March 22, 2021 On In-House Counsel’s Desk

Trending Group Captive Insurance Programs: What’s Attracting A/E Firms?

Catherine Bragg and Beverly M. Tompkins

Group captive insurance programs have seen increasing popularity among A/E companies in the last couple of years. These programs are not new to the construction industry and, in fact, a few group captive programs have been operating for 30 years. Factors that are drawing the attention of design firms and other A/E businesses to captive programs include a desire to better control premium costs and the possibility of a positive return on premium investments.  In this article, we describe the basics of a captive, key considerations for joining a captive, and some noteworthy benefits of a captive.  We also provide some first-hand feedback from a captive member firm, as well as insight from insurance experts in the A/E/C industry. 

What is a Captive?

A captive, in its simplest form, is an insurance company that is wholly owned and controlled by its insureds.  While its primary purpose is to insure the risks of its owners, it is also a financial vehicle. Consequently, existing group captives are looking for members who exhibit best practices in their loss control strategies for the risks being insured. Captives require sufficient premiums to cover the members’ ordinary risks and to transfer the catastrophic risks. They are structured to allow members to earn income on the invested premium and dividends on returned premium. The key advantage of captive programs is that premiums are lower than premiums of traditional insurance by 20% or more initially and as much as 50% over time. Group captive insurance programs insure the typical variety of casualty risks faced by A/E firms, including general liability, workers compensation, and automobile liability. Some A/E firms use a single parent captive to insure professional liability, which is not covered within the scope of this article.  Given the frequency and severity of losses that are covered, the vast majority of firms opt to leverage the commercial insurance marketplace using their self-insured retention to manage the premium cost.   

As with traditional insurance companies, a group captive is recognized as an admitted insurance carrier and regulated by state law. Group captive policies are fronted (or issued) and administered by a licensed insurance company, who is the members’ risk-sharing partner, and who can offer services, including, but not limited to, underwriting, loss adjusting and regulatory support. The group captive underwrites and drafts the insurance policies (issued by A-rated carriers), and a third-party claim administrator handles claims, all while the insured members maintain their relationship with their commercial broker.

Understanding the different risk profiles across the pool of members is an important due diligence item before entering a group captive.  Because construction defect and workers compensation risks are so specific to the construction industry, there exist captives that are made up solely of general contractors (homogenous), as well as captives that include general contractors and members operating in other industries (heterogenous). Risk exposure for A/E firms is more generic and, therefore, they are free to select a captive comprised of members operating across differing industries.

As a captive member, a firm will assign a representative (usually an officer or director) to join the Board of Directors of the captive and is granted voting rights. It is important to know whether each member of the captive receives only one vote. Because a captive is a separate company with its own operations, members should devote the requisite time and resources to monitoring the operations of their captive. Most A/E firms will appoint representatives from their legal, finance and/or safety teams as primary representatives. Marc Faecher, Chief Risk Office at TRC Companies, stated, “In addition to the clear financial benefits, our decision to participate in a group captive dovetails with our commitment to the safety of our staff and customers. In addition to having a strong risk management program that is focused on the reduction of both the frequency and severity of claims, we prioritize the resources dedicated to our participation in the captive.”

Is a Group Captive the right choice for your A/E firm?

Once you and your broker have piqued the interest of your executive leadership, finance team and tax advisors, the next step may be to undergo a feasibility study of your firm’s past claims.  This is a key analysis for determining if a captive is the right fit.  If you already have a good loss history (i.e., an aggregate loss ratio of less than 35% under the insured policies) and annual premiums over a certain dollar amount (aggregate annual premium not less than $250,000), you should consider what your organization’s goals will be for the group captive. These may include reduced premiums, improved claims and administrative management, and controlling premium fluctuations. Other important considerations include the financial strength of your organization (needed to fund the self-insured fund and the capital commitment) and the firm’s continuing commitment to risk management practices.  If your firm does not meet the loss history standards, then a commitment to worker safety, fleet safety and loss control for a two-year period is a realistic path to entry.  According to Diane Crowe, Vice President, Risk Finance, Lockton Companies, “Participating in a captive program promotes risk control and effective claims management, as each member’s total cost of risk is directly impacted by claim outcomes and is the key driver of a captive’s success.”

Remember to consider set-up costs of the group captive. Membership requires an initial capital contribution.  Members also post collateral (usually a percentage of annual premium), which can be in the form of cash or a letter of credit.

What else should you be aware of when considering a Group Captive?

With the help of an experienced and knowledgeable broker, firms considering a group captive should factor in the following: an objective assessment of the firm’s loss control practices (notwithstanding good loss experience); leadership’s commitment to safety; the captive’s ability to provide coverage extensions required by design firms; the extent of shared loss experience with other members (commonly referred to as the “B Fund”); and claims management practices. A captive is a long-term investment and a proper feasibility study and due diligence by legal and finance are required.

There are three other significant considerations. First, certain design firms do, in fact, experience reasonably frequent and severe losses in general liability. These losses may not be best insured in a group captive general liability program because the duty to defend is a cost ultimately borne by the membership through the cost of its fronting arrangement. Second, many firms bundle their casualty, property and umbrella insurance with one insurer. The group captive requires unbundling those coverages and a cost analysis should be conducted. Finally, certain group captives have exit costs (others don’t). If a firm is considering a merger or sale, then consideration should be given to the exit strategy in terms of both time and money.

What are the advantages of joining a Group Captive?

Rates for commercial coverage through a group captive are based on an insured’s actual loss experience rather than market rates, so there can be significant premium savings in joining a captive.  According to Gregg Bundschuh, co-founder of Greyling Insurance Brokerage and Risk Consulting, if a firm maintains a good loss history over time, the difference between captive premiums and commercial market premiums (which are based on either revenue or payroll) can be striking. For example, an engineering firm that entered a captive 10 years ago pays roughly the same premium today at $1B in revenue than it did at $400M in revenue due to its excellent loss experience. Also, unlike a traditional insurance company that retains unused premiums, a captive returns unused premium (net of costs) to its insureds.  Dividends are typically realized beginning in the third policy year.  In a recent study of its A/E firm group captive clients, Greyling found that the initial cost to enter the captive was 33% less than traditional insurance, with a final net cost after dividend that was 70% lower than traditional insurance.

If your firm has a good claims history, strong risk management profile and financial strength, a group captive insurance program may be the right insurance option for your firm.

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Catherine Bragg, Esq.

TRC Companies, Inc., Huntersville, NC, Division 11 (In-House Counsel)

Beverly M. Tompkins, Esq.

Simpson Gumpertz & Heger Inc., Waltham, MA, Division 11 (In-House Counsel)