This is a cost-effective alternative for AEC leaders seeking to manage enterprise risk.
Managing enterprise risk is a constantly evolving challenge for any AEC firm’s leadership team. The harsh reality that economic damages can arise from a failure to perform professional duties, or the mere allegation of it, is just one of the many reasons enterprise risk is the single largest long-term threat for many AEC firms.
Successful enterprise risk management relies upon qualified and experienced professionals who create well scoped and efficient projects which they deliver through professional services. But things happen: Communications sometimes break down and projects can go in the wrong direction. People are humans after all and will make mistakes.
In the era of COVID-19, AEC leaders must prepare for a wide range of complicating factors when developing and executing on their ERM strategies. These include shortage of qualified and experienced staff, increases in severity of claims, compressed schedules, inflationary pressure, supply chain disruptions, and a “hard” insurance marketplace.
That last factor is especially relevant in this environment. The economics of the U.S. commercial insurance market have been leading larger insurance carriers away from providing highly customized coverages while at the same time seeking higher revenues in the form of increased premiums. Several recent drivers – notably cybersecurity risk, climate patterns, and COVID-19 – appear to have accelerated this trend. During the first half of 2012, U.S. net premiums written in the property and casualty insurance segment totaled $231.6 billion, according to the NAIC. In the first half of 2021, that figure was more than $351.2 billion, a net increase of more than 51 percent.
As a result, innovative AEC firms are looking to deploy all tools available to help mitigate the cost of enterprise risk. In addition to quality control procedures and managing contract-related risk, we believe evaluation of current commercial insurance arrangements should be part of the plan. Captive insurance companies, in particular, may be especially useful for AEC firms. Here are some common questions we get when talking to our clients about captives:
- What is captive insurance? A captive is a risk financing mechanism that takes the form of an insurance company owned and controlled by its insureds, which may be its parent company or a group of related companies. The history of captives in their modern form date back to the early 1900s in Europe. Once thought to be only applicable to large multinational corporations, the captive marketplace has developed as a viable ERM solution for many AEC firms.
- What are the benefits of a captive? A captive affords the parent company more control than purchasing standard insurance. The captive allows the tailoring of insurance coverage to meet the unique risks of the parent, particularly in cases where coverage might otherwise be unavailable or prohibitively expensive. Captives provide an alternative to the traditional means of financing enterprise risk. In general, captives can provide:
- Broader and bespoke coverages that often are unavailable in the traditional commercial marketplace
- Stability of insurance pricing and availability
- Cash flow through insurance company tax treatment and investment opportunities
- Reduction in insurance costs
- Direct access to reinsurers
- How relevant are captives to architects and engineers? The AEC sector is changing rapidly because of pressure to build projects quicker and at lower cost, while adapting to an ever changing operating environment. Municipalities nationwide rely on facilities to provide sewer and water treatment, but struggle to find experts who can operate them properly. Municipal architects and engineers are increasingly being asked to design, build, operate, own, finance, and manage wastewater facilities. This brings new risks that current insurance policies may not address. Some municipal architects and engineers are self-funding captive programs to fit their needs before taking on this type of project.
- How relevant are captives to the construction industry? Captive insurance has been available to the construction industry for quite some time. With most construction companies, the need to address and manage third-party risks, such as those related to subcontractors, is essential. For safety-conscious, best-in-class risk management focused construction companies, captives can provide a cost-effective approach including owner-controlled programs, contractor-controlled insurance programs, and construction defect and warranty rework exposures.
- Where are captives domiciled? Captives were once almost exclusively domiciled in locations like the Caymans and Bermuda. However, as of 2020 more than 3,100 captives were domiciled in the U.S., with Vermont, Utah, Delaware, and North Carolina accounting for nearly half of that figure, according to A.M. Best. Since 2000, U.S. captives have topped traditional commercial insurers in operating performance, A.M. Best found, in part due to the perception by companies in need of insurance that underwriters overprice the company’s risks and fail to understand their business model. The highest growth of captives in the past 10 years has been domestic captives, and 39 of 50 states now have some type of captive law allowing captives to domicile in those states.
- Are captives expensive to form? The cost of setting up a captive has never been lower, and – if amortized over a five-year period – are well within reach for most AEC firms. Captives can actually provide a greater level of financial protection for firms than by taking a large deductible or retention through traditional commercial insurance.
- Can an AEC firm establish a captive program on its own? Yes, in theory. But just as any proper AEC project is best handled by AEC experts, the same concept applies to captives. Creating a successful program usually calls for working with experienced professionals that understand the intricacies of ERM, captive insurance, and the AEC industry. Zweig Group and Stephens Insurance have partnered to provide guidance on whether a captive program is right for your firm.
- What is the process? The process starts with a comprehensive evaluation of a firm’s current risk profile and risk management program. This includes gathering all pertinent data to develop a five-year captive financial model or pre-feasibility study, to show how the captive can integrate into your firm’s ERM plan. This data resembles information you provide for insurance quotes. After the model is developed, your firm’s key decision makers review it and determine whether to proceed. The next step is implementing the captive program, and securing authority from the chosen domicile. Your firm also should modify or restructure your pre-existing commercial insurance program to maximize your captive’s impact.
- How do we get started? To learn more about captive insurance and whether it may be right for your AEC firm, reach out to Zweig Group’s Dathan Gaskill at dgaskill@zweiggroup.com, or email Ted Grace at ted.grace@stephens.com.
Ted Grace is executive vice president, Risk Management at Stephens Insurance. Contact him at ted.grace@stephens.com.