Reasons for Forming a Captive: Spiking Premium Costs

On Wednesday, June 15th, we're hosting a webinar titled "An Introduction to Captive Insurance."  It starts at 1PM CST and will last for about half an hour.  You can sign up at this link.

We formed and operate the first series LLC in Montana (named Aegis) for captive insurers.  Several other firms provide key services such as accounting, audit and actuarial work.  Please contact us at 832.330.4101 if you'd like to discuss forming a captive for your company. ​     

   While the laws of supply and demand affect the cost of insurance, the singular nature of the insurance business adds unique nuances to the pricing calculus.  The most important is the negative impact caused by higher than anticipated claims.  A number of sizeable payouts indicates insurers charged too little, a problem that can only be solved by increasing current rates.  Spiking premiums are a recurring cause of captive formation: they led to the creation of several early structures, contributed to the mid-1980s “insurance crisis” that led to Congress passing section 831(b), and are currently driving the formation of captives that underwrite cyber-liability coverage.

     Spiking insurance costs forced two pioneering captive companies to form a captive.  In the late 1960s, the Humana Hospital chain’s general liability policy became so expensive the company almost went without coverage.  And Stearns Rogers, a construction company specializing in building large manufacturing facilities, couldn’t find affordable general liability insurance during the same time period.  Rather than go “naked” (sometimes referred to as “self-funding”), both formed their own captive to address their needs. 

     This situation repeated in the 1980s.  The roots of the “liability crisis” can be traced to the late 1960s, when the plaintiff’s bar began filing cases alleging products liability, medical malpractice and environmental damage.  The latter category became the insurance industry’s Achilles’ heel, eventually causing astronomically large payouts.  Some companies went bankrupt; others were left less financially sound.  The end result was a large increase in insurance premiums.

     The situation is repeating today in the cyber liability market.  During the last year and half, retail chain Target, hospitals, and even central banks have reported large cyber breaches.  These have led to a “hardening” of the cyber liability market.  According to Reuters:

A rash of hacking attacks on U.S. companies over the past two years has prompted insurers to massively increase cyber premiums for some companies, leaving firms that are perceived to be a high risk scrambling for cover.

On top of rate hikes, insurers are raising deductibles and in some cases limiting the amount of coverage to $100 million, leaving many potentially exposed to big losses from hacks that can cost more than twice that.

These premium increases are normal and to be expected.

  Have you seen large increases in your insurance premiums?  If so, then forming a captive may be a viable option.  Please contact us at 832.330.4101 to discuss this idea in more detail.