Captive surpluses help fund risk strategies

More organizations are tapping into their captive insurance funds to finance an expanding range of risk management projects and loss control activities as they deploy emerging technologies such as artificial intelligence.

But captive owners should conduct careful due diligence to ensure that using captive surpluses to fund the efforts is appropriate, experts say.

Risk managers and captive owners are having more conversations about how to access captive surpluses “in a compliant, constructive way to help improve company risk profiles,” said David Arick, president of the Risk & Insurance Management Society Inc. in New York.

Captive owners are gaining more data on issues such as climate risk as they use captives to build out insurance programs in emerging sectors such as green energy, said Mr. Arick, Memphis, Tennessee-based managing director, global risk management, at Sedgwick Claims Management Services Inc.

Captive owners are also looking at how to use surplus funds to fulfill loss recommendations, especially in property markets affected by climate change, he said.

Mature captives that have built up a robust capital and surplus base are a good fit for this strategy, several experts said.

Some organizations like using their captives as profit centers and issue dividends back to the parent companies but investing in future loss-control efforts across worldwide operations can be advantageous, said Steve Bauman, New York-based global programs and captives director, Americas, at Axa XL, a unit of Axa SA.

“It could be any type of loss control for any line of coverage or situation, whether it be property or casualty,” Mr. Bauman said. Captives are funding property improvements, vehicle telematics in auto and trucking fleets, and cyber awareness and training programs for employees, he said.

When captives have built up capital by writing profitable business there’s an opportunity for captive owners to decide how to deploy that capital, said Nancy Gray, Burlington, Vermont-based regional managing director-Americas at Aon PLC.

“If you can take some of that built-in capital and deploy it to help reduce your losses, you’re ultimately able to reduce your total cost of risk,” Ms. Gray said.

Captives are writing more cyber coverage and funding cyber assessments and surveys, said Michael Serricchio, Norwalk, Connecticut-based managing director of Marsh Captive Solutions, a unit of Marsh LLC.

Technology and artificial intelligence-enabled loss mitigation strategies are gaining prominence, and some captives are investing in AI-powered surveillance cameras, Mr. Serricchio said.

“Let’s say you have a big distribution center, and you’re going to monitor forklift use, employee behavior, employee lifting and stretching. The cameras will pick up on a bad act and then report it to the manager, and then that manager will say, ‘Correct this behavior.’ And it saves claims,” he said.

Karen Hsi, executive director, captive programs, University of California Office of the President in Oakland, said the university uses captives to mitigate insurance market fluctuations, control claims and access new reinsurance markets.

In 2022, its most mature captive, Fiat Lux Risk and Insurance Co., funded a $3.64 million unit to centralize and standardize cyber risk assessments across the university, Ms. Hsi said.

The initiative helped maintain or lower premiums despite market volatility at last year’s renewal, she said.

Risk management initiatives funded by captives can help lower insurance costs by reducing claims, said Anne Marie Towle, Indianapolis-based CEO, global risk management and captive solutions, at Hylant Group Inc.

Manufacturers are using captive funds to provide slip-resistant shoes for workers to help prevent slips and falls, while health care facilities might deploy funds to provide employee training on how to lift and assist patients, Ms. Towle said.

Transportation companies are installing vehicle telematics that track driving behavior and help prevent accidents, she said.

Mature captives with built-up equity can fund upgrades of physical assets such as vehicle fleets, said Nate Reznicek, president and principal consultant at Captives.Insure LLC, based in Knoxville, Tennessee.

“Instead of the business buying the 20 new power units to keep the fleet upgraded, the captive will buy those assets and then lease them back to the operating entity,” Mr. Reznicek said. Captives can also support payrolls for risk management departments, he said.

These strategies align the interests of the captive and insured business, potentially reducing loss ratios, Mr. Reznicek said.

Large organizations find that captives are more efficient vehicles than traditional capital expenditures, because they’ve already paid in premium to the captive, which helps save them money in the long run, Ms. Towle said.

“It’s a corporate mindset around risk management. It positions the captive not just as a piggy bank but as a risk management force within the corporation,” Mr. Bauman said.

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Captive-supported projects subject to tax rules, face regulatory hurdles

Captive owners should conduct thorough due diligence and consider potential tax and regulatory implications before deploying captive funds for risk management projects, experts say.

From a tax perspective, captives should be guided by what commercial insurers do, said Chaz Lavelle, a partner at Dentons Bingham Greenebaum LLP in Louisville, Kentucky.

“If this is a service that commercial insurance companies provide, some sort of consultation on risk management, it’s probably OK,” Mr. Lavelle said.

“If it’s really an expenditure that ought to be incurred by the insureds, then the insureds should incur that expense. They may lower their premiums if they incur those expenses,” he said.

Soft dollar consulting may be viewed differently to installing a sprinkler system, he said.

Regulators may need to be informed if there are changes in how a captive is used, which could attract additional scrutiny, said Nate Reznicek, president and principal consultant at Captives.Insure LLC, based in Knoxville, Tennessee.

“If the captive or the insured are in some financial difficulties, the regulator is going to start to ask deeper questions about why changes are being made and potential solvency concerns,” Mr. Reznicek said.

Regulators want to ensure a captive is positioned from a going concern standpoint to meet its risk retention, said Nancy Gray, Burlington, Vermont-based regional managing director-Americas, at Aon PLC.

Captive owners should consider whether a captive has the excess funding necessary to fund these types of projects without impairing the capital that’s required for the long-term retentions within the captive, Ms. Gray said.