A common myth foisted upon small and mid-size business owners by self-proclaimed captive experts is “your business does not have enough risk to justify a captive insurance company.” We often encounter this myth when meeting with prospective captive owners and their advisors whose cursory web search on captives has stumbled across high profile “experts” and bloggers who disguise marketing in the form of on-line articles. Not surprisingly, these articles are designed to scare business owners and their advisors, as a means of trying to poach prospective captive owners away from other captive managers. One such approach we have encountered is for the self-proclaimed “expert” to act really concerned that a business may not have enough risk to justify owning their own captive insurance company. After establishing this context, the “expert” does “research” and acts as if they have done a favor for the business owner in finding enough risk. Unfortunately, these nonsensical tactics create confusion, fear and doubt in the minds of business owners and advisors. The result is that they often choose to forego the tremendous benefits of owning their own captive insurance company.
At the outset, it is worth noting that some businesses do not have enough risk to justify a captive. However, many businesses have far more risk than they might imagine, and we have rarely encountered a small or mid-size business where the feasibility study conducted by an actuary suggested a captive was not justified, if we had recommended captive ownership as part of an Enterprise Risk Management (ERM) analysis.
Why is this the case? As a company matures, its risk management strategy should mature as well. This includes a shift from insuring as little as possible to conserve cash during start-up or expansion, to tying risk management to the overall health and survivability of the business. Once this paradigm shift occurs and all real risks facing a business are considered and evaluated, it becomes clear that a more mature approach to risk management is required to ensure the long term health and sustainability of the business.
When we sit down with business owners and ask them to list all risks and threats facing their business, we usually fill up an entire page of a legal pad. And, in all cases, we discover only a fraction of those risks are formally insured with third party commercial insurance. Consider the illustration below titled “Universe Of Risks Facing An Enterprise.” The x axis on the bottom represents all the risks facing their business, and the y axis on the left side represents the potential amount of loss their business could face if adverse events occur. This chart is a fair representation of most businesses we encounter. The green box depicts the portion of their business risks that are formally insured with third party commercial coverage, and the white space represents all of the risks that they are informally self-insuring. In the event of an adverse event, informally self-insured risks are typically covered out of future operating profits or after tax savings. In some cases, an adverse event that is informally self-insured can result in the closure of the business.
Also note that the green box in the illustration representing third party commercial insurance looks like a piece of Swiss cheese. These holes represent the many exclusions written into commercial insurance policies.
Taken as a whole, it is readily apparent that most business owners are informally insuring a wide range of risks. In fact, most are informally self-insuring the vast majority of the risks facing their business, including operational and strategic risks that can prove fatal to the enterprise. Operational and strategic risks can include (but are not limited to) loss of a key employee, loss of a key account, supply chain risk, reputational risk, excess claims above third party commercial insurance limits, administrative actions, employment practices, product liability, cyber, litigation defense, commercial crime, existing deductibles, business interruption, terrorism, sub-contractors, difference in conditions, loss of franchise, regulatory and legislative changes, and business risk indemnity. These are all risks that threaten the long term health and survivability of the business.
With a mature risk management strategy dedicated to the long term health and survivability of the enterprise, it is certainly reasonable for some businesses to commit a double digit percentage of gross revenue to risk management. For many businesses the suggestion that “you don’t have enough risks to justify a captive” is just pure myth.