Considerations about whether the time is right to create a captive should walk hand in hand with an analysis of the overall market, not just the market for insurance, but the economy on which the market for insurance stands. One factor in the argument against forming a captive is that previous economic cycles won't be much help in determining the future performance of this economy. American business leaders are now digesting the fact that eight percent to nine percent unemployment in the U.S. is the new normal. The assumptions that they might have used to decide whether to form a captive in the past won't hold water today.
The financial administrators of global economies have also embarked on measures, like creating cheap currency, to stimulate their economies. These efforts will no doubt create a raft of unintended consequences. And here is where a company considering forming a captive should take note.
What happens, to use just one example, when cheap currencies end up chasing a limited pool of goods and services as they eventually must? This will create inflation in spots and it will create inflation in places that will be difficult to predict. Would you want to be the risk manager who talked his chief financial officer and his CEO into forming a captive based on one set of economic projections who then watches that calculus change dramatically? What risk manager wants to go back to the C-suites to tell them that he or she now needs more money to fund the now much greater future liabilities of their captive, their captive which cost a lot of money and time to form to begin with?
The other part of the new normal is that anything resembling a recognizable price cycle in insurance premiums has been disassembled. It is now eight years that insurers have been looking for places to increase pricing and yet they can find few. There is still plenty of capacity chasing the risk exposures that are out there. Do we need more proof of this than the bankruptcy of American Airlines, which failed to move the pricing needle in the aviation market?
Risk management is not a static science. The financial crisis created a much better educated group of business leaders and it did a lot to raise the profile of the profession of risk management.
This is a bad time to form a captive. Soft pricing and an economy that will be less than stellar going forward mean the costs of forming a captive and the uncertainty around how it will perform outweigh the benefits of forming one.
DAN REYNOLDS is managing editor of Risk & Insurance®. He can be reached at firstname.lastname@example.org.
March 1, 2012
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