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By DAVE LENCKUS, who has covered the insurance industry for more than two decades

Captive insurance experts aren't surprised pure captives performed better than traditional insurers last year in soft commercial market conditions, but not all agree how captive owners should respond while cheap commercial capacity abounds.

In the report, "U.S. Captive Insurance -- Market Review," published in the Aug. 5 edition of BestWeek U.S./Canada, the agency gives pure captive insurers a stable outlook but commercial insurers a negative outlook.

The survey's results highlight the basic principle of captive insurance: a stable long-term financing solution to manage risk, said insurance industry consultant and investment banking advisor John Wicher, principal at John Wicher & Associates Inc. of San Francisco.

Wicher said he expected pure captives to post "superior results" compared to commercial insurers because captive owners have demonstrated "greater discipline in the art of underwriting and pricing."

That holds true throughout the commercial market cycle, he said.

"Once you make that decision (to finance risk in a captive), it's not a world of vacationers but a world of permanent residents," Wicher said.

Sophisticated risk managers will not "lose their religion" and purchase cheap commercial coverage during soft market conditions but instead opt to maintain control over risk financing, he said.

Plus, with the maturity of captive insurance, this risk-financing option is "no longer a cobbled-together solution where you couldn't achieve what you wanted to achieve in the traditional market," Wicher said."This report underscores that."

But some captives owners like to take advantage of the short-term buying opportunities in a soft commercial market rather than use their captive's capital, said John Lochner, a director with Towers Watson Co. in Hartford, Conn.

Indeed, captive owners should try to "arbitrage" the insurance market when capacity is cheap, said Jim Swanke, a Minneapolis-based director with Towers.

"There are times to use the captive less," he said. "Captives are nothing more than a tool."

Even so, "in some cases, captives are the better way to go" during a soft market, Swanke said."We recommend they reinsure less predictable, catastrophic risk."

Indeed, Swanke observed, the surveyed captives' results might have benefited from the facilities ceding more catastrophic risk to commercial insurers to take advantage of cheap commercial rates and leave commercial insurers to shoulder those losses and take the hit to profits.

But even when captive owners turn to the soft commercial market to cover their predictable losses cheaply, using a captive to finance the risk initially and then cede it can be more advantageous than shelving the facility altogether until the commercial market hardens, said John Svoboda, chairman of the Captive Insurance Companies Association.

By shelving a captive, "you risk losing focus on the fundamentals" of risk management, underwriting and the claims process, said Svoboda, who also is president of Denver-based risk retention group National Home Insurance Co.

Another reason to keep a captive in service continually and encourage all of a parent company's operating units to use it is to keep claims data flowing, said Peter J. Mullen, the Hamilton, Bermuda-based chief executive officer of Aon Captive & Insurance Management, a division of Aon Global Risk Consulting.

"A good captive program needs good data," Mullen said.

August 12, 2011

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