Captives for Small and Medium-sized Enterprises
By some measures, the Captive Insurance industry has been remarkably
unsuccessful. The brokers and consultants that help form Captives can count among
their clients many of the largest Companies. However, these make up less than 1%
of all firms. They have been far less successful at penetrating the far larger market
represented by Small and Medium-sized Enterprises (SME’s).
SME’s are the backbone of advanced economies. In the European Union, SME’s are
estimated to make up 99% of all firms, and to employ over 65 million people. In
many sectors, SME’s drive business innovation and competition.
What exactly are SME’s? Such companies are classified by reference to the number
of people they employ. In US terminology, Small Enterprises are those that employ
up to 100 individuals, while Medium Enterprises employ up to 500. SME as a
category excludes both micro-enterprises (with fewer than 10 employees) and large
firms that employ more than 500 people.
Why would SME’s be interested in Captive Insurance?
SME’s that have established Captives have done so for similar reasons as their larger
Risk Management is often as big an issue for smaller firms as it is for larger ones and
in some cases arguably even more important. SME’s often occupy distinct market
niches, where their reputation is a competitive advantage, and makes a major
contribution to their business success. Their ability to manage risk effectively is a
key to their continued success. They often do not have the luxury of size to weather
problems brought about by poor risk management. Such firms can often
demonstrate better loss histories than the Commercial Insurance market is willing to
recognize in their premiums.
For SME’s, effective cost control can significantly contribute to the bottom line. At
the same time, savings on commercial insurance are not easy to achieve. Often
SME’s cannot afford to employ dedicated expert risk managers to negotiate with
Insurers. This means they are often limited to taking packaged insurance products
that may not be well adapted to their business. Further, they are not in a position to
negotiate on equal terms against large, possibly multi-national Commercial Insurers,
and because of the smaller volume of premium, Insurers’ overheads can often
represent a larger element of their Insurance costs than those of larger enterprises.
SME’s benefit as much if not more than large companies from the ability to secure
ongoing insurance coverage for mission critical risks. Medical Malpractice or
Construction Guarantees are non-negotiable if you are a primary medical services
provider or a Construction Contractor. Many firms cannot afford the risk posed to
the viability of their business by the cycles of interest or disinterest in those lines of
business by the Commercial Insurance market, let alone the budget uncertainty this
As closely controlled Corporations, many SME’s do not have access to Capital Markets
to grow their business. As such they recognize the importance of maximizing the
return on their assets. Many SME’s that have set up Captives have been attracted by
the tax efficiencies a properly set up Captive can offer, and the ability to benefit from
the investment returns on retained premiums and reserves.
As Wealth Managers, London & Capital has been able to blend over twenty years
experience of managing assets on an absolute return basis – producing positive
returns regardless of overall market direction – with an expert understanding of
Captive insurance and the scope for asset management within regulatory
requirements. In our experience, those Captives that have focused on managing
assets as well as insurance risk in their Captive, have been those that have
succeeded in reducing the long terms cost of risk in their business while generating
enough free cash in their Captive to make it self-financing and in some cases even a
In the light of such benefits, why has there not been a better take up of Captives
While these benefits are clear to those SME’s that have established Captives, many
other SME’s have not understood the benefits of this approach for their business,
The ability of a Captive Insurance arrangement to monetize good risk
management through the capture of underwriting profits that would otherwise
end up with Commercial Insurers,
The ability to secure a reliable source of insurance coverage at a known cost over
an insurance cycle, allowing the Parent Company to focus on its core business,
Access to wholesale Reinsurance markets for difficult to place risks,
Closer involvement in the handling of claims, leading to a better understanding of
the operational risks in the business,
The ability to tailor insurance coverages to their precise requirements, including
the ability to include specialist coverages or catastrophic risks not available in the
commercial market, and
The ability to manage premium timing to match the cash flow of the parent
Company and even more importantly over the long term, the ability to capture
investment returns for the benefit of the Captive on the premiums and reserves.
There are a number of contributing factors that account for the low penetration rate
of Captives among SME’s. These include:
A lack of awareness of the benefits offered by Captives among SME’s,
The inability to generate enough premium volume to justify a program,
The perception of high direct and indirect costs of ownership, and
SME’s concerns over the retention of insurance risk in-house.
It is for the Captive Industry to find ways of reaching decision makers among SME’s
with the arguments in favour of Captives. So far the focus has largely been on
reaching Companies through their Insurance Brokers. Increasingly, it is being
recognized that the attractions of Captives as effective financial vehicles also needs
to be communicated to financial decision makers through their CFA’s, Banks, Wealth
Managers, Tax Consultants and Legal Advisers.
It is true that a minimum volume of premium needs to be available to justify the
establishment and operating costs of a Captive. However, the Captive Industry has
gone some way to make Captives a viable alternative at lower premium levels.
The perception that owning a Captive implies high direct costs has never been less
justified. In part the problem of perception arises as a result of the unbundling of
the costs of insurance – Insurance Companies’ overheads are rolled into the
premium cost and not easily identified. Once a captive is discussed, all the individual
expenses become transparent. However, often immediate cost savings can be
achieved, even allowing for the amortization of the initial establishment costs.
In many instances however, SME’s are just as concerned about indirect as direct
costs. How much Management time will be required to run an Insurance subsidiary?
What resources are needed to ensure statutory requirements are fully met? What
are the risks of non-compliance?
It is for these reasons that SME’s often find it more attractive to take part in a
Captive that is not directly owned, than in a single-parent Captive. The Captive
Industry has been very responsive to these concerns, offering a range of solutions
that provide most if not all of the advantages of a single parent Captive, in an easier
to operate package. These include Agency Owned Captives, Group and Association
Captives, Cell Captives, and Rent-a-Captive arrangements.
In addition to more flexible Captive structures, service providers that make up the
Captive Industry have developed services better suited to SME captive Owners. For
example, Insurance Managers that specialize in alternative Captive structures are
available in most jurisdictions. Some Consultants can now offer streamlined
feasibility studies that can quickly and more cost effectively identify whether a
Captive is a suitable solution.
Many SME’s – being smaller Companies – have a closer connection between
functions such as Operations, Risk Management and Financial Control. This makes it
easier for the Company to learn from its risk management experience, and to
implement initiatives designed to reduce operational risk, thereby reducing loss and
waste, and improving its products and services.
For those Captive service providers that have focused on the needs of SME’s, a
number of issues are evident – Captives are well suited to manage the insurance
needs of many SME’s, and their requirements, though often smaller, are no less
challenging than those of large enterprises. In many instances SME’s rely even more
heavily on their advisers than larger Companies do, to bring to bear expertise that
may not be available at the Parent Company. However, working with SME’s can be
even more rewarding, as reporting lines are shorter, and decision making can often
be much quicker.
Following the success of the Captive concept among large Corporations, the Captive
Industry has demonstrated that it can adapt its offerings to SME’s. As the industry
continues to innovate, it will open up a far larger market for its services, among
those Companies that are both the backbone of the economy now, and the breeding
ground for tomorrow’s corporate giants.