Hurricane Harvey Captive Insurance Ruminations: The Importance of Controlling the Claims Process

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            I live in Houston, Texas.  And while the last few weeks have been understandably difficult, I could not be prouder of my city or state.  Watching the first responders work tirelessly for days was awe-inspiring.  Seeing large numbers of people risking their lives to help rescue their fellow citizens was one of the greatest acts of selflessness I have personally witnessed.  Kudos should also be given to numerous city, county, state and federal employees who swiftly and efficiently responded to the disaster.

       As the press reports damage totals, I find myself thinking how this natural disaster highlights several key benefits of captive insurance.  While I don’t want to appear too opportunistic in making these observations, I also want to highlight several important lessons we can take from this tragedy, starting with how captives give the insured much more control over claims management.

        Insurance companies serve two masters with conflicting goals.  On one hand, they are contractually obligated to indemnity the insured who naturally wants the largest settlement possible.  While several legal principals will contain the total settlement amount, the insured will push these boundaries to obtain the largest amount allowed by law.  But the insurance company is also a profit maximizing enterprise whose driving force is to increase shareholder value.  This demands the company contain costs, a goal diametrically opposed to the insureds desire for a maximum settlement.  A natural disaster like Hurricane Harvey – which creates the potential for a huge spike in claims – puts additional cost-minimizing pressure on the insurer, compromising its contractual duty to fully indemnify the insured.
   
            The following example illustrates this point.  After Hurricane Ike in 2008, a commercial real estate investment company that I worked with on other matters filed a claim with its insurance carrier to repair the roof of an apartment complex damaged by the storm.  It took the insurer 18 months to pay, during which time the complex was uninhabitable.  The company eventually declared bankruptcy; the delayed settlement was partially responsible. 

            I’ve long suspected (although never received any proof) that one or both of the following situations caused the lengthy delay in settlement: 1.) The insurer was flooded with claims, lengthening the settlement process.  2.) The insurer delayed paying the settlement to obtain a larger compounded investment return, offsetting the total cost of claims.  Owning a captive insurance company would have insulated my client from both these problems.  Because the captive only had one client (the parent company) they would only have to process claims for one insured, streamlining the settlement process.  And the captive would have far less incentive to delay settlement because that would have betrayed its fundamental business purpose -- to indemnify the parent company in the even off loss.

            Controlling the claims process is but one captive advantage highlighted by Hurricane Harvey.  I’ll touch on a few more over the next few weeks.