Expert Commentary

Why You Should Start a Captive in a Soft Market

Many recent articles in the trade press have cited surveys talking about the softening insurance market. Liability rates have declined, property coverage is available, and underwriters are looking for business.

August 2006

Profits are up, and the future looks rosy for traditional insurers. Even some medical malpractice rates have declined noticeably. So, why would a business consider financing its own risk when so much risk transfer is available? This is a question frequently addressed by the captive community. It is a good question that goes to the heart of the captive philosophy and thus deserves a bit of attention.

Certainly thoughtful analysis must be given to the cost of transferring risk. When rates are low, perhaps a buyer should take advantage of the situation and purchase traditional risk transfer products. Establishing and running a captive involves heavy up-front costs and is dependent on some factors that may be difficult to influence let alone control. It is often a good choice to transfer the risk of loss to a larger firm with professional resources and capital.

However, if you believe that the industry remains subject to pricing cycles, then perhaps the best time to look into a change is when the market pricing is soft, and underwriters are accommodating and responsive.

Reasons To Move Now

There are several good reasons to consider launching your captive when the traditional market rate structure is on the down side. The first reason is that most of us believe that what goes down goes up. For risk and financial officers who are frustrated with an inability to forecast accurate risk costs into the future, a slowing insurance market is not always a good thing. Predictability is often valued more highly than soft rates followed by hard rates.

In my experience, insurance rates are frequently responsive to the overall economy. We know that there have been and believe that there will be again changes in the overall economy. Thus, I believe it is safe to assume that there will continue to be changes in insurance pricing. The pricing approach may not look like approaches in the past, but change they will.

If you have designed a business model with set costs and profits, and sold this model to investors/employees/the board/regulators, it is particularly frustrating to see costs fluctuate unpredictably. You likely want to take control of these costs. Captives are all about control. If you are able to accurately forecast costs into the future, your business will likely gain acceptance and profitability. If you can control the costs of operating your business, you can improve its overall results.

Another good reason to consider a captive in a soft market is to expand coverage lines for risks that are not covered in the traditional market. While the rates may have softened for basic insurance, there are still many exposures to loss which are not addressed completely. Terrorism remains an exposure which is not well addressed in the traditional market place, even as premiums have softened.

Employment liability and directors and officers coverage may not be affordable in a hard market, but perhaps the small, private company which has declined such coverage in the past can now write it in their own captive and obtain reasonable excess risk transfer. Construction industry risks, particularly in residential building, continue to face a lack of availability and a plethora of exclusions and restrictions. These exclusions and restrictions can render the coverage useless for lenders and other interested parties.

How To Move Forward

To take full advantage of the situation, I would suggest that a captive owner, or potential captive owner, analyze the cost of traditional products with a view to incorporating some of them into a captive program in which costs can be controlled and moved about depending on the then current state of the traditional market. Buy traditional risk transfer when it is cheap; move the coverage to your captive when it is dear. But the captive should be in existence and ready to perform when needed.

It is certainly easier to set up a captive and begin learning how to use it profitably when there is less pressure for it to address pressing needs. Get it up and running, learn about corporate governance, get to know your regulators and managers, and watch the performance of your risk sharing partners in a less demanding situation.

If excess costs have come down, consider a lower attachment point for that coverage. Lock-in the rate for an extended period. Underwriters are usually interested in adding new accounts and new lines of coverage when their pricing has reduced premium inflow.


All in all, one should consider the wisdom of being prepared, and making hay while the sun shines. When the market turns, and time is short to solve challenges, it won’t be as pleasant an experience to form a captive than when the pressure is nonexistent or lessened by the soft premiums.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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