Captive insurance: Not a quick fix, but a long-term solution
May 8, 2012
by Kevin Smith, CPCU, ARM, Vice President
When Steve Becker, Vice President, General Counsel and Secretary of Premier Magnesia, LLC (Premier), formerly Premier Chemicals, LLC, joined a Group Captive in 2004, he did it for all the right reasons. He was seeking to gain more control over his company’s insurance program and decided the best way to do that was to become part owner in a group captive insurance company. Under a group captive, members take control over their claims handling, loss control and service providers to stabilize the cost of risk, with the expectation of ultimately reaping underwriting profits and investment income.
Headquartered in Conshohocken, Pa., Premier Magnesia is a global market leader in Magnesite based products and solutions for agricultural, industrial and water treatment markets. They are one of the world’s primary suppliers of high-purity Caustic Calcined Magnesium Oxide and Magnesium Hydroxide products. For over 50 years, Premier Magnesia and its predecessor companies have owned and operated a Magnesite mine and processing plant located in Gabbs, Nev., that offers the only domestically mined source of Magnesium Oxide in the United States.
In considering joining a Group Captive, Premier sought the advice of its insurance broker, The Graham Company. Having strategically designed Premier’s property and casualty insurance programs since 2001, The Graham Company recognized the limitations Becker faced with traditional insurance and therefore began evaluating how its Group Captive could help Premier Magnesia gain more control over its insurance program.
The Graham Company’s Group Captive is a member-owned group captive operated by companies in a variety of industries, from construction and distribution to manufacturing and financial services. Under a group captive, business owners assume a portion of the risk by taking on a large retention, as much as $300,000 per occurrence. Unlike traditional insurance where business owners pay a premium and let the carrier pay for the claim, members of a group captive are shareholders and are required to fund a large portion of a claim. That is why it is critical that group captive members operate as safely as possible – members have a vested interest to raise their safety standards and elevate their risk management standards.
According to Kevin D. Smith, CPCU, ARM, Vice President at The Graham Company, “When a business owner and its executives embrace the concept of a captive, they have to be fully committed to operating as safely as possible in order to reap the rewards of the program. Captive members see the benefits of good loss performance but also feel the pain when it is not so good. The captive forces them to put the emphasis in the appropriate areas – safety and loss control.”
With that in mind, Premier and The Graham Company began evaluating the Group Captive for its workers compensation, general liability and automobile insurance. The process began with educating Premier Magnesia on the captive concept, as well as the other business partners involved in this member-owned Group Captive. “It was not only important to understand how the mechanics of a captive worked but also as important, if not more so, to understand who your partners would be and how their companies were run,” said Becker.
Once Becker was comfortable with the captive structure and the other members, a feasibility study was conducted to analyze past claim experience to determine the appropriate level of funding for the captive. In addition, a risk management assessment was conducted by The Graham Company to evaluate the company’s claims handling practices, loss control and safety measures, as well as interviews with senior management to determine the level of commitment to safety throughout the entire organization. For existing members, evaluating a new member’s safety culture is the single most important criteria because the profitability of the group depends on reduced claim costs so that members get their underwriting profit back in the form of a dividend.
Regardless of how safely you operate, Smith advises, “Joining a group captive is still a long-term decision. Member companies are likely to have losses, and you can’t bail out when they are bad and jump back in when they are good. If you remain committed to your safety culture over the long term, your business will prosper.”
Premier’s first few years in the Group Captive were not stellar by any means. In the five years prior to joining the Group Captive, the company had an average loss ratio of less than 24 percent. Within its first two years in the Captive, Premier experienced several large losses. Smith explains, “When losses exceed the funding estimated by the captive’s actuary, that individual member is responsible for a portion of those losses up to a maximum amount; beyond that the other members may have to participate in paying for the losses. Being structured this way puts an emphasis on claims and safety, not only within each individual member company, but for the group as a whole. No member wants to be the one that causes losses that need to be shared with other members.”
In Premier’s case, it depleted much of its loss funding within the first two years and was therefore responsible for an additional amount in excess of the initial funding to satisfy its responsibility under the Captive. In addition, a portion of those losses had to be funded by other members. Because the Captive is a real insurance company, and in order for members to get a full tax deduction for premiums paid into the Captive, there must be risk shifting and sharing. “Part of any group captive formula requires members to share in other members’ losses. But at the end of the day, you need to limit that as much as possible, so you need to keep it exclusive to members who share the same safety culture. Otherwise, the captive won’t be successful and profitable for its members,” explained Smith.
Despite Premier’s significant losses and the financial impact on the group, the members of the Group Captive supported Premier and looked for ways to assist in strengthening its safety culture. Gary Nolan, a founding member of the Group Captive and owner of Brothers Electric, said, “We knew what performance to expect from Premier based on the vetting process before they joined. If we thought that they were going to bring the group down, we would not have let them in. We all experience rough patches in our business, but the backbone of the Captive is that we all stand behind one another.”
While these claims were larger and out of the norm for Premier, Becker did reap the benefit of gaining more control over the claims process and felt he was more informed on the outcome of the claims as a result of the process under the Captive structure. Becker explains, “Convincing our plant management that we had a vested interest in the outcome of claims and getting them to buy-in to the captive concept was the most challenging aspect early on.” For Premier, a significant loss at its Florida plant highlighted this challenge and as a result Becker proactively identified the risk that caused the accident and then engineered the risk out of Premier’s system completely. That particular loss was significant enough that it caused other members to share in Premier’s loss. “I felt the peer pressure when we caused a sharing event; I felt disappointed and embarrassed, but all members know this is a possibility– that’s why it requires a certain leap of faith to enter a captive in the first place. It surprised me that members were not primarily concerned with the actual loss event, rather it was more important to understand the loss and improve than the fact that a loss happened.
Since those losses in 2004-2006, Premier has experienced much better years from a loss standpoint. As a result of its success, Premier is building up the underwriting profits, which the company will get back in the form of dividends in future years. Kim Sharkey, CPCU, AIC, Vice President at The Graham Company who coordinates the safety and claims management programs for the Group Captive, said, “Becker was instrumental in getting his risk management team to accept accountability and implement the risk improvement action items we outlined for Premier. As a result of the safety culture Becker has helped cultivate, Premier will now get to see the rewards of these efforts in the form of reduced claims and dividend return.”
Premier’s decision to join The Graham Company Group Captive was not entered into lightly, and the decision came under internal questions when the company suffered losses early on. However, Premier’s commitment to its safety and loss control, along with support from other Group Captive members and The Graham Company, was strong enough to turn Premier’s loss control track record around. Quote from Nicole Hill, CFO
“When you make any investment for the long term you cannot be dissuaded by a few bad years. I believe first and foremost Premier has improved the safety climate for our employees and as an added benefit we are situated to reap a meaningful financial reward as well.”
Looking back, Premier is convinced that joining the Captive in 2004 was the right decision for its business and the welfare of its employees. Although a tough, long-term decision to make, Premier has emphasized the importance of a top-down safety culture, ultimately benefiting employees and the bottom line.
Philadelphia, PA, 19102