationship between both parties. Today, the broker of record has a unique, time-sensitive opportunity that should be given the utmost consideration.
This really comes down to a simple decision: As an agent/broker, do you want to continue to be an insurance salesman to your association clients, or would you prefer to be a partner with them as they develop a captive solution for their risk-financing needs? For many association-sponsored programs, the future is today, and as Eldridge Cleaver observed: "You are either part of the solution or you are part of the problem."