Captives and premium financing

Things had been looking very promising for the insurance industry as a whole, and the captive insurance arena in particular. On the commercial property and casualty side of the business, the industry had been braced for the hardening market, which forces most insurance carriers to become more restrictive with their underwriting guidelines and increase premiums, to offset current or future underwriting losses.

With the market already hardening when COVID 19 hit, many property and casualty experts have been left wondering to what extent the pandemic will further the trend.

This is where captives can shine brightest. They allow an insured to pay premium that is commensurate with its true risk, rather than being determined by a pool of other insureds, over which they have no control.

As the hardening commercial insurance market starts pushing more companies toward a captive model, many will be wondering how they can pay their premiums without having an adverse effect on their cashflow. The answer is, very simply, premium financing. Premium financing is common in the commercial arena, and even more so when you factor in market conditions that support growing premiums and economic uncertainty.

With a potentially large influx of captives on the horizon, due to commercial market hardening and adverse economic conditions, many captives will likely need financial assistance with all aspects of formation.

Coming up with funds to capitalise a captive can be a heavy lift for some captive owners. One way that premium financing can ease the burden is by creating a payment plan for the annual premium. This allows the insured to use the funds it would normally pay toward premium to be applied to the capitalisation of the captive.

“Premium financing has been an important tool for our company and our clients,” says Mark Jacobs of captive insurance consultancy Captive Alternatives.

“Our clients are small and mid-size businesses with the typical cash flow issues faced by this sector. Premium financing allows them to purchase enterprise coverages they need, while maximising their budgeting flexibility, to ensure predictable and affordable instalments.

“The key to a good vendor is efficiency, simple documentation, and fast underwriting.

“Premium financing is an essential tool for most insurance companies, it helps develop and strengthen relationships with new and existing clients, by assisting them to manage the core resource of their business more wisely,” Jacobs explains.

The same premium finance lending model can assist captives with contributing capital to a newly formed captive, or borrowing money from an existing captive (loan-back). However, these types of loans typically require more stringent underwriting than a traditional premium finance loan and may require regulatory consent as well.

A group captive is a captive that is, typically, formed and owned by its members. Rather than an individual insured forming its own captive, a group captive will pool together a small or large number of insureds that operate in a common industry looking to save money on their general liability, workers’ compensation and several other types of coverage.

A group captive can take the capital requirements and risk and spread it among a large number of insureds, making the barrier to entry easier for commercial insureds to participate in the benefits of a captive. For most commercial insureds in a group captive, cash flow is always an important factor. Premium financing will assist with relieving the burden of paying the premiums in full.

Many group captives, such as risk retention groups (RRGs), will form their own premium finance company. Bringing the premium financing in house, rather than outsourcing to a third party, allows the RRG to gain better control over the flow of funds from the insured. It allows an important monthly touch-point with the insured to better the relationship.

“Forming our own finance company has been central to the success of our RRG,” says Michal Walter, president and chief executive officer of Hoxbridge Insurance Company.

“It allows us to provide the flexibility to help our insureds with a payment plan that best suits their needs. It also allows us to provide an additional service to our insureds which we feel enhances our overall relationship with them.”

An additional benefit is that premium financing can be a revenue generator for a group captive. If the group captive has the ability to finance its premiums internally and is able to charge a reasonable interest rate of 6 to 8 percent., that rate of return can potentially double what the group captive might make from investing the fully collected annual premiums in a high quality fixed income investment portfolio.