This is the first in a three-part series of articles on the ten questions all prospective captive owners should ask themselves (or, that their financial representatives should ask them) to help in the captive formation decision making process. Part 2 can be found here, and Part 3 can be found here.
Forming a captive insurance company is an incredibly big decision. To help decide if you should form a captive, please answer the 10 questions, the first three of which are presented below.
Has there been a problem with one of my existing property and casualty insurance plans?
For example, have I had a difficult time getting a claim paid, have I have a hard time reaching my agent, or have I found the service to be lacking?
Two personal stories should help to illustrate this point. I have several friends who are corporate counsel, meaning they are attorneys whose client is a corporation rather than an individual. When asked what their biggest problems are, dealing with insurance companies tops the list.
Or, consider another story from my personal experience. I had a real estate development corporation client that had a claim related to Hurricane Ike. It took the company two years and the actual filing of a lawsuit to receive payment on their claim. During those two years, the property could not be rented, negatively impacting the company (which eventually dissolved).
Most professionals in business for a number of years typically have at least one insurance company horror story to tell. This is a prime reason to form a captive: to take control of the captive in order to prevent an insurance company horror story from happening to you.
Do my current policies cover all my risks?
Even if you have an insurance policy, it's likely there are big gaps in your coverage. For example, most manufacturers have inadequate (or non-existent) product liability and product recall insurance.
I was recently looking at an employment practices policy for a company that had an annual cap of $300,000 — which is not going to provide adequate coverage in case of a large claim. In short, most policies don't have adequate coverage for certain risks that, should they occur, could seriously jeopardize a company's financial well-being.
A captive insurance company can help to fill gaps in coverage, ultimately creating what I call an insurance tapestry where third party policies cover standard risk and the captive covers specialty risk.
Can I actually negotiate the coverage terms with my current insurance carrier, or do they hand me a policy to sign?
Remember that an insurance policy is in fact a contract between the insured and the insurance company.
Case law provides an excellent example of this benefit. The Beech Aircraft Company was sued in the early 1970s, but their insurance company maintained complete control over the attorneys during litigation; the insured had zero input.
Beech did not like their attorneys — in fact, they went so far as to file a motion to remove their counsel a few weeks before trial. The court denied this motion and Beech went on to lose the case to the tune of $21.7 million. Because of this loss, Beech formed a captive in order to gain control of their attorneys during litigation.
There are many other contract terms that can be included in the policy — in fact, the only limitations are commercial reasonableness and legality (which are standard restrictions on a contract).
The above three reasons are all great reasons — in and of themselves — to form a captive. However, in Part 2 of this series, we'll add to the list.