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Captive insurance: A vehicle to controlling risk

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Tired of the volatile property and casualty insurance marketplace? Are insurance carriers benefiting off your performance over the years? Do you have the ability to hold significant premium dollars for exceptional risk management performance? If your answer is no, a captive insurance program may be suited for your business.

Without question, insurance for firms engaged in the construction arena are among the most expensive and restrictive compared to virtually any other industry.

As an overall percent of revenue, contractors and developers allocate a significant portion of their cost to insurance-related products. As the construction industry continues to boom in Southern California and San Diego in particular, taking control of your overall insurance and risk management program is becoming more important than ever for construction-related firms.

While the insurance market has softened (premium reductions and carrier capacity) to a certain extent, firms involved in the construction arena will always be subject to high exposure, high premiums, and high retentions (deductibles) for their insurance program.

Captive insurance programs for contractors have become more available and relevant in recent years, and can prove to be a very successful tool in managing a company's overall risk management portfolio. Captives can save a construction firm considerable premium and expense dollars over time.

Typically, an insurance policy will be written either on a guaranteed cost basis or a high deductible/self-insured retention program. Both guaranteed cost and self-insured retention programs offer significant risk transfer in terms of liability and workers' compensation, but do not necessarily give the control, investment and profit opportunities that a captive program offers the right construction-related company.

Typically, a captive program is designed for firms that are interested in taking control of their overall risk management program. For the most part, a captive-related program is self-insurance with reinsurance for severe and aggregated losses over time.

For the right captive prospect, these vehicles can prove to be highly successful in terms of stabilizing a contractor's insurance portfolio, taking more control of the risk management program, and ultimately receiving great returns for good performance.

A captive is designed to give back those monies that otherwise would have been collected by an insurance carrier to a good performing firm. In the world of construction where premiums run high and claims can be severe, a captive program can prove to be exceptionally beneficial for the right company. If a company has a strong financial position, as well as an excellent risk management program, a captive can offer the following advantages:

* Control -- Greater control can be exercised on those activities that impinge on risk management, such as claim settlement, loss control, and safety activities.

* Investment income -- Premiums paid are invested with the resultant income going to the benefit of the member rather than the insurance carrier as in a traditional insurance program.

* Direct access to the reinsurance market -- A captive has direct access to the reinsurance market where companies work on substantially lower expense ratios than direct first-dollar insurance companies. Thus, the pure risk transfer component of the insurance transaction is shifted to a higher dollar level, thus reducing the overall cost of insurance.

* Retention of underwriting profit -- The captive member, not the insurance company, retains any underwriting profit earned. This is significant and can run well into seven figures if a captive is run correctly and the member(s) are performing at expected loss ratios.

* Stabilization of pricing -- Self-insuring the working layer of coverage insures the client affordable and available cover that tends to be substantially more stable and much more responsive to the individual captive member opposed to the cyclical and unpredictable insurance marketplace. Pricing is stabilized and consistent, leading to an easier budgeting and forecasting process for business owners.

* Tax reduction -- If a captive is set up correctly, there are many tax advantages and deductibility options available for firms engaging in this product. Obviously, the impetus of moving into a captive should not be tax related, but if set up correctly will prove to be advantageous from a tax standpoint.

* Wealth transfer -- The captive shareholder can be a next generation family member or trust. Closely held companies can transfer assets off the balance sheet in a tax advantaged way. Ultimately a captive is an investment or financial vehicle with which to transfer risks, but as a program matures and the captive performs from a loss standpoint funds can be transferred and used for outside planning.

Captive programs are certainly not a new concept, but over the last five years the management companies and carriers have developed much stronger and long-lasting programs that can truly benefit the right client. As construction firms continue to pay exceedingly high premiums, a captive can offer a company as much as a 50 percent savings over the long term compared to those standard insurance products now being offered in the marketplace.

As noted above, the benefits are many when implementing a captive program, but it is important to evaluate the amount of risk and control you are willing to absorb as a business owner because there will be those scenarios in which a captive member will have a significant loss event and allocate funds otherwise insured on a guaranteed basis.

This being said, a construction firm that historically performs from a loss standpoint will prove to be exceedingly profitable in a captive program. This will lead to a more competitive business model and long-term security for the best in class firms.

Brennan is a principal with Barney & Barney and chairs the firm's Construction Niche Practice. For more information, call (858) 587-7404 or e-mail bbrennan@barneyandbarney.com.>

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