Embracing Risk Financing Vehicles: Exploring the Alternatives

By Pelland, Dave | Risk Management, March 1997 | Go to article overview

Embracing Risk Financing Vehicles: Exploring the Alternatives


Pelland, Dave, Risk Management


Seeking reduced premium costs and other financial benefits, a growing number of middle market companies are exploring the use of captives, risk retention groups and other alternative market approaches. Although there are a number of options to examine, middle market employers can often reduce their cost of risk considerably by shifting some coverages away from traditional insurance programs.

"Alternative market programs are becoming increasingly common, and middle market companies represent the fastest-growing segment of the alternative market," says Michael Murphy, ARM, president of RiskCap, a risk management consulting firm in Denver. Mr. Murphy says that for most companies, the shift into the alternative market has basically followed two paths. The first movement generally came from companies that experienced difficulty finding or affording liability coverage from traditional carriers. For many of these organizations, self-insurance was the only option. The second group, which has been growing rapidly for several years, includes companies with favorable loss histories that recognize the potential financial advantages obtainable within the alternative market.

"Accessing the alternative market gives companies direct savings when compared to insurance premiums and also provides substantial cash flow advantages," Mr. Murphy says. "One of the major reasons is that alternative programs have much lower expense loads. For many traditional insurance policies, about 35 percent to 45 percent of every premium dollar can be attributed to overhead, but middle market companies that become involved in a group captive, for instance, usually can expect expense loads as low as 8 percent or 12 percent."

In addition to reduced expense loads, Mr. Murphy says the ability to establish reserves for future losses and retain investment earnings increases the profitability and attractiveness of captives and other funding mechanisms.

But achieving these benefits requires a critical mass that most middle market companies are usually unable to achieve on their own. According to Mr. Murphy, about 80 percent of the mid-sized companies that access the alternative market do so through arrangements generally referred to as program business under which a group of employers establish or join a captive or similar mechanism to combine their premiums and consolidate their expenses.

"Only about 20 percent of middle market employers have enough premium volume to warrant establishing their own self-insurance device. It's far more common for these companies to join a group program that has been made available through an industry association," Mr. …

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