I divide the insurance market between “third-party insurers” and “captives.” The former are large, publicly-traded insurance companies. “Asset-liability management” -- the science (or art, depending on your perspective) of timing the payment of liabilities with investment income -- forces this group of companies to favor predictable risks. For example, suppose an insurer has a claim payable in 12 months. Their investment department will purchase an asset that will mature when the claim comes due. Unpredictable risks complicate this relationship, explaining why the large insurers shy away from these policies (If you’d like to learn more about this discipline, please see Frank Fabozzi’s Asset Liability Management)
Enter captive insurers, who often lead the way in the insurance market by underwriting new and exotic events. The Ocean Drilling case offers a prime example:
During the 1960's plaintiff faced difficulties insuring its drilling rigs. At that time the drilling rig business was written predominately by the Lloyd Syndicate ("Lloyd's"), with the London Market serving as an ancillary market to Lloyd's. As the technology of drilling rigs developed rapidly, Lloyd's adjusted its insurance rates in an attempt to cover itself against potential losses from the new drilling rigs. Because of the limited experience in insuring the new rigs and a number of substantial losses on these rigs, insurance rates increased sharply. By the end of the 1960's, rates were as high as 10 percent of the value of insured vessels, and plaintiff was unable to obtain full coverage of its rigs through the existing insurance market. In response to this dilemma, plaintiff analyzed its history of premiums and losses and determined that establishment of a captive insurer could alleviate the problems that plaintiff faced in the insurance market. In 1968 plaintiff established Mentor as a wholly-owned subsidiary incorporated in Bermuda.
A recent article in Business Insurance provides an excellent example of how a captive could provide coverage for a new risk: driverless cars:
Captive insurers can be a solution to cover the emerging risks presented by driverless cars that traditional insurers have either been slow to respond to or have quoted unacceptably high premiums for.
There are about 1.2 billion vehicles on the road worldwide, with more than 1.2 million fatalities per year, said Christine Kogut, a principal for Milliman Inc. based in South Burlington, Vermont.
“The thought is that driverless and connected vehicles can eliminate all of the negatives that we have now,” she said. “They can help us be safer, save energy, cut pollution, increase the city capacity without adding concrete, and they can provide mobility to millions of people that don’t have access to transportation. The endgame is that we can be safer and more productive, and our mobility can be more personalized, more affordable and more convenient, which is what all of us really want.”
The driverless car scenario is very similar to Ocean Drilling: each insured encountered higher than desired premiums due to the newness of the risks involved. This opens the market up to captives
So, if your company has a new and hard to place risk, please contact us at 832.330.4101 to learn more.
On Thursday, August 10th, at 10AM, we're giving a 1-hour course in captive insurance. If you're a CPA, CFP or Texas insurance Agent, it's good for 1-hour of CE. You can sign up at this link.
If you'd like to add captive insurance to your professional offerings and would like to become an affiliate, please contact us at 832.330.4101.
We own and operate the first Montana based series LLC named Aegis. We run it in conjunction with Aceterrus Insurance Resources
My knowledge of popular culture is at best limited – and quickly declining. I know who Kanye West is. That’s it. But despite my less than literate knowledge of popular culture, this story from the Washington Post perfectly illustrates why he should have had a captive:
Lloyd’s, the London-based insurance underwriter, is proud of its reputation as the company that “specializes in unusual risks.” They include: the legs of Betty Grable, Rudolf Nureyev, Michael Flatley and David Beckham; the breasts of Dolly Parton; the hands of Keith Richards and, moving away from body parts, the 69.42 carat diamond Richard Burton bought for Elizabeth Taylor.
The company’s vintage (founded in 1688) and its ye olde nickname (Lloyd’s used to be called “Lloyd’s of London”) gives it a special aura. Some call Lloyd’s “venerable.”
But Kanye West does not venerate Lloyd’s. He and his company, Very Good Touring, are engaged in a battle with the insurance underwriting giant over a multimillion dollar policy purchased for West’s 2016 Saint Pablo Tour to cover the possibility it might get canceled, which some part of it did.
And now West’s lawsuit against Lloyd’s, filed in a federal court in California earlier this week, is shaping up to be one of the ugliest superstar insurance disputes since Michael Jackson’s estate took on Lloyd’s for concert losses due to his death in 2009.
A quick summary: West paid his premiums, hundreds of thousands of dollars of them. Lloyd’s hasn’t paid the millions West is seeking to cover the losses from the cancellation. West believes the company is trying to use “unfounded” allegations about marijuana use as a reason for not paying, the lawsuit says.
And he accuses Lloyd’s of trying to smear him with news leaks in an effort to get him to back off.
This is an all-too-common situation. The insured purchases coverage for a specific risk. After filing a claim, the insurer argues that it doesn’t have to pay for one or more specific reasons. A lawsuit ensues, enriching litigators and creating aggravation for everybody else.
These facts are tailor made for a captive. West went to Lloyd’s of London -- a tacit admission that his risk is unique. By involving Lloyd’s, he’s already 75% of the way to forming a captive. Had he done so, West’s lawyers could have written the insurance policy, thereby preventing this situation altogether. But instead, he’s learned the hard way that insurers don’t like paying large claims.