Perspectives: Captive Insurers Find Caution Keeps Them in the Black

A sudden downpour could not dampen the spirits of those attending the opening reception at the 24th annual Vermont Captive Insurance Association's conference at beautiful Shelburne Farms on the shores of Lake Champlain in Shelburne, Vt. As attendees sought refuge under a tent or a nearby building, sampling Vermont's famous cheddar cheese and summer sausage, the rain subsided, the skies cleared and not one, but two rainbows appeared.

Some may wonder if Vermont's captives could be the pot of gold at the end of the rainbow.

While Molly Lambert, president of the VCIA, jokingly took credit for planning the colorful display of nature, John Lochner, principal of Towers Perrin, closed a well-attended session on the financial crisis and captives by saying, "Captives have been a ray of sunshine in this otherwise financial storm."

Vermont is the largest captive domicile in the United States. That not a single Vermont captive has become impaired during the recent recession, while one of the mightiest and most profitable companies of all time, American International Group, stumbled, is remarkable. While AIG's problems stemmed from the holding company, not the still-financially sound insurance operations, there's no doubt that AIG and many other insurance industry giants saw profits fall dramatically in recent months.

Meanwhile, 186 captives studied by A.M. Best Co. actually turned an underwriting profit in 2008. Sure, they suffered some investment losses, mostly stemming from one single captive, but their five-year average combined ratio beat the traditional commercial market by 5 points -- that's a lot of cheddar.

Some in the insurance industry have viewed captives like amateur insurers, part-time players who start their own insurance subsidiary to save a few bucks. How could they perform better than the "professional" players in the market?

For one thing, captives might be a little more cautious, a little more conservative with how they spend their money. They aren't interested in taking big risks to get big profits, they're more interested in making sure they have the cash needed to pay claims, when and if they come.

Also, because they insure themselves, they are very interested in risk management -- much like a savvy policyholder who raises his car insurance deductible to score a lower premium is likely to be a more alert driver. Captives would rather prevent a claim than pay one. In the words of Greg Lang, head of business development for Munich Reinsurance America Inc., captives are "smarter consumers."

Another factor in their favor: captive managers are also smart enough to know when they need help. They aren't shy about calling in experts to help with claims, underwriting, fronting, reinsurance and investments.

And, while regulators cannot prevent companies from making bad decisions, it is interesting that Vermont regulators perform more examinations on insurance companies than regulators in any other state in the country, except for the much more populous states of New York and California.

As the current financial clouds lift, perhaps it's time the industry look to captives for a lesson or two on how to keep safe and dry, even in the darkest storm. Captives might prove to be easier to follow than leprechauns, and building your own pot of gold, instead of chasing rainbows, might be a better strategy.