Not all organizations are viable candidates for forming captives. An ideal candidate falls within the intersection of three sets of conditions as described below. It is important to note, however, that each situation is unique and the three universes do not necessarily have equal weight nor do all the conditions need to exist to warrant further investigation.
Challenging External Conditions/Unmet Needs: One principal objective in forming a captive is to secure adequate coverage to mitigate major risk exposures. The first question to ask, therefore, is “Are you experiencing challenges in securing adequate and broad commercial insurance coverage for all aspects of your operations?” You may be in an underserved industry or be subject to changing or emerging risks that commercial insurers find undesirable. We are currently in a very hard market with significant scope, capacity and price challenges. While this may be a temporary situation in the commercial market, there are industries and coverage areas that are historically underserved with no competitive market for risk transfer. Forming a captive is a long-term play, however, and so you need to consider market challenges on both a short-term and long-term basis.
Manageable Internal Conditions/Capabilities: If you form a captive to cover certain risks, you will be in the insurance business underwriting those risks. Is your organization capable of doing so? The questions you should be asking with both a short-term and long-term horizon are:
· Is your loss experience predictable and/or better than average?
· Can you control the underlying losses?
· Do you have a critical mass of potentially retained losses e.g., greater than $1 million in annual losses or avoided insurance premium costs?
· Can you make a long-term commitment including funding and investment?
Achievable Internal Goals/Objectives: Forming a captive is the most formalized risk retention tactic and insofar as it involves significant long-term financial and management commitments, good candidates achieve some internal objectives of management. For example:
· Do you want to reduce your reliance on risk transfer to commercial insurance?
· Does volatility in insurance pricing create budgetary problems that would be solved with the increased budgetary certainly of a captive?
· Are you looking to control costs and capture some of the profits and investment income currently enjoyed by your insurers?
Even if your analysis results in deciding that your organization is not an ideal candidate for forming a captive, the exercise should prove helpful in developing other risk retention tactics such as unfunded or funded higher retentions or formal prefunded vehicles.