Many mature and successful businesses have an immature approach to risk management. For many business owners and CFOs, risk management is not an enjoyable topic. Also, taking steps to develop a mature risk management approach sounds like code for “spend more money.” However, the opposite is the case. Developing and executing a more mature risk management approach will almost always increase the total wealth of a business and its owners while better managing risks.
CIC Services recently attended the 2014 Captive Insurance Companies Association (CICA) conference in Scottsdale, Arizona. CICA touts itself as the only domicile-neutral captive insurance association. We are members of CICA and attend the conference to stay abreast of legislative and regulatory changes that impact the captive insurance industry. The CICA conference also addresses new alternative risk concepts, emerging trends and best practices in the industry. We attended a presentation at the conference titled Enterprise Risk Management For Captives And Their Parent Organizations. This session was presented by Robert Walling, FCAS, MAAA, CERA, Principal and Consulting Actuary at Pinnacle Actuarial Resources and Barry Franklin, SVP & Chief Risk Officer, Zurich North America.
Large corporations have employed Enterprise Risk Management (ERM) for some time, and this mature approach to risk management can also be adopted by mid-size and smaller companies. Mr. Walling noted that a captive insurance company “offers the opportunity to engage in ERM because it enables the business (or business owner or CFO) to take an active versus a passive approach to risk management.” Ownership of one or more captive insurance companies makes ERM possible, because a business is able to both:
– Increase depth of insurance coverage
– Increase the time horizon of its risk management approach
Increase Depth Of Insurance Coverage
When employing a mature ERM model, risk managers and business owners categorize risk as core risk, insurable risk and business risk. Most businesses and individuals simply insure core risk and usually do so via third party commercial coverage. Utilizing an ERM approach, a captive insurance company, in its formative years, gives businesses depth of cover by addressing the second and third layers of risk management (insurable risk and business risk). As the captive matures and amasses reserves, it can also play a role in addressing core risk. In addressing the role a captive insurance company plays in an ERM approach to risk management, Barry Franklin of Zurich noted, “The difference in ERM maturity lies in the second line of defense.” Clearly, a captive insurance company is integral to implementing ERM.
Walling noted that many non-core risks evolve into core risks. He noted, for example, “many firms used to address cyber threats as an insurable risk in their CIC, but commercial insurers have caught up to the realities of the market and now offer third party commercial coverage for cyber risks.” Because of its flexibility, a captive insurance company will often insure risks that are difficult to cover via third party commercial coverage. Walling noted that many third party coverages have evolved because captives covered them first. As examples, he cited cyber, supply-chain risk, extended warranties, and even sleep apnea insurance cover for truck drivers.
Increase The Time Horizon Of Risk Management
Another characteristic of a mature risk management approach is taking a forward looking stance. A short term approach to risk management typically buys insurance from year-to-year with the goal of keeping costs as low as possible. Each year, all premiums paid for third party commercial coverage are a “sunk cost.” At the end of the year, if there are no claims, the money is gone. Because a captive insurance company is owned by the business owner(s) or the parent company, premiums paid to the captive insurance company are retained after claims are paid. Wealth accumulates in the captive as insurance reserves and provides flexibility to the business in its risk management in future years. A captive facilitates and ERM strategy because it enables a multi-year approach to risk management.
Financial Impact Of A “Grown Up” Risk Management Approach
Adopting an ERM approach with a captive insurance company as the chassis can be a financial game changer for business owners. Because the business owner and/or company can reap additional profits from its captive insurance company, the organization will inevitably make risk management and risk mitigation a higher priority. Furthermore, as the CIC grows its reserves, it is in a position to help reduce total reliance on third party commercial cover for core risks. This can often be achieved by reinsuring deductibles and insuring additional potential losses not covered by commercial insurance (including losses above third party insurance policy limits). Finally, CIC ownership enables the business owner or owners to capitalize on the favorable tax treatment that insurance companies receive on their reserves set aside for future claims. A well-structured ERM strategy with a CIC can save a business owner $500,000 or more per year in taxes.