INSURANCE: Alternative Insurance Paints a Pretty Picture

While they are known as some of the world's best artists, in their day, Impressionist painters such as Monet, Renoir and Degas were considered alternative. The word “alternative” often conjures up unconventional or bohemian images, but the “alternative” insurance market quickly is becoming mainstream for many businesses.

The alternative insurance market provides a way to purchase policies bypassing established insurance companies. Alternative options include: self-insurance, captive insurance and insurance pools. With rising insurance costs, tighter underwriting and signs of a “hardening” insurance market, more businesses need to control insurance costs, including workers' compensation costs.

The alternative market helps to do this by eliminating the middle-man. In 1999, the alternative insurance market comprised nearly 40 percent of the nation's commercial insurance market. According to global insurance rating firm A.M. Best Company, Oldwick, N.J., alternative insurance's overall market share will approach 50 percent by 2003.

Self insurance allows large businesses, including some of the nation's largest waste companies, greater control over insurance expenses — although a self-insured company retains its risks and must be prepared to handle losses. Often, a company that directly retains its risks will pay closer attention to preventing damages through loss control programs, especially when a large loss could severely impact the company.

Types of self insurance include workers' compensation, general liability, product liability, and auto insurance and property insurance. While some self insurance programs do not need to be regulated, workers' compensation programs and auto liability programs do.

Another effective type of alternative insurance includes forming or joining a “captive.” Captive insurance companies are owned and controlled by the companies they insure. Single parent captives are owned and controlled by one company, which insures that company and its subsidiaries. Group captives are owned by two or more non-affiliated organizations. Mutual insurance companies, for instance, essentially are captives controlled by their policyholders.

A group captive can be either homogeneous and insure similar types of businesses risks, or non-homogeneous and insure several types of risks. In the United States, group captives are licensed by a domiciliary state, most frequently Bermuda, Cayman Islands, Vermont or Hawaii, and use a “fronting” carrier.

Fronting refers to a business that is not approved in a particular state to contract with a licensed insurance carrier to issue an insurance policy for regulatory or certification purposes. If a captive is not licensed by a domiciliary state, it operates under the Federal Risk Retention Act. This legislation does not allow a state insurance regulator to prohibit captives that are domiciled in other states from operating in the regulator's state.

Estimates indicate that the number of captives in the world exceed 3,500. According to A.M. Best, the annual growth of captive insurance companies has been between 4.5 percent and 5.5 percent during the past several years.

There are many benefits to forming a captive insurance company, including:

  • Coverage is tailored to a business' specific needs;

  • Premium dollars are retained by the captives' owners, not a commercial insurer;

  • Investment income is accumulated to help reduce net loss costs;

  • Cash flow is improved;

  • Incentive exists to implement effective loss control programs;

  • Greater control over claims administration is established;

  • Underwriting and retention funding flexibility is gained; and

  • Insurance costs are reduced.

  • Another alternative insurance option is forming an insurance pool, commonly used by government agencies, municipalities and other public entities. Insurance pools are owned by public agencies or municipalities. Although they are fundamentally captives, most are not subject to the more extensive state regulations imposed on captive insurers.

    In the cyclical insurance market, businesses are finding the alternative market a good option to help control expenses and exercise more control over insurance programs.