Cover Yourself

In trucking, insurance rates bounce back and forth from periods of unforgiving increases to unsustainably cheap. This is what’s known as a hard and soft cycle: In a hard market, insurers profit mostly from underwriting instead of from selling policies and investing the premiums in stocks and bonds. As the economy improves, interest rates rise, and the stock market recovers, insurance returns to soft market conditions, with more competition for your business and more stable costs.

At least, that’s the theory.

Since early 2001, trucking companies have been hit with a market as hard as a two-by-four. The cost of liability, collision, cargo, and catastrophic coverage have been predictable only in that you can be sure your premium will go up, and perhaps your deductible, too-even if you haven’t incurred serious losses.

With fewer companies writing insurance for truckers, the hardened market has shed light on a different opportunity for providing coverage: a form of self-insurance called a group captive program.
For mid-size carriers, a well-managed group captive looks like an enticing alternative to traditional insurance. Simply put, captives are insurance companies that are owned by the policyholders. Each member makes a financial contribution to the business, in turn taking a share of stock. Members set aside an amount for routine claims, buy umbrella insurance for catastrophic or unusual losses, and hire a third party to handle the administrative details of running the company. The captive has a board of directors that sets and enforces underwriting standards, determines premium rates, and oversees outside companies that provide services such as claims handling and safety training.
And each year, the captive reviews the losses of each member and then returns any excess “contributions” to its members based on their performance in the form of unused reserves.

Contrast that with being fully insured, says Mike Lopeman, vice-president of Gallagher Captive Insurance Services, one of the largest managers of captive insurance operations in the world. Lopeman, based in Chicago, has set up and currently manages two group captives whose members are in trucking or logistics.
“If you’re a trucking company and you reduce your losses by 15 or 20 per cent, who gets to keep the extra profit? The insurance company,” Lopeman says. “If interest rates go up and there’s profit made on the insurance company’s investments, who keeps the money? The insurance company. With a captive, these benefits come back to the shareholders.”

Gallagher is partnering with Brownstone Insurance Services Group, LLC, and together they are setting up a group captive for Canadian trucking companies. Launching in September, it hopes to attract 30 to 40 companies based in Canada that are big enough to be paying hundreds of thousands of dollars in insurance premiums.

“The basis of our program,” says Ted Puccini, General Counsel/Partner of Brownstone, “is to give companies control over their insurance costs, to the point where the hardness of the market, the wild fluctuations in premiums, and the fickleness of traditional insurers become generally irrelevant to their insurance program”.
“Say you’re fully insured and paying your insurance company $4,000 a power unit – your safety record is very good,” says Lopeman, who will oversee the day-to-day operations of the Brownstone captive with Puccini and Scott Cober. “But yet actuarially, you might be down at $2,000. The reason you could be up at $4,000 is because there are guys who are also insured by your insurance company who are paying $5,000 but who should be paying $7,000. Yet the insurance company keeps their premium at $5,000 because they have the good guys making up the difference. You don’t have that in a captive.”

In a captive, premiums are determined by your company’s losses plus the fixed cost of running the captive insurance company.
The captive creates a five-year profile of each member company and then the actuary develops the premium and collateral requirements based on that company’s individual loss experience.
About 60 per cent of a member’s premium will go to the loss fund, while the rest is used to cover the fixed costs of running the captive.

The loss funding structure is divided into two parts: a frequency fund and severity fund. “Out of the 60 per cent of your premium that goes to the loss fund, typically 80 per cent would be the frequency and 20 per cent would be the severity,” Puccini says. “A frequency loss is a loss from the first dollar to $125,000, and the severity would be $125,000 up to $350,000. Above $350,000 goes to a reinsurer.

“The program we have has an aggregate stop loss,” he continues. “So when members come into the captive we can say here’s what you pay in, and if you have a good year, here’s the money that can come back, and in your worst-case scenario here’s the most you would pay in any given year, and after that it becomes fully insured.”

There should be enough dollars in your funds to pay out all of your claims in a given year, with your collateral there to back you up in a terrible year. Because of the five-year snapshot, that one terrible year won’t cause a wild adjustment to your premium. You’d need to have back-to-back extremely good years to see the premium drop significantly, or back-to-back bad years to see it jump.

“You can’t even consider taking money out until the fourth year,” he says. “At that point you go back and look at the first year and those members who were in it the first year and have reserves can elect to take some of their money out, but by the rules they can only take up to 50 per cent of the reserve. But by the fifth year they can take another 25 per cent of the first and 50 per cent of the second. You keep it rolling like that so you always have your money in the captive for three years in case there’s that IBNR out there.” IBNR is an ominous acronym, standing for “incurred but not reported.”
Money that’s in the captive will be invested and grow tax deferred, in the captive’s case through a financial institution which has an expertise dedicated to investing money in captives.

And what happens to the captive when the market softens? “As the market gets soft, you’ll see the service providers reflect that in the fees they charge to the captive,” Puccini says. “But again, the premiums are based on the individual loss records of the companies in the captive, and whether the market is soft or hard, a loss is a loss. This is all about taking the ups and downs of the market and giving you some stability.”

For more information contact Scott Cober at 905-388-3333. S